Mark McLaughlin looks at what ‘by reason of employment’ means and a Supreme Court decision highlighting its significance for tax purposes.
The UK tax system is full of potential surprises. For example, it sometimes treats certain situations and events as having occurred, which did not necessarily happen in the ‘real’ world. Land of make believe This ‘deeming’ can sometimes create a tax charge. The point was illustrated in Revenue and Customs v Vermilion Holdings Ltd (Scotland) [2023] UKSC 37 (see below). Shares and securities acquired in connection with employment generally fall within the scope of the employmentrelated securities (ERS) tax regime. Within those provisions, the ‘securities options’ rules impose an income tax liability as employment income for gains on the exercise of an option if it is treated as an ERS option. ‘Securities’ includes shares in a company. The rules apply to an option acquired by a person where the opportunity to acquire it is available ‘by reason of an employment of that person’ (ITEPA 2003, s 471(1)). A right or opportunity to acquire the option made available by a person’s employer (or connected person) is ‘to be regarded’ as available by reason of that person’s employment, unless the right or opportunity was made available by an individual in the normal course of their domestic, family, or personal relationships. This ‘by reason of employment’ treatment requires a causal link between a person’s employment and the grant of the option. However, if a person’s employer (or connected person) provides the employee with an option, that option is conclusively treated as having been made available by reason of their employment (subject to the domestic, family, or personal relationships exception). This ‘deeming’ rule can have unexpected and unfortunate consequences.
Investor or Employee?
In Vermilion, in 2006 a company (VH) granted another company (Quest) owned by an individual (N) of which he was a director, an option to acquire shares in VH (the ‘2006 option’). However, VH underperformed, and a rescue funding package was formulated. N was appointed as a paid director of VH from 16 March 2007. In July 2007, VH and Quest entered into a new option agreement (the ‘2007 option’), for Quest to acquire shares in VH. The 2006 option expired. In 2016, Quest transferred the 2007 option to N, who exercised it. VH was sold in November 2016. HM Revenue and Customs considered that the 2007 option was an ERS option, making N liable to income tax as employment income on exercise. The case reached the Supreme Court, which unanimously held that N was deemed to have acquired the securities option because of his employment as a director of Quest, and it was therefore subject to income tax.
A Different Outcome?
The Supreme Court’s decision indicates that the deeming provision (in ITEPA 2003, s 471(3)) takes precedence over the ‘by reason of employment’ test in section 471(1). This will potentially result in a larger number of income tax charges. The outcome in Vermilion might have been different had the option in 2006 (when N was only an investor) been varied instead of cancelled and a new option granted in 2007.
Practical tip
A comforting note of judicial caution about ‘deeming’ provisions was expressed in Fowler v Revenue and Customs [2020] UKSC 22: “A deeming provision should not be applied so far as to produce unjust, absurd or anomalous results, unless the court is compelled to do so by clear language.”