UBS AG & Anor v Revenue and Customs [2016] UKSC 13

Two banks devised schemes paying employee bonuses via restricted shares in offshore vehicle companies to exploit Chapter 2 ITEPA 2003 exemptions and avoid income tax. The Supreme Court, applying a purposive Ramsay construction, held the artificial restrictions should be disregarded, making the bonuses taxable.

Facts

UBS AG and DB Group Services (UK) Ltd, the principal UK employer in the Deutsche Bank group, devised bonus schemes for the 2003/2004 tax year designed to exploit Chapter 2 of Part 7 of the Income Tax (Earnings and Pensions) Act 2003 (ITEPA), as amended by the Finance Act 2003. Rather than paying bonuses in cash, each bank used the bonus sums to subscribe for redeemable shares in a special purpose offshore company (ESIP Ltd in Jersey for UBS; Dark Blue Investments Ltd in the Cayman Islands for DB). The shares were awarded to employees subject to restrictive conditions intended to qualify them as ‘restricted securities’ under section 423(2) ITEPA, thereby attracting the exemption on acquisition in section 425(2) and, on later removal of the restriction, the exemption in section 429.

In the UBS scheme, the restriction was a forced sale provision triggered if the FTSE 100 rose above a specified level within a three-week window (a 6-12% probability), with hedging call options ensuring employees would lose at most 0.8% if triggered. In the DB scheme, the shares were forfeitable if the employee resigned or was dismissed for misconduct before 2 April 2004. Once the restrictions lapsed, the shares could be redeemed for cash.

Issues

The principal issue was whether, on a purposive construction of Chapter 2 ITEPA, the shares awarded to employees were ‘restricted securities’ within section 423, such that the exemption from income tax on acquisition under section 425(2) applied. A subsidiary issue was, if not, on what basis the employees fell to be taxed (cash bonuses or shares at acquisition value).

Arguments

HMRC argued, in its broad Ramsay submission, that the schemes were merely mechanisms for delivering cash bonuses and should be taxed as such. In a narrower submission, HMRC contended that the shares, while genuine, were not ‘restricted securities’ because the restrictive conditions had no business or commercial purpose and existed solely for tax avoidance.

The banks argued that Chapter 2 contained no indication that conditions inserted purely for tax avoidance fell outside its scope; that Parliament had dealt expressly with avoidance in Chapters 3A-3D; and that, given the detailed nature of Part 7, no unexpressed legislative intention to exclude such schemes could be imputed.

Judgment

The Supreme Court (Lord Reed giving the leading judgment, with whom Lord Neuberger, Lord Mance, Lord Carnwath and Lord Hodge agreed) allowed HMRC’s appeals.

Purposive construction

Lord Reed reviewed the legislative history of taxation of employment-related securities, from Weight v Salmon and Abbott v Philbin through to the 2003 amendments, observing that Chapter 2 was enacted partly to forestall avoidance. Drawing on Grays Timber Products, he identified Part 7’s threefold purpose: encouraging employee share ownership, addressing the valuation problem where benefits are contingent on performance, and countering avoidance.

Applying the Ramsay approach as restated in Barclays Mercantile Business Finance Ltd v Mawson, the court held that the words ‘any contract, agreement, arrangement or condition which makes provision’ in section 423(1) must be construed as limited to provision having a genuine business or commercial purpose, not commercially irrelevant conditions devised solely to obtain the exemption.

Rejection of the Chapter 3A counter-argument

The court rejected the argument that the express anti-avoidance provisions in Chapters 3A-3D meant Parliament’s anti-avoidance intent had been exhaustively expressed. Section 446B(3) presupposes that restricted securities can have artificially depressed value, but does not address the separate question of whether a condition makes shares restricted securities in the first place.

Application to the facts

In the UBS case, the FTSE 100 trigger was arbitrary, had no commercial rationale, and its economic effect was substantially nullified by hedging. Applying the reasoning in Inland Revenue Comrs v Scottish Provident Institution, a deliberately included commercially irrelevant contingency creating only an acceptable risk does not save the scheme. In the DB case, the leaver provision operated for a brief period and largely within the employee’s control, with no business or commercial purpose. In both cases the restrictions fell to be disregarded, and the shares were not ‘restricted securities’.

Cash or shares?

The court rejected HMRC’s broad argument that employees should be taxed as if they had received cash. The employees actually received genuine shares whose redemption value depended on the performance of the vehicle companies’ investments. Accordingly, ordinary principles under Abbott v Philbin applied: tax was chargeable on the value of the shares at acquisition, taking account of the effect of the conditions (and the offsetting call options in the UBS scheme).

Implications

The decision reaffirms and applies the Ramsay purposive approach to fiscal statutes as restated in Barclays Mercantile and Scottish Provident. Where a statutory provision draws its life-blood from real-world transactions with real-world economic effects, conditions or steps inserted into a composite transaction with no business or commercial purpose other than the obtaining of a tax exemption may be disregarded for the purposes of applying the relevant provision.

The judgment confirms that detailed express anti-avoidance provisions elsewhere in a statute do not preclude a purposive construction of other provisions to exclude artificial avoidance arrangements. It is significant for tax practitioners advising on employee remuneration structures and for HMRC’s response to bonus avoidance schemes of this generation.

The decision is, however, carefully bounded: the Ramsay approach must be applied ‘with sensitivity to the particular fiscal context’. Conditions disregarded for the purpose of section 423 may still be relevant when valuing the shares for the purpose of charging tax on acquisition under ordinary principles. The case does not authorise wholesale recharacterisation of share awards as cash where genuine shares are received.

Verdict: Appeals allowed. The Supreme Court held that the shares awarded under both schemes were not ‘restricted securities’ within section 423 ITEPA, because the restrictive conditions lacked any genuine business or commercial purpose. The employees were therefore taxable on the value of the shares at the date of acquisition under ordinary principles (Abbott v Philbin), subject to adjustments to reflect any effect the conditions had on that value.

Source: UBS AG & Anor v Revenue and Customs [2016] UKSC 13