HMRC challenged whether accounting debits arising from employee share options granted to subsidiary companies' employees could reduce trading profits for corporation tax. The Supreme Court held the debits were deductible, being properly recognised expenses under IFRS2 and generally accepted accounting practice, not disallowed by any statutory provision.
Background
The respondent companies, NCL Investments Ltd and Smith & Williamson Corporate Services Ltd, employed staff and made them available to other group companies for a fee. The ultimate holding company, Smith & Williamson Holdings Limited (SWHL), established an employee benefit trust (EBT) whose trustee granted share options over SWHL shares to the companies’ employees as part of their remuneration. Under International Financial Reporting Standard 2 (IFRS2), the companies were required to recognise accounting debits (‘the Debits’) in their profit and loss accounts representing the fair value of the options granted, reflecting the consumption of employee services. The companies also paid SWHL a ‘Recharge’ equal to the fair value of the options and passed this cost on to other group companies with a mark-up.
HMRC contended that these Debits should not reduce the companies’ trading profits for corporation tax purposes under the Corporation Tax Act 2009 (CTA 2009). The First-tier Tribunal, Upper Tribunal, and Court of Appeal all rejected HMRC’s arguments. HMRC appealed to the Supreme Court.
The Issues
Four principal issues arose:
Issue 1: Whether disregarding the Debits was an ‘adjustment required or authorised by law’ under section 46(1) CTA 2009
HMRC argued that the Debits were inapt to affect trading profits, relying on the House of Lords decision in Lowry v Consolidated African Selection Trust Ltd [1940] AC 648 and contending that the Debits represented no real cost to the companies and arose from capital contributions rather than genuine profit computation.
Issue 2: Whether the deduction was disallowed by section 54(1)(a) CTA 2009
HMRC argued the Debits were not expenses ‘incurred’ by the companies and/or were not incurred wholly and exclusively for the purposes of the trade.
Issue 3: Whether the deduction was disallowed as capital expenditure under section 53 CTA 2009
HMRC contended that because the matching credit was a capital contribution from the parent, the Debits were items of a capital nature.
Issue 4: Whether the deduction was disallowed or deferred by section 1290 CTA 2009
HMRC argued the Debits were deductions in respect of ’employee benefit contributions’ within section 1291, and therefore disallowed unless qualifying benefits were provided to employees within the relevant period.
The Court’s Reasoning
Issue 1: The ‘golden rule’ and section 46
The Court affirmed the long-established principle that trading profits must be computed in accordance with generally accepted accounting practice (GAAP), subject only to adjustments expressly required or authorised by law. Lord Hamblen and Lady Rose cited the ‘classic formulation’ from Odeon Associated Theatres Ltd v Jones [1971] 1 WLR 442 and Lord Hope’s description in William Grant of computation in accordance with accounting principles as ‘the golden rule’:
The golden rule is that the profits of a trading company must be computed in accordance with currently accepted accounting principles. They are the best guide as to a true and fair view of the profit or loss of the company in the relevant accounting period.
The Court held that Lowry was decided under a different statutory regime without a provision equivalent to section 46 giving primacy to GAAP. HMRC failed to identify any express statutory provision or established judge-made rule requiring adjustment. The Court also rejected HMRC’s attempt to distinguish between accounting practices directed at computing profit and those directed at preserving balance sheet integrity:
There is nothing in the cases cited to us, or in the taxing statute or in the accounting standards themselves that make a distinction between those accounting practices which are directed at showing a true and fair picture of profit and those which are directed at showing a true and fair picture of something else.
Section 48 CTA 2009 further supported the respondents, providing that items brought into account as debits in calculating profits are ‘expenses’ whether or not any amount has actually been paid.
Issue 2: Section 54 – ‘wholly and exclusively’
The Court held that section 54 does not import a freestanding requirement that an expense must be ‘incurred’ in the sense of bearing an economic burden. Sections 46 and 48 in Chapter 3 set the basic rules for calculating profits; section 54 in Chapter 4 restricts deductions and is manifestly directed at expenses incurred for a dual purpose. The Court agreed with the FTT:
… when Parliament uses the word ‘incurred’ it does so simply as a participle that takes its colour from the word ‘expenses’ and does not intend to impose a free standing requirement to be applied to accounting debits …
As to purpose, the FTT’s findings that the Debits arose from options granted as part of employee remuneration, were directly linked to earning revenue profits, and were incurred wholly and exclusively for the purposes of trade were upheld as findings of fact open to the tribunal.
The Court also sounded a note of caution regarding the use of pre-Tax Law Rewrite case law, observing that the word ‘incurred’ is a plain English word that can be construed satisfactorily in its context without reference to earlier statutory wording or case law glosses.
Issue 3: Capital nature – section 53
The Court upheld the FTT’s findings that the Debits arose from the remuneration of employees, were recurring costs with a direct connection to the earning of income, and reflected the consumption of employees’ services — all characteristics of revenue expenditure. The character of the matching credit as a capital contribution did not change the revenue nature of the Debits:
What matters is the character of the Debits, not that of any corresponding credit. For the reasons given by the FTT, these were revenue in nature, not capital.
Issue 4: Employee benefit contributions – section 1290
The Court held that section 1290 did not apply because the grant of options was not an ’employee benefit contribution’ within section 1291. Once granted, the Options were actual emoluments belonging to the employees absolutely and were not ‘held’ under an employee benefit scheme. The Court also rejected the argument that the Options themselves constituted an ‘other arrangement’ amounting to an employee benefit scheme, holding that such term must denote something akin to a trust or scheme. Additionally, the causal link between the grant of Options and the EBT Trustee’s acquisition of shares was insufficient to bring the arrangement within the provisions. The Court noted that Parliament’s policy of encouraging employee share option schemes by not charging income tax on grant was inconsistent with HMRC’s contention that the employer’s deduction should be disallowed.
Practical Significance
This decision confirms that accounting debits required by IFRS2 in respect of share-based payments to employees are deductible as trading expenses for corporation tax purposes. It reinforces the primacy of GAAP in computing trading profits under section 46 CTA 2009 and the broad definition of ‘expenses’ in section 48. The judgment clarifies that the statutory restrictions on deductions in sections 53, 54, and 1290 CTA 2009 do not operate to disallow such debits. The decision is significant for corporate groups operating employee share option schemes, confirming that the accounting cost of incentivising employees through share options can reduce taxable profits notwithstanding that the options are granted by a parent company’s EBT and involve no direct cash outflow by the employing subsidiary.
Verdict: The Supreme Court unanimously dismissed HMRC’s appeal. The accounting debits arising under IFRS2 from the grant of employee share options were deductible in calculating the respondent companies’ trading profits for corporation tax purposes. None of the statutory provisions relied upon by HMRC (sections 46, 53, 54, or 1290 CTA 2009) operated to disallow the deductions.
Source: Commissioners for Her Majesty’s Revenue and Customs v NCL Investments Ltd and another [2022] UKSC 9
