Deutsche Bank/UBS: restricted securities remuneration schemes

Unusually, the Court of Appeal has found for both taxpayers in the twin cases of Deutsche Bank and UBS regarding similar employee remuneration avoidance schemes. These schemes involved each bank using restricted securities to pay bonuses to employees in order to circumvent the PAYE and NICs provisions.

Restrictions on shares lapsed within five years of acquisition

The essence of both schemes was that Deutsche Bank and UBS (the Banks) were issued a special class of redeemable share in offshore special purpose vehicles (SPVs). These shares were then transferred to their employees as per their bonus allocations. The shares were subject to certain restrictions which automatically lapsed soon after acquisition. Shortly after the restrictions fell away, the Banks' employees became entitled to redeem their shares, although some held them for two years to maximise taper relief, or even longer. The SPVs invested the subscription monies in the Banks' shares so the value of the SPVs' shares mirrored those of the Banks.

Deutsche Bank and UBS each argued that the acquisition of these securities was exempt from any charge to income tax by virtue of section 425 ITEPA 2003, which provided that no income tax charge arises on acquisition of a share where the restrictions automatically cease within five years of acquisition. The subsequent removal or lapse of the restrictions would normally have been subject to an income tax charge under the restricted securities regime. However, an exemption in section 429 ITEPA 2003 applied to prevent an income tax liability provided certain conditions were met, including that the recipients of the shares were not employees of the share issuing company or a company associated with it.

The intention of the schemes was to prevent income tax charges arising under the employment-related securities provisions contained in Chapter 2 of Part 7 of ITEPA 2003. UK domiciled individuals could have redeemed the shares after holding them for two years and qualified for business asset taper relief, reducing their rate of taxation on any chargeable gain to 10 per cent. Non-domiciled individuals could have escaped UK taxation altogether provided that they did not remit the proceeds of any redemption of the shares to the UK.

Ramsay principle is not applicable

Rimer LJ first considered whether a Ramsay argument that could strike down the schemes. HMRC argued this point both on the basis that "in reality" each scheme as a whole was merely a complicated method of paying bonuses without PAYE/NICs, and the forfeiture provisions specifically were commercially irrelevant as being either short-lived (in the case of Deutsche Bank) or hedged such that the risk of receiving a lower than market value for the shares on forfeiture was neutralised (in the case of UBS).

However, he noted that the Ramsay principle involved two steps: a purposive construction of the statute to see, on a "close analysis", what transaction will answer to the statutory provision, and a realistic analysis of the transaction to see whether it answers to that description. The question was not whether this legislation applied to schemes aimed at tax avoidance but whether what the employees received was money or securities. It was not possible to use Ramsay to re-characterise the share awards as payments of money to the employees when the shares were "real shares which functioned as such" with the amount of money obtainable on redemption not preordained but varying with the fortunes of the underlying shares. Similarly, the provisions relating to the restrictions focus on whether these reduce the shares' value and not whether they are there for commercial reasons.

As in the Upper Tribunal judgment, this discussion is helpful in confirming that there are limits to the width of the Ramsay principle.

The scheme shares were "restricted securities"

In the UBS scheme, the arguments centred around whether the restriction had the effect that the holder of the share was not entitled on the transfer to receive an amount of at least their market value. The securities issued to UBS employees were subject to a forced sale provision that provided that the shares had to be sold for 90 per cent of their market value in the event of a specified movement in the FTSE 100. HMRC argued that certain call options held by the SPV (designed to hedge against the risk of a forced sale) and which HMRC described as "the one truly commercial element in the whole structure", had the effect of ensuring that the employees never made an economic "loss".

The Court of Appeal held that, when assessing whether the employee would receive less than market value on a forced sale, the determination of market value of the shares:

• should disregard the forced sale provisions in the articles of the SPV (as this is part of the provision for transfer, reversion or forfeiture which section 423(c) plainly requires to be disregarded); but
• should take into account the effect of the call option arrangements (as these were purely collateral to the transfer reversion or forfeiture provisions and served a different purpose of ensuring that the employees would not end up significantly out of pocket if a forced sale occurred).

Consequently, the requirement to sell at 90 per cent of market value as so determined meant that the securities were restricted securities and no income tax charge arose on their acquisition under section 425 ITEPA 2003.

The Deutsche Bank share restriction consisted merely of a requirement to transfer the shares if the employees ceased employment, and was not faced with serious argument. The Court of Appeal therefore had no difficulty in holding that these shares were "restricted".

Neither SPV was "associated" with the employing Banks

When the shares ceased to be "restricted securities", an income tax liability would have been triggered unless the exemption in section 429 ITEPA 2003 applied. One of the requirements of this section is that the majority of shares held in the relevant class of shares must not be held by certain persons, including employees of an associated company of the SPV.

A company is defined as another's associated company in section 416 ICTA 1988 if at any time in the previous year one of the two has control of the other, or both are under the control of the same person. Control is defined by reference to the ability to exercise or being entitled to acquire direct or indirect control over the company's affairs and in particular where a person is entitled to acquire:

• the greater part of the share capital or issued share capital of the company or the voting power in the company;
• the greater part of income available to be distributed to participators in the company; or
• the greater part of assets available on a winding-up.

The UBS scheme

In the case of UBS, the First Tier Tribunal had held that "it saw no evidence to suggest there was control of the kind envisaged by section 416". Two of the three directors were appointed by the independent company Mourant and "held real meetings and made real decisions". The Court of Appeal upheld this, stating that "What UBS wanted was clear enough. It was, however, in no position to dictate to Mourant to do its bidding… Mourant exercised its shareholder powers in respect of [the SPV] independently".

The Court also rejected HMRC's argument that an Article self-evidently inserted into the UBS SPV's Articles to ensure it could not be controlled by UBS should be disregarded as artificial or a sham. This was because there was genuine commercial risk, albeit remote, under the Article and it represented the true arrangement to which UBS intended to submit.

The Deutsche Bank scheme

In the Deutsche Bank scheme, as a technical matter, Investec (an independent company) had a controlling interest throughout but was held by the First Tier Tribunal to have acted only "to earn the full fee" for implementing the scheme and never to have exercised any independent discretion with regard to the scheme. The First Tier Tribunal had concluded that Deutsche Bank did not control the SPV on the basis that Investec had not acted under the necessary "degree of compulsion" which would amount to control.

Rimer LJ considered that the Upper Tribunal had misunderstood the First Tier Tribunal's reference to "compulsion". He found that, although Investec and the SPV were guided closely about what they had to do and when, involving close co-ordination and co-operation, this did not amount to section 416 control. Investec could rationally only be regarded as doing what it did by consulting its own interests in doing so. While the companies were working together towards a common goal, the suggestion that one was controlling the decision of the other makes no commercial sense.

Contrary to the view of the Upper Tribunal, therefore, the Deutsche Bank scheme did qualify for the exemption in section 429 ITEPA 2003 and no income tax liability was held to arise when the restrictions fell away. This may also be of comfort in other situations where the parties wish to avoid section 416 control but are following preordained, closely co-ordinated courses of action.

Please click on the links below for the other articles in the April 2014 tax newsletter.

• Littlewoods: compound interest
• Felixstowe Dock: consortium link companies
• Mixed member partnerships and AIFM partners
• MG Rover and Standard Chartered: VAT group repayments