In Vermilion Holdings Ltd v HMRC, an individual originally held an option to subscribe for shares which HMRC accepted was not "employment-related". As part of a refinancing, that option was released for the grant of a less favourable replacement option. At the same time, the individual became a director of the issuing company.
At the First-tier Tribunal (FTT), HMRC had argued that because the individual was an employee when the replacement option was granted, the deeming provision should apply, regardless of the actual reason for the original option grant, meaning that the option should be taxed as employment income on exercise. The FTT decision was that the option was as a matter of fact granted to replace an earlier option (which was not employment-related) rather than in connection with the individual's employment and that as the application of the deeming provision would lead to an anomalous and unjust result, the deeming provision should be limited.
On appeal to the Upper Tribunal (UT), HMRC argued instead that the replacement option was, as a matter of fact, granted by reason of the individual’s employment and so "employment-related". The UT decided that the FTT had erred in its interpretation of "by reason of employment" and that it was sufficient that employment was an operative cause of the grant.
The Court of Session (Inner House) (CSIH) by a majority determined that the FTT had not erred , holding that the replacement option was not as a matter of fact granted by reason of employment, and that the deeming rule is limited where its application to the facts would result in an outcome that is "anomalous, absurd and unjust". The CSIH held that the deeming provision was subordinate to section 471(1), not a "separate and distinct route to taxation".
This decision overturns the orthodox interpretation of section 471(1) and (3) of ITEPA 2003.
Case: Vermilion Holdings Ltd v HMRC [2021] CSIH 45 (TCC) (20 August 2021) (Lords Carloway, Malcolm and Doherty).
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