Publish Date
Feb 07, 2024
A&M Tax Advisor Update
In this update, we provide key takeaways from the Supreme Court’s decision in HMRC v Vermilion Holdings Ltd [2023] UKSC 37 for asset managers and outline how A&M can help. The Vermilion case emphasises the importance of considering the deeming provisions in the UK employment-related securities (“ERS”) rules and is highly relevant for those who seek to argue that securities awarded do not fall within the ERS rules. For asset managers, a typical scenario is the participation in carried interest and co-invest arrangements of a fund by individuals who are partners in the asset management business rather than employees, but who may also be directors of one or more entities in the fund structure or of companies invested in by the fund.
The ERS rules are very broad and cover a wide range of securities acquired by reason of employment, or are deemed to be so acquired because the opportunity to acquire them is made available to employees by an employer or a person connected with an employer (note that there is a limited ‘friends and family’ exemption). Securities can include limited partnership interests, carried interest awards, co-investment awards, shares, share options and other interests. If applicable, the ERS rules can result in employment tax liabilities (i.e. Pay-As-You-Earn (“PAYE”) income tax and National Insurance Contributions (“NICs”)) on acquisition as well as on disposal of securities or other receipts of income from them. Employment related securities also give rise to annual employer reporting requirements.
Although the Vermilion case focuses on whether share options granted to directors should be treated as ERS under section 471 of the Income Tax (Earnings and Pensions) Act 2003 (“ITEPA 2003”), this case has relevance to other securities granted to UK employees/directors as similar provisions apply for other securities (namely, s. 421B ITEPA 2003).
In 2006, Mr Noble via Quest Advantage Limited (“Quest”) was granted share options by Vermilion Holdings Ltd (“Vermilion”) in lieu of payment for the advisory services received from Quest. Due to Vermilion’s subsequent financial difficulties and as part of recovery efforts, Mr Noble became a director of Vermilion in 2007 and the 2006 share options were cancelled. In 2007, share options were granted under a new agreement.
Vermilion was previously successful in the earlier hearing in arguing that the 2007 options were not made available because of Mr Noble’s directorship and so were not ERS, but rather, the options were an outcome of restructuring the 2006 options which were originally awarded to Quest in lieu of payment for the advisory services received. HMRC appealed this and the Supreme Court found in favour of HMRC.
The Supreme Court decision focuses on the deeming provision set out in section 471(3) of ITEPA 2003, which broadly states that if an employer provides an employee with a security, it should be treated as having been made available by reason of employment, such that the security will be within the scope of the ERS rules. The fact that Mr Noble was a director of Vermilion when the 2007 options were granted was enough for the deeming provision to apply. It was irrelevant that the 2007 options were an outcome of restructuring the 2006 options which were originally awarded to Quest in lieu of payment for the advisory services received.
Lord Hodge in the case states: “The statutory provision makes clear that if an employer makes available to an employee a securities option, that option will be treated in the employee’s hands as an employment-related securities option and taxed accordingly. Vermilion, which at the relevant time was Mr Noble’s employer, made available to his nominee such an option. Vermilion’s reason for so doing is irrelevant when section 471(3) applies.”
Therefore, it is clearly not enough to just look at whether the securities options were acquired by reason of employment, focussing on the intention or purpose behind the award. The deeming provision which looks at who is making available the award must also be considered, and if this is met, the reason behind the award becomes irrelevant.
From an asset manager’s perspective, individuals may acquire awards in the fund (i.e. carried interest and co-investment awards as self-employed partners), however, may hold directorships elsewhere in the fund structure or in the portfolio companies owned by the fund. Where the entity issuing the award is “connected” to the entity of which the individual is a director, the deeming provisions will be in play and the application of the ERS rules should be considered. “Connected” for this purpose is widely drafted, and in our experience is likely to apply to a significant majority of structures where an individual partner participating in the carried interest or co-investment arrangements of a fund is a director of a company in the fund structure or controlled by the fund. It may also apply more broadly to taint the participation of such individuals in other funds, even ones in which they do not hold a directorship.
We would generally expect that for new funds with new carry and co-invest participations, the risks and exposures in relation to this matter can be effectively managed provided appropriate steps are taken, including filing certain elections. For existing structures, the position of both individual partners and entities of which they are directors should be considered on a case-by-case basis.
At A&M, we can help you develop effective policies, procedures and processes in place to manage and evidence compliance with the ERS rules. Particularly for asset managers, we can help provide tax advice on the application of these rules to your existing and future carried interest and co-investment arrangements, and on the implications for you, your fund executives and the companies of which they are directors.
Note that we have dealt with HMRC enquiries into ERS compliance, which we have previously written about in relation to carried interest here.
If you would like to discuss any of the above, please feel free to get in touch with your usual A&M point of contact, Rhys Owen, Joe Macklin-Gray or Shirley Ly.
