Employment related securities options

The Supreme Court has held that the deeming provision in ITEPA 2003 s.471(3) that treats a securities option issue by an employer as (except in limited circumstances) an employment related securities option should be applied, even where it replaced an earlier option that was not an employment related securities option: HMRC v Vermilion Holdings Ltd [2023] UKSC 37. The deeming provision had been included to avoid difficult questions over causation where an employer issues such an option and there was no reason to give it a more restricted application.

Background

Vermilion Software Ltd was incorporated in 2003 to market a software product for the fund management sector. In 2006, it raised further funding which involved the creation of a new holding company Vermilion Holdings. That funding involved the use of advisers who were remunerated for their services through the issue of supplier options. One of those suppliers was a company called Quest owned by Mr Noble.

In 2007, it became clear that the business was failing. A further rescue package was put together which involved Mr Noble being appointed as executive chairman of Vermilion Holdings and new option agreement being put in place in favour of Quest with the old options lapsing.

In June 2016, in the context of a proposed sale of Vermilion Holdings, a novation agreement was entered into whereby Quest was replaced by Mr Noble as the holder of the 2007 options. Mr Noble then exercised the option and sought a non-statutory ruling from HMRC that gain on the option was subject to CGT. HMRC replied that the 2007 was an employment related securities option and the taxable gain on exercise of the option was taxable as employment income. This was on the basis of the application of ITEPA 2003 s.471. Section 471(1) applied to "securities option acquired by a person where the right or opportunity to acquire the securities option is available by reason of an employment of that person or any other person". Section 471(3) then provides that a right or opportunity to acquire a securities option made available by a person's employer is to be regarded as made available by reason of employment.

The FTT held that the option was not an employment related securities option. The FTT considered that a literal interpretation of s.471(3) would lead to absurdity in this case where the 2007 option replaced the earlier 2006 option (which would not have been an employment related security). The UT overturned that decision on the basis that it was a condition of the 2007 option that Mr Noble was employed as a director of Vermilion Holdings. The Inner House of the Court of Session then allowed the taxpayer's appeal deciding that, on a realistic view, the reason Mr Noble through Quest received the 2007 option was that he agreed to give up the 2006 option.

Decision of the Supreme Court

The Court has allowed HMRC's appeal. The Court has held that the whole reason for the inclusion of the deeming provision in section 471(3) is to avoid questions of causation where a person's employer makes a right available and the type of uncertainty that had arisen in this case. There was no reason to apply it restrictively or consider that it would be absurd to apply it to the facts of this case.

"It is not difficult to ascertain the purpose of the deeming provision in section 471(3). The causation questions which can arise under section 471(1) may be difficult and may give rise to disagreement among judges as has occurred in this case." As a result, section 471(3) created a bright line rule to avoid such difficult questions. It replaces the question of why the option was provided with who it was provided by.

The approach of the lower courts had robbed the deeming provision of its substance. There was no "anomaly, absurdity or injustice" in giving effect to the deeming provision in this case. Vermilion, Mr Noble's employer at the time, had made available a securities option to his nominee and Vermilion's reason for doing so was irrelevant.

Comment

The decision removes doubts over the correct interpretation of ITEPA 2003 s.471. The deeming provision was included for the very purpose of preventing difficult issues arising over causation and in those circumstances the fact that the deeming provision produced a result that was the opposite to that which would have applied if s.471(1) alone had applied was simply not relevant.