Shares and granting share options are often provided to motivate and retain key employees but there are often circumstances such as where shares are provided to family and friends for a domestic purpose. The recent case of
Vermilion Holdings Ltd v HMRC [2021] CSIH 45 highlights the importance of considering whether shares are received ‘by reason of employment’ as this can have tax consequences.
Securities and Securities Options
The rules regarding receiving shares ‘by reason of employment’ govern both securities and securities options. The definition of ‘securities’ under legislation includes shares, rights under a contract of insurance (other than excluded contracts of insurance), debentures, debenture stock, loan stock, bonds, options and futures and units in a collective investment scheme.
Securities options are not considered a ‘security’, but legislation defines it as the right to acquire securities other than a right to acquire securities which is acquired pursuant to a right or opportunity made available under arrangements where the main purpose (or one of the main purposes) is the avoidance of tax or national insurance contributions.
The rules regarding ‘by reason of employment’ applies to securities, an interest in securities or a securities option, acquired by a person where the right or opportunity to acquire these is available by reason of an employment of that person or any other person.
A person acquires securities, or an interest in securities, when they become beneficially entitled to them and not when then are conveyed or transferred (if this is a different time).
It is important to note that it is not just employees that these rules apply to as they equally apply to directors of the company. The legislation also extends this to former employment and prospective employment.
When are securities or securities options deemed available ‘by reason of employment’?
For securities or an interest in securities, these are deemed to be available ‘by reason of employment’ where a right or opportunity to acquire these is made available by a person’s employer (or a person connected with a person’s employer) unless:
- The person by whom the right or opportunity is made available is an individual; and
- The right or opportunity is made available in the normal course of the domestic, family or personal relationships of that person.
For securities options, there is an identical provision in legislation when they are deemed to be available ‘by reason of employment’.
Therefore, it will clearly be a question of the factual circumstances and motivations in each individual case to determine whether it would be available ‘by reason of employment’ especially where there is family or personal relationship involved, such as family members handing over shares in a company.
What happened in the case of Vermilion Holdings Ltd v HMRC?
Mr Noble worked through a company called Quest Advantage Ltd (“Quest”). Quest was granted share options in Vermilion Holdings Ltd ("Vermilion") in lieu of fees for carrying out work. Vermilion found themselves in financial difficulty but managed to sort out a rescue package. As part of this package, Mr Noble became Director and Executive Chairman. The original share options were cancelled and new options were granted to Quest in July 2007 under different terms.
In June 2016, following a novation agreement, Mr Noble replaced Quest to become the holder of the new options in Vermilion and exercised the options later that year. Vermilion sought a non-statutory clearance from HMRC that the new options were subject to Capital Gains Tax and not Income Tax as neither option could be ‘by reason of employment’. HMRC responded by stating that whilst the original options in 2006 were not employment related, they considered the new options to be employment related.
The First-Tier Tribunal (“FTT”) agreed with Vermilion that the new options were not made available ‘by reason of his employment’ and when onto say that the right to acquire the new options originated from the original options and that the new options were not granted by reason of Mr Noble’s employment.
It was also stated that another reason for their decision was that the deeming provision discussed above
“… can be limited by adopting Mr Simpson’s submissions in relation to the interpretation of who (or what) had ‘made available’ the right or opportunity for Mr Noble to acquire the 2007 Option.”
The FTT stated by looking at the underlying causes of the grant of new options and the “
economic mechanism” behind the grant, "...
meant that Mr Noble's right to acquire the 2007 Option was not 'made available' by Vermilion as his ‘employer’".
HMRC appealed to the Upper Tribunal (“UT”) effectively stating that the new options were by reason of his employment in accordance with legislation and would otherwise be caught by the deeming provision discussed above.
The UT overturned the original decision of the FTT stating that the grant of new options were made available 'by reason of employment'. The UT stated the FTT erred in law and that the employment “…
need not be the sole cause or even dominant cause, and that it is sufficient that the employment was a condition of the benefit being granted”. The UT also stated that there was more than one reason why the new options were granted in 2007:
- The original options in 2006 could no longer continue in its current form; and
- The new options in 2007 were part of a package of measures which included the employment of Mr Noble.
In addition, the UT stated that the employment of a director was an operative clause "...
in the sense that it was a condition of the option being granted".
However, an appeal was made to the Court of Session. The Court of Session ruled by a majority verdict in favour of Vermilion. The Court of Session found that the new options were not made available ‘by reason of his employment’. It was commented during the case that:
“…it would be anomalous, absurd and unjust if that right or opportunity were to be treated as having been made available to Mr Noble by his employer”.
Why is this important?
The Court of Session appears to have taken a pragmatic approach with consideration to the facts, rather than a strict interpretation of the legislation as made by the UT.
It is important to note that HMRC may still make an appeal to the Supreme Court for a further decision to be made so this position could be tested again.
If the securities are employment relates securities option, then an income tax charge could arise.
In addition, employers are required to report to HMRC any shares acquired by reason of employment or options to acquire these shares through an Employment Related Securities return on or before 06 July each year.
If you require advice or assistance with employment related securities or options, please
contact a member of
our team.
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