On October 25 2023, the Supreme Court made a landmark decision, ruling in favour of HMRC in the HMRC v Vermilion appeal. Earlier, there was some surprise among professional advisors when the taxpayer received a favourable ruling in the Court of Session. However, that precedent was met with caution, and the recent judgment provides a clearer understanding of how rules apply in Employment Related Securities 'ERS' tax legislation.
This case is significant for any business considering whether they can argue that an award of shares or share options should not be subject to income tax as employment earnings.
What does the outcome of this mean for UK businesses?
- When a company gives its employees or officers (like executives or non-executives) shares or share options, this is automatically considered part of ERS, which has certain tax implications. It doesn't matter why the company did it; it still counts.
- This affects reporting to HMRC: Every year, by July 6, companies have to report these shares and options to HMRC. And when employees actually exercise these options, the company often needs to collect the right taxes from their pay.
- The recent Supreme Court decision in the Vermilion case means that there is limited scope to argue against these tax rules. So, if people were relying on the narrower interpretation of the rules by the lower-tier courts , they should get advice on how to follow the new rules properly.
- Is it still important to consider the reason for the share award? Yes, this test checks if the reason for giving shares or options was connected to someone's job. It's especially important when dealing with awards made before or after employment.
- The tricky part is when someone used to work for the company or might work for them in the future. This situation wasn't discussed in the Vermilion case. It's a complicated topic for many taxpayers, especially when this issue comes up on deals. So if you think this issue might be a red flag on a deal, it’s worth taking advice to understand how any employment-tax risks can be mitigated in advance.
About the case and the outcome
Mr Noble, working with Quest Advantage Limited, advised technology businesses like Vermilion on funding, business growth, and corporate deals. In 2006, instead of paying him for his advice, Vermilion Holdings Limited offered Mr Noble 2.5% of their company's shares as share options (called the "2006 option").
In 2007, when Vermilion faced financial difficulties, Mr Noble became a director, and they canceled the 2006 share options. They then arranged a new deal, granting Mr Noble 1.5% of the company's shares, known as the "2007 option". In 2016, Vermilion wanted to pay Capital Gains Tax on the 2007 option, but HMRC insisted they pay Income Tax and National Insurance because the shares were considered related to employment.
Employment tax laws generally treat shares given by employers as related to your job, unless you qualify for a "friends and family" exception. Different tax rules apply to shares given to employees or directors due to their job. Initially, it was decided that the 2007 option, given to Mr Noble while he was a director, wasn't related to his job but was viewed as a modification of the 2006 option, which was given to a consulting company instead of monetary payment for their advice. The Supreme Court ruled in favor of HMRC in the end.
Our Head of Employee Incentives, Samantha Lenox, comments:
The market takes a broad view of when the ERS rules can apply and this case supports that position. In an environment where capital gains tax rates are significantly lower than employment tax rates, it’s easy to see why the taxpayer was seeking capital gains tax treatment. The guiding principle is where there is an employment relationship in the factual matrix, the award will be employment-related and fall within these tax rules.