HMRC have succeeded in the Supreme Court in these cases on the grounds of the Ramsay principle.
The two cases were heard together as they relate to similar arrangements. These were arrangements designed to pay bonuses without triggering income tax and NIC further to application of the restricted securities legislation in Chapter 2 of Part 7 ITEPA 2003. The actual planning has been blocked by legislative changes to s429 ITEPA. Further, we now have the statutory GAAR that could potentially apply. The outcome of these cases is relevant, though, both to other historical cases with similar fact patterns and in the context of the courts’ approach to tax avoidance more generally.
The First-tier Tribunal (FTT) found for HMRC in both cases. At the Upper Tribunal stage UBS succeeded and DB failed due to detail around implementation and in particular the meaning of “control”. The Court of Appeal held that both schemes succeeded and was unimpressed by HMRC’s argument that, despite meeting the definition, the shares were not restricted securities because there was no commercial rationale for the restrictions.
The Supreme Court decision
In the Supreme Court Lord Reed handed down the (unanimous) judgment, holding that both schemes ultimately failed. He found that a key purpose of the Part 7 legislation was to counteract opportunities for tax avoidance, which,“self-evidently makes it difficult to attribute to Parliament an intention that it should apply to schemes which were carefully crafted to fall within its scope, purely for the purposes of tax avoidance”. Applying this to the facts he found that the restrictions on the shares in both cases were artificial mechanisms with no business or commercial purpose and should therefore be disregarded in determining whether the shares were restricted securities. The restrictive condition in the DB case was a short forfeiture provision on cessation of employment other than as a good leaver. Whilst Lord Reed acknowledged that leaver provisions in employee benefit arrangements often serve a genuine business or commercial purpose, he found this particular provision artificial and inserted solely to create a minor risk and make the securities restricted. And in the UBS case he said that “the [forfeiture] condition – whether the FTSE100 rose by a specified amount during a three week period – was completely arbitrary”.
Accordingly, he agreed with the FTT that the shares were not actually “restricted securities”. Lord Reed concludes that: “the error of the Court of Appeal in these cases lies, in my opinion, in adopting a literal construction of Chapter 2, and applying it to a correspondingly formal analysis of the facts.” In particular, the word “provision” in s423(1) ITEPA is to be construed as being limited to provision having “a business or commercial purpose”, and not to commercially irrelevant conditions “whose only purpose was the obtaining of the exemption”.
However, he states that the FTT was wrong to regard the schemes as “a mechanism for the payment of cash bonuses” and tax as if the employees had received a cash bonus. The correct end result was to tax the employees based on the value of the shares (taking account of the restrictions) at the date they acquired them.
The judgment underlines recent decisions whereby the courts have increasingly taken the view that there needs to be a clear underlying business or commercial purpose in order for a taxpayer to benefit from an anticipated tax exemption in relation to a particular structure or transaction. Non-commercial terms which are implemented purely for the sake of bringing a party within the literal terms of an advantageous tax exemption are likely to be ignored in deciding whether or not that exemption should apply.
The judgment also makes it clear that this approach should apply even where the relevant legislation does not have any expressly stated purpose or (as here) contains targeted anti-avoidance provisions that, on a literal construction, do not appear to apply to the structure or transaction being considered.
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