UBS AG and DB Group Services (UK) Ltd v HMRC [2016] UKSC 13

Two banks paid bonuses in shares whose forfeiture conditions had been designed to bring them within a tax exemption. The Court held that the legislation concerned genuine commercial restrictions. The employees received shares, and it was their value at acquisition that mattered.

HMRC appealed in two cases concerning discretionary bankers’ bonuses paid in the 2003/04 tax year through specially created offshore companies. In each scheme the bank decided the employees and amounts, funded redeemable shares equal to those amounts, and allocated the shares to participating employees. Short-term conditions were attached so that the shares might qualify as restricted securities under section 423 of ITEPA, attracting an exemption on acquisition under section 425(2) and a further exemption when the restriction ended under section 429. The shares could later be redeemed for cash. National insurance followed the income-tax result.

The UBS scheme

UBS subscribed about £91.88 million for non-voting shares in a Jersey company, ESIP Ltd, created for the scheme, and awarded them to 426 employees in place of cash bonuses. For three weeks the shares were subject to automatic sale to an employee benefit trust at 90 per cent of unrestricted market value if the FTSE 100 rose more than 6.5 per cent. That contingency was unlikely but real. ESIP bought call options that would largely offset any loss if the trigger occurred, so employees would receive about 99.2 per cent of the unrestricted value. The index did not rise enough. Employees could redeem from March 2004; many did, while others held shares longer and received dividends and higher redemption prices linked to UBS shares.

The DB scheme

DB paid £91.3 million for redeemable shares in Dark Blue Investments Ltd, a Cayman company created for an off-the-shelf scheme, and allocated them to about 300 employees. The shares were forfeited if, before 2 April 2004, the holder left employment other than for redundancy, death, disability or without cause, or received or gave notice to that effect. Resignation or dismissal for misconduct was largely within the employee’s control and financially unattractive; section 424(b) already excluded forfeiture for misconduct alone. The provision reduced market value by a small amount, at most about 2–3 per cent. No employee triggered it. Shares were redeemed from July 2004 onwards at prices reflecting the company’s low-risk investments.

Decisions below

The First-tier Tribunal treated both arrangements, viewed realistically, as mechanisms for paying cash bonuses and dismissed the banks’ appeals. The Upper Tribunal disagreed. In UBS it held that the statutory hypothesis in section 423(2)(c) required only the forced-sale provision, not the hedging options, to be ignored, so the shares were restricted securities, and it rejected equating the shares with cash. In DB it held that Dark Blue was in fact controlled by DB, so the section 429 exemption failed, but otherwise rejected a broad Ramsay approach. The Court of Appeal agreed that the shares were restricted securities and that a realistic appraisal did not take the schemes outside Chapter 2; it reversed the finding of control in DB. A narrower argument that the shares were securities but not restricted securities was rejected, and permission to appeal on that ground was refused.

Purposive construction

Lord Reed, with whom the other Justices agreed, applied the approach in Ramsay and Barclays Mercantile: the statute is construed purposively to identify the transaction to which it was intended to apply, and the facts are then viewed realistically. Chapter 2 sits in Part 7, whose purposes, as discussed in Grays Timber, include encouraging genuine employee share ownership, waiting to tax contingent benefits until a chargeable event, and countering avoidance. Its history, from Weight v Salmon and Abbott v Philbin through later Finance Acts, concerned real restrictions used for business reasons, not conditions inserted solely to obtain an exemption.

Section 423(1) therefore refers only to a contract, agreement, arrangement or condition that makes provision having a business or commercial purpose. Commercially irrelevant conditions whose only purpose is to obtain the section 425 exemption fall outside it. The detailed anti-avoidance rules in Chapter 3A, including section 446B, do not show that Parliament intended every avoidance device to qualify as a restriction: those rules address artificial depression of market value and expressly do not apply where section 425(2) applies. Section 429’s limited exemptions for employee-controlled companies and for classes mostly held by unrelated persons are consistent with that reading.

Application to the schemes

The UBS trigger was arbitrary and had no business rationale. The hedging was intended to neutralise it except to a predetermined and insignificant extent, so the scheme is considered as it was intended to operate, following Scottish Provident. The DB leaver condition lasted only about eight weeks, depended largely on the employee, and existed only to enter section 423(2). In both cases the inserted conditions are disregarded for the purpose of section 423. The shares were therefore not restricted securities.

The employees did, however, receive shares rather than cash. The companies’ assets were invested, redemption values were not fixed when the shares were awarded, and redeemability alone does not make shares “money” under section 420(5)(b). Ordinary principles, including Abbott v Philbin, therefore tax the perquisite at its true value on acquisition. The conditions, and in UBS the offsetting options, are taken into account for valuation even though they are disregarded when asking whether the shares were restricted securities.

Verdict: The Court unanimously allowed both HMRC appeals. The employees were taxable on the value of the shares when they received them. The assessments could be adjusted to reflect any effect the actual conditions had on that value.

Source: UBS AG and DB Group Services (UK) Ltd v HMRC [2016] UKSC 13