In this post, Jack Prytherch, Of Counsel in the Tax team at CMS, previews the decision awaited from the Supreme Court in Commissioners for His Majesty’s Revenue and Customs v Vermilion Holdings Limited. The appeal was heard by the Supreme Court on 7 February 2023.
The Supreme Court was asked to consider whether the grant of an option to acquire share capital in the appellant (“VHL”) to one of its directors should be treated as an employment-related securities option for the purposes of section 471 of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”), and thus chargeable to income tax and national insurance contributions (“NICs”). References below to legislation are to ITEPA unless stated otherwise.
In early 2006, an equity fund raising took place whereby VHL was incorporated and became the new holding company of Vermilion Software Ltd.
Mr Noble, acting through his company Quest Advantage Ltd (“Quests”), advised technology businesses on fundraising, business growth, acquisitions and divestments. Quest produced a business plan and financial projection in respect of the fund raising, while the law firm Dickson Minto was instructed as VHL’s legal advisers. In lieu of fees for their respective services, Quest and Dickson Minto were each granted options to acquire 2.5% of equity in VHL.
By December 2006, VHL was in serious financial difficulty. As part of the rescue package put in place in 2007, it was agreed that Mr Noble would become a director (working 1 to 2 days per week over the following year in return for £4,167 per month).
Under the terms of the refinancing implemented as part of the rescue package, existing equity holders in VHL agreed to have their equity stakes diluted. However, Quest’s and Dickson Minto’s existing options were immune from dilution as their terms referred to an equity percentage rather than a fixed number of shares. To avoid disparity with other equity holders, Quest and Dickson Minto agreed to a reduction in the value of their options in line with the broader dilution, achieved through the lapse of the existing options and Quest/Dickson Minto each being granted new options to acquire 1.5 % of equity in VHL (in respect of Quest, the “2007 Options”).
In November 2016, VHL was sold to a US-listed company. In anticipation of that sale, Mr Noble had replaced Quest as the named shareholder under the 2007 Option. Following the exercise of his 2007 Option, Mr Noble then received a payment of £636,238.
Section 471 provides as follows (so far as relevant):
“(1) This Chapter applies to a securities option acquired by a person where the right or opportunity to acquire the securities option is available by reason of an employment of that person…
(3) A right or opportunity to acquire a securities option made available by a person’s employer….is to be regarded for the purposes of subsection (1) as available by reason of an employment of that person unless –
(a) the person by whom the right or opportunity is made available is an individual, and
(b) the right or opportunity is made available in the normal course of the domestic, family or personal relationships of that person…”
It was common ground that the exclusions in subsections 471(3)(a) and (b) did not apply. On a literal reading of subsection 471(3), therefore, the fact that Mr Noble was a director of VHL meant that the 2007 Option was an employment-related securities option; meaning that the payment received on exercise would be subject to income tax and NICs (rather than capital gains tax). VHL sought clearance from HMRC that such a literal reading should not apply in the circumstances of this case, where (according to VHL) the 2007 Option had simply replaced the earlier option (which HMRC accepted was not an employment-related securities option).
HMRC disagreed and determined that the exercise of the 2007 Option gave rise to a charge to income taxes and NICs.
Decisions of the Tribunals
At the first instance appeal, the First-tier Tribunal (Tax Chamber) (“FTT”) held as a matter of fact that Mr Noble’s right to acquire the 2007 Option emanated from the right under the earlier option – it had not been caused “by reason of an employment” within the meaning of subsection 471(1). Contrary to that finding, subsection 471(3) had the effect of deeming the right to have been so causing. The FTT decided that this anomaly gave rise to an injustice. On that basis, having examined case law on the interpretation of deeming provisions, the FTT concluded that subsection 471(3) should be limited in effect in the circumstances of this case.
On further appeal, however, the Upper Tribunal (Tax and Chancery Chamber) (“UT”) held that the FTT had erred in treating as a matter of fact that the right to acquire the 2007 Option emanated from the right under the earlier option. For the purposes of subsection 471(1), the employment need is not the only reason for the grant of the 2007 Option. In this case, it was sufficient that Mr Noble’s employment was a condition of the benefits being granted. On that basis, the UT overturned the FTT’s decision.
Decision of the Court of Session
The Court of Session, by a majority of 2:1, upheld the appeal and restored the FTT’s original decision.
In the majority, Lord Malcolm held that the statutory provisions should be applied in a purposive fashion and adopted a realistic view of the facts. In this case, the 2007 Option was not granted to Mr Noble because he was a director, nor was it a fringe benefit of his employment. Rather, the rescue package and refinancing caused both the directorship and the 2007 Option; they were not a cause of each other. The UT had therefore erred in determining that Mr Noble’s employment was a condition of the benefits being granted. Lord Malcolm also agreed with the FTT on the limited application of subsection 471(3): Parliament did not intend that tax would be payable on the basis that something should be deemed to have occurred by reason of an employment when it had already been established that the employment was not a reason for it.
Lord Doherty, also in the majority, agreed that the FTT was entitled to have concluded that Mr Noble’s right to acquire the 2007 Option had not been caused by reason of his employment, and that the facts in this case did not engage the deeming provision in subsection 471(3). On the facts, it would be”anomalous, absurd and unjust” if the right to acquire the 2007 Option were to be treated as having been made available to Mr. Noble by his employer.
Dissenting, Lord Carloway agreed with the UT that Mr Noble’s employment was a condition of the 2007 Option being granted. Lord Carloway also disagreed that the 2007 Option was caught by the legislation only on a “literal” view of subsection 471(3); rather, it was simply affording that deeming provision its plain and ordinary meaning in the statutory context. On that basis, Lord Carloway held that the appeal should be dismissed.
The decision of the Court of Session was finely balanced. Indeed, Lord Doherty made clear in his opinion that he had initially intended to refuse the appeal but had changed his mind upon further reflection and having read the other Lords’ decisions. It was no surprise then that HMRC was granted permission to appeal.
While the Supreme Court’s eventual decision will undoubtedly have important implications for the interpretation of section 471 and the principles to be applied in respect of deeming provisions more broadly, it is worth remembering that the facts in this case are of course unique. As Lord Carloway’s opinion suggested, VHL and Mr Noble could have potentially structured their arrangement by way of an amendment to the existing option (rather than the new grant of the 2007 option) to avoid triggering section 471.