Taxation of long term employee incentives

The Upper Tribunal has held that the House of Lords decision in Abbot v Philbin does not require all contingent rights that might possibly be monetised to be taxed on receipt rather than on payment: Saunders v HMRC [2025] UKUT 374. In this case, a payment made to an ex-employee under the terms of contingent rights to pay participants a sum of money in the event of a sale of the group was taxable as earnings from his employment. It was not the grant of the rights themselves that were the taxable event, even though it was possible to conceive that they might be turned to value in some way.

Background

Mr Saunders was employed by Hibernia Atlantic UK Ltd (HAUKL) from April 2008 to July 2016, working and residing in the UK. In April 2013, he was granted Stock Appreciation Rights (SARs) under a long-term incentive plan (LTI Plan) by HAUKL’s parent company. This involved a promise to pay participants a sum of money representing the amount of the increase in the group’s share price from a stipulated base in the event of a sale. The SARs vested in tranches between 2013 and 2015, conditional on continued employment. Saunders left HAUKL on 31 July 2016 and became non-UK resident from 1 August 2016.

In January 2017, following the sale of the parent company, Saunders received a payment of £1,236,956 from HAUKL, representing the value of his vested SARs. The payment subjected to PAYE and NICs. Saunders claimed split-year treatment in his 2016/17 tax return, treating the payment as foreign earnings not taxable in the UK. HMRC disagreed and assessed the payment as taxable UK employment income.

The FTT dismissed Saunders’ appeal, holding the payment was taxable as UK employment income and not attributable to the overseas part of the split year. Saunders appealed to the Upper Tribunal, arguing that: (1) the payment was not taxable as employment income under s.62 ITEPA 2003, but rather the relevant taxable event was the grant of the SARs (following Abbott v Philbin) and (2) even if taxable as employment income, the payment was attributable to the overseas part of the split year, which was when the sale occurred (and thus not taxable in the UK).

Upper Tribunal decision

The Upper Tribunal agreed with the FTT that the payment received in January 2017 was taxable as employment income under s.62 ITEPA 2003. The SARs were granted and vested as a reward for Saunders’ employment, they were designed to incentivise employees and the payment was made pursuant to the terms of the SAR Agreement.

The Tribunal rejected the argument that it was the grant of the SARs that was the taxable event and not the payment received as a result of the sale. The Tribunal extensively reviewed the decision of Abbot v Philbin and its subsequent treatment. In essence, the House of Lords in that case held that the grant of a share option to an employee was taxable on grant and the subsequent profits made by the grantee on exercise were not emoluments arising from the employment. Legislation has subsequently been enacted to deal specifically and in detail with the taxation of employee share options, but it was accepted that the broader principle in Abbot v Philbin still apply. This broader principle was, in essence, that the grant of a contingent right capable of monetisation is taxable on grant, rather than on exercise. The taxpayer in this case argued that the SARs were contingent rights equally taxable on grant.

The Upper Tribunal noted that, in applying Abbot v Philbin, the court is ultimately required to adopt a realistic approach to the identification of earnings for the purpose of s.62, considering the substance rather than focussing on mere form and not taking an overly formalistic approach. Therefore, the question was, on a realistic appraisal of the facts and having regard to the substance of the position, were the payments to Saunders earnings or did those payments arise from the earlier taxable receipt of a contingent asset. Did the receipt of the contingent asset, in effect, break the chain of connection between the ultimate payment and the employment (as it did in Abbot v Philbin).

The Tribunal noted that there were material differences between the share options in Abbot v Philbin, which (in their cumulative effect) lead to the conclusion that it was the payment that amounted to the taxable earnings. In particular, the Tribunal noted that:

• The SARs were highly contingent rights, not a widely traded asset class like share options.
• The value of the SARs at grant was highly uncertain and difficult to value, unlike share options.
• Saunders had no control over the timing or occurrence of the sale event that triggered the payment, unlike the exercise of options. As such, the payment was not the result of Saunders’ “judicious assessment” (as in Abbott), but of an event outside his control.

Therefore, whilst accepting that these factors were not identified in Abbot v Philbin itself, which gave the Tribunal “real pause for thought”, the Tribunal concluded the taxable event was the receipt of the payment, not the grant of the SARs. The decision in Abbot did not require any contingent right that that might conceivably be monetised to be taxed on receipt.

Attribution to the Split Year

The Tribunal held that the payment was “earned in respect of” Saunders’ UK employment, even though it was received after he became non-resident. The payment was for services performed while Saunders was UK resident and employed by HAUKL. “The payment was made by his employer, pursuant to the SARs which had been awarded to him with the express purpose of incentivising his work during the period of his employment.” The fact that the payment was contingent on a later sale did not change its character as a reward for past UK employment. The FTT’s finding that the payment was “for” the period of UK employment was a finding of fact, and there was no basis to overturn it.

Comment

The decision contains extensive analysis of the principles to be derived from Abbot v Philbin concerning the taxation of contingent rights, concluding that not every contingent right that might be monetised is to be taxed on receipt. In this case, the nature of the rights and payment were significantly different to the share options in Abbot v Philbin and a more realistic assessment was that it was the payment that amounted to earnings, not the grant of the highly uncertain rights.

The Upper Tribunal also confirmed that a payment made under a long-term incentive plan, received after the end of UK employment and after the employee became non-resident, was taxable as UK employment income because it was a reward for earlier services performed in the UK.