Her Majesty's Inspector of Taxes v Jelley

Where an option is exercised, the acquisition of the option and the acquisition of the underlying asset are treated as a single transaction for capital gains tax purposes. The relevant asset for the deemed market-value rule is therefore the underlying asset, not the option. If that acquisition was otherwise than by way of an arm’s-length bargain or was made by reason of employment, the underlying asset is deemed to have been acquired for its market value at the time the option was exercised. The actual option cost and exercise price are then irrelevant to the deemed acquisition cost.

The taxpayer acquired employment-related options over shares while non-resident and exercised them after becoming resident. He disposed of the shares shortly after exercise. The Revenue assessed capital gains tax on the basis that the acquisition cost comprised the exercise price and the market value of the options when granted, treated as nil.

The Special Commissioner allowed the taxpayer’s appeal. Mr Justice Lightman dismissed the Revenue’s appeal: [2002] EWHC 442 (Ch). The Revenue appealed to the Court of Appeal on the construction and interaction of sections 29A(1) and 137(3) of the Capital Gains Tax Act 1979.

1. Appeal dismissed. The order of Mr Justice Lightman was upheld, with costs.
2. Section 137(3) required the acquisition of the option and the transaction entered into on exercise of the option to be treated as a single transaction. On exercise, the option ceased to be the relevant asset for this purpose; the relevant acquisition was that of the underlying shares.
3. The question under section 29A(1) was therefore whether the acquisition of the shares, viewed as a whole transaction, was otherwise than by way of a bargain made at arm’s length or was by reason of employment. The employment-related grant of the options was an incident of the taxpayer’s employment, and the acquisition of the shares was not an arm’s-length bargain.
4. Where section 29A(1) applied, section 27(2) required the shares to be treated as acquired for their market value at the time the option was exercised. The actual cost of the option and the exercise price were irrelevant because the statute substituted the market value as the deemed consideration.
5. Where section 29A(1) did not apply, the ordinary rules operated: the option cost formed part of the acquisition cost of shares acquired under a call option, subject to the relevant provisions of section 137.
6. Abbott v Philbin was distinguishable. It concerned the timing and character of an employment income benefit, whereas sections 137(2) and 137(3) expressly required the option and its exercise to be treated as a single transaction for capital gains tax.
7. Lord Justice Chadwick gave the judgment. Lord Justice Jonathan Parker and Lord Justice Kennedy agreed. Permission to appeal to the House of Lords was refused.

• Court of Appeal (Civil Division) dismissed the Revenue’s appeal with costs.
• High Court, Chancery Division Mr Justice Lightman dismissed the Revenue’s appeal from the Special Commissioner: [2002] EWHC 442 (Ch).
• Special Commissioners allowed the taxpayer’s appeal against the capital gains tax assessments.