A recent Supreme Court decision clarified the tax treatment of directors and other individuals who have received shares or other securities from their employer.
The outcome may be a surprising one for some shareholders whose shares will be treated as employment-related (and therefore subject to income tax as earnings) if they have received these from their employing company even if, as a matter of fact, their shares were not acquired by reason of an employment.
When can income tax arise on the acquisition of shares?
In the UK, income tax charges can arise where an individual acquires securities, such as shares or share options, in connection with their employment. Importantly, it relates to shares acquired by reason of any past, present or future employment. An acquiring shareholder is not exempt from the charge simply because they no longer work at the employing company or because they are a founder.
The purpose of the legislation is to tax the acquisition of shares or other securities acquired by reason of an employment, preventing the use of securities to incentivise employees and avoid income tax. However, the wide drafting of the legislation means that even where shares are not acquired "by reason of employment", the shares may still be subject to income tax if the shares have been made available by their employer.
This means that employees, directors (including non-executive directors) and/or office holders who acquire shares in their employing company may (in certain circumstances) be subject to income tax on those shares, even if they have not in fact acquired those shares by reason of their employment. This may also create tax-withholding obligations and NIC liabilities for the employer.
HMRC v Vermilion
Historically, in determining whether an acquisition of shares would be treated as employment income and subject to an income tax charge, the focus had been on whether they had been acquired by reason of their employment. Legislation relating to employee related shares changed in 2002 which provided that shares which were made available by an employer would be deemed to be provided by reason of employment.
In HMRC v Vermilion, Mr Noble was granted an option to acquire shares in Vermilion Holdings Limited (Vermilion) in return for providing business consultancy services. As part of a rescue funding exercise in 2007, Mr Noble was subsequently appointed a director of Vermilion and a replacement share option was granted to him. In June 2016, Mr Noble exercised his option, realising a gain of £636,238, and it was disputed whether this gain would be subject to capital gains tax or income tax as employment income.
The Court of Session had found that on a realistic view of the facts, the option had not been made available by reason of Mr Noble's employment but instead as a result of his previous option. However, on appeal, the Supreme Court held that a share option was an employment-related option because it was granted, as a matter of fact, by the employer and so fell within the "deeming" provision. The reason for granting the share option was found to be irrelevant if the share option had been made available by the employer.
The court had to determine whether the following tests were met:
- whether the share option was made available to Mr Noble by reason of his employment (i.e., because he was a director); or
- whether the share option was made available by his employer, or a person connected to his employer.
The court held that where test (ii) was met, there is no defence available under (i) to avoid an income tax charge where the security was not made available by reason of an employment.
As the share option was made available to Mr Noble by Vermilion and Vermilion was Mr Noble's employer, the court held that test (ii) applied and the option subject to income tax. Vermilion’s reason for providing the option under test was held to be irrelevant as test (ii) was met.
How Brodies can help
Many shareholders may be surprised to hear they may be caught by these rules, particularly for non-executive directors or for shareholders in owner-managed or family-run businesses where the shareholders are also employees or directors of the company. Whilst some exemptions do apply, it is important to take advice on the implications of shares being treated as employment related, ideally before significant value accrues to the shares.
If you have any questions in relation to the matters discussed in this article or would like to hear more about the tax implications of awarding shares to employees, please contact a member of the Corporate Tax & Incentives team.
Contributors
Partner
Tax Manager,Trainee Solicitor
