5. Share scheme related recent decisions of the First-tier Tax Tribunal
Tower Radio Ltd and Total Property Support Services Ltd vs HMRC [2013] UKFTT 387 : striking out on the basis of the ‘Ramsay’ principle
This First-tier Tribunal decision (in a lead case heard pursuant to a ‘Rule 18 Direction’ – i.e. there are many other cases under formal challenge by HMRC to which this decision will apply) is perhaps the first example of a situation in which HMRC has succeeded in arguing that an artificial tax avoidance scheme based on the award of (restricted) forfeitable shares in a specially-formed company (“SPV”) should be wholly ignored on the basis of “the Ramsay principle”.
It will be recalled that, in the UBS/Deutsche Bank cases ([2013] STC 68) – currently the subject of appeals to the Court of Appeal and in which the schemes adopted were very broadly analogous to that here (see earlier bulletins) – the Upper Tribunal upheld the employers’ contentions that, insofar as the admittedly tax avoidance schemes had been properly executed (which, in the case of UBS, it was), the acquisition of forfeitable shares, and their subsequent release from forfeiture in circumstances specifically provided for in Part 7 ITEPA 2003, fell to be exempt from charges to income tax by reason of Part 7 and because the Ramsay principle did not apply.
Here, the Tribunal determined that, on the facts, the scheme – involving the acquisition, by the employee/directors who controlled the employer companies, of valuable shares in an SPV which each employee transferor later wound up (this not being a ‘chargeable event’ under Part 7) – could be struck down on the basis that it was a composite transaction consisting of a series of steps that began with the decision to use what was a marketed (and disclosed) tax avoidance scheme, and ended with the receipt of the liquidation distributions by the employee. By contrast with the Aberdeen Asset Management case ([2012] STC 650), the composite transaction did not in this case end with the transfer of shares to the employees: it ended with the receipt of cash on liquidation of the SPVs. Although the Tribunal accepted that the shares acquired were ‘forfeitable’ shares (per s423 ITEPA 2003), this was not relevant as the entire scheme, of which the acquisition of those shares formed part, could be ignored. The employees concerned were properly to be treated as being in receipt of cash subject to income tax and NICs under PAYE. Adopting the “neat apothegm” of Ribeiro PJ, in Collector of Stamp Revenues v Arrowtown Assets Ltd (2004) 6ITLR 454 at para 35 (as cited by Lord Nicholls in BMBSF Ltd. v Mawson (2004 UKHL 51), the Tribunal found it “inconceivable” that Part 7, applied purposively, was intended to apply to the realistic view of the transaction.
The decision of the Upper Tier Tribunal in the UBS case was distinguished on the grounds that, here, there was a close identity between the employers and their respective employees; it was the employees’ decision to implement the scheme proposed by accountants; and the only aim was to extract surplus cash from the employer company (there was, for example, no element of ongoing incentive to the employees). The use of shares in an SPV was irrelevant to the employees: it was merely the mechanism advised by the accountants to be a tax-efficient manner of putting surplus cash into the hands of the employees. The only rationale for the SPV was to put cash in, and then strip it out again as soon as possible thereafter. The decision of the Court of Appeal in the PA Holdings case ([2012] STC 582) – which is now final – was distinguished on the basis that the point in that case was whether dividends paid on the SPV shares were remuneration : the taxpayer there accepted that the award of the shares was remuneration (albeit tax exempt). Here, the contention was whether the award of the shares was a money bonus.
The approach of the Tribunal is neatly summarised in the following passage: “In UBS, the Upper Tribunal on the facts in that case, considered it needed to respect the existence of the restricted securities and thus apply Part 7 to them. That cannot be a general approach to be applied regardless of the facts of the individual case before the Tribunal – otherwise any planning device, even the most “unacceptable” and “artificial” that happened to include employee-related (sic) securities would be immune from the Ramsay approach, which is clearly not the case.”
Benedict Manning vs HMRC [2013] UKFTT 252 (TC) : the application of s222 ITEPA 2003
In a first-tier tribunal case which again points up the perils of s222 ITEPA 2003, Sir Stephen Oliver QC applied an interpretation to the stated facts which, whilst saving the taxpayer from what would clearly have been an unfair result had HMRC succeeded in upholding their demand for penal tax under that section, has perhaps strained the law to breaking-point (perhaps reminding the lawyers among us of the approach of Lord Denning…?). It was a condition of exercise of an employee share option that the employee pay to the employer, within 30 days after exercise or within 14 days after the end of the month in which it was exercised, the amount of tax due under PAYE. This amount was to be determined by the employer. The taxpayer paid the exercise monies, but the employer did not notify him of the additional amount of PAYE tax due until more than 90 days after the date of exercise, thereby – according to HMRC – triggering the penal charge under s222. The taxpayer paid over the tax when eventually notified of the amount, but this was more than 90 days after the date of exercise of the option, and long after the 30-day period provided for in the option agreement. However, the Tribunal interpreted the option agreement as meaning that the taxpayer did not acquire a beneficial interest in the option shares until he had paid over (i.e. ‘made good’, as required by s222) the PAYE tax due. According to the Tribunal, his rights under the option contract had by then already lapsed and the company had ceased to be obliged to vest beneficial ownership of the shares in the taxpayer. In effect, the Tribunal said, the option was exercised, and beneficial ownership of the shares acquired, when the taxpayer was notified of the amount of tax due (or, possibly – the judgement is unclear in this respect – when the contract went ‘unconditional’ because the taxpayer paid over the amount of tax due). On this basis, the taxpayer ‘made good’ the PAYE tax due within the 90-day period, which ran from the date on which he was notified of the amount, that being the ‘relevant date’.
Not all of the pertinent facts are recorded by the Tribunal and, whilst its analysis produced what many would regard as a ‘fair and just’ result for the taxpayer, it appears likely that, even on the Tribunal’s own analysis, the taxpayer had already acquired beneficial title to the shares otherwise than pursuant to his rights under the option (as the terms of the option had not all been satisfied and, as the Tribunal asserted, such rights had therefore lapsed). The taxpayer did not deny that he had in fact acquired beneficial ownership of the shares when he had paid his exercise monies and the shares had been issued or transferred to him and, if he had in fact done so, such acquisition would still have been a ‘notional payment’ (per s698, if not s700), with the 90 days running from that earlier time. The fact that the taxpayer’s contractual right to acquire such shares subsequently lapsed, by reason of non-payment of the tax due, would then surely be irrelevant. An alternative enquiry which the Tribunal might have pursued is whether the employer had been able to deduct the PAYE tax due, but simply failed to do so. If so, the requirement of s222(1)(b) would not have been met (see s710(4)), and the charge under that section would not have arisen.
Michael Phair vs HMRC [2013] UKFTT 349 (TC) : deductible amount for options
In Michael Phair vs HMRC [2013] UKFTT 349 (TC) the First-Tier Tax Tribunal held, inter alia, that an employee who elected to give up his prospective and conditional entitlement to cash bonuses in respect of future periods of employment in exchange for the grant of ‘rights to acquire shares’ (under his employer’s ‘Capital Accumulation Program’ or “CAP”) did not thereby give consideration for the acquisition of such rights which could be deducted (pursuant to s480(2) ITEPA 2003) in determining the amount of the gain on exercise of such rights which fell to be charged to income tax under s476.
The Tribunal took the view that, because the employee had no immediately enforceable right to payment of a cash bonus at the time he elected to participate in the CAP, he did not give up any entitlement to cash. As there was no forfeiture of an enforceable right to cash, “his submission, that he gave consideration (in the form of forfeiture) for the acquisition of the option, becomes redundant”. Whilst it is correct that, for a bonus to become chargeable to income tax, an employee must have an immediate entitlement to immediate payment of the cash (per the Upper Tier Tribunal in the UBS case), it does not follow that an entitlement to such a contingent future bonus payment under an employment contract is not capable of being consideration of some (albeit probably small) value. The Tribunal did not, it seems, consider whether that pre-existing prospective and conditional entitlement (albeit not itself an immediately taxable benefit) could, when given up in exchange for participation in the CAP, count as ‘consideration given’ and, if so, what value should be ascribed to such consideration.
Julian Martin vs HMRC [2013] UKFTT 40 (TC) : negative earnings ?
A First-tier Tribunal judgement has thrown the spotlight on the tax treatment of earnings paid in one tax year and which are later ‘clawed back’ pursuant to the operation of a provision in the contract of employment. If HMRC accept the analysis in the judgement, it could pave the way for those employees, whose annual bonuses are awarded subject to the potential operation of a so-called ‘malus’ clause, to obtain relief against general income for income tax paid on an amount ‘clawed back’.
A clawback provision will typically provide that the employee shall be required to forfeit all or part of a bonus which has been paid if conditions relating to the conduct and performance of the company, business or individual concerned are not met. Typically, these relate to circumstances involving not only the discovery that the facts on the basis of which the bonus was quantified and paid were incorrect, but also to a subsequent failure to achieve anticipated levels of minimum performance or conduct.
The mechanisms by which such a recovery of paid bonus can be effected are normally based on the terms of the employment contract or of the arrangement under which the bonus is paid, such as a cash or share-based incentive plan. (An example of such a clawback provision is set out at Clause 11 of the precedent Form of Senior Executive Deferred Share Bonus Plan in Appendix A of Vol 2 of our book “Employee Share Schemes”.) In practice it may, particularly in the case of an employee who has left employment, prove difficult to enforce. One difficulty for the (ex-) employee who is called upon to repay a bonus has been the fact that, at least in the view of HMRC, it has not been possible for the individual to recover from HMRC the income tax and NICs on that part of the bonus which is repaid pursuant to the operation of such a provision.
In the case of Julian Martin vs HMRC, the employee had been paid a bonus in the tax year 2005/06 of £250,000, subject to deduction of income tax and NICs under PAYE, in consideration of his agreement to remain with the employer for a further 5 years. Under the employment contract, as amended, he was liable to repay a proportion of that sum if, inter alia, he gave notice at any time to terminate his employment before the end of that period. In the event he did give early notice and it was agreed that his employment terminated in the following tax year, 2006/07. In consequence, and under the terms of the employment contract, he became liable to repay £162,500, which he duly did. In that year he had earnings of approximately £140,000.
The appellant argued that (a) he was entitled to make an “error or mistake” claim to reduce his taxable earnings in 2005/06; or (b) the arrangement fell to be taxed as a beneficial loan which was partly repaid and partly released; and (c) that he was entitled to ‘employment loss relief’ against general income, in 2006/07, under s128 Income Tax Act . The contentions in (a) and (b) were dismissed : the bonus fell to be taxed as earnings actually received in 2005/06, per s18 ITEPA 2003; and on the facts it simply was not a ‘loan’.
However, the Tribunal determined that s11 ITEPA 2003 expressly recognises the concept of negative taxable earnings (“negative TE”), and here was an example of a situation in which the concept is relevant. In 2006/07 the appellant had earnings of £140,000 and was required as a term of his contract of employment to pay back to his employer £162,500. This resulted in ‘negative TE’ of approximately £22,500 for which the appellant was entitled to relief against general earnings in 2006/07 under s128 Income Tax Act 2007 (HMRC having conceded that, in the circumstances, they would allow such a claim to be made ‘out of time’, there being a 1-year limit on the making of claims under s128). That section is headed “Losses in an employment or office”.
The appellant argued that he suffered a loss in an employment or office by repaying part of the bonus. HMRC argued for a more restricted scope to the section. It was, however, agreed between the parties that a “loss in the employment” as mentioned in s128 does refer back to the concept of negative TE mentioned in s11 ITEPA 2003. So, if in a year the employee has earnings paid of 100 and is required to pay back 110, he will pay no tax on the earnings received and have negative TE of 10 for which relief is available by way of a deduction in calculating net income (and, to the extent that it cannot be fully utilised as mentioned in s129 ITA2007, by way of an allowable capital loss – see s130). If, by contrast, he has earnings of 100 and is required to pay back 20, then he will have net taxable earnings of 80.
The Tribunal commented that, whilst s11 ITEPA was unclear and could only be ascribed a sensible meaning by reference to s128 ITA, it clearly envisaged a situation in which such negative TE would be recognised. As to what exactly would count as such negative TE, the Tribunal held that the phrase must mean a contractual reversal, under the terms of employment, of what had constituted taxable earnings. By contrast, damages sought from an employee on termination of employment would not, for example, rank as negative TE. Likewise, if an employee is awarded shares under a share-bonus arrangement, and the shares fall in value, such loss in value cannot rank as negative TE.
Contrary to HMRC’s contention, there is no requirement that such negative TE has to have arisen in the period of the employment. In the present case it arose after the employment had ended.
HMRC had, until now, asserted that the application of relief under s128 is restricted to circumstances in which an employee, in effect, shares in a loss of the employer, for example, by a cashier being required to make good a shortfall in the till. (The examples given in HMRC’s Employment Income Manual are not correct – they appear to refer to situations in which it is doubtful if the individual is even an employee !). The Tribunal declined to comment on the NICs implications of the decision.
It would now appear that an employee who is required to, and does in fact, pay back an amount of bonus pursuant to such a ‘clawback’ provision in the employment contract, may claim relief under s128 ITA 2007 for the amount by which the amount repaid exceeds the amount of positive taxable income in the relevant year. HMRC’s view that s128 is more restrictive in its application is incorrect. It remains to be seen if HMRC will, in such circumstances, refund the employee’s and employers’ NICs on the amount repaid.
Share-based bonuses
If shares awarded subject to such a ‘clawback’ arrangement have increased, or fallen, in value at the time when some or all such shares are transferred back (typically to an employees’ trust), what is to be taken as the amount or value to be deducted in determining the taxable earnings of that year and, if it be the case, what is the amount of ‘negative TE’ for which loss relief would be available? Notwithstanding the comments of the Tribunal mentioned above, it is unclear what would be the amount concerned. Is it:
a) The value at the time they were first received as earnings of the employee; or
b) The value at the time of transfer back of such number of those shares as are later forfeited or transferred back?
If, as the judgement suggests, it is a ‘reversal of what had constituted earnings’, the correct answer might be (a). In fairness, the Tribunal did not consider the application of the principle to such share-based awards. In any event, care is needed as HMRC might contend that s128 relief is inapplicable where such an award is made under a plan which, by its terms, is expressed to be outside the scope of, and in addition to, the employee’s entitlements under his employment contract.
Scotts Atlantic Management (and others) vs HMRC [2013] UKFTT 299 (TC) : no CT relief for EBT contributions
In a case with complex facts, the First-Tier Tax Tribunal has confirmed that convoluted arrangements entered into in 2003 and 2004, with the deliberate intention of avoiding the (original) statutory restriction in para 1, Schedule 24 FA 2003 (since superseded) on claims made for corporation tax deductions for contributions to an employees’ trust intended to provide benefits to controlling directors, would have succeeded if they had been properly executed, as that legislation was deficient. However, claims for relief from corporation tax for such contributions failed in any event on the basis that, as the artificial steps taken were taken with the purpose of circumventing the restriction in para 1, Sch 24 and achieving a tax deduction in circumstances which were not intended by Parliament, this “duality of purpose” (i.e. the entirety of the expenditure being incurred not only for a trading purpose, as there was accepted to be here, but also for a non-trading purpose of ousting the application of para 1, Sch 24) meant that the whole of the amounts concerned were to be disallowed on general principles. On a separate point, the Tribunal held that the arrangements for structuring the contributions did not give rise to liabilities to account for income tax under PAYE, as the employees in question did not thereafter have the funds “unreservedly at their disposal” (per Warren J in Aberdeen Asset Management plc vs HMRC [2012] STC 650).
Hema Tailor vs HMRC [2013] UKFTT 199 (TC) : SAYE options – no relief on takeover
In Hema Tailor vs HMRC [2013] UKFTT 199 (TC), the First-Tier Tax Tribunal considered whether the early exercise of an SAYE option was pursuant to a “general offer to acquire the whole of the ordinary issued share capital of [a] company,” according to the terms of the option scheme. An employee exercised her options in the context of a management buyout of her company, in which, while non-management shareholders received an offer of cash for their shares, the management entered into complex special arrangements to receive loan notes and shares in the acquiring company.
The Tribunal took the view that, although the offer made to the non-management shareholders was a “general offer” in the sense that it was made to the generality of the shareholders who had not entered into special arrangements, it was not an offer to acquire the whole of the issued share capital: on the facts, the arrangements with management could not be considered part of the same “offer”. The employee did not, therefore, acquire her shares under the SAYE option scheme, so that income tax was due on the option gain under PAYE, rather than the self-assessment regime.
The Finance Act 2013 has now altered the law under which this case was decided, both so that the early exercise of an SAYE option on a takeover of the company no longer attracts a charge of income tax on the option gain, and to clarify that an offer is still a general offer for the purposes of each of the three HMRC approved share schemes and EMI options even if it is made “to different shareholders by different means,” or does not include shares already held by the offeror (or a person connected with them).