The judgement of Lord Reed in a case decided on 9 March 2016 in favour of HMRC begins with the line:  “In our society a great deal of intellectual effort is devoted to tax avoidance”. 

The facts of the case for the ordinary tax paying public are truly shocking.  The case concerned Deutsche Bank (and a parallel case involved UBS). 

The tax avoidance scheme involving employee shares was marketed by Deloitte & Touche in 2003.  It worked as follows:-

1. Deutsche Bank had decided to award £90million in discretionary bonuses to 300 employees.  Rather than pay these in cash (with considerable PAYE/NICs arising) Deloitte devised an ingenious scheme;
2.  An off-shore company was set up.  It was designed not to be under the control of Deutsche Bank.  The chosen 300 were invited to apply for redeemable shares in the company;
3.  The shares were subject to an eight week period where they were liable to forfeiture.  This applied if the employee resigned or was dismissed for misconduct;
4.  On the strict wording of the tax legislation (the loophole was closed for such avoidance schemes in the 2006 Finance Act) no tax charge arose on the day one value of the shares.  This was because the shares had restrictions that did not last for five years;
5.  The structure of the legislation was for the shares to be subject to a tax charge when the shares were sold, or if earlier, the date on which the restrictions were released (which was not the case here);
6.  By electing to pay tax on the minimal reduction in the value of the shares consequent upon the imposition of the (illusory) restriction, the tax advisers expected the tax when the shares were sold would be CGT not income tax.

Happily the Supreme Court judges were having none of this.  They concluded, applying the established Ramsay anti-avoidance case law, that the transactions were a sham.  The restrictions and the tax election could be ignored.

Instead the day one value of the shares (minus a tiny reduction due to the risk of forfeiture during the eight week period) would be subject to income tax.

The principle that shares given to an employee are a benefit in kind had been established in the case of Abbot -v- Philbin as long ago as 1961.

The underlying difficulty to be reconciled historically with share incentives is apparent from this case.  For the employee it is unfair to tax him when he receives shares if they are liable to be forfeited.  For the Exchequer the problem has been trying to value shares that are subject to restrictions in private companies that are difficult to value at the best of times.

It is good to see the Supreme Court cracking down on artificial schemes such as this.

For those of us operating outside the rarefied world of sophisticated tax avoidance the case is a good reminder of three simple things:-

1. Engage in non-commercial structures at your peril;
2. Restrictions that are designed artificially to depress share values should be avoided;
3. When at all possible make use of Revenue approved or tax-advantaged employee share schemes.

For a no obligation discussion about Employee Share Schemes or EMI Options, please contact us on 0845 868 0960 or email james.hunt@everymanlegal.com