HM Revenue & Customs ("HMRC") has
won yet another case on the tax treatment of an annual bonus scheme
involving shares, which was used before 2004 since when legislation
has been significantly tightened so as effectively to block further
use of these schemes.
The case was heard with a recent case on a similar scheme operated
by UBS, which HMRC also won.
It will be of interest to those companies still negotiating with
HMRC as to how these arrangements should be taxed, and may also
serve as a useful reminder to those thinking of what would now be
aggressive bonus tax planning.
Background
Although the structure used was extremely complicated, at its
simplest the scheme involved employees receiving shares in a
special purpose vehicle ("SPV") which paid a large
dividend and/or could be redeemed. As a consequence, the schemes
were more favourably taxed than straight employment income, which
is taxed under PAYE and has NIC consequences.
When awarded, the shares were subject to forfeiture provisions
which meant that if the employees left employment within a short
period (just under two months) they would cease to be beneficially
entitled to their shares.
Under the legislation at the time, it was argued that this meant
that no tax charge arose when the shares were awarded because of
the exemption from tax on award where the shares were
"restricted shares" which were "forfeitable".
Other exemptions could also be used to avoid an employment income
tax charge arising when the forfeiture provisions were
lifted.
HMRC argued that the shares were not restricted securities or, if
they were, that the exemptions in the legislation did not apply. In
addition, it argued that the scheme as a whole went against the
intention of Parliament when it adopted the anti-avoidance
legislation and so the restricted securities regime should be
disapplied in this case, as what was in essence happening was just
the straight payment of bonuses.
Were the shares "restricted securities" and did the
exemptions apply?
Here HMRC lost. The Tribunal held that the shares were restricted securities, on the basis that:
- they were subject to genuine forfeiture provisions which would
result in the employees losing beneficial interest in the shares
and receiving less than market value. Although the restrictions
were limited in scope and time, they were not so limited as to be
ignored; and
- the restrictions reduced the market value of the shares, even though by only a small amount (thought to be 2-3%). This is relevant because restrictions must reduce the market value of the shares to be restrictions within the meaning of the legislation.
This part of the ruling is in contrast to the UBS decision where
the Tribunal found that those shares were not restricted securities
because, although technically they were subject to forfeiture, in
practice employees always received at least market value on
forfeiture as part of ancillary arrangements.
The exemptions were also available. An income tax charge did not
arise when the shares were acquired because the forfeiture
restrictions did not last more than five years. Further, an income
tax charge did not arise when the forfeiture restrictions were
lifted because all of the shares ceased to be subject to forfeiture
restrictions at the same time and the majority of the shares were
not held by employees of the SPV.
Did the scheme fail because its sole purpose was tax avoidance?
In very broad terms, there is a tax principle that HMRC can cut
through a structure and apply tax on the basis of what is actually
happening if the structure is artificial. This is known as the
"Ramsay" doctrine. When assessing any "scheme",
a company therefore needs first to check whether it works
technically and secondly consider whether HRMC can cut through the
details and just tax the scheme as if it were a straight payment of
cash bonuses. In this case, the first test was passed - the
Tribunal held that the shares technically fell within the
restricted securities legislation and the exemptions outlined above
– but the second test was failed because the Tribunal
held that the sole purpose of the scheme was tax avoidance and so
the restricted securities legislation should not apply.
Accordingly, PAYE and NICs were due on the underlying bonuses being
received as if they were outright cash payments.
The Tribunal held that the scheme should be viewed as a whole,
rather than separate steps, and that it should look at the reality
of the scheme. Having done so, the Tribunal held that the scheme
was a closely co-ordinated, pre-ordained scheme which had the sole
aim of falling within the exemptions in the restricted securities
legislation so that no income tax or NICs would be payable under
the arrangements which ultimately provided cash sums to employees.
The Tribunal did not consider that Parliament intended that in
these circumstances employees should be able to rely on the double
exemption afforded by the legislation.
This approach had been trailed in the UBS decision where the
Tribunal held that even if the UBS scheme in that case had worked
technically (which it did not), it would have applied the Ramsay
doctrine to see through artificial steps and allow HMRC to tax the
share awards as cash payments in any event.
Comment
In practice, schemes like this and the one used by UBS were
mostly blocked by anti-avoidance legislation announced in 2004.
Another reason why this activity has decreased is that many banks
have now signed up to the Government's Code of Practice on
Taxation for Banks which prevents banks, who were often the biggest
users of these arrangements, engaging in tax avoidance schemes such
as these.
This decision may still have some uses for taxpayers, in that the
case demonstrates that the Tribunal will not in a technical
analysis ignore genuine restrictions even where they are limited in
scope and time and have only a marginal impact on the market value
of the shares. However, the fact is that the technical defences
which advisers have often relied upon have now been shown for a
second time not to be a strong enough defence to the Ramsay
doctrine of tax avoidance.
A copy of the judgment in this case can be found by clicking here.
A copy of our previous Law-Now on the UBS case can be found by
clicking here.
This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq
Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.
The original publication date for this article was 17/02/2011.