Fourth time unlucky for HMRC at Supreme Courtby
What were HMRC lawyers thinking when they decided to fight Smith & Williamson’s employee benefit trust case all the way to the Supreme Court?
The Supreme Court’s judgment on the Smith & Williamson (EBT) case (2022 UKSC 9) offers disturbing hints of illogical, if not insane, thinking within HMRC.
There is a saying that insanity is doing the same thing over and over and expecting different results. This is the repeated pattern of HMRC’s appeals in this case:
- May 2017: First-tier tribunal (FTT) hearing, HMRC lost.
- February 2019: HMRC appealed to the Upper Tribunal (UT), and lost.
- March 2020: HMRC appealed to the Court of Appeal (CA) and failed, for the same reasons as it had in the previous hearings.
- February 2022: HMRC appealed to the Supreme Court, and failed again.
Smith & Williamson Holdings Ltd (SWHL) is the holding company of a professional services group, which also included NCL Investments Ltd (NCL) and Smith & Williamson Corporate Services Ltd (SWCS). Those companies employed staff whose services were supplied to other group companies in exchange for a fee (computed on a cost-plus basis).
The group operated a number of employee share schemes to encourage its employees to hold shares in SWHL and an EBT was established in Jersey to facilitate this.
The options formed part of the employees’ remuneration package, but significant numbers of options granted were never exercised. NCL and SWCS’s objective in paying the recharge was to benefit their trade by incentivising their employees. Those companies passed the cost of the recharge on to the other group companies with a mark-up by including it in the fee.
The parties in the case agreed that the group’s accounts complied with all applicable accounting standards, principally IFRS2, which required the companies to:
- “Recognise an expense in their income statements equal to the fair value of the options… granted”; and
- Make a corresponding credit in the balance sheet, treated as a capital contribution received from the parent company.
Both entries were required whether or not the companies had to pay any amount such as the recharge.
For accounting periods ending on or after 20 March 2013 corporation tax relief is specifically disallowed for situations where options were never exercised (section 1038A of CTA 2009). This provision was not in force in the three years ended 30 April 2012, which are the subject of this case, so one might imagine that the companies were well within their rights to claim the tax relief.
However, HMRC imagined differently. It disallowed the deduction, and the companies appealed.
HMRC raised the following arguments.
Adjustment required or authorised by law – HMRC attempted to suggest that a 1940 case (Lowry) constituted authority for the court itself to disallow deductions made in connection with the issue of shares, in the absence of any specific statutory rule. The Supreme Court disagreed.
It is by no means certain that Lowry, which had been heard before the primacy of generally accepted accounting practice, had been enshrined in statute, provided any principle applicable to the present situation.
HMRC also argued that only accounting practices that are “directed at showing a true and fair picture of profit” fall within CTA 2009, s 46, and that practices directed to some other end (such as a company’s capital health) should be disregarded. This argument was roundly rejected. The concept of treating the P&L and the balance sheet as “separate and severable” enjoys no more support in law than it does in accounting.
Disallowed by CTA 2009, s 54(1)(a)? – HMRC argued that the expense mandated by IFRS2 was neither “incurred” nor “for the purposes of a trade”, and therefore fell within the realm of section 54.
The justices dealt swiftly with these arguments. “Incurred” is simply “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 the suggestion that the expenses were not “for the purposes of a trade”, that was easily dismissed. The FTT’s finding, that the purpose was to incentivise employees and to earn profits from their activities, was a ruling of fact and HMRC had not offered any grounds to challenge it in law.
Disallowed by CTA 2009 s53? – HMRC argued that the debit in the P&L is nothing more than a necessary reflection of the credit on the balance sheet arising from the issue of shares, and should therefore be regarded as of a capital nature, and was disallowed by section 53.
The court preferred to look at the motivation for the entire transaction: “the IFRS2 debits arose because the… employees were remunerated with share options and the remuneration of employees has a revenue, not a capital, nature”. “What matters is the character of the debits, not that of any corresponding credit”.
Disallowed/deferred by CTA 2009 s1290? – Section 1290 relates to “employee benefit contributions”, and is designed to ensure that CT relief for such contributions is aligned with the time when employees receive the actual benefit of them.
HMRC argued that relevant “property” as mentioned in section 1291 consisted of either the shares that employees received on exercising their options or the options themselves. In the first situation, the shares were being held by the EBT as part of an employee benefit scheme subject to s1291; in the second, the options were held by the employees under an arrangement which constituted an employee benefit scheme.
The court disagreed. Once an option had been granted, it was not “held” under any scheme: it was the absolute property of the employee, and represented a right exercisable against the EBT with no future reference to the preferences of the employer.
As for the shares, the EBT “acquired the shares in order to fulfil its contract – it was not conferring some benefit on the employees in addition to the benefit already conferred on them by their employer”.
The justices of the Supreme Court unanimously agreed with three successive judgments that HMRC’s arguments were simply wrong.
This case has little practical effect, since the 2013 changes mean that its circumstances cannot recur. Its primary outcome is to highlight the bloody-minded determination that HMRC so often appears to exhibit when pushing a weak case in pursuit of a sizeable chunk of tax.