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Corporation tax relief for lapsed share options – HMRC loses at Court of Appeal

Corporation tax relief for lapsed share options

HMRC have lost their appeal in NCL Investments Ltd, confirming that IFRS 2 debits were deductible as trading expenses.


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The Court of Appeal (CA) has upheld the lower tribunals’ decisions that accounting charges associated with employee share options were deductible when calculating the profits of a trade. The legislation has been amended since the relevant accounting periods. However, this decision will interest employers who claimed corporation tax deductions in respect of lapsed employee share options in periods that ended prior to 20 March 2013.

The key facts

The taxpayers were required to recognise accounting charges under International Financial Reporting Standard 2 (IFRS 2) in respect of share options granted to their employees by an employee benefit trust (EBT).

Those options lapsed without being exercised. A deduction was therefore not available under the legislation that gives statutory corporation tax relief in respect of qualifying employee share acquisitions (i.e. CTA 2009, Part 12). However, under IFRS 2, there was no reversal of the relevant accounting charges. Each employer therefore claimed corporation tax relief in respect of the accounting debits under general principles.

HMRC denied those deductions and the employers appealed to the First-tier Tribunal (FTT). The FTT held that the IFRS 2 charges were deductible as trading expenses of the employers ([2017] UKFTT 495 (TC)), which was upheld by the Upper Tribunal (UT) ([2019] UKUT 111 (TCC)). HMRC appealed to the CA.

The decision

HMRC unsuccessfully argued before the CA that IFRS 2 debits were not deductible for corporation tax purposes on four grounds:

1) In the absence of any actual or prospective cash expenditure, accounting debits recognised under IFRS 2 were not ‘expenses … incurred’ (the ‘incurred’ issue).

The CA rejected this argument on the basis that there was no freestanding requirement that amounts be ‘incurred’.

2) As they did not reflect any outflow of resources from the company, but rather reflected the application of IFRS 2 to transactions which the employer was not itself party, it was not possible to regard the debits as expenditure which the employer had a particular purpose in incurring, and so these necessarily failed the requirement to be incurred ‘wholly and exclusively for the purposes of the trade’ (the ‘purpose’ issue).

The CA rejected this argument on the basis that it was possible to assess the ‘wholly and exclusively’ test by investigating the underlying reasons for the debit. In this case, that was the need under IFRS 2 to reflect the consumption of the services of the relevant employees, and that consumption was ‘wholly and exclusively’ for the purposes of the trade.

3) The relevant IFRS 2 debits were items of a capital, rather than revenue, nature and so not deductible (the ‘capital’ issue).

The CA disagreed, arguing again that it was necessary to investigate the reasons for the debits and, that if this was done, the debits were clearly revenue in nature.

4) The grant of an employee share option represents an ‘employee benefit contribution’, because a result of the grant was that shares held or to be acquired in the future by the EBT ‘may be used’ to provide benefits to the employees. This meant that any potential deduction was disallowed under legislation intended to match the timing of corporation tax relief for employer contributions with that of income tax charges for the employee.

The CA rejected this argument on the basis that the shares in question were not used to provide benefits to the employees, but rather to fulfil the contractual obligations created by the options.

The CA, having rejected all four of HMRC’s arguments, held it followed that the IFRS 2 debits were deductible as trading expenses ([2020] EWCA Civ 663).


The corporation tax legislation dealing with share based payments was amended in relation to accounting periods that end on or after 20 March 2013, specifically to preclude relief in the circumstances considered in this case.

This decision will therefore only directly affect companies that claimed corporation tax relief in respect of IFRS 2 debits in earlier accounting periods which are still subject to challenge by HMRC. The arguments advanced by HMRC in those cases are principally those which have now been rejected three times in the Courts and the aggregate tax at stake may lead HMRC to seek leave for a final appeal to the Supreme Court.

More generally, the decision in this case can be seen as another in a long line upholding the importance of generally accepted accounting principles for tax purposes, and it provides helpful clarification as to how to apply long-standing tax rules to the results of modern accounting standards which can be, as the CA candidly admitted, ‘counter-intuitive’. In particular, the CA’s confirmation that corresponding cash expenditure is not required in order for accounting debits to be deductible removes some unwelcome uncertainty created by obiter remarks of the UT in its judgment in Ingenious Games.

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