Vermilion Holdings – Court of Session confirms that the grant of a share option by an employer was not an employment related securities option

In Vermilion Holdings Ltd v HMRC [2021] CSIH 45, the Court of Session overturned the decision of the Upper Tribunal (UT) and confirmed that an option granted by a company as part of a refinancing exercise was not an employment related securities option, for the purposes of section 471, Income Tax (Earnings and Pensions) Act 2003 (ITEPA).

Background

Vermilion Holdings Ltd (Vermilion) granted a share option (the 2006 Option) to its advisor, Mr Noble, through his company, Quest Advantage Ltd (Quest), as payment for services rendered in relation to a fundraising exercise. As part of a later refinancing exercise, Mr Noble was appointed as a director and the executive chairman of Vermilion, the 2006 Option was cancelled, and Quest was granted a new share option (the 2007 Option). Under a novation agreement entered into in 2016, Mr Noble replaced Quest as the "Existing Optionholder" under the 2007 Option. After Vermilion was sold in November 2016, the 2007 Option was exercised, resulting in a payment to Mr Noble of £636,238.

Vermilion sought a non-statutory clearance from HMRC that the 2007 Option was subject to capital gains tax rather than income tax, because neither the 2006 Option nor the 2007 Option was an employment related securities option for the purposes of section 471,  ITEPA. HMRC accepted that the 2006 Option was not employment related, but was of the opinion that the 2007 Option was employment related. Accordingly, HMRC issued decision notices which determined that the exercise of the 2007 Option was chargeable to income tax and subject to national insurance contributions. Vermilion appealed to the First-tier Tribunal (FTT).

FTT decision

The appeal was allowed.

Section 471, ITEPA, provides:

“471 Options to which this Chapter applies
(1) This Chapter applies to a 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 ...
…
(3) A right or opportunity to acquire a securities option made available by a person’s employer, … is to be regarded for the purposes of subsection (1) as available by reason of an employment of that person unless …”.

Applying Wicks v Firth [1982] 1 Ch 355, the FTT found that Mr Noble's appointment as a director of Vermilion was not the cause of the grant of the 2007 Option. The right to acquire the 2007 Option emanated from the right under the earlier option and therefore was not "by reason of an employment".

The FTT went on to consider HMRC's argument that the deeming effect of section 471(3) meant that share options must be treated as provided by reason of employment if they are issued by the employer, and therefore the 2007 Option was within section 471.

In the view of the FTT, the relevant question was simply whether the right to acquire the 2007 Option was “made available” by Vermilion. That question had to be answered in the affirmative, because Vermilion granted the 2007 Option. However, the FTT thought that an anomaly resulted from this. It had concluded that the 2007 Option was not within the scope of section 471(1), as it had not been caused by reason of employment, yet it was nevertheless to be deemed to have been so caused by section 471(3). In the view of the FTT, this would lead to an injustice and an absurd outcome and therefore the deeming provision should be limited accordingly.

HMRC appealed to the UT.

UT decision

The appeal was allowed.

The UT considered there was more than one reason for the grant of the 2007 Option. One reason was that the 2006 Option could no longer continue in its current form. Another was that it was part of a rescue package, including the employment of Mr Noble. His employment was a condition of the granting of the 2007 Option and therefore the option was employment related and fell within section 471(1). It was therefore not necessary to consider the alternative argument which was based on the deeming provision in section 471(3).

Vermilion appealed to the Court of Session.

Court of Session judgment

The appeal was allowed. 

In the Court of Session, Lord Malcolm and Lord Doherty decided that the 2007 Option was not employment related and the deeming provision was not triggered.

Lord Malcolm stated that he was not persuaded that there was any sound basis for interfering with the decision of the FTT. In his view,  Mr Noble's employment was not an “operative cause” of the 2007 Option. On a realistic view of the facts, when receiving the 2007 Option, Mr Noble did not acquire something which he did not already have. On the contrary, albeit for good reasons, he had agreed to give up part of his existing entitlement. It was not correct to categorise section 471(3) as a separate and distinct route to taxation which is available even if it has been established that section 471(1) has no application.

Lord Doherty noted that, on a fair reading of its findings, the FTT decided that it was the existence of the 2006 Option which had enabled Mr Noble to enjoy the benefit of the 2007 Option. He considered that it would be "anomalous, absurd and unjust" if the right or opportunity to acquire the 2007 Option was to be treated as having been made available to Mr Noble by his employer.

In a dissenting judgment, Lord Carloway decided that Vermilion's appeal should be dismissed. He considered that, applying the words in section 471(1), the option was made available "by reason of" Mr Noble's employment. The 2006 Option was effectively worthless by the time of the 2007 refinancing and the 2007 agreement was a new scheme which had been devised to revive the fortunes of Vermilion. Mr Noble agreed to become director and executive chairman of Vermilion and he was thereafter granted the option. Had he not agreed to become a director and executive chairman, he would not have acquired the 2007 Option.

Comment

It is relatively rare for the appellate courts to deliver a split decision and Lord Doherty (one of the two judges in agreement) noted in his opinion that he was initially inclined to the view that the appeal should be refused, before changing his mind upon reflection and having read the other Lords' opinions in draft. Given the far-reaching consequences of this judgment, which reverses what had generally been the previously accepted interpretation of sections 471(1) and 471(3), and the ambivalence of the Court of Session, it is likely that HMRC will seek to appeal the judgment to the Supreme Court.

The judgment can be viewed here.