UBS AG v Commissioners for Her Majesty’s Revenue and Customs

A tax statute must be construed purposively. The actual transaction must then be viewed realistically to decide whether it answers the statutory description. Composite steps may be considered together when that is the factual focus required by the provision.

Under section 423(1) of the Income Tax (Earnings and Pensions) Act 2003, provision capable of making employment-related securities restricted must have a genuine business or commercial purpose. A commercially irrelevant condition inserted solely to obtain the section 425(2) exemption is disregarded for that classification. This does not make the condition irrelevant for every fiscal purpose. Where employees actually receive shares, ordinary income tax principles charge their true value at acquisition, taking account of conditions and associated hedging which affect that value.

These conjoined appeals concerned schemes under which two banks used money allocated for discretionary bonuses to acquire redeemable shares in special-purpose offshore companies. The shares were awarded to employees subject to short-lived conditions intended to qualify them as restricted securities under Chapter 2 of Part 7 of the Income Tax (Earnings and Pensions) Act 2003. The schemes were designed solely to obtain exemptions from income tax under sections 425(2) and 429.

The First-tier Tribunal dismissed both banks’ appeals against tax determinations. The Upper Tribunal allowed the appeal concerning UBS AG v Commissioners for Her Majesty’s Revenue and Customs, but held that the other scheme failed under section 429 because the bank controlled the vehicle company. The Court of Appeal, in [2014] EWCA Civ 452, rejected the Revenue’s purposive-construction arguments in both cases.

The central questions were whether tax-motivated conditions without a business or commercial purpose could make the shares restricted securities under section 423, and whether the employees should consequently be taxed on shares or treated as having received cash bonuses.

1. Disposition. Lord Reed delivered the unanimous judgment, with which Lord Neuberger, Lord Mance, Lord Carnwath and Lord Hodge agreed. The Revenue’s appeals were allowed. The assessments were subject to any adjustments required to reflect the value of the shares when acquired.

2. The modern approach to fiscal legislation is the ordinary purposive approach to statutory interpretation. The court must identify the transaction to which the provision was intended to apply and then decide whether the actual transaction, viewed realistically, answers that description. Depending on the provision, this may require consideration of the overall effect of commercially linked steps. The approach does not depend on whether genuine legal arrangements constitute a sham.

3. Chapter 2 of Part 7 of the Income Tax (Earnings and Pensions) Act 2003 addressed practical valuation problems arising where employment-related shares were restricted for genuine business reasons. It also formed part of legislation intended to counter tax avoidance. Section 423(1) therefore refers to provision having a business or commercial purpose. It does not include a commercially irrelevant condition whose sole purpose is obtaining the exemption in section 425(2). The specific anti-avoidance rules in Chapter 3A did not require a different construction because they addressed artificial reductions in market value, not the meaning of restricted securities.

4. The conditions in both schemes were artificial and existed solely to bring the shares within section 423(2). In the UBS scheme, an arbitrary stock-market contingency was economically neutralised by hedging, apart from an insignificant predetermined amount. In the other scheme, the short-lived forfeiture condition created only a minor risk largely within each employee’s control. Applying Inland Revenue Comrs v Scottish Provident Institution, the schemes had to be considered as intended to operate, without treating such commercially irrelevant contingencies as effective restrictions. The shares were therefore not restricted securities.

5. The broader contention that the shares should be disregarded and the employees treated as receiving cash was rejected. They received genuine shares whose redemption values depended on the vehicle companies’ investments. Redeemability did not make the shares money. Ordinary principles nevertheless charged income tax on their value when acquired. For that valuation, the conditions could not be ignored: their effect on value, together with the value-enhancing effect of the associated hedging, had to be taken into account. The same outcome applied to national insurance contributions by agreement.

1. United Kingdom Supreme Court: allowed the Revenue’s appeals unanimously. It reversed the Court of Appeal’s conclusion that the tax-only conditions brought the shares within Chapter 2, while rejecting the Revenue’s argument that the employees should be treated as receiving cash.
2. Court of Appeal: in [2014] EWCA Civ 452, rejected both the broad and narrow purposive-construction arguments. It also reversed the Upper Tribunal’s conclusion that the vehicle in the DB scheme was controlled by the employer.
3. Upper Tribunal: allowed the UBS appeal because the employees received genuine shares rather than cash. In the DB case, it rejected the broad purposive argument but held that the section 429 exemption was unavailable because the vehicle company was controlled by the employer.
4. First-tier Tribunal: dismissed both banks’ appeals. It regarded each scheme, viewed realistically, as falling outside Chapter 2 and treated the employees as having received cash bonuses.