John Charman v The Commissioners for HMRC

For the purposes of Chapter 5 of Part 7 of the Income Tax (Earnings and Pensions) Act 2003, a securities option is a right to acquire securities. The right is acquired when granted, even if its exercise is conditional, deferred or dependent on vesting. Immediate exercisability is not required.

The special employment-related securities rules displace general principles concerning contingent benefits. In deciding whether shares were acquired by reason of employment, the tribunal must evaluate what enabled the person to enjoy the benefit. The employment need not be the sole cause or satisfy a but-for test. A share-for-share exchange does not necessarily sever the employment nexus where employee rights changed in form but not substance.

John Charman appealed against the Upper Tribunal’s decision allowing HMRC’s appeal and dismissing his appeal concerning the taxation of share options and restricted shares. The First-tier Tribunal had held that options were acquired when they vested, so that the third tranche was outside the charge because Mr Charman was then non-resident. It also held that restricted shares received through a share-for-share exchange were acquired by reason of employment.

The Upper Tribunal reversed the first conclusion and upheld the second. The Court of Appeal considered whether a securities option was acquired on grant or vesting, and whether the replacement shares were acquired as a director or employee.

The appeal was dismissed unanimously. Lord Justice Arnold gave the judgment. Lord Justices Snowden and Green agreed.

1. Options. Section 420(8) of the Income Tax (Earnings and Pensions) Act 2003 defines a securities option as a right to acquire securities. The wording does not require the right to be immediately exercisable. A contractual right remains a right even where exercise is conditional upon continued employment or future vesting. The third tranche was therefore acquired when the option was granted, not when it vested.
2. Statutory scheme. The special rules in Part 7 displace the general rule concerning contingent financial benefits. Section 473 is principally an introductory signpost. Section 475 removes the charge on acquisition of an employment-related option, while sections 476 to 480 impose the charge on a later chargeable event and calculate the taxable gain. The residence exception in section 474(1) therefore operated by reference to the date of grant. The Upper Tribunal was correct on issue 1.
3. Previous authorities. Abbott v Philbin [1961] AC 352 established, on the law then applicable, that an option was taxable on acquisition because it had a value capable of immediate realisation, not because it was immediately exercisable. That result was subsequently reversed by statute. Authorities concerning approved share option schemes under the earlier legislation did not materially determine the present issue because the point had not arisen for decision under that legislation.
4. Employment nexus. On an appeal confined to questions of law, the appellate court must not re-decide the FTT’s factual findings. The applicable test under section 423(1)(a) is whether the benefit was provided by reason of employment, assessed by asking what enabled the person to enjoy it. The employment need not be the sole cause, and the inquiry is not a but-for test. Tribunals should not force cases into artificial categories such as linear and convergent cases.
5. Restricted shares. The FTT was entitled to find that the share exchange changed the form, but not the substance, of rights originally obtained through employment. The employment-related restrictions on the replacement shares supported that conclusion. A share exchange does not automatically break the employment nexus, although the result depends on all the circumstances. The FTT was also entitled to consider the risk of tax avoidance in rejecting the contrary construction. The charge under section 427 was therefore upheld.

• Court of Appeal (Civil Division) — dismissed Mr Charman’s appeal against the Upper Tribunal’s decision.
• Upper Tribunal (Tax and Chancery Chamber) — in [2020] UKUT 253 (TCC), allowed HMRC’s appeal and dismissed Mr Charman’s appeal.
• First-tier Tribunal (Tax Chamber) — in [2018] UKFTT 765 (TC), held that the first two tranches of options were taxable but that the third tranche was outside the charge, and held that the restricted shares were acquired by reason of employment.