HMRC have eventually won in the Supreme Court the UBS/Deutsche Bank cases relating to the tax avoidance schemes used in 2003 to structure bankers’ bonuses by way of the acquisition of (supposedly) forfeitable shares in special-purpose companies (“SPVs”).
The judgement (of Lord Reed) is significant in that he upholds the principle that, notwithstanding the clear literal wording of a taxing statute, it must be construed and applied purposively in the context of real-world transactions having a business or commercial purpose. So, here, whilst the banks asserted that the terms of the scheme complied with the literal wording of the Income Tax (Earnings & Pensions) Act 2003 (“the Act”), there was “nothing in the background to suggest that Parliament intended that the particular provision in point (s423, as then drafted) should apply to transactions having no connection to the real world of business, where a restrictive condition [on the shares acquired by employees] was deliberately contrived with no…purpose other than to take advantage of the exemption.”
On this basis, the shares acquired by employees were not to be regarded as “restricted” and therefore the exemption from tax on their acquisition did not apply. However, the judgement goes on to say that the conditions in question must nevertheless still be taken into account for the purposes of assessing their taxable value, “since ordinary taxation principles require the tax to be based on [their] true value”.
In the cases of both UBS and Deutsche Bank, it was held that the employees were to be taxed on the value of the shares (in the SPV) they acquired as at the time of such acquisition. The Court rejected a broader argument that the employees should be treated as having received, and been taxed on, amounts of cash (as originally so determined by the First-Tier Tribunal) : it accepted that what they received were shares, albeit not “restricted” shares. The Court of Appeal had erred in adopting a literal, not a purposive, construction of Chapter 2, Part 7 of the Act
We cannot now, it seems, take a taxing statute at its word, but must interpret and apply it having regard to the intention which should be attributed to Parliament ! Here the shares were created and issued solely for the tax avoidance scheme and the SPV undertook no activity beyond its participation in the scheme. “The encouragement of such schemes, unlike the encouragement of employee share ownership generally, or share incentive schemes in particular, would have no rational purposes….bearing in mind the general aim of income tax statutes.”
What then is the position where Parliament clearly intended to afford an exemption from tax (e.g. ‘employee shareholder shares’ or ‘share incentive plans’) but, to secure such relief, an employer company – desiring for good commercial purposes to benefit its employees by the acquisition of shares – inserts a step which, whilst it accords with the literal words of the legislation, has no business purpose other than securing the relief clearly intended by Parliament – as opposed to one which was not so intended ?
The consequences for HM Treasury will be significant as many other banks established similar tax avoidance structures at that time (the clear wording of the legislation having been amended in 2004 to prevent such abuse). HMRC will no doubt ‘breathe a sigh of relief’ as this allows them to challenge many other tax avoidance schemes based on the use of ‘restricted securities’ in SPVs with restrictions having no commercial purpose other than to avoid tax.
Pett, Franklin & Co. LLP are experts in employee share schemes, share plans and executive incentives. To find out how we can help you, call David Pett on 0121 348 7878 or email David at david.pett@pettfranklin.com.