On 5 January the Upper Tribunal (‘UT’) released its judgment Sjumarken v The Commissioners of Her Majesty’s Revenue and Customs  UKUT 0568 (TCC).
The UT’s decision highlights the proper tax treatment of employee share options which lapse or are released and illustrates the limits on the concept of ‘consideration’.
As we reported in August 2015, Mr Sjumarken had been granted share awards by his employer over a number of years. When his employment ceased, Mr Sjumarken held share options (‘the Options’) and was also entitled to shares under an unapproved share scheme that his employer referred to as the 2004 Share Incentive Plan (‘the SIP Shares’).
Mr Sjumarken entered into a compromise agreement with his employer and it was agreed that he would receive payments in connection with a cash incentive plan and a termination payment. Mr Sjumarken was also allowed to keep the SIP Shares. Following the termination of Mr Sjumarken’s employment he lost the right to exercise the Options.
Although he had some limited success before the First Tier Tribunal (‘FTT’), Mr Sjumarken wished to appeal against an aspect of their decision concerning the options. His counsel advanced three arguments:
- that the release of the Options was valuable consideration that should be treated as reducing the amount of the termination payment that was subject to tax;
- that the SIP Shares were acquired in consideration of the release of the Options, which would reduce the amount treated as taxable employment income; and
- the issuance of the closure notice in the case meant that HMRC were not entitled to raise ITEPA 2003, s 477(3)(b), which imposes a tax charge on amounts received in consideration for the release of an option.
The UT’s decision
The FTT’s decision was upheld by the UT, albeit that they differed in their reasoning. The UT did not consider that it was necessary to decide whether Mr Sjumarken had acted positively to release the Options as part of his compromise agreement or if the Options had automatically lapsed when his employment ceased, this distinction did not affect their reasoning.
The UT decided that there was no scope to argue that any element of the termination payment should be reduced because consideration had been given for the payment: ITEPA 2003, Part 6, Chapter 3 does not provide for deductions in respect of rights given up as ‘consideration’ for the payment; the legislation simply contemplates that payments received in connection with the termination of an employment will be taxable.
The UT also found that the SIP Shares could not be treated as having been acquired in part consideration of the release of the options. Although the release of a right could constitute consideration in law, the documentation in this case could not support such an interpretation: the compromise agreement did not stipulate that the options should be released in consideration for the release of the SIP Shares, instead it effectively provided for the SIP Shares to be released to Mr Sjumarken in accordance with the rules of the 2004 Share Incentive Plan. This impression was reinforced by the fact that Mr Sjumarken himself did not realise that he was losing the Options until after the compromise agreement had been signed and concluded.
Mr Sjumarken’s counsel had argued that HMRC was not entitled to raise arguments relating to ITEPA 2003, s 477(3)(b), as this provision had not been raised before the issuance of the closure notice. The UT disposed of this point quite quickly: before the closure notice was issued, Mr Sjumarken had not himself argued that the release of the Options should be treated as consideration, reducing the value subject to tax; if it was proper to allow him to argue this point then it was reasonable to permit HMRC to review the implications of the law relating to employee share options.
On the substantive question of s 477(3)(b), the UT observed that the FTT had made findings of fact that the Options were employment-related securities options that fell within the scope of ITEPA 2003, Part 7, Chapter 5. This means that the occurrence of any of the chargeable events set out in s 477 would be treated as giving rise to taxable employment income. The release of an option for consideration is chargeable within this section.
The UT pointed out that this leaves Mr Sjumarken caught between tax charges: if his arguments were correct and the Options were released in consideration for the termination payments or the SIP Shares, then Mr Sjumarken would reduce the amount chargeable to tax under one part of ITEPA, but a matching amount would be treated as taxable employment income under s 477(3)(b).
In conclusion, the case highlights two core points:
- although it is possible for the relinquishment of a right to be treated as consideration, there must be evidence to show that it was the intention of the parties to a transaction that the right is being given up in order to acquire something, it isn’t enough to have a right lapse at the same time as a payment is made; and
- the value of an option that is within the rules on employment-related securities options will always be within the scope of income tax, if the option is released or sold for consideration then that consideration will be treated as taxable employment income.