Under appeal: Director’s share options were not Employment-Related Securities

In Vermilion Holdings Limited v HMRC [2021] CSIH 45, the Inner House of the Court of Session found that replacement share options issued to a director were not made available by reason of his employment. The share options had originally been given to a consultant company in lieu of fees for advisory services. 

The case was appealed to the Supreme Court in 2023, their judgment is anticipated in October 2023.

Mr Noble, via Quest Advantage Limited (Quest), advised technology businesses on fundraising, business growth, acquisitions and divestments.

• Quest provided advisory services to the Vermilion group. In 2006, Vermilion Holdings Limited (Vermilion) granted share options over 2.5% of its Ordinary share capital in lieu of payment for the advisory services received (the 2006 option).
• By December 2006, Vermilion was in serious financial difficulty, although commercial prospects were good.
• In 2007, as part of a rescue package for Vermilion, Mr Noble became a director and the 2006 share options were cancelled with options over 1.5% of the equity being issued under a new agreement which named Mr Noble as the option holder (the 2007 option).
• Vermilion submitted a non-statutory clearance request in 2016 to confirm that the 2007 option would be subject to Capital Gains Tax.
• HMRC subsequently assessed for Income Tax and Class 1 National Insurance totalling £385,589 on the basis that the shares acquired under the 2007 option were Employment-Related Securities (ERS).
• Vermilion appealed to the First Tier Tribunal (FTT).

Subject to a limited 'friends and family' exception, section 471 ITEPA 2003 broadly states that where an option to acquire securities is made available by a person’s employer it is deemed to have been made available by reason of their employment. 

Share options granted to an employee or director by reason of their employment are ERS and can be subject to a number of Income Tax charges. 

The FTT found that the 2007 options were not ERS.

• The 2007 option replaced the 2006 option which had been issued in lieu of payment for services. It could not be said that the 2007 option was made available by Vermilion as Mr Noble’s employer.

HMRC appealed to the Upper Tribunal (UT), which overturned the FTT decision finding that the options were ERS.

• The UT found that employment does not have to be the sole or dominant cause for the granting of the benefit.
• In the UT’s view, Mr Noble’s employment as director was a condition of the 2007 option being granted and so the options were ERS.

Vermilion appealed to the Court of Session which, by majority, found that the UT should not have disturbed the FTT conclusion. Vermilion’s appeal was allowed.

The majority of judges which allowed the appeal agreed with the FTT that it would be “anomalous, absurd and unjust” if the right or opportunity to acquire the 2007 option were to be treated as having been made available to Mr Noble by his employer.  

• Vermilion was merely arranging a surrender or dilution of Mr Noble’s 2006 option. This was necessary if the refinancing was to proceed.
• It was difficult to see that Mr Noble was given a ‘right or opportunity to acquire’ the 2007 option as it was in fact a diminution of his entitlement under the 2006 option. Mr Noble did not acquire something which he did not already have.
• If Mr Noble had not possessed the 2006 option, he would not have received the replacement and reduced 2007 option, whether a director or not. 
• The substance of the transaction was one of compromise and exchange. The 2007 option was granted in return for the 2006 option being given up: the right or opportunity was not made available by Vermilion as Mr Noble’s employer.
  • As there was no real link between Mr Noble’s employment and the right or opportunity to acquire the 2007 option, the deeming provision in s.471(3) was not triggered. 

Comment

A useful decision for advisers on share and option awards, due to its review of the deeming provision in s.471(3), this wording applies 421B(3) too, in relation to share awards. It is not uncommon for advisers to be given share awards in start-ups in lieu of fees and this case confirms that provided that you are not intending to become a director or employee such shares are firmly outside the ERS regime.

Useful guides on this topic

Employment-Related Securities & Share Schemes
What are the tax consequences when a company gives shares to an employee or director? What are employment-related securities? What is best: shares or share options? How do you set up a share scheme?

ABC or alphabet shares: directors & employees
Can you set up different classes of shares? How do you create Alphabet or ABC shares? What are the rules in giving different classes of shares to directors and employees? 

EMI: Enterprise Management Incentive Scheme
What is the Enterprise Management Incentive (EMI) scheme? What's the difference between EMI and an unapproved share scheme?

Employment-Related Securities: What’s New? August 2021
HMRC have issued their latest Employment-Related Securities Bulletin which includes some useful tips. Here is our enhanced version with links to our guides.

Shares, securities & options: Tax compliance
What are the filing requirements for share-based remuneration? What needs reporting? When does it need reporting?  What penalties are there for late filing?

Directors share options were not employment-related securities
In Vermilion Holdings Limited v HMRC [2019] TC07077, the First Tier Tribunal (FTT) found that share options granted to a director were not Employment-Related Securities. They were not issued by reason of his employment.

Director's share options were 'by reason of employment'
In HMRC v Vermilion Holdings Limited v [2020] UKUT162, the Upper Tribunal (UT) held that share options granted to a director were Employment-Related Securities. The employment did not have to be the sole reason for the grant of the options, it was enough that it was one of the reasons.

External links

Vermilion Holdings Limited v HMRC [2021] CSIH 45