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In a long-awaited judgement handed down on 25 October 2023 in Commissioners for His Majesty's Revenue & Customs (Appellant) v Vermillion Holdings Limited (Respondent) (Scotland) [2023] UKSC 37, the Supreme Court unanimously allowed HMRC's appeal and determined that an option to acquire shares in Vermillion Holdings Limited (Vermillion), granted to Mr Noble (a director of Vermillion) would be treated as an employment-related securities option and therefore subject to income tax.
Background
In 2006, Vermillion granted an option to acquire shares to Quest Advantage Limited, a corporate advisory and accounting company owned by Mr Noble.
In 2007, a new option agreement was entered into between Quest and Vermillion (the "2007 Option") and the earlier 2006 option agreement lapsed.
By the time the 2007 Option was granted, Mr Noble had been appointed as a director of Vermillion. In 2016, the 2007 Option was transferred to and exercised by Mr Noble.
Vermillion and Mr Noble sought confirmation from HMRC that the gain arising on exercise of the 2007 Option was subject to capital gains tax rather than income tax.
HMRC disagreed, citing section 471 of the Income Tax (Earnings and Pensions) Act 2003 ("Section 471").
The Judgement
The Supreme Court highlighted that the purpose of Section 471 is to define the circumstances in which the exercise of a securities option would be subject to income tax as opposed to capital gains tax.
There are two ways this is established:
- Firstly, a causal test which considers if the securities option was made available to the holder 'by reason' of their employment with the company (Section 471(1)); and
- Secondly, avoiding the question of causation altogether, a securities option will be deemed to be employment-related if it is acquired as a result of an opportunity made available by a person's employer regardless of whether the option was granted by reason of employment (Section 471(3)).
Prior judgements considered causation and whether the 2007 Option was made available to Mr Noble "by reason" of his employment with Vermillion.
However, highlighting that this approach would be untenable and require case by case analysis, the Supreme Court emphasised the 'bright line' rule in Section 471(3).
If an employer grants an employee an option, that option will be treated as being made because of that employment, regardless of the actual reason for the grant.
The only limited exception is if the option was granted due to a domestic or personal relationship.
The 2007 Option was granted to Quest (as nominee for Mr Noble) at a time when Mr Noble was in the employment of Vermillion.
There was no domestic or personal relationship in this case and the reason for the grant of the 2007 Option is therefore irrelevant. The Supreme Court concluded that Mr Noble's option must be subject to income tax and not capital gains tax.
Impact
The Supreme Court judgement has established certainty, perhaps unwelcomed by some, that an award of securities made by an employer to an employee during a period of employment will (in almost all cases) be treated as an employment related security.
The Supreme Court acknowledged that the rule in Section 471(3) should not be applied in a way that would produce unjust, absurd or anomalous results.
However, in most cases the outcome is clear – when determining the tax treatment of options granted to employees the key question will be who granted the award and not why the award was granted.