UBS and Deutsche Bank restricted securities scheme appeals decided by Upper Tribunal (detailed update)

The tribunal considered whether any employees became entitled to payment of their bonuses before the sums allocated to them were paid into the arrangement. The tribunal considered section 18 of ITEPA 2003 in detail, which provides that (for individuals who are not directors) money earnings are treated as received (for tax purposes) on the earlier of:

HMRC argued that certain employees had "become entitled" to payment of a bonus, because they had an enforceable right to receive a minimum bonus in the future. The tribunal noted that the question to be determined was whether the words "entitled to payment" mean a present right to present payment or include a right to payment in the future (with or without contingency). The tribunal held that the former interpretation was correct, and that "becomes entitled" must mean that an individual has an immediate right to payment. The tribunal noted that if an amount were taxable at a time when an individual obtained a future entitlement, the practical implications would be significant. The tribunal also noted that HMRC's own guidance on the meaning of "becomes entitled" in section 18 of ITEPA 2003 did not support such a wide interpretation. Paragraph 42290 of the Employment Income Manual states that the rule is concerned with the date when a person becomes entitled to a payment of earnings, which "is not necessarily the same as the date on which an employee acquires a right to be paid". The tribunal held that:

The First-tier Tribunal had held that the ESIP shares acquired by UBS employees were not restricted securities. The key issue for the Upper Tribunal to consider was whether or not the employees, on the transfer or forfeiture of the shares, would be entitled to receive an amount of at least their market value (determined on an unrestricted basis) (if so, the shares would not be restricted securities under section 423(2)(c) of ITEPA 2003). The First-tier Tribunal found that they would because, it seemed, when determining whether or not the individual was entitled to receive less than market value on forfeiture, they took into account the effect of a call-option mechanism, which operated to increase the value of ESIP's shares.

The Upper Tribunal held that the shares were restricted securities, and agreed with some of the criticisms of the First-tier Tribunal's reasoning that Counsel for UBS put forward. The Upper Tribunal found that the First-tier Tribunal had focussed on the fact that the employees, because of the operation of the call option, did not suffer an overall "loss", and that they would receive an amount equivalent to the bonus they would otherwise have received. The real question to be answered, according to the Upper Tribunal, was whether or not the employees were entitled to receive less than market value for their shares on a forced sale. The answer to that question was yes, and the Upper Tribunal found that the ESIP shares held by UBS employees were restricted securities.

It was common ground that the exemption from a restricted securities charge contained in section 429 of ITEPA 2003 would not be available if the majority of ESIP shares of the class are held by, or for the benefit of, (amongst others) employees of any associated company of ESIP. If ESIP was an associated company of UBS, the conditions of section 429 of ITEPA 2003 would not be met. The Upper Tribunal considered the meaning of section 416 of ICTA 1988, which defined "associated company" for the purposes of ITEPA 2003, in detail. Broadly, section 416 of ICTA 1988 provides that a company is associated with another if one of the two controls the other. Section 416 of ICTA 1988 defines control as circumstances where a person "exercises, or is able to exercise or is entitled to acquire, direct or indirect control over the company's affairs". Section 416 of ICTA 1988 then sets out three circumstances which "in particular" amount to control, including holding the majority of a company's voting power. The Upper Tribunal considered authorities on the meaning of control under section 416 of ICTA 1988, and concluded that it was bound by the Court of Appeal decision in Steele v EVC International NC [1996] STC 785, in which Morritt LJ concluded that control of a company, within the meaning of section 416 of ICTA 1988, means control at the shareholder level. The First-tier tribunal had found that, as a matter of fact, there was no evidence to suggest that there was any evidence of control of ESIP by UBS, nor was there any evidence that UBS together with Mourant (the majority shareholder in ESIP) exercised control over ESIP. The Upper Tribunal, finding no error in law, was bound to reach the same conclusion.

The tribunal also considered an argument advanced by HMRC that a certain provision in ESIP's articles of association were a "sham". Section 416 of ICTA 1988 deems control of one company over another if such control has actually been exercised at any time during the year prior to the time in question. If the provision in the articles were a sham, then UBS would have had control of ESIP for approximately one day during the arrangement, and the exemption under section 429 of ITEPA 2003 would not be available. The article in question operated to remove the rights attaching to shares at any time when a shareholder was a group company, with certain exceptions. The tribunal accepted that the purpose of the provision in the articles was to remove control under section 416 of ICTA 1988. However, the tribunal did not accept that the article could be swept aside as a sham.

The First-tier Tribunal found that the UBS scheme, as a whole, could not be described as one providing restricted securities under Chapter 2 of ITEPA 2003, applying the Ramsay principle. The Upper Tribunal noted that they found the First-tier Tribunal's reasoning on this point "very difficult to follow". Once it was accepted that the shares were restricted securities within the meaning of Chapter 2, then it was impossible to argue that the scheme fell outside Chapter 2. The Upper Tribunal acknowledged that there was plenty of authority to apply the Ramsay principle to "money in money out" avoidance schemes, but in the case of the UBS scheme concluded that: