UT/2021/000192 - [2024] UKUT 00242 (TCC)

Mr Wood was formerly employed as head of UBS’s Senior Risk Management (“SRM”) Equity Investment Team. His remuneration arrangements involved the entering into, in October 2002, of three gilt option agreements between UBS, a UBS EBT and the trustees of a settlement of which Mr Wood was the principal beneficiary. There were three separate agreements for the three calendar years 2003 to 2005. The agreements were intended to reflect the performance of the SRM equity investment team in each immediately preceding calendar year. The performance would determine the amount of a basket of notional investments and the value of that basket would then determine what was delivered to Mr Wood’s trust in the form of treasury gilts when the options came to be exercised. The options were exercised in February 2012, some years after Mr Wood had left his employment with UBS. The gilts which are the subject of this dispute were received in 2016/17 (UBS explained the length of time between exercise and delivery arose because of the time UBS and Mr Wood’s trustees took to resolve the valuation of certain notional investments which included illiquid private equity-type investments). Under the employment-related securities provisions of ITEPA, the delivery of gilts would, in broad terms, result in taxable employment income to the extent the market value of the gilts when delivered exceeded the money’s worth value of the option when granted back in 2002 and the consideration paid on exercise (in this case £1,000). According to UBS, valuing that money’s worth at the time of grant (to inform what amount if any of tax was payable) involves a hypothetical exercise of predicting, as at October 2002 when the agreements were entered into, the future performance of the SRM equity investment team which was managed by Mr Wood.

Liability to tax on employment income under ITEPA is ultimately that of the employee. Under PAYE the employee’s liability is collected from the employer by imposing obligations on the employer to make deductions from sums paid or else to account for the tax. The delivery of gilts constituted “notional payments” under ITEPA and were accordingly dealt with under Regulation 62 of the Income Tax (Pay As You Earn) Regulations 2003 (“PAYE Regulations”). That obliged UBS to deduct tax so far as possible from any other payments made at the same time, or else payments made later in the same tax period. However where, as here – because by the time the gilts were delivered Mr Wood had long since left UBS – the employer was unable to deduct tax from an actual payment, UBS was under an obligation pursuant to Regulation 62(5) to “account [to HMRC] for any amount which the employer is unable to deduct”.

The 7A discretion which is central to the dispute before us enables HMRC to relieve the employer from its obligation to comply with the PAYE Regulations (which may include removing the obligation from the employer to deduct or, as in this case, account for tax) where an HMRC officer “is satisfied that it is unnecessary or not appropriate for the payer to do so”.

As regards the amount to which UBS’s PAYE obligations applied, the gilts delivered came within the definition of “readily convertible assets” under s696 ITEPA. Section 696 stipulated the amount UBS was required to account for under Regulation 62(5) as the:

“amount which, on the basis of the best estimate that can reasonably be made, is the amount of income likely to be PAYE income in respect of the provision of the asset”.

The terms “best estimate” and the reference to the amount of income “likely to be” PAYE income foreshadow the fact it is possible that the amount the employer is liable to account for will not necessarily correspond to the correct amount of tax for which Mr Wood would be liable. There may therefore be a mismatch between UBS’s best estimate of Mr Wood’s income and the correct amount of income on which Mr Wood is liable to pay tax in respect of the delivery of the gilts. As will be seen, UBS contrasts this with the usual situation where wages or salary are paid and the amount the employer is liable to deduct or account for will be the same as the amount the employee is liable for. If there is a shortfall due to the mismatch HMRC can still collect the correct amount from the employee by issuing a closure notice at the end of an enquiry into the employee’s Self-Assessment (“SA”) tax return for the relevant year. In this case, HMRC have opened an enquiry into Mr Wood’s SA return for 2016/17.

In October 2018, HMRC informed UBS that they had concluded that the value of the option agreement was considerably less than the value of gilts delivered but did not specify a particular figure. After exchanges of correspondence HMRC arrived at a figure of £22.5 million, subsequently issuing a determination under Regulation 80 of the PAYE Regulations (“Regulation 80 determination”) to UBS in the amount of £13,439,600.51. (HMRC’s cover letter explained they would continue to work with UBS on the valuation but that HMRC had to take action within time limits to protect their recovery position.) UBS has appealed to HMRC against that Regulation 80 determination. HMRC have not produced a view of the matter and the appeal has therefore not been notified to the First-tier Tribunal (“FTT”).

In May 2021 UBS then asked HMRC to make a direction under Regulation 72 of the PAYE Regulations that tax be collected from Mr Wood, not UBS. (Under Regulation 72 HMRC may make a “redirection” to recover amounts (which the employer ought to have deducted but did not) from the employee in circumstances which include those where the employer took reasonable care to comply with the PAYE Regulations and failed to deduct due to an error in good faith.) UBS did not receive a response and issued a judicial review claim challenging HMRC’s failure to make the Regulation 72 direction and the lawfulness of the Regulation 80 determination. UBS also appealed HMRC’s refusal to make a Regulation 72 direction which resulted in proceedings before the FTT. Those proceedings have been stayed by the FTT by consent pending the outcome of this judicial review (because if UBS were successful in obtaining the exercise of the 7A discretion then the Regulation 72 redirection would become unnecessary). HMRC do not accept Regulation 72 can apply as on its terms it only applies where the employer is obliged to deduct tax from a payment made whereas here the relevant PAYE obligation was to account for tax.

In May 2022 the Court of Appeal gave judgment in Stephen Hoey & Others v HMRC [2022] EWCA Civ 656, a case which we will address in more detail later. The issues it dealt with included a judicial review by an employee who objected to HMRC’s exercise of the 7A discretion. In rejecting that claim the Court of Appeal set out various propositions regarding the scope of the 7A discretion emphasising its wide nature. On 1 June 2022, UBS asked HMRC to exercise the 7A discretion to relieve UBS of its obligation to account for the best estimate amount under s696 ITEPA. The relevant tax would accordingly then be recovered from Mr Wood instead of UBS.

The 7A discretion is provided for as follows:

“Nothing in PAYE regulations may be read -

[…]

(b)

as requiring the payer to comply with the regulations in circumstances in which the Inland Revenue is satisfied that it is unnecessary or not appropriate for the payer to do so.”

The 7A discretion accordingly would, if exercised, have enabled HMRC to relieve UBS from UBS’s obligation to account for the best estimate of tax amount if the HMRC officer was “satisfied that it [was] unnecessary or not appropriate” for UBS to do so.

On 27 September 2022 Mr Wood wrote to HMRC supporting the exercise of the 7A discretion in UBS’s favour and indicating he understood the consequences.

On 3 November 2022 HMRC Officer Sue Harper responded to UBS’s request as follows:

“On the basis of the information currently available, I am not satisfied that it is appropriate for HMRC to make a decision in respect of its discretionary power found in section 684(7A)(b) at this time. HMRC would be able to consider the application of this legislation once we have confirmed what liabilities are due.

Your letter seems to base the request on:

• your view that HMRC’s analysis of Regulation 72(5) Income Tax (Pay As You Earn Regulations) 2003 is incorrect and unfair (with which we disagree), and,

• the idea that if HMRC agree UBS AG do not have to comply with their PAYE obligations that that would absolve UBS of any obligation to assist with our enquiries to understand the valuation, and to establish the correct amount of employment income delivered to Mr Wood through the 2005 gilt option agreement, which Mr Wood participated in by reason of his employment with UBS AG.

HMRC’s view is, in this case, we still need to agree the valuation and how much tax needs to be paid before we consider collection. We will write to you separately on the information we require to move this matter towards conclusion.

While I note your view that the amount for which Mr Wood is ultimately liable could be recovered more efficiently though an amendment to his self-assessment tax return, this would not be the case for National Insurance Contributions (NICs).

…

HMRC considers that any decision about the application of s684(7A)(b) at this time would not assist the parties in bringing these matters towards conclusion.”

Whether the above letter, the November 2022 decision, is properly characterised as a refusal to consider or as a substantive refusal to exercise a discretion is a matter of dispute. However either way the position following the letter remains, as it does now, that HMRC have not exercised their 7A discretion as requested by UBS.

With the Upper Tribunal’s permission, the parties subsequently amended the original judicial review pleadings. A permission hearing took place in September 2023 following which the Upper Tribunal (Judge Raghavan) granted permission to bring a claim for judicial review on two grounds (set out below) relating to the refusal of the 7A discretion (the Claimant having explained in its skeleton argument for that hearing that it was no longer pursuing its original grounds concerning the unlawfulness of HMRC’s decision not to issue a Regulation 72 direction and the issue of the Regulation 80 determination).

HMRC later filed detailed grounds of resistance on 3 November 2023 and a substantive judicial review hearing was listed to take place in late May 2024. On 21 March 2024 HMRC filed a Notice of Withdrawal. This sought consent to withdraw stating that HMRC:

“…intend to give further consideration to the [Claimant’s] request to use its discretion under s684(7A)(b) ITEPA 2003 and will issue a new decision once they have done so.”

The Notice suggested that where a new decision was yet to be made it was inappropriate for the present proceedings to continue. In the further rounds of representations to the Upper Tribunal that ensued HMRC’s position was disputed by UBS and the current hearing was duly listed.

UBS’s judicial review claim, as it now stands, raises the following two grounds detailed below.