Employment-related securities: Supreme Court’s decision in HMRC v Vermilion Holdings Limited
November 16, 2023
The Supreme Court has recently published its decision in HMRC v Vermilion Holdings Limtied  UKSC 37 providing clarity on what constitutes ‘employment related’ securities (ERS) options (and accordingly, ‘employment related’ securities) and the scope of the deeming provisions, for the purposes of the employment related securities legislation.
In 2006, Mr Noble, a consultant, received a share option over 4.5% of Vermilion Holdings Limited (2006 Option and Vermilion, respectively) in consideration for services provided to Vermilion. Mr Noble held the 2006 Option through his nominee company. The following year, Vermilion fell into financial difficulties and the investors agreed a rescue funding package provided that Mr Noble became the executive chairman and the number of shares under the 2006 Option was reduced. Mr Noble became the executive chairman, the 2006 Option was cancelled and a new share option over 1.5% of Vermilion was granted in its place (2007 Option). In 2016, Mr Noble exercised the 2007 Option.
The question arose whether the ‘gain’ on the exercise of the 2007 Option should be subject to taxation under PAYE and NICs or to capital gains tax. If the 2007 Option was an ERS option, the gain would be subject to income tax and NICs.
Section 471 of ITEPA provides the test for securities options to be determined as ERS. Sub-section (1) states that if the right or opportunity to acquire the securities option is made available by reason of a person’s or any other person’s employment, the securities option is an ERS option. Sub-section (3) states that a right or opportunity to acquire a securities option made available by a person’s employer or a person connected with a person’s employer is to be regarded as ERS unless (a) the person by whom the right or opportunity is made available is an individual, and (b) the right or opportunity is made available in the normal course of the domestic, family or personal relationships of that person.
The question arose as to the interaction between the two sub-sections described above and their application in the given facts.
Decisions in the lower courts
The First-Tier Tribunal held that the 2007 Option was not ERS. Although the test in sub-section (1) was met, so far as the test in sub-section (3) was concerned, the reason for being granted the 2007 Option was not made by Vermilion by reason of Mr Noble’s employment.
The Upper Tribunal held that the 2007 Option was indeed ERS because, as the test in sub-section (1) was met, there was no requirement to consider the test in sub-section (3).
The Court of Sessions held that the 2007 Option was not ERS, amongst other things, because the test in sub-section (1) was not satisfied as employment was not the operative cause for the grant of the 2007 Option and sub-section (3) was not satisfied because sub-section (3) was not a separate test once it is established that the option was not employment-related.
Supreme Court’s decision
The Supreme Court judgment lays down the application of the ‘bright line’ test to first ask ‘who’ has provided the right or opportunity to acquire securities (or securities option) to the employee. If the right or opportunity to acquire the shares and securities (or securities option) has been made available by an employer or a person connected with the employer, such shares and securities or options over them automatically become ERS, unless the right or opportunity is made available in the normal course of the domestic, family or personal relationships of that person. In that case, there is no need to analyse the causation i.e. ‘why’ has the securities (or securities option) been provided.
If, however, it is not the employer who has provided the right or opportunity to acquire securities (or securities option), then it needs to be assessed ‘why’ was the right or opportunity to acquire securities (or securities option) provided to that person.
In practical terms, the causation test would need to be applied in the case of shares and securities acquired by former or prospective employees or cases where the right or opportunity was not provided by an employer.
The Supreme Court’s decision has given much needed clarity on how the legislative provisions should be applied to determine whether shares and securities are within the ERS legislation in Part 7 of ITEPA and establishes a wide interpretation of the legislative provisions.
The decision makes it clear that if an employer provides the right or opportunity to acquire shares and securities or options over them, such shares and securities are clearly ERS. However, even if shares and securities are not provided by an employer, for example, if they are shares and securities awarded to past or prospective employees, those shares and securities would still be regarded as ERS where the reason for awarding the right or opportunity to acquire them was provided because of their past or prospective employment, as the case may be.
This decision is perhaps particularly helpful to practitioners and non-employee officeholders, for example, non-executive directors. Even if non-executive directors provide their services through a consultancy agreement, any shares or securities that they receive as fees or incentives will clearly be under the charging provisions of the ERS legislation. as they would be provided by the company of which they are an office holder.