Vermilion Holdings Ltd, the respondent to the appeal, had previously had its position upheld by the Inner House of the Court of Session. HMRC had assessed the company in the tax year 2016-17 in the sum of £285,148.76 under Pay as You Earn regulations and for £100,709.98 in National Insurance contributions.

The appeal was heard by Lord Hodge, Lord Lloyd-Jones, Lord Leggatt, Lord Burrows, and Lady Rose. Julian Ghosh KC, Roddy MacLeod and Laura Ruxandu appeared for the appellants and Philip Simpson KC and David Pett for the respondent.

By reason of employment

The respondent was created as a holding company for a software firm in order to arrange further equity funding from new investors. In 2006, it granted an option to Quest Advantage Ltd, a company owned in part by Mr Marcus Noble, to acquire shares in Vermilion. By the end of 2006, it became clear that Vermilion was underperforming and as part of a rescue package a new option was created in 2007.

In 2016, Quest transferred the 2007 Option to Mr Noble, who had become the executive chairman of Vermilion as a precondition of further investment. Quest asked HMRC to confirm that this transfer was subject to capital gains tax. HMRC disagreed, informing Quest that it was subject to income tax as it had been granted to Mr Noble because of his employment as a director. This decision was challenged in the First-tier Tribunal, which found the 2007 Option was not granted due to Mr Noble’s employment.

HMRC successfully appealed to the Upper Tribunal, however the respondent appealed to the Inner House of the Court of Session, which made a majority ruling in favour of the respondent with the Lord President dissenting. It was held by the majority that on a realistic view of the facts, the reason that Mr Noble received the 2007 Option was that he agreed to give up part of his entitlement under the 2006 Option.

Before the Supreme Court, HMRC maintained that under section 471 of the Income Tax (Earnings and Pensions) Act 2003, the exercise of the option imposed a liability to treat gains made on the exercise of the option as income tax. Because Vermilion employed Mr Noble as a director and provided his nominee, Quest, with the right to acquire an option by granting him the 2007 Option, the right so conferred was to be regarded for the purposes of section 471(1) as available by reason of Mr Noble’s employment.

No absurdity or injustice

Lord Hodge delivered a unanimous decision of the court, said of the Act: “[Section 471(3)] creates a bright line rule: if a person’s employer (or a person connected to that person’s employer) provides the employee the right or opportunity to acquire a securities option, that right or opportunity is conclusively treated as having been made available by reason of the employment of that person (unless subsections (a) and (b) apply). This involves a straightforward examination of the agreement or transaction to ascertain who conferred the right or opportunity. The question is not concerned with the reason why the employer conferred the right or opportunity.”

He continued: “What Parliament has done in enacting section 471(3) is to make clear that if an employer makes available, in this case confers by contract, a securities option, that option is treated as being an employment-related securities option. 25. That is what has occurred in this case. The 2006 option was cancelled, not varied. Vermilion conferred a new option, over a different and new class of shares, on Quest. In so doing Vermilion fell within the deeming provision.”

Addressing the Inner House’s finding that the provision produced an unjust result, he added: “Both the FTT and the majority of the Inner House considered that the application of the deeming provision produced an absurd, anomalous, or unjust result. I disagree. The FTT stated that it was appropriate to limit the effect of the deeming provision because its application yielded a result which contradicted the conclusion which the FTT had reached on the causation question raised by section 471(1). This was an error of law. It put the cart before the horse: the purpose of the deeming provision is to avoid the decision-maker having to carry out the section 471(1) assessment. There is no anomaly here.”

Lord Hodge concluded: “There is to my mind no anomaly, absurdity or injustice in giving effect to the deeming provision of section 471(3) in this case. As I have said, the purpose of section 471(3) is to circumvent the difficult issues that can arise in the application of section 471(1). The statutory provision makes clear that if an employer makes available to an employee a securities option, that option will be treated in the employee’s hands as an employment-related securities option and taxed accordingly.”

The appeal was therefore allowed.