By Vasiliki Koukoulioti, Lecturer in Law at Newcastle University, Newcastle upon Tyne, England
In its judgment of March 23 in Commissioners for Her Majesty’s Revenue and Customs v NCL Investments Ltd and another, the UK Supreme Court held that accounting debits relating to the grant of share options to employees are a deductible expense for corporation tax purposes.
Facts
The taxpayers were wholly-owned subsidiaries of a holding company, Smith & Williamson Holdings Ltd (SWHL). They employed staff whom they made available to other companies within the corporate group in return for a fee. It was accepted that that constituted earnings from a trade for corporation tax purposes.
In 2003, SWHL set up an employee benefit trust that gave employees a contractual right to acquire shares in SWHL for a specified price. When options were granted to the taxpayer’s employees, the relevant taxpayer was required by International Financial Reporting Standard 2 (IFRS 2) to recognise a debit in its income statement to SWHL equal to the fair value of the options, regardless of whether the taxpayer had to pay any amount to the holding company or the benefit trust in relation to the grant of those options. That debit had to be matched by a corresponding credit on the taxpayers’ balance sheets, which had to be treated as a capital contribution received from the holding company.
The taxpayers claimed the debits as deductions in the computation of the profits of their trade for the purposes of corporation tax. The UK HM Revenue & Customs (HMRC) refused the corporation tax deduction and issued closure notices disallowing the deductions. The First-tier Tribunal, the Upper Tribunal, and the Court of Appeal rejected HMRC’s arguments, all agreeing that the taxpayers were entitled to deductions in respect of the debits.
Issues
The Supreme Court examined four issues.
First, whether disregarding the debits is an “adjustment required or authorised by law,” according to section 46(1) of the Corporation Tax Act 2009 (CTA 2009) (paras 20-33). This provision derives from case law, including Odeon Associated Theatres Ltd v Jones [1971] 1 WLR 442, which has established that the profit of a taxpayer’s trade is to be determined in accordance with “ordinary principles of commercial accountancy.” The Supreme Court held that tax is the creature of statute, and while it is possible for a judge-made rule to authorise an adjustment, that rule would have to be clearly applicable. Also, the Supreme Court rejected HMRC’s argument that a company’s balance sheet and profit and loss account are separate and severable. The Supreme Court concluded that there is no law requiring an adjustment to the taxpayers’ financial accounts so as to exclude the debits from the computation of profits.
Second, whether the deduction is disallowed as an expense that was “not incurred wholly and exclusively for the purposes of the trade,” according to section 54(1)(a) CTA 2009 (paras 34-50). The Supreme Court rejected HMRC’s argument, on the basis that section 54 does not address how profits are to be calculated, but rather what deductions were to be disallowed from profits calculated in accordance with the basic rules. Also, the Supreme Court agreed with the FTT that the debit had been incurred wholly and exclusively for the purposes of the taxpayers’ trades and no grounds for challenging that finding had been made out.
Third, whether the deduction is disallowed, on the basis that the debits are of a capital nature, according to section 53 CTA 2009 (paras 52-56). The Supreme Court rejected HMRC’s argument, holding that the debits had a revenue, rather than capital, nature. The fact that the taxpayers were treated for accounting purposes as receiving a capital contribution from the parent company was not determinative of whether, as a matter of law, the debits were capital in nature.
Fourth, whether the deduction is disallowed or deferred as a deduction in respect of “employee benefit contributions,” according to section 1290 CTA 2009 (paras 58-71). The Supreme Court held that this case did not involve any property being “held… under an employee benefit scheme,” as per section 1291 CTA 2009, so the provision preventing the deduction was not applicable.
Decision
The Supreme Court unanimously dismissed the appeal and held that the correct treatment, for corporation tax purposes, of accounting debits relating to the grant of share options to employees is that they are a deductible expense.
Importance of the judgment
This Supreme Court judgment is important for its approach to the interaction between generally accepted accounting principles and tax rules. The court attaches importance to the principle that the starting point in determining a company’s profits and losses is the accounting treatment. Similarly, the Court of Appeal remarked that accounting standards are the product of “careful expert evaluation and wide consultation” and “it is not for this court to question whether a standard is appropriate.” It should be noted that this is not the first time that HMRC has attempted to challenge the result provided for by the accounting treatment, but again, with no success.
In addition, at the time when these debits were deducted (accounting periods 2010, 2011, and 2012), there was no specific statutory provision allowing or denying relief in respect of the grant of options. For this reason, the courts had to look at the general provisions for a taxpayer carrying on a trade to obtain tax relief for the expenses of that trade. This case and its interpretation of these general provisions thus has a wider impact beyond the area of employment tax.
Lastly, the tax legislation dealing with share-based payments was amended in relation to accounting periods that end on or after March 20, 2013, to preclude relief in the circumstances considered in this case (Part 12 CTA, amended by Finance Act 2013). Therefore, the specific facts of this decision will only directly impact companies that claimed corporation tax deductions in respect of IFRS 2 debits relating to employee share options in periods that ended prior to March 20, 2013.
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Vasiliki Koukoulioti is a lecturer in law at Newcastle University in Newcastle upon Tyne, England.
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