In more detail

Overview

Overturning the Court of Session, the decision makes it clear that, where the deeming provisions are satisfied (i.e., that the opportunity to acquire securities or a securities option is provided by an individual’s employer, or a person connected with their employer) other than a narrowly drawn exception for opportunities arising by virtue of family and personal relationships, those securities or securities options will be considered Employment Related, and therefore subject to specific employment income charging provisions (instead of more favourable trading income, or capital gains provisions). This will be the case even where it is clear that the opportunity to acquire the security of securities option has arisen by some other reason.

This decision will impact a wide range of individuals, where those individuals invest in businesses for reasons other than employment. The deeming rules could catch non-employee individuals (e.g., LLP members) who have acquired securities/securities options by virtue of their non-employee role, but whom also hold a smaller employment or office within the wider group. 

For example, an LLP investment firm which acquires a new company and places an LLP member on the board to oversee the investment. If the employer (i.e., the newly acquired company in the example) is connected to the party which issues the securities (likely to be the case if under common control) then any securities received by the LLP member could be considered ‘employment related’. 

Background to the case

The individual concerned provided consultancy services on a self-employed basis and received stock options as a form of payment for these services. Years later, the company ran into financial hardship, and as part of a rescue package, the individual became a Director of the company, and his stock option agreement (along with other investors) was renegotiated, and a new option was granted. The option appeared to be provided in respect of the individual’s prior role as a self-employed consultant, but the renegotiated option had been provided at a time when he was a director of the company, and so it was a question as to whether the deeming provision would apply and render the option as ‘employment related’.

Technical analysis & judgement

Section 471(1) Income Tax (Earnings & Pensions Act 2003) provides a causal test as to whether the right or opportunity to acquire a securities option “is available by reason of an employment of that person or another person”.  Section 471 (3) ITEPA deems a right or opportunity to acquire a securities option as being made by reason of employment if made available by a person’s employer or a person connected with a person’s employer.

In a unanimous decision, the Supreme Court held that, where the deeming provision in section 471(3) applies, this takes precedence over the causal test. Only if the deeming provision does not apply does one carry out an assessment of causation under section 471(1) ITEPA.

As Lord Hodge concluded, “there is to my mind no anomaly, absurdity or injustice in giving effect to the deeming provision of section 471(3) in this case. As I have said, the purpose of section 471(3) is to circumvent the difficult issues that can arise in the application of section 471(1). The statutory provision makes clear that if an employer makes available to an employee a securities option, that option will be treated in the employee’s hands as an employment-related securities option and taxed accordingly. Vermilion, which at the relevant time was Mr Noble’s employer, made available to his nominee such an option. Vermilion’s reason for so doing is irrelevant when section 471(3) applies”.

Although the decision was specifically in relation to a securities option, there is a mirroring provision for securities at section 421B ITEPA 2003, and so it will impact the issuance of securities as well. 

The decision can be found here.

Key Takeaways and Next Steps

The Supreme Court decision has provided clarity on the interpretation as to when the employment related securities rules will apply. However, the Supreme Court decision will pose huge tax issues for individuals who are employees or directors, who also invest in businesses for reasons other than employment. The rules have a wide ambit as they catch both current, former employees and/ or directors or other office holders.

Businesses with partnership structures, which provide partners with securities and/or securities options should consider this recent judgement in further detail and whether the securities could now be considered as employment related. To be conclusive on this, it will be necessary to consider the relationship between the parties, and ownership structure.

The impact of the securities being designated as 'employment related’ should be considered. It is worth noting, that just because a security is considered as ‘employment related’ for the purposes of Part 7, ITEPA 2003, doesn’t necessarily equate to the acquisition of the security being charged to income tax as general earnings as an emolument from the employment. It will be necessary to consider whether specific provisions apply, and their impact.

Businesses should consider whether smaller employments within the same group are genuinely necessary.

If you need any assistance with determining how the recent judgement could impact your business or other employee share-plan issues, please do not hesitate to contact a member of your Baker McKenzie team.