UBS AG v Commissioners for HMRC; DB Group Services (UK) Ltd v. Commissioners for HMRC, [2016] UKSC 13

In order to avoid income tax employees of the respondent banks were not paid bonuses in cash, but instead were awarded redeemable shares in offshore companies. These awards were intended to qualify for an exemption for “restricted securities” (defined as shares which were subject to provision for their forfeiture if a contingency occurred) contained in s. 425(3) in Chapter 2 of Part 7 of the Income Tax (Earnings and Pensions) Act 2003. In the case of the DB employees, the contingency was being dismissed for misconduct or voluntarily resigning within the next six weeks. In the case of the UBS employees, the contingency was a rise in the FTSE 100 within the next three weeks of greater than 6.5%, thereby triggering a requirement for the shares of the offshore company to be sold for 90% of their market value to a UBS employee benefit trust (but with such an increase being hedged against through the purchase by the offshore company of call options so as to increase its NAV by 10% in such event so that the employee would suffer less than a 1% loss).

In the course of discussing the Ramsay doctrine, Lord Reed stated (at para. 66):

The position was summarised by Ribeiro PJ in Arrowtown Assets, para 35, in a passage cited in Barclays Mercantile:

“The ultimate question is whether the relevant statutory provisions, construed purposively, were intended to apply to the transaction, viewed realistically.”

In finding that these arrangements were contrary to the purpose of Chapter 2, and before finding that the employees were taxable on the value of the shares when received by them (with a small reduction in the shares’ value to reflect the restrictive conditions), Lord Reed stated (at paras. 73, 77-78):

[B]earing in mind that Part 7 generally, and Chapter 2 in particular, are extensive and highly detailed, counsel argued that it was impossible to attribute to Parliament an unexpressed intention to exclude schemes of the present kind from the ambit of Chapter 2. It cannot be denied that these are forceful arguments, and the Court of Appeal found them persuasive.

… [T]he fact that Chapter 2 was introduced partly for the purpose of forestalling tax avoidance schemes self-evidently makes it difficult to attribute to Parliament an intention that it should apply to schemes which were carefully crafted to fall within its scope, purely for the purpose of tax avoidance. Furthermore, it is difficult to accept that Parliament can have intended to encourage by exemption from taxation the award of shares to employees, where the award of the shares has no purpose whatsoever other than the obtaining of the exemption itself… .

More specifically, it appears from the background to the legislation that the exemption…was designed to address the practical problem which had arisen of valuing a benefit which was, for business or commercial reasons, subject to a restrictive condition involving a contingency. The context was one of real-world transactions having a business or commercial purpose. There is nothing in the background to suggest that Parliament intended that section 423(2) [respecting “restricted securities”] should also apply to transactions having no connection to the real world of business, where a restrictive condition was deliberately contrived with no business or commercial purpose but solely in order to take advantage of the exemption… .

Lord Reed found that a scheme to avoid income tax on bankers’ bonuses, which entailed awarding the employees redeemable shares in an offshore company (“ESIP”) which were subject to a commercially remote risk of forfeiture of a portion of their value. The contingency was a rise in the FTSE 100 within the next three weeks of greater than 6.5%, thereby triggering a requirement for the shares of ESIP to be sold for 90% of their market value to a UBS employee benefit trust (but with such an increase being hedged against through the purchase by ESIP of call options so as to increase its NAV by 10% in such event - so that the employee would suffer less than a 1% loss). After finding that the employees were taxable on the value of the ESIP shares awarded to them, Lord Reed stated (at para. 94):

The Revenue argued that the shares should be valued for income tax purposes without regard to the restrictive conditions, since those conditions were not intended to be commercially relevant. I am unable to agree. The shares were subject to conditions which, as the First-tier Tribunal found, had the effect of reducing their value on the date of acquisition by a small amount... . Applying ordinary taxation principles, as laid down in Abbott v Philbin, the value of the shares has to be assessed as at the date of their acquisition, taking account of those conditions. … It is however also necessary to take account of the call options purchased by ESIP out of the sum paid by UBS for its subscription for the shares. Since the options offset the risk to shareholders arising from the conditions, they presumably enhanced the value of the shares and are therefore relevant to the valuation of the perquisite received by the employees.