NCL Investments - Tribunal allows deductions against trading profits in EBT case
In NCL Investments Limited and another v HMRC [2017] UKFTT 495, the First-tier Tribunal (FTT) has held that accounting debits relating to the grant of share options to employees were a deductible expense for corporation tax purposes.
BackgroundThe Appellants were members of a corporate group of companies whose ultimate parent was Smith & Williamson Holdings Limited (SWHL). The group provided tax and accountancy and wealth management services.
The Appellants employed staff and made those staff available to other group companies in return for a fee. By deed, dated 6 March 2003, the Appellants established an employee benefit trust (the EBT) which gave employees a contractual right to acquire shares in SWHL for a specified price.
Whenever the EBT granted the employees a share option, the Appellants agreed to pay SWHL an amount equal to the fair value of the option.
That obligation was reflected in an inter-company balance owed by the Appellants to SWHL and was settled each month. For the accounting periods ending 30 April 2010-2012, inclusive, the Appellants prepared their accounts under International Financial Reporting Standard (IFRS). The applicable accounting standard was IFRS2.
Under IFRS2, on the grant of an employee share option, the employer company must debit the fair value of the option in its accounts. It is the employer company that must account, even if the shares which are subject to the option are shares in another group company.
On this basis, the Appellants debited their accounts when the share options were granted to the employees by the EBT, in accordance with IFRS2. HMRC refused the corporation tax deduction on the grounds that:
1. the expenses were not incurred "wholly and exclusively" for trading purposes;
2. the expenses were capital rather than revenue in nature; and
3. section 1038, Corporation Tax Act 2009 (CTA) prevented a corporation tax deduction.
The Appellants appealed to the FTT.
FTT's decision
The FTT allowed the appeal.
With regard to the first issue, HMRC argued that the debits had not been "incurred" as they did not represent a real expense and represented consideration for the services of employees. The FTT rejected this argument. In its view, the word incurred has no special meaning in this context and it was clear from sections 46 and 48, CTA, that it is sufficient that the debit was properly chargeable in the accounts.
In relation to the second issue, the FTT rejected HMRC's argument that the debits were merely a contra entry to the capital contribution made by SWHL, and were therefore capital. The debits reflected the consumption of the services provided by the employees in earning profits and were not "one off" items.
The FTT rejected HMRC's third argument that section, 1038, CTA, restricted expenses associated with the grant of an option 'unless and until' the option was exercised. The FTT held that in relation to shares acquired through options, relief under Part 12, CTA, does not become available until the option is exercised and shares acquired.
Comment
This decision will be of interest to employers who have claimed corporation tax deductions in earlier accounting periods in respect of 'underwater' share options that were not exercised where those claims have been challenged by HMRC.
Part 12, CTA , was amended by Finance Act 2013, for accounting periods ending on or after 20 March 2013. HMRC's view appears to be that these changes served only to "clarify and confirm" the correct position, namely, that (i) no corporation tax deduction is available in respect of the employee share options that are not exercised, and (ii) an employer company should not be able to benefit from both a statutory deduction under Part 12, CTA , and a deduction for accounting expenses on a grant of an option. Although the FTT rejected HMRC's arguments, it has appealed the decision to the Upper Tribunal and it will be interesting to see if HMRC fare any better before that tribunal.
A copy of the decision can be found here.