A Supreme Court decision has highlighted the issue of how shares and other securities are taxed. The HMRC v Vermilion Holdings Ltd appeal centred on whether share options should be treated as employment-related securities (ERS) and therefore charged income tax rather than capital gains tax.
Although the court made its judgment a few months ago, I wanted to talk about it here because of what it clarifies for anyone involved with family-owned companies and other types of company.
Background to the HMRC v Vermilion tax appeal
In 2006, Vermilion granted an option to Quest Advantage Ltd to acquire shares in Vermilion.
By the end of 2006, it became clear Vermilion was underperforming. Vermilion and Quest agreed to amend the 2006 option, as part of a rescue funding package.
In July 2007, Vermilion and Quest entered into a new option agreement, under which Quest subscribed for a new class of shares in Vermilion, and the 2006 option expired.
In 2016, Quest transferred the 2007 option to Marcus Noble.
Mr Noble and Vermilion asked HMRC to confirm the gain of more than £600,000 on the exercise of the 2007 option by Mr Noble was liable to capital gains tax (CGT).
But HMRC disagreed, stating the 2007 option was an employment-related securities option. It said it was subject to income tax as it had been granted to Mr Noble because of his employment as a director.
HMRC said Vermilion was liable for income tax of around £285,000 and National Insurance of around £100,700 for the tax year 2016-17.
Passage of the employment-related securities case through the courts
Quest challenged HMRC’s decision in the First-tier Tax Tribunal (FTT), which found the 2007 option wasn’t granted by reason of Mr Noble’s employment.
HRMC appealed that ruling to the Upper Tribunal, which overturned the FTT’s decision.
This was subsequently appealed to the Inner House of the Court of Session, which, by majority, found in favour of Vermilion.
HMRC then appealed that decision to the UK Supreme Court.
The Supreme Court decision
The Supreme Court unanimously backed HMRC by allowing its appeal.
It ruled that – under section 471 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA) – Mr Noble was deemed to have acquired the securities option because of his employment by Vermilion. The option was therefore subject to income tax.
And the court added that the application of section 471 hadn’t produced an “absurd, anomalous, or unjust result”.
Our thoughts on the tax treatment of company shares
Taxpayers aren’t always aware of the tax implications of making changes to the ownership of their company shares.
There are reliefs available to enable trading family businesses to transfer shares to other family members to help with succession planning. But you shouldn’t assume that simply because shares are given to family members that they are tax free.
There are several things to consider when you’re thinking about transferring shares, such as the CGT position when gifting shares or altering a company’s shareholding structure.
It’s important to consider whether those shares will be deemed as employment-related securities for the purposes of PAYE and National Insurance.
As a rule of thumb, it’s possible to prevent the ERS rules from applying because there is an exemption if:
- The person by whom the right or opportunity is made available is an individual, and
- The right or opportunity is made available in the normal course of the domestic, family or personal relationships of that person.
However, there may be situations where it’s unclear whether that removal of the deeming provision applies.
So, you should always get advice before you issue or gift shares in any type of company, whether family owned or not.
Advice on the taxation of shares and other securities
For advice about the taxation of employment-related securities, such as share options and share awards, contact us today on 01902 585 311 or email stephanie.churchill@churchilltaxation.co.uk
We can also help with HMRC tax enquiries and investigations – and we offer a tax expert witness service.
