The UT has held that loan notes received by employees were not restricted securities for the purposes of Part 7 ITEPA.
The taxpayer company (Cyclops) entered into an arrangement broadly as follows. The employee incorporated a new company (NewCo). Cyclops then subscribed for loan notes issued by NewCo. The loan notes were subsequently transferred to the employee, and the loan notes were redeemable and would be forfeited if the employee died within one year. In which case, the loan notes would have to be returned to Cyclops with no compensation for the estate of the deceased. As a consequence of the forfeit provision, it was argued by the taxpayer that the loan notes were restricted securities and therefore no income tax or NIC arose on the transfer to the employee. In addition, it was argued that due to the detailed provisions in Part 7 ITEPA, no income tax or NIC charge arose on redemption of the loan notes. The Upper Tribunal (UT) rejected the taxpayer’s arguments, finding that the principal amount of the loan notes were earnings in the hands of the employees when they received the loan notes and should have been subject to PAYE and NIC.
In their decision, the UT found that the loan notes were not restricted securities for broadly the same reasons given by the Supreme Court in UBS/Deutsche Bank v HMRC – i.e. that the legislative definition of what makes a security a restricted security “is to be construed as being limited to provisions having a business or commercial purpose, and not to commercially irrelevant conditions whose only purpose is the obtaining of the [restricted securities] exemption.”
The UT also held that the transfer of the loan notes to the employee was akin to a cash payment for PAYE and NIC purposes, in line with the judgment in Aberdeen Asset Management v HMRC. As such, the UT did not need to consider the final issue of whether income tax or NIC arose on the redemption of the loan notes (since the tax point occurred on receipt of the loan notes).
Interestingly, HMRC did invite the UT to consider whether the judgment in Rangers v HMRC applied to the subscription by Cyclops for the loan notes. This, in effect, would have treated the payment to NewCo as a redirection of earnings and so PAYE and NIC would have applied at that point.
However, the UT declined to apply Rangers and, ultimately, nothing turned on this. As the Judge put it: “[it is] accepted that an analysis based on the Rangers decision (the payment made to NewCo was earnings) and an analysis based on the UBS decision (the transfer of the Loan Notes to the Employee was earnings) produced the same outcome, namely that the Employee is taxable on the amount subscribed by the Employer for the Loan Notes. In those circumstances, the point is academic and we say no more about it.”
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