The UK Supreme Court’s recent decision in HMRC v Vermilion provides crucial guidance on the taxation of share options or securities granted to employees or directors.
The case involved Mr. Noble, an individual investor whose company, Quest Advantage Ltd, advised Vermilion on a turnaround strategy. When project costs exceeded the budget, Vermilion granted Quest an option to acquire shares instead of payment. A year later, a restructuring led to the cancellation of the original option and the issuance of a new one over a different class of shares. Nine years later, Mr. Noble exercised the new option, seeking confirmation from HMRC that the gain was subject to capital gains tax. HMRC decided that the gain was subject to income tax. Mr Noble appealed the decision and the dispute was ultimately heard in the UK Supreme Court.
The relevant law, under section 471(1) of the Income Tax (Earnings and Pensions) Act 2003, imposes income tax on share acquisitions through options linked to an individual’s office or employment. Section 471(3) extends this to include options made available by an employer or a person connected to the employer. The Supreme Court ruled in favour of HMRC, establishing a “bright line” rule that if an employer or connected person provides the right to acquire a share option, it is conclusively treated as employment-related income.
The court rejected the argument that section 471(3) could lead to unjust results, as highlighted in Fowler v Revenue and Customs Comrs. The decision emphasizes that the employer’s reason for granting the option is irrelevant; if the employer provides the option, it is treated as employment-related security, subjecting gains to income tax.
This decision has far-reaching implications, particularly for founders, non-executive directors, and directors acquiring securities as investors. While the judgment acknowledges the potential for unjust results, it clarifies that section 471(3) should not be applied to produce absurd outcomes. Taxpayers should carefully consider the implications before implementing arrangements involving shares or share options granted to UK employees and officers. Moreover, the risk extends beyond HMRC challenges, as potential buyers or investors may scrutinize such arrangements during diligence exercises.