A consultancy company (“Quest”) providing services was granted share options by a client company (“Vermilion”) for work carried out. At a later date it was apparent that Vermilion was struggling and appointed a director of Quest to their board to assist, following which Vermilion went through a restructure and the original options issued to Quest were replaced with options granted to the director.
The parties believed that the exercise of the option would be outside the scope of Pay As You Earn and National Insurance Contributions as the option being exercised was issued to replace an option in place prior to the employment of the director. However, HMRC disagreed relying on the ‘deeming provision’ of the ERS.
Initially HMRC were unsuccessful, however on appeal to the Supreme Court it has now been ruled in their favour confirming a wide application of the ‘deeming provision’.
The case is based on the interpretation of section 471 of the Income Tax (Earnings and Pensions) Act 2003. This section (and related provisions) impose a liability to income tax on the exercise of share options if those options are to be treated as ERS options.
Section 471(1) considers the purpose of an award, considering whether it was “by reason of employment”. However, this case has confirmed that the correct approach is to first consider section 471(3) the ‘deeming provision’ which tells us that a securities option will be deemed to be employment-related if it is acquired as a result of an opportunity made available by a person’s employer (or person connected with an employer) regardless of whether, as a matter of fact, the option was granted by reason of employment with only a narrow ‘friends and family’ exception. If this provision applies no further consideration is necessary and HMRC will not consider specific facts to attempt to disapply the provision.
An award of shares or share options to an employee or officer of the company will be deemed to be within the ERS provisions regardless of whether the purpose or motivation of that award related to the employment. They should therefore be reported appropriately and provisions for related tax and deductions dealt with accordingly.
Companies and employees should factor this into their considerations for potential ERS awards going forwards and any historical awards relying on an alternative implementation of the provisions should be considered for potential mitigation of liabilities.