A taxpayer and his employing company have lost their case at the Supreme Court (SC) after earlier winning at the Scottish Court of Inner Session (CIS) and Frist-tier Tribunal (FTT) relating to income tax and national insurance contributions on employment related securities. Our analysis of the decision of the CIS is available here.
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 and not income tax. 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 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 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.
The SC has now overturned the decision of the CIS and found that the purpose of the deeming provision was to charge gains on securities options to income tax, irrespective of the reason of the grant, on employees of companies that grant them. The SC held that the deeming provision was included to avoid the difficult judgements required when considering whether something was ‘made available by reason of employment’ as the long-drawn-out litigation is a testament of. The SC held, the whole point of the deeming provision was to avoid drawn-out litigation.
The decision can be found at: Commissioners for His Majesty’s Revenue and Customs (Appellant) v Vermilion Holdings Ltd (Respondent) (Scotland) – The Supreme Court
This is a clear decision from the SC helping businesses understand when securities options are to be considered employment related and therefore subject to income tax, and possibly National Insurance contributions. There may be many differing reasons why securities options are granted but the SC judgement has clarified that where a person is employment by the company granting the options (or a company connect to it) then these are automatically considered employment related.
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.
