The decision of the Upper Tier Tax Tribunal in the cases (heard together in February 2012) of UBS AG and Deutsche Bank Group Services (UK) Limited v Commrs for HMRC (320 (TCC)) have been released.
UBS have won their appeal. Deutsche Bank have lost theirs. The decision is of significance in that it confirms that an arrangement deliberately crafted to fall within the scope of clearly worded statutory exemptions, from clearly worded charging provisions, cannot be defeated by HMRC merely because it does not accord with a presumed intention of Parliament or results in the avoidance of a substantial amount of tax.
Although the Upper Tribunal held that where, as in the case of UBS, the scheme had been properly executed it achieved its aim, the legislation has been amended, with effect from May 2004, so as to block the use of such arrangements.
Both cases concerned complex arrangements established by the banks (and by a number of other large companies) in 2004 with the intention of enabling selected employees to receive, free of income tax and NICs, substantial rewards which would otherwise have been paid as discretionary bonuses. The amounts involved were in excess of £100m. In the UBS case, rather than pay cash bonuses, selected employees were invited to acquire shares, intended to be “restricted securities” falling to be taxed under Chapter 2 of Part 7 ITEPA 2003, in a specially-formed company (ESIP) of substantial value. If the shares acquired were restricted by reason of being subject to a “risk of forfeiture” (per s.423(2)(c)) then, under s.425, no charges to income tax (and accordingly no charges to NICs) would arise on acquisition. It was further intended that any charge which would otherwise have arisen under s.426, when the shares later ceased to be subject to restriction, was exempted by the application of s.429 on the basis that, inter alia, a majority of the shares of that class were not then held for the benefit of (i) employees of ESIP, or (ii) any company associated with ESIP (which UBS would be if ESIP had been under the “control” – per s.416 ICTA 1988 – of UBS) per s.429(4). If both exemptions (first on acquisition of the shares, and on any later “chargeable event”) applied, the amounts realised by participants would be free of income tax and NICs.
The shares in ESIP could then be redeemed for cash chargeable, in the case of UK employees, to CGT.
The First Tier Decision
The First Tier Tribunal held that, in the UBS case, elements of the planning meant that the shares acquired were not “restricted securities” as (on the basis of the Tribunal’s interpretation of s.423(2)(c)) the shares were not subject to a “risk of forfeiture”. Accordingly, the participants fell to be charged to income tax and NICs on the value of the shares when acquired. The FTT did accept that, if the shares had been “restricted securities”, the structure would have fallen within the scope of the exemption in s.429.
In the Deutsche Bank case (heard at around the same time and by the same First Tier Tribunal) the scheme was broadly similar to that established by UBS save that the shares were held to be properly regarded as “forfeitable securities” and that the relevant conditions for relief under s.429 (as it then applied) had been satisfied. However, the FTT went on to state that: “on the ‘actual facts’ found in this decision the Tribunal does not consider that Parliament intended to provide the double exemption from income tax for DB employees … claimed by [DB]. The Tribunal therefore finds that … the scheme is not within Chapter 2 of Part 7.” In the writers’ view, and that of many other commentators, this appeared to involve a leap of reasoning. Nowhere in either decision of the FTT was there a clear explanation of why, or on what basis, the Tribunal could disregard the application of the clear statutory provisions to the actual facts (having found that the steps taken were not “shams”) simply because either the purpose of the scheme as a whole was wholly tax avoidance, or the result would not accord with what the Tribunal considered to be the intention of Parliament in enacting Part 7 of ITEPA.
Decision of the Upper Tier Tribunal
The appeals were held together. In the case of UBS, the UTT examined the legislative history and pointed out that, having regard to the terms of the exemptions in ss. 425 and 429, Parliament must have contemplated that certain types of restricted securities would escape any charge to income tax under Chapter 2 where the exemption in s.425 applied on acquisition, and the charge under s.426 is removed by the exemption in s.429. It was therefore impossible to start from the position that Parliament must have intended any reward of restricted employment related securities always to generate a charge to income tax either at the time of acquisition or on the happening of the chargeable event.
Given the findings of fact, the participants did not become entitled to payment of their bonuses in money before the sums allocated to them within UBS were applied in the acquisition of, and the grant to participants of beneficial interests in, the shares. Rule 2 of s.18 provides that tax is charged on a receipts basis and here there was no receipt of money earnings before the scheme was set in motion.
On a proper interpretation of s.423(2)(c), the question, of whether the shares are subject to a risk of forfeiture, was whether the amount receivable on a forced sale of the shares would be less than the market value of those shares at that time, determined as if there were no forced sale provision. The fact that, in consequence of other elements of the scheme, an employee might not then receive less than the initial value of the shares or what might be received on redemption, was not relevant. As, on a proper application of the relevant provisions in the Articles of Association of ESIP, an employee would, on a forced sale, not recover at least the market value of their shares (disregarding the transfer provision) at that time, it followed that the shares were forfeitable securities and the effect of s.425 was to exclude a charge to income tax on acquisition of those shares. In this respect the FTT’s conclusion was wrong.
Further, given the findings of facts by the FTT, ESIP could not be said to have been under the “control” (per s.416) of UBS. That test of control means control at shareholder level and the shareholder who had such control (the trustee of a charitable trust) did in fact exercise such control independently of UBS, which also held shares in ESIP. Accordingly ESIP was not “associated” with UBS and, as all other requirements of the exemption in s.429 were satisfied, there was no charge to income tax when the restricted period in relation to the shares came to an end. Subject only to the possible application of the “Ramsay” principle of construction, the scheme achieved its intended purpose.
In relation to the application of the Ramsay principle, the UTT commented that the reasoning of the FTT was “very difficult to follow”. If, as was unarguable, the shares were “restricted securities” within the meaning of Chapter 2, how can it then be said that the scheme as a whole falls outside the scope of Chapter 2? The mere existence of a tax avoidance motive was, in itself, irrelevant. “Securities” as defined for the purposes of Part 7, include securities which are convertible into money. Although “money” is excluded from that definition, the facts of the present case fell well outside that exclusion. Although some shares were redeemed at the first opportunity, nearly half of them were not and, given that the assets of ESIP were invested in UBS shares, the amount received on redemption bore no necessary relation to the initial amount paid into the scheme. There was no intellectually coherent way, in this case, of equating the payment in with the ultimate payment out received by the employee. The Tribunal added that “experience has shown that advantage can sometimes be taken of detailed statutory codes of this general nature in a way that is resistant to a Ramsay analysis, with the result that even the most artificial of tax avoidance schemes may succeed in their object (see, for example, Mayes v R&CC)”.
In relation to the Deutsche Bank scheme, the UTT confirmed that the FTT had been entitled to find that the shares concerned were restricted securities within the meaning of Chapter 2. However, in relation to the availability of the exemption in s.429, the key issue (as in the UBS case) was whether, immediately before the chargeable event, DB was an “associated company” of the special purpose company whose shares were the subject of the scheme. This in turn depended upon whether DB in fact exercised control at shareholder level over that company, despite the fact that DB was only a minority shareholder. The questions which the FTT should have asked were (a) whether Investec (the trustee company), holding 66% of the issued shares and having voting control, had agreed to exercise that control in accordance with the wishes of DB, and (b) whether, at shareholder level, DB was in practice always able to rely upon Investec to act unthinkingly in accordance with the wishes of DB. The FTT had found as a fact that Investec had no interest in the scheme apart from the cash fee paid for its involvement, and that it never exercised any independent discretion with regard to the scheme which was pre-ordained in all material respects. It followed that the exemption under s.429 was not available and DB’s appeal was dismissed. But for this “control” issue, the appeal would have succeeded. As with UBS, the Ramsay principle did not apply: there was no legitimate process of construction of Chapter 2 which could lead to the conclusion that the relevant exemptions in Chapter 2 did not apply to the facts.
Given the sums, and principles involved, further appeals are likely.