Corporate tax relief for employee share option awards – a surprising case

26 June 2017

The NCL investments case demonstrates the need for and wisdom of putting in protective claims for tax deductions that experts after careful analysis think are due even if HMRC disagrees.

The NCL case revolved around tax deductions companies can claim on share options granted to employees. The tax legislation (Part 12 of Corporation Tax Act 2009 - "CTA 2009") allows companies to claim a tax deduction on an employee's share option when they exercise it ("Part 12 deduction"). The tax relief claimable is the value of the shares under option at the date of exercise less the exercise price. That is straightforward and beyond doubt being a specific tax relief set out in the legislation.

However on top of this, companies are obliged under International Accounting Standards to put an expense in their Profit & Loss Account for the imputed cost of granting the option. I won't go into the calculation of this deduction or why the International Accounting Standards Board (“IASB”) thought it was necessary as both are complex matters and not necessary for this article. However, I will say that the deduction once calculated is divided and spread over the life of the option ‎and is due in the accounts from the accounting year in which the options were granted. This deduction is known as a "share based payment" or an IFRS2 deduction.

When the corporation tax law was rewritten and put into Corporation Tax Act 2009 (CTA 2009), accountants realised that there was a mismatch between the ‎Part 12 tax deduction due on the exercise of the option and the IFRS2 deduction due on the grant of an option. There was provision in CTA 2009 to prevent a company claiming a tax deduction under general principles for costs incurred on the exercise of option in addition to the Part 12 tax deduction. HMRC was anticipating what was to come next.

Tax experts realised though that this preclusion from being able to claim relief for other costs only related to other costs incurred at the time of exercise of the option. It didn't relate to costs incurred at other times like, for example, accounting deductions incurred at the time of grant.‎ Many advocated that companies who were granting stock options to employees should claim a tax deduction under general principles for the IFRS2 accounting deduction in addition to the Part 12 tax deduction that would be due on the options' exercise. HMRC did not agree that this was possible thinking that the legislation as it then currently stood was sufficient to prevent this double deduction. But to make sure, they changed the legislation with effect for all company accounting periods ending on or after 20 March 2013 to ensure that if a Part 12 tax deduction was claimed on the exercise of an option, a tax deduction for costs incurred on the option at any time from grant to exercise could not be claimed.

So that dealt with things after 20 March 2013, but what about beforehand? HMRC thought the legislation was strong enough. Well according to the decision in the NCL Investments Ltd case which was published last week, it wasn't.  The detail of the NCL case, a subsidiary of Smith and Williamson, doesn't need to be gone into in detail, except to say it simply involved the award of options over shares by NCL Investments and Smith & Williamson Corporate Services Ltd (“SWCS”) for which they claimed tax deductions both for the Part12 tax deduction on options' exercises and the IFRS2 deductions due on the options' grant and each year thereafter until exercise or lapse. After deliberation, summarised in a 32 page judgement, the tribunal judge ruled that:-

  1. The IFRS2 P&L deduction was properly claimable under general principles even though it had not been "incurred" as such;
  2. The accounting expense was incurred wholly and exclusively in the course of NCL's trade;
  3. It wasn't capital in nature; and
  4. The provision in CTA 2009 designed to prevent double deduction (section 1038 as it happens), didn't apply to preclude NCL or SWCS from claiming a tax deduction for the IFRS2 expense as it was incurred on the options’ grant not on their exercise. Interestingly, the judge set great store here on the fact that HMRC had felt it necessary to change the law in March 2013.

Bear in mind that the NCL case at the moment is just a First Tier Tribunal decision and so does not set a precedent, but it does add a lot of weight to the contention that the argument tax experts were putting in 2009 and afterwards was correct.

This is, in a sense, all a history lesson, as the law was changed for accounting periods ending after 30 March 2013‎. The time limit for making a claim to amend earlier years' corporation tax returns is 4 years after the end of the accounting period which means that with this decision in May 2017, it is now too late to reopen any years where this relief could have been claimed.

Like I said at the start, if a tax expert is saying the relief could be claimed, probably best to put in a protective claim.

If you want assistance in claiming Part 12 tax deductions on share option exercises or want to talk generally about awarding share incentives to your employees‎ or want to review employee share incentives you already have in place, please get in touch.

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