UKSC holds director's option subject to income tax
The UK Supreme Court has allowed an appeal from the Court of Session in a case concerned with the tax treatment of an option to acquire shares in a company, holding that by the operation of s 471(3) of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”) the transfer of an option to an employee was subject to income tax rather than capital gains tax.
The option, to acquire shares in Vermilion Holdings Ltd (“Vermilion”), was transferred to a Mr Noble, a director of Quest Advantage Ltd (“Quest”), by Quest. HMRC considered that it was subject to income tax as it had been granted to Mr Noble because of his employment as a director of Quest. The First-tier Tribunal found that the 2007 option was not granted by reason of Mr Noble’s employment. The Upper Tribunal overturned the FTT’s decision, and this was upheld by a majority in the Inner House.
Lord Hodge, Lord Lloyd-Jones, Lord Leggatt, Lord Burrows and Lady Rose unanimously allowed HMRC's appeal. Lord Hodge, with whom the other Justices agreed, ruled that under s 471(3) of ITEPA, Mr Noble was deemed to have acquired the securities option because of his employment as a director of Quest and it is therefore subject to income tax.
In his judgment he explained that the purpose of s 471 was to define the circumstances in which the exercise of a securities option was subject to income tax instead of capital gains tax. It did so in two ways. First, the grant of a securities option would be subject to income tax where it “is available by reason of an employment of that person or any other person”. To answer this question, a decision-maker had to consider carefully the facts of each case to decide whether there was a causal connection between the person’s employment and the grant of the option.
However, that analysis was difficult, and s 471(3) therefore created a straightforward rule: if a person’s employer (or a person connected) provided the employee with an option, that option was conclusively treated as having been made available by reason of their employment. However, an exemption was provided where both limbs of the following test were satisfied: (a) the person was an individual, and (b) the option was granted in the normal course of the domestic, family, or personal relationships of that person.
In applying s 471(3) in this case the key question was: did Vermilion confer the option on Mr Noble while it was his employer? The answer was that it did, and as Mr Noble did not satisfy the exception in s 471(3), there was no need to undertake a more detailed analysis under s 471(1). The option was therefore conclusively treated as having been granted to Mr Noble because of his employment, and subject to income tax.
While s 471(3) should not be applied in a way that would produce unjust, absurd, or anomalous results, the court concluded that no such result was produced in this case.