Time of acquisition of employment related securities

The Court of Appeal has held that a securities option is acquired by an employee for the purposes of the employment related securities rules when it is granted rather than when the option vests: Charman v HMRC [2021] EWCA 1804. As such, the taxpayer was subject to UK tax on the securities option despite the fact that it did not vest until after he became non-UK resident.

In addition, the Court held that a corporate reconstruction which resulted in a share for share exchange and the replacement of his original restricted shares with restricted shares in a new holding company did not mean the new shares were no longer acquired by reason of employment for these purposes.

Background

The taxpayer, Mr Charman, became an employee in an insurance company, Axis Speciality, in late 2001 when he was UK resident. At the time, he also entered into a Share Purchase Option Agreement (SPOA), under which Mr Charman was granted options to purchase Axis Specialty shares. The options were stated to vest in three equal tranches on the first, second and third anniversaries of October 2001. In addition, the options were conditional on Mr Charman continuing to be an employee at the relevant time. The SPOA recited that the options were an inducement to Mr Charman to enter into the employment contract. Mr Charman also acquired restricted shares in Axis Speciality in 2002.

In 2003, Axis Specialty became a wholly-owned subsidiary of a new holding company, Axis Capital Holdings Limited. To achieve this, Mr Charman and the other shareholders in Axis Specialty exchanged their Axis Specialty shares for shares in Axis Capital. Following the exchange, the options under the SPOA were superseded by options over Axis Capital shares.

The FTT found that Mr Charman was resident in the UK until November 2003, when he ceased to be UK resident. The restrictions on Mr Charman's Axis Capital Restricted Shares were lifted on 19 September 2005, at which point they were worth about $11.5m. In March 2008 Mr Charman exercised some of his share options and sold the shares, making a profit of around $33m.

A dispute arose as to whether Mr Charman was taxable in the UK on the third tranche of options. These did not vest until October 2004 when he was no longer UK resident and he argued that he was, therefore, outside the scope of UK tax on those options. HMRC contended that the options were acquired in 2001 (not when the vested in 2004) when Mr Charman was UK tax resident and so he was subject to UK tax on them. Mr Charman also argued that the options were not acquired by reason of his employment.

The FTT held that the securities options were acquired by Mr Charman by reason of his employment, but also found in his favour that the relevant acquisition date for the third tranche was 2004 after he was no longer UK tax resident. The Upper Tribunal overturned that decision and Mr Charman appealed.

When did Mr Charman acquire "a right to acquire shares"?

Mr Charman contended that the restricted securities rules in Chapter 5 of Part 7 of ITEPA 2003 did not apply by virtue of section 474(1) because, "at the time of the acquisition" of the "securities option" (ie of the "right to acquire securities"), he was resident outside the UK. The first issue therefore was whether Mr Charman the third tranche of options were acquired when they were granted in October 2001 or when the options vested in October 2004.

HMRC argued that section 420(8) defines a "securities option" as "a right to acquire securities". HMRC contended that the straightforward meaning of this was that a right to acquire securities is no less a right if the ability to exercise that right either does not vest for a period of time or is contingent upon some future event. The legislation does not say that the right must be immediately exercisable, and there is no reason for reading those words in. All that is required is that the employee has a contractual or other legal right, upon whatever terms, to acquire securities.

Mr Charman's argued that there was a "general principle" that a "right to acquire shares" must be a right that is immediately exercisable. The taxpayer, in particular, relied on earlier case law, including in particular the judgment of Lord Hodge in RFC 2012 plc v Advocate General for Scotland [2017] UKSC 45. In that case, Lord Hodge suggested that where “on a proper analysis of the facts there is only a contingent right, the taxable earnings or emoluments are not paid by the employer as remuneration until the occurrence of the contingency”.

The Court of Appeal has rejected that argument. In particular, the Court held that the employment related securities rules overrode any such general principle. Having regard to the rules in Part 7, the Court held that it was clear that the purpose of section 475(1) was to ensure that no tax is levied when an employee acquires a share option. Instead, tax is levied when there is a chargeable event, following the "wait and see" approach. It does not follow that the employee has not acquired a right to acquire shares within the meaning of the legislation if the right is not immediately exercisable.

Were shares acquired by reason of employment?

Although Mr Charman accepted that his original shares (Axis Speciality shares) were acquired by reason of employment, he contended that the shares he later acquired in Axis Capital were acquired by reason of his shareholding in Axis Speciality and not by reason of his employment. As such, he contended that no tax charge arose when restrictions were lifted on those shares.

On this point, the FTT had recognised that there was more than one operative cause of the taxable income. It found that the ultimate cause was Mr Charman's employment with Axis Specialty. It considered that the effect of the share for share exchange was that Mr Charman's rights as an employee had changed in form but not substance. It found support for its view in the amendments to the contractual documents which transferred the obligation to issue shares from Axis Specialty to Axis Capital and provided that the restrictions applied to the shares in Axis Capital.

The Court of Appeal noted that the correct test had been set out by Oliver LJ in Wicks v Firth [1982] 1 Ch 355 at 371: “One is directed to see whether the benefit is provided by reason of the employment and in the context of these provisions that, in my judgment, involves no more than asking the question 'what is it that enables the person concerned to enjoy the benefit?' without the necessity for too sophisticated an analysis of the operative reasons why that person may have been prompted to apply for the benefit or to avail himself of it."

Although the Court of Appeal accepted that the FTT may not have directed itself to the test set out by Oliver LJ, nevertheless the FTT did not apply a "but for" test and nor did it err in law in any other way. Its reasoning was entirely consistent with the application of Oliver LJ's test. As such, there was no reason to overturn the FTT’s decision on this point.

Comment

Interestingly, the Court of Appeal did not rule out entirely the prospect of a share for share exchange changing the reason for the acquisition of the relevant securities. The Court stated that “the FTT [had not] made the mistake of saying that a share exchange could never lead to a situation where the resultant shares were not enjoyed by reason of employment. The position might perhaps be different if, for example, the share exchange came about as a result of a contested take-over of the employer some years after the employee received shares in the employer. Even then, it would be necessary for the tribunal carefully to consider all the relevant circumstances.”

However, the current version of ITEPA 2003 now contains specific provision in s.421D designed to ensure that once a security is an employment related security it will remain one, even where it is exchanged or converted into a different security.