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Fact or Fiction? - Director’s share options are deemed to be Employment-Related Securities per the Supreme Court decision in HMRC v Vermilion Holdings Limited

Posted on 25 October 2023

Taxpayers expecting their tax obligations to be assessed solely based on their specific facts and circumstances are often puzzled by the notion of deeming provisions. These are legislative provisions that treat a situation as existing when it does not, in fact, exist. An example of such a ‘legal fiction’ can be found in the employment-related securities ("ERS") legislation to require a share award, or share option award, to be ‘treated as’ being made by reason of employment even if the true motive for the incentive provision was different.

The Supreme Court's decision, a landmark ruling, on 25 October 2023, finding in favour of HMRC in the appeal hearing of HMRC v Vermilion, was widely anticipated. It is probably fair to say that there had been some surprise, amongst professional advisers, at the ruling in favour of the taxpayer in the earlier Court of Session hearing. That prior precedent was widely viewed with caution and the more recent judgment clarifies understanding in relation to the application of the deeming rules in the ERS tax legislation.

This case has relevance for any company or executive pondering if there is means to argue that an award of shares or share options does not fall to be taxed as income earnings from employment.


Mr Noble, via Quest Advantage Limited ("Quest"), advised technology businesses (including Vermilion) on fundraising, business growth, acquisitions and divestments.

In 2006, Vermilion Holdings Limited ("Vermilion") granted share options ("the 2006 option") over 2.5% of its Ordinary share capital in lieu of payment for the advisory services received from Quest.

Following a period of financial difficulty for Vermilion, as part of a rescue package for the business, Mr Noble became, in 2007, a director and the 2006 share option was cancelled. An option over 1.5% of the equity was then granted under a new agreement which named Mr Noble as the option holder ("the 2007 option").

Vermilion submitted a non-statutory clearance request in 2016 to confirm that the 2007 option would be subject to Capital Gains Tax. HMRC subsequently assessed for Income Tax and Class 1 National Insurance on the basis that the shares acquired upon exercise of the 2007 option were ERS. Vermilion appealed.

Subject to a limited 'friends and family' exemption, section 471 ITEPA 2003 broadly states that where an option to acquire securities is made available by a person’s employer it is deemed to have been made available by reason of their employment.

Share options granted to an employee or director by reason of their employment are ERS and can be subject to a number of Income Tax charges.

The taxpayer was successful in earlier hearings and in the Inner House of the Court of Session judgment it was held that the replacement share option issued to Mr Noble in 2007 when he was a director of Vermilion was not made available by reason of his employment but was a restructuring of the share option that had originally been given to a consultant company in lieu of fees for advisory services. 

The case was appealed to the Supreme Court and we now have its judgment, finding in favour of HMRC.

The law and the outcome

The Vermilion appeal concerned the interpretation of section 471 of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA”). This section, with its related sections, imposes a liability to income tax as employment income in relation to gains made on the exercise of a share option if it is treated as an ERS option. (A national insurance ("NIC") liability will also arise where the shares are readily convertible assets.)

A starting point for identifying an ERS option has often been first to consider the cause of an award, having regard to the meaning of “by reason of an employment” in section 471(1) of ITEPA. It is not, however, sufficient to only look to cause and the finding as regards correct treatment may turn, as here, on the application of the deeming provision in section 471(3).

What the Supreme Court's judgment tells us is that we need to look first at the bright line rule in subsection (3): 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 the specific exemptions apply, namely that the right is made available by an individual (and not a company) and made in the normal course of their domestic, family or personal relationships (e.g. the passing of shares between a father and daughter).

We are therefore instructed to now look at the who and the what, but not the why. We're told not to put the cart before the horse: the purpose of the deeming provision is to avoid the need for any decision-maker having to carry out the section 471(1) causation 'by reason of' assessment. It is not open to the taxpayer to defend a demand for tax from HMRC by carrying out the subsection (1) exercise in order to disapply the subsection (3) deeming provision.

The fact that Mr Noble was a director of Vermilion when the 2007 option was granted was sufficient to bring that later option within the ERS charge remit. It was irrelevant that the 2007 option was intended to simply be a restructuring of a prior 2006 option in connection with a rescue refinancing of the business.   

Our comment on what this means for companies and executives

Where an employer makes an award of shares or share options to an officer (whether executive or non-executive) or employee this will be deemed to be within the ERS regime (the motive, purpose or intention behind the award is irrelevant). This has implications for annual compliance reporting in respect of ERS returns that need to be filed with HMRC annually by 6 July and also in relation to the potential operation of employer payroll withholding to collect PAYE and NIC when the options are exercised. Where the shares acquired are restricted securities it will also mean considering the timely (within 14 days) joint election between employer and employee under section 431(1) ITEPA to mitigate risk of further downstream income tax charges under the post-acquisition ERS charging rules.  

The Vermilion Supreme Court ruling means there is no 'reason' that will rebut this charge so anyone who has been placing reliance on the earlier precedents should now take advice on the remedial tax compliance action that may be required.

Is the causation test in s 471(1) then redundant? No, it is not. Key to note is the wording of section 471(2) which states that for the purposes of subsection (1) "employment" includes a former or prospective employment. This definition is not extended to apply to subsection (3) i.e. the bright line test in the deeming rule in subsection 3 only applies where there is an active employment and employer relationship at the time of the award.

Indeed Lord Hodge, delivering his judgment states: "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. Vermilion, which at the relevant time was Mr Noble’s employer, made available to his nominee such an option. Vermilion’s reason for so doing is irrelevant when section 471(3) applies."

The causation test of s 471(1) therefore seems to remain the correct assessment when dealing with a share or share option award made prior to or post an employment relationship.

The knotty question of how proximate a prospective employment or past employment needs to be and how closely linked that is to the reason for provision of such a securities award was not a matter that required examination by the Supreme Court in Vermilion. It will, however, remain a point of challenge and difficulty for many other taxpayers, particularly in the context of transaction due diligence. There remains an enduring need to therefore carefully consider employment nexus in such circumstances but what is clear today is that the deeming rules are considered separately and distinctly when determining an income tax event trigger.

For further information, contact Liz Hunter, Incentives Partner. 

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