HMRC has recently published an extract from a Personal Tax Contentious Issues Panel (PT CIP) decision dealing with a long-running dispute that has arisen out of their interpretation of the law on the tax treatment of shares sold by employees who had exercised unapproved share options.
In 2002 the courts handed down a decision in the case of Mansworth (HMIT) v Jelley  EWCA Civ 1829, which upset the widely agreed interpretation of the legislation dealing with capital gains tax on shares acquired when an employee exercised a share option.
In Mansworth the courts decided that the exercise of an option should be treated as a transaction to which s17 TCGA 1992 applied, which meant that the optionholder was treated as having acquired their shares at their market value on the date of exercise for CGT purposes.
HMRC quickly amended the law by inserting s144ZA TCGA in Finance Act 2003, which was intended to ensure that the law matched what had previously been understood to be the case: when an option is exercised by an employee, s17 TCGA does not apply and the exercise price of the option will be treated as the base cost of the shares; if any of the “spread” on the exercise of the option is treated as taxable employment income, the value that has already been taxed will be added to the exercise price under s120 TCGA.
In other words, after the Finance Act 2003 changes, an employee paying £100 to exercise a non-statutory option over shares worth £100,000 will be treated as receiving taxable employment income of £99,900 (i.e. £100,000 minus £100) and his base cost in the shares will be made up of the £100 that he paid to exercise the option plus the £99,900 on which he has already paid tax.
Following Mansworth HMRC issued guidance to the effect that, for options exercised by an employee before the Finance Act 2003 changes came into force on 10 April 2003, the base cost for CGT purposes should be calculated as the sum of:
- the market value of the shares on the date of exercise (following Mansworth); and
- the value treated as taxable employment income when the option was exercised (following s120 TCGA).
This quixotic interpretation of the law meant that, if the same unapproved option, described above, had been exercised before 10 April 2003, the employee’s base cost would be calculated by adding the £100,000 value of his shares when he exercised the option to the £99,900 that was taxed under the income tax rules: for CGT purposes his base cost in the shares would have been £199,900 and, if he sold the shares when he exercised the option, the employee would be treated as realising a CGT loss of £99,900, which could be offset against other taxable gains.
A large number of taxpayers returned losses on the basis of this guidance and many sought to carry forward those losses to utilise in future tax years.
In May 2009 HMRC announced that it had been advised by its lawyers that its original interpretation of Mansworth was wrong: amounts that had been treated as taxable employment income should not be added in to the calculation of base cost.
HMRC announced that it would apply its new understanding of Mansworth to any appeal or enquiry that was open at that point.
HMRC subsequently went on to advise taxpayers to amend open returns and set out their view that very few taxpayers would be able to maintain an argument that their Mansworth losses should be allowed on the basis that they had a legitimate expectation that HMRC’s guidance was effective.
The latest position
The decision of the PT CIP is that in certain cases it would be appropriate for HMRC to allow taxpayers’ claims for Mansworth losses where:
- a taxpayer can make a realistic case that, on the balance of probabilities, he or she relied on the incorrect guidance given by HMRC;
- the taxpayer would suffer detriment if those losses were denied by HMRC; and
- there would have been a legitimate expectation except that, on the balance of probabilities, HMRC’s delay in working the enquiry means that the level of evidence that they are now able to provide is limited.
It is understood that HMRC has agreed claims on this basis.
For taxpayers who do have outstanding Mansworth cases, who are able to show that HMRC has taken time to deal with enquiries into their returns, the key steps will be to document:
- how they would be prejudiced if the losses were not allowed; and
- in what way they had relied on the original guidance issued by HMRC in making their returns.