The First-tier Tribunal recently expressed the view that a payment to surrender an intangible asset, such as a share option, fell within ITEPA 2003 s 401 merely because it arose on the termination of employment. The view seems at odds with HMRC’s guidance and the FTT decision in Reid.
In Essack v HMRC [2014] UKFTT 159, the taxpayer’s employer developed proposals for a share option plan for senior management. The taxpayer seems to have received some sort of commitment that he would be included in the plan, but the plan does not appear to have been activated and no options were formally granted to him. However, on the subsequent termination of his employment, the taxpayer received a termination payment which included substantial compensation for ‘loss of all and any entitlements to shares’.
Let’s hope that another case reaches the tribunal soon confirming at least that such payments are not within s 401
On the facts, the FTT concluded that the taxpayer had no legally enforceable right to shares and that the purpose of the payment was to stop him taking the employer to the employment tribunal or making any claims in relation to the share option plan. As such, it fell to be taxed under ITEPA 2003 s 401 (termination payments). There is no mention of a possible charge under the restrictive undertakings legislation or any explanation why a payment not to make claims in relation to a share option plan is taxable under s 401.
However, the FTT went on to say that, even if the taxpayer had a legally enforceable right to shares, the compensation would still have been taxable under s 401 (ousting any CGT charge).
Does a payment to surrender an intangible asset, such as a share option, fall within s 401 merely because it arises on termination of employment? It is not easy to find any authority directly refuting this proposition, but there are two pieces of evidence which undermine it.
Firstly, HMRC itself confirms in its Employment Income Manual at EIM13910 that, where on termination an employee is required to sell back his shares in the employer, the sale price is not within s 401. The price is for the sale of an asset, not for the loss of employment. There is no rational distinction between a share sale and the surrender of a share option because, like shares, a share option is an asset in its own right (including for CGT purposes) (see Abbott v Philbin [1961] AC 352).
Secondly, in Reid v HMRC [2012] UKFTT 182, an employee paid £30,000 to acquire an EMI option giving him the right to acquire 30,000 shares in his employer company at a zero exercise price. If his employment was terminated before exercise, the position appears to have been that he would surrender the option for a payment (effectively, a refund) of £30,000. When his employment was subsequently terminated, he was paid £77,731, without any mention of this amount including his refund. On the facts, he failed to prove that the £77,731 included the refund of £30,000. However, the tribunal proceeded on the basis (apparently accepted by HMRC) that, if the termination payment had included the refund, the refund would not have been taxable under s 401. This must be right. How could the employee be taxed under s 401 on the release for £30,000 of a contractual right which it had cost him £30,000 to acquire?
Even if payments to surrender options on termination are not within s 401, they are not necessarily liable to CGT. There could still be a prior charge under ITEPA 2003 Part 7 (employment-related securities and securities options). Nevertheless, let’s hope that another case reaches the tribunal soon confirming at least that such payments are not within s 401.
