UT (Tax & Chancery) UT-2024-000088 - [2025] UKUT 00374 (TCC)

We were referred to a number of cases which considered the “ordinary rule” which Abbott v Philbin has been held to establish.

The first was Grays Timber, in which the Supreme Court was concerned with one of the statutory carve-outs from Abbott in relation to employee share options. Lord Walker referred at [5] to “the general principle that employee benefits are taxable as emoluments only if they can be converted into money, but that if convertible they should be taxed when first acquired” (citing Abbott). He continued:

“That case was about share options, which are now dealt with separately in Chapter 5, but it illustrates the general approach that applied in the days when the taxation of employee benefits was very much similar than it is now.”

The next decision is PA Holdings. A company wished to pay annual discretionary bonuses to its directors. Profits were paid into employee trusts, which made awards to employees reflecting their contribution to the company and to the company’s success. In 1999, it adopted a different approach with a view to securing a more favourable tax treatment. A new trust was established with the trustee being empowered to award employees shares in a Jersey SPV, with the employees receiving the dividends due in respect of the shares so allotted. The shares allotted to employees were intended to meet the requirements of restricted shares, so as not to be taxable at the time of transfer.

The FTT and the UT found that the dividends were a profit arising from employment, noting (a) that employees who left the company ceased to be eligible to receive them, and (b) the stated purpose of the scheme as being a means of remunerating employees who received dividends

The issue before the Court of Appeal was whether the dividends were to be regarded as a profit from employment, or simply as the right of the directors as owners of shares allotted to them to the fruits of their ownership. The case did not directly raise the point covered by the ratio of Abbott, but something quite close to it. The immediate receipt – the shares allocated – involved a benefit (albeit a non-taxable one) which was in turn the source of the dividends. The second (and we believe closely related) aspect of Abbott was very much in issue. At [33]-[35], Moses LJ stated:

“No one can doubt but that there are circumstances in which employees may be awarded shares as an incentive or reward and that those employees may subsequently receive dividends or distributions in respect of their shareholding, the source of which may properly be identified as the shares and not their employment. The employees, in such a case, receive those payments in their capacity as shareholder or investor and not as employee. When employees were granted options to acquire shares in their employer and exercised those options, they profited by the increased difference between the option price and the market price when they exercised their options. The profit accrued to the employees as holders of their options and not as employees; it was derived from the option and not from employment (Abbott v Philbin).

But it is not in every case that an employee who is awarded shares and receives dividends can escape the conclusion that the dividends are remuneration and not investment income … How then is the distinction to be made between the receipt of payments in the form of dividends as employee and the receipt of dividends as shareholder? What determines the character of the income in the hands of the recipient? What determines the capacity in which the recipient receives such income? The answer lies not in the administration of some post- Ramsay prophylactic against tax avoidance but in the methods which the courts have long been accustomed to deploy whenever it is necessary to decide whether income is from employment and should thus be charged under Schedule E.

The conventional approach of the courts is to look at all the circumstances of the case in order to answer the one statutory question, namely whether the income receipts of the employee are emoluments or profits from employment.”

At [38]-[39], he noted that answering the question to be answered was “one of substance and not form” and “the court should not be seduced by the form in which the payments … reached the employees. It should focus on the character of the receipt in the hands of the recipients”. He stated that the FTT’s decision that the emoluments were “rewards for services past, present or future” having regard to (i) the fact that the employer funded the purchase of shares with the employees acquiring the shares and dividends at no cost”; (ii) the intention behind the scheme was to motivate employees; and (iii) leavers were eligible, all fully supported the FTT’s conclusion. At [42]-[43] he continued:

“It is that approach which enables a distinction to be drawn between Abbott v Philbin and White v Franklin. In Abbott v Philbin, a realistic appraisal of the facts led to the conclusion that the benefit which arose as a result of the exercise of the option accrued through what Lord Radcliffe (at 369) described as the “judicious exercise” of the holder's option rights. It accrued to him in his capacity as option holder exercising his discretion as to the best time to exercise his rights having regard to the increase in value of the shares, an increase due to what Viscount Simonds described as “the adventitious prosperity of the company in later years” (367) (that it was exercised less than two years after acquisition of the option was neither here nor there).

The facts of this case are miles away from the circumstances in Abbott v Philbin. The payments received by the employees owed nothing to fluctuations or increases in the value of shares in Ellastone and everything to the amount which PA had decided to award as bonuses to its employees. Whilst it is true that the Mourant trustees exercised a discretion in the sense of independently questioning who should be recipients, the quantum of that which the employees received was entirely dictated by the amount PA decided to award as bonuses. The receipts were triggered by PA's decision to continue its policy of making bonus payments and to fund the 1999 Trust and arrived in the hands of employees, as they were intended to do, as bonuses.”

The next decision, UBS AG v Revenue and Customs Commissioners [2016] UKSC 13, was also concerned with an attempt to secure the favourable tax treatment afforded by legislation to certain classes of share option. The employers acquired shares in offshore SPV companies and awarded them to employees in lieu of bonuses. Conditions were attached to the shares to secure the benefits of certain statutory exemptions from income tax. The UBS scheme involved subjecting the shares to a risk of forced sale if the FTSE 100 hit a certain level (there being a 6-12% chance of this happening), which condition had a slight but more than de minimis impact on the value of the shares in the employees’ hands. The condition was only included for tax avoidance purposes, and its potential adverse effect was off-set by call options. The DBGS scheme was similarly constructed. It included a condition that benefits would be forfeit if an employee voluntarily designed or was dismissed for cause (at [52], Lord Reed noted “neither contingency was likely to occur, not least because its occurrence lay largely within the control of the employee”).

The Court concluded that the options did not benefit from the tax exemption, the restrictions imposed having no commercial purpose but having only been included for tax avoidance purposes. However, that left the basis on which the remuneration should be valued:

We would note that this second point was concerned with the valuation of shares, and the statement that they were to be valued by reference to the conditions attaching to them at the date of receipt was, considerations of tax avoidance apart, wholly uncontroversial. While Abbott v Philpin was cited, the issue considered in [94] was not concerned with the issue of “grant of contingent rights v. realisation”.

The final decision was RFC 2012 Plc v Advocate General [2017] UKSC 45. That case was concerned with whether payments made by an employer in return for an employee’s services to an employee benefit trust (at the employee’s direction) rather than to the employee were nonetheless taxable remuneration so far as the employee was concerned. The answer to that question was yes, but in the course of its analysis the Supreme Court considered those circumstances in which payment to a third party would not, at the point of payment, fall to be treated as a remuneration of the employee. At [41], the Supreme Court identified three such exceptions: (i) the taxation of perquisites, at least since the enactment of ITEPA, (ii) where the employer uses the money to give a benefit in kind which is not earnings or emoluments, and (iii) an arrangement by which the employer's payment does not give the intended recipient an immediate vested beneficial interest but only a contingent interest.

When discussing the first exception at [42]-[43], Lord Hodge referred to Tennant and Abbott v Philbin, observing of the latter:

“In Abbott v Philbin [1961] AC 352 a majority of the House of Lords held that an employee of a company was liable to income tax on the grant by his employer of an option to purchase shares in that company in the tax-year in which the option was granted because the option itself had a monetary value which the employee could realise.”

When discussing the third exception at [47] (“where the person entitled to receive the sums paid by the employer does not acquire a vested right in those sums until the occurrence of a contingency”), Lord Hodge referred to Edwards v Roberts (1935) 19 TC 618 in which an employing company entered into an employment contract to give an employee, in addition to his salary, an interest in a “conditional fund”, into which it would make annual payments from its profits, as an incentive for him to advance the company's interests. In that case the employee was entitled to receive the annual income from the fund but had no right to receive any of the capital of the fund other than that which had been held in the fund for five years or more. The taxpayer argued that the relevant remuneration occurred when the employer paid the sums into the fund. That argument was rejected.

We noted that the right to receive was said to arise “at the expiration of five … financial years”. Lord Hanworth concluded that this was “an emolument which accrued and was not payable in each successive year but the sixth year.” The judgment is not wholly clear, however, with Maugham LJ referring to the employee having “a right given to him conditionally”.

There was some debate before us as to whether Edwards v Roberts represented (a) a case in which an employee had a contingent legal right to the amounts in the fund, or (b) a case in which no legal right vested until the employee had completed five years’ service.

Our view is that the latter is correct, for the following reasons:

We would note that Abbott v Philbin has been applied by other courts to share option schemes, and treated as establishing a “general rule” that such options are taxable by reference to their value when granted, from which statute has departed in certain cases. However, none of the cases has had cause to consider the particular type and nature of rights which can bring the Abbott v Philbin approach into play, and whether there are any limitations on them. We also note that PA Holdings stresses the importance of a realistic appraisal of the facts when considering whether the relevant remuneration is the grant of a right or its subsequent realisation.