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UBS AG v HMRC; DB Group Services v. HMRC - (09 Mar 2016)

HMRC gets payday on bankers’ bonuses

Direct Taxation

Hearing a case that ties together the two bugbears of today’s commercial world - executives’ bonuses and offshore companies - the British Supreme Court may have opened a pandora’s box of legal hurt for prolific tax avoiders.

Whereas incorporating ‘offshore companies’ to hide ones identity, avoid tax and other regulatory concerns are commonplace for companies and influential individuals, such vehicles are also used for avoiding tax liabilities on executive bonuses - specifically bankers’ bonuses.

The Court looked into schemes that took advantage of Chapter 2 Part 7 of the Income Tax (Earnings and Pensions) Act 2003 to avoid income tax liability. Ordinarily, an employee receiving remuneration in the form of redeemable shares is liable to income tax, but the instant schemes worked by awarding bankers shares in offshore companies. By imposing conditions that could lead to forfeiture of equity, the shares were manipulated to fall under “restricted securities” under Section 423 of the Act. Such a construction would accrue exemptions to tax for the beneficial employee, who could then redeem the shares for cash.

Her Majesty’s Revenue and Customs (the United Kingdom’s tax collector) decided to assess tax on employees as if the bonus was paid to them in case, instead of the convoluted share scheme.

The Supreme Court discussed the increasing application of the ‘purposive approach’ and a shift towards a trend that “transactions must always be viewed realistically, if the alternative is to view them unrealistically”. It added, “if a fact is of no relevance to the application of the statute, then it can be disregarded for that purpose.” The court opined that for conditions entitling one to Section 423 of the Act, the same would have to be construed as ones having a business or commercial purpose, not commercially irrelevant conditions whose sole purpose was to obtain exemption.

It held the conditions to be unrelated to the transaction - such as the employee being dismissed, time restrictions of a few weeks - and unlikely to be triggered. Moreover, a triggering of the conditions would have had little economic effect on the value of intended disbursement. The conditions were determined arbitrary and as serving no commercial rationale beyond tax avoidance. Exemption as ‘restricted securities’ was unavailable and income tax would be payable on the value of the shares as at the date of their acquisition.

Despite the common sense outcome, the industrial scope of the schemes is perhaps their most concerning aspect. Perceived as financial tactics of the upper echelon of a bank’s management, HMRC discovered UBS to have sent brochures inviting interest to hundreds, if not thousands, of its employees. Eventually, 426 employees agreed to participate in the scheme. In the instance of DB Group Services (part of Deutsche Bank), 300 employees were selected to take advantage of a similar scheme.