A taxpayer and his employing company has won his case at the Scottish Court of Inner Session (CIS) regarding income tax and national insurance contributions on employment related securities.  The taxpayer was an angel investor and had invested in a company based on four IT professionals that had worked in the financial services industry but had decided to set up their own software company.  The taxpayer had helped the new company arrange financing.  The taxpayer was granted options in the company equal to 2.5% of the company’s share capital.

The company didn’t perform very well, and it was decided that another emergency round of financing would have to take place and that the existing shareholders, the taxpayer included, would have to suffer dilution of their holdings in the company.  The terms of the second round of financing dictated two relevant matters, one; the taxpayer would be employed as a director (for 1 or 2 days a week) of the company and two; that his options over 2.5% of the company’s share capital would be reduced to 1.5%, in line with the other investors’ dilution.

The company then started to perform much better and eventually the taxpayer exercised his options and generated a gain of £636k.  The company then requested non-statutory clearance from HMRC to treat gain made by the director as non-employment related, ie any gain would only be subject to capital gains.  HMRC disagreed and levied income tax and national insurance contributions (the shares would be deemed readily convertible) on the gain and issued notice to the company, as the taxpayer’s employer.  The company disagreed with this treatment and appealed to the First-tier Tribunal (FTT).

The FTT found for the taxpayer and his employing company holding that the second options were granted to him not because of his directorship of the company but because was a prior option holder.  HMRC appealed and the Upper Tribunal (UT) found for HMRC holding that a deeming provision within the relevant should be invoked and the result was not absurd.

A majority of the CIS has now also found that the reason for the grant of the second, diluted, options was not because of the taxpayer’s directorship with the company but rather were replacement options.  One the judges noted that the taxpayer’s directorship and diluted options were requirements of the refinancing so while options were issued shortly after the directorship began they were not issued as a reason of his employment but rather were conditions of the refinance.

The decision can be found at: 2021csih45.pdf (scotcourts.gov.uk)

This is good decision for angel investors, though the circumstances of the case are sufficiently unique and unlikely to repeat.  It is interesting that only a majority of the judges of the CIS found for the taxpayer and it will be good to see whether HMRC appeal to the Supreme Court.

Please contact if you have any questions over employment related securities, we are experienced with approved and unapproved schemes and can assist.  As this case highlights, employment related securities can be quite technical.