Deeming provisions are common in tax provisions. As their names suggests, they ‘deem’ certain situations to satisfy specific conditions when they might not otherwise meet the strict wording of the legalisation. In the complex world of tax, the resultant ‘fictions’ that derive from the application of the deeming provisions can provide simplicity, but they can also produce unfair results where the ‘fiction’ is too far removed from the truth. This was shown by the long-awaited judgement by the Supreme Court in Vermilion Holdings Ltd v R&C Commers [2023] BTC 26 (Vermilion).
Vermilion concerned the deeming provision in respect of employee share options, which deems when the opportunity to acquire options has been made available by reason of a person’s employment.
Quick Overview
The Supreme Court overturned the ruling of the Court of Appeal. It held that share options and shares obtained through these options, granted to a director were deemed to have been granted ‘by reason of employment’ as a result of the deeming provisions. This is despite credible arguments suggesting that the employment may not have been a direct cause and that instead, it related to a previous matter unrelated to employment.
Background
Mr Noble provided consultancy services through Quest Advantage Ltd (‘Quest’). In early 2006, Quest had been granted a share option (‘the 2006 Option’) in Vermilion Holdings Ltd (‘Vermilion’) in lieu of fees for services provided.
However, in 2006, Vermilion encountered financial difficulties, leading to a rescue package that was contingent upon Mr Noble being a director of Vermilion and an amendment of the original 2006 option. Rather than varying the option, it was agreed the existing option would be cancelled and Quest was granted a new option in July 2007 (‘the 2007 Option’).
Prior to an upcoming sale, in June 2016 the 2007 Option was transferred to Mr Noble and then exercised. While it appeared the 2007 Option was provided as a result of Mr Noble having held the 2006 Option, with the 2006 Option having been provided in lieu of fees for services, the question was whether the 2007 Option was granted ‘by reason of an employment’ of Mr Noble or any other person.
If the 2007 Option was indeed granted ‘by reason of an employment’, then Pay As You Earn (‘PAYE’) and National Insurance Contributions (‘NICs’) would apply to the subsequent gain on exercise of the option.
Legislation
S.471 ITEPA 2003 applies to a securities option acquired by a person where the right or opportunity to acquire the securities option is available by reason of an employment of that person or any other person [s.471(1) ITEPA 2003]. This is a factual test and can be difficult to apply given it raises the question of causation i.e. “by reason of employment”. For example, the earlier decisions in Vermilion were conflicted as to the extent which the employment needs to be the operative cause of the opportunity to acquire the options.
Under s.471(3) ITEPA 2003, a right or opportunity to acquire a securities option made available by a person’s employer, or a person connected with a person’s employer, is to be regarded for the purposes of s.471 ITEPA 2003 as available by reason of employment of that person. This is subject to a carve out where the person by whom the right or opportunity is made available is an individual and it is made in the normal course of the domestic, family or personal relationship of that person [s.471(3) ITEPA 2003]. This operates as the ‘deeming provision’ and the key matter considered by the Supreme Court.
Supreme Court decision
Vermilion argued that the new option was simply a replacement of an option which had been granted at a time when Mr Noble was not a director and had no plans to become one. Therefore, it should not be considered acquired ‘by reason of his employment.’ However, HMRC contended that the original option was irrelevant and put forth the following arguments:
- The new option was granted while Mr Noble was a director.
- The grant was, at least partly, due to his employment.
- Even if employment was not the primary reason, s.471(3) ITEPA 2003 would deem it as such.
The crux of the matter was whether s.471(3) ITEPA 2003 is a distinct and separate route to taxation or if it necessitates consideration and fulfilment of s.471(1) ITEPA 2003 first. On this latter interpretation, the effect of s.471(3) ITEPA 2003 would be restricted to resolving conflicts between alternate causes of the provision of an option. Where employment was a cause, applying s.471(3) ITEPA 2003 in this way would give it priority such that the option would be within the employment related securities taxing provisions. It would not, however, bring an option within the scope of the provisions where s.471(1) ITEPA 2003 would not be satisfied by itself.
The Supreme Court took the view that s.471(1) ITEPA 2003 was not relevant to this case and that s.471(3) ITEPA 2003 was a standalone provision, and that any other interpretation “robs the deeming provision of its substance”. Therefore, where an employer makes available the opportunity to acquire an option, s.471(3) ITEPA 2003 would be satisfied (unless the carve out were to be applied). This then avoids the complexity of having to consider s.471(1) ITEPA 2003 by drawing a ‘brighter line’ as to when the receipt of options is by reason of employment.
Consequently, as the 2007 Option had been granted by Mr Noble’s employer and not in the normal course of the domestic, family, or personal relationship, it was sufficient to deem it ‘by reason of employment.’ This is notwithstanding that the reason why the 2007 Option was offered was because it could reasonably be linked to Mr Noble’s previous 2006 Option, rather than the employment that commenced in 2007.
Thoughts
What Vermilion perhaps illustrates is that deeming provisions can be unfair where the fiction deviates widely from the reality. This was acknowledged by the Supreme Court by quoting Brigs LJ’s summary of the interpretation and application of deeming provisions in Fowler v Revenue & Customs. Briggs LJ set out guidance approved by the Supreme Court which included:
(4) A deeming provision should not be applied so far as to produce unjust, absurd or anomalous results, unless the court is compelled to do so by clear language.
(5) But the court should not shrink from applying the fiction created by the deeming provision to the consequences which would inevitably flow from the fiction being real.
In terms of Mr Noble’s position, those consequences were a PAYE liability of £285,000 and an NIC liability of £101,000. While this may seem unfair or harsh, it did not deter the Supreme Court to use s.471(3) ITEPA 2003 to create a ‘brighter line’ as to when options fell within s.471 ITEPA 2003 and indeed to further to say that any other interpretation robs the deeming provision of its substance.
The Supreme Court’s decision seems to align with how s.471(3) ITEPA 2003 is understood to be applied in most cases: If an individual’s employer (or someone connected to the employer) offers an employee the right or opportunity to acquire securities option, that right or opportunity is conclusively treated as having been made available by reason of that employment unless acquired the normal course of the domestic, family, or personal relationship. In the majority of cases, this is unlikely to yield an unfair or absurd result, and the simplicity and certainty is useful for practitioners. But in the minority of cases, it may result in a tax liability that would otherwise not arise if the fiction were ignored.
There was an interesting part of the judgement which states: “The 2006 option was cancelled, not varied. Vermillion conferred a new option, over a different and new class of shares, on Quest. In doing so Vermillion fell within the deeming provision”. It begs the question that if the 2006 options were simply varied, would that not have fallen with the deeming provisions. I suspect it may have provided Vermillion with a stronger argument, but we will never know.
