The Supreme Court handed down its judgement in Commissioners for His Majesty's Revenue and Customs (Appellant) v Vermilion Holdings Ltd (Respondent) (Scotland) [2023] UKSC 37 (the "Vermilion Decision") on 25 October 2023.
In its judgement, the Supreme Court confirmed what had been the "orthodox" view of securities options granted to employees. The previous decision at the Court of Sessions had seemed to open the door to a potentially fairer, more nuanced, but considerably less certain interpretation.
This bright line is generally welcome, but could lead to compliance issues and anomalous results in certain cases, particularly in the context of corporate rescues or restructuring.
What is a securities option?
A securities option is a right to acquire securities. In most employee incentive arrangements, this will be a right to acquire shares. The definition of securities is wider than just shares and would also include debentures, bonds, units in a collective investment scheme and depositary receipts (amongst others).
Facts of the case
The relevant facts of the case can be summarised as follows:
- Vermilion Holdings Ltd ("Vermilion") granted Mr Noble (via his nominee company) options to subscribe for shares (at nominal value) in Vermilion in 2006 in return for services provided to Vermilion (when Mr Noble was not employed by, or a director of, Vermilion);
- As part of a corporate rescue funding exercise in 2007, Mr Noble:
- a) agreed to become the "executive chairman" (and director) of Vermilion; and
- b) a few months later surrendered (via his nominee) the 2006 options in return for new diluted share options in Vermilion; and
- The 2007 share options were novated to Mr Noble in 2016 shortly following which the novated share options were exercised, the shares sold and Mr Noble received significant proceeds.
The key question was: were the share options "employment related"? This in turn determined whether the 2016 proceeds were subject to income tax and national insurance (taxed under PAYE), or to capital gains tax at a much lower rate.
Employment related
The legislation states that a securities option, or a security, is employment related if: "the right or opportunity to acquire the securities option is available by reason of an employment of that person or any other person". "Employment" includes reference to prospective or former employment and to directors.
While clear in many cases, this test can lead to difficult factual analysis and areas of uncertainty. In complex scenarios, it can be difficult to isolate to the operative cause for the grant of a securities option.
To largely eliminate having to make subjective judgements, the legislation also includes a "deeming provision". This states that a securities option is deemed to be made available by reason of employment if the right or opportunity to acquire the securities option is "made available by a person's employer, or a person connected with a person's employer". This is subject to narrow exceptions for securities options which are both made available due to family or personal relationships and made available by an individual.
The Supreme Court decided that the deeming provision is to be applied first in any analysis and where it applies, no further analysis is required.
This means that, where securities options are granted by an employer (or connected person) to a person who is, at that time, an employee, these are employment related. The actual reasons for the grant of the securities options are only relevant if this deeming provision does not apply.
Key points to note
The Supreme Court has established that the deeming provision is wide (and inflexible). This is not particularly surprising given the way that the legislation is framed but it it does give rise to potential difficulties.
For example, if securities options, or securities, are granted, or issued, to a large pool of investors by a listed business solely to provide a basis for raising future capital, the issuing companies may have ongoing compliance obligations if any of those investors happened to be employees.
Further, where existing securities options granted to an investor prior to any employment relationship (e.g. an angel investor who subsequently becomes a director) are to be altered after that investor has taken on a non-executive directorship, there is a risk that this could involve (or be treated as involving) the grant of a new employment related securities option.
Therefore, particular care is required when dealing with existing securities options (and securities) in the context of a corporate restructuring, private equity investment or corporate rescue.
The courts have affirmed a strict interpretation of the letter of the deeming rule and have rejected reading in any additional terms. Logically, this should also support an argument that the interpretation should also be narrow as well as strict. This would mean that the deeming rule would not apply where a right or opportunity to acquire securities options is made available to:
- someone who is not an employee, but is related to an employee in some way (such as a family member);
- someone who is not yet an employee, but is likely to become one; and
- someone who was an employee, but has ceased to be one.
Grants of securities and securities options in any of these cases could still be employment related but only where it can be shown that the grants are (subjectively) by reason of employment.
Whether or not securities and securities options are employment related can materially impact their tax treatment.
It was always the case that there are only very narrow circumstances in which an employee or director could take shares in their employer without those shares being employment related securities. In many ways Vermillion simply reinforces that basic position but it should never be forgotten that this does not mean they never can be. It is important to keep this in mind when planning to grant securities options or award securities.
If you are considering awarding securities options, we recommend that you seek appropriate tax (and legal) advice.
