The decision of the Supreme Court in Vermilion Holdings v HMRC ([2023] STC1834) (“Vermilion”) has not clarified what is, and what is not, an employment-related security (“ERS”) for the purposes of Part 7, ITEPA 2003. I say that because each of the relevant sections of the legislation (sections 421B and 471 ITEPA), in at least five places, differentiates between (a) acquisition of a share or the grant of a share option, and (b) the right or opportunity to acquire that share or be granted that option. So, s471does not say that an option is an employment-related securities option (“ERSO”) if granted by the employer or a connected person. Rather, it says an option which is not granted “by reason of employment” is nevertheless deemed to be an ERSO if the right or opportunity for that option to be granted was made available by the employer or a connected person.

On the facts of Vermilion, the opportunity for the employee to be granted what was a replacement share option, on terms little different in substance from those of the option he already held (agreed not to be an ERSO), was made available by a consortium of non-controlling shareholders (unconnected with the employer). However, and simply for ease of administration, the new option was granted by the employer company. On that basis, according to Lord Hodge, in doing so, the employer company had itself “made available” or, to use his words, “conferred” the opportunity. See paras [24] and [25]. To his mind, this avoided any question of causation.

This, however, ignored the substance of the situation which was that, in granting the option, the employer company was merely giving effect to an agreement between the non-controlling consortium, the other members and the individual that, inter alia, if he accepted office as a director (and became chairman) and agreed to a reduction in his option rights, the consortium members would put up the funds to save the company. The opportunity for that individual to be granted the option (by accepting office as a director and agreeing to a reduction in the “slice of the cake” to which he would be entitled upon an exit event) was created by the non-controlling shareholders, not by the employer company or any connected person(s). In resolving to grant the option, the directors of the employer company simply acted as agent of the members in enabling the option to be acquired pursuant to that opportunity.

It is the answer to the question: “who made available the right opportunity for it to be granted?” – which should be determinative. That does require an enquiry into how and why the grant of the option came about. In the mind of Lord Hodge, as it was the employer which granted the option, so, to use his language, it was the employer who “conferred” the right or opportunity for that option to be granted. He did not look behind the mechanics of the grant to ask “who created the opportunity for the employer to do so?”

So, now it would appear that, if two directors are each granted options on similar terms otherwise than by reason of an employment, one option being granted by the employer and the other by a non-connected shareholder, the tax consequences for the grantees will be different even if the opportunity for the directors to be granted the options was, in both cases, made available by the non-controlling shareholder (as in Vermilion) rather than the employer company.

It is widely accepted, not least by HMRC, that the ruling in Vermilion, although concerning options, applies equally in relation to acquisitions of shares and other forms of “security” as the wording in s421B is similar, if not identical.

A recently-published decision of the FTT in the case of Coopervision Lens Care Limited v HMRC [2026] UKFTT 324 illustrates how that Tribunal Judge (Harriet Morgan) has attempted to “push-back” against the approach taken by Lord Hodge. (At the time of writing, enquiries as to whether the decision will be appealed by either party have been rebuffed on the basis that the parties and their counsel have been “sworn to secrecy”!) The case concerned whether income tax charges arose under Chapter 3D, Part 7 because ERS had been sold for a consideration greater than their market value (answer: yes). A preliminary question was whether the shares sold were ERS in the first place. Over time there had been four distinct acquisitions of shares by the individual directors concerned, Messrs Wells and Maynard.  In relation to the first three acquisitions, the Tribunal readily decided that the shares were in each case acquired as ERS. This was not a situation in which the individuals were founders of the company (as to which, see my separate post) or had established its business from the outset. The business had been that of a group owned by other individuals (“the CLM owners”) which had been demerged into a company controlled by the CLM owners but in which Mr Wells and Mr Maynard – who had been keen to acquire the business as entrepreneurs – agreed in 1985, and pursuant to what was described as a “shareholders’ agreement” (although they did not yet hold shares), to become employees and directors. The agreement provided for them to be granted options to subscribe for up to a total of 36% of the issued share capital of the company. At that time only the CLM owners were members of the company. Nevertheless, Mr Wells became effective controller of the business. Messrs Wells and Maynard gave evidence that they would not have joined the business had they not been given the options and the opportunity to become part-owners. The Tribunal, however, determined that the options were an incentive for them to agree to become directors and were part of their remuneration for acting as such.

Some of the options were later exchanged for convertible loan notes and, in 1987, these were converted into shares. The Tribunal held that the shares acquired on this first acquisition were ERS both under s421B(3), the deeming provision, and s421B(1), the “by reason of employment” provision. The employments were the effective cause of the acquisition of the loan notes, and the first tranche of options were granted by reason of their prospective employments as directors.

In 1988 the company was in financial trouble. The shareholders’ agreement was varied in part to allow Messrs Wells and Maynard to purchase shares from the CLM owners at a price far below the option exercise price. The Tribunal held that this was nevertheless a fulfilment of the option exercise rights and that the shares so acquired were therefore ERS under s421B(1).

In 1991, related private equity funds (“Questor”) invested and one of the funds granted options to acquire shares from that fund to each of Messrs Wells and Maynard. These were exercised shortly thereafter using their own monies. Thereafter, they together held 39% of the company. The Tribunal held that this third tranche of shares acquired were acquired as ERS under s421B(1): the options were granted in return for continued employment and were conditional upon the optionholders continuing to remain as employees. They were, at least in part, like-for-like replacements of the balance remaining of the options granted in 1985, save for the change in exercise price, being subject to Mr Wells remaining with the business at the time of exercise, and the fact they were options to buy existing shares from the fund. The Tribunal held that this did not “[change] the essential character of the option rights…originally acquired in 1985 by reason of their employments.” The Tribunal held that the third tranche of shares acquired were acquired “by reason of employment”.

That the first three tranches of shares acquired should be held to be ERS is at least consistent with the authorities. The employees were not “founders” of the company (see my separate post) which already existed and had acquired, by demerger, a subsisting business. The individuals may have adopted a “risk-taking”, or entrepreneurial, stance in negotiating to join the business and effectively take over day-to-day operational control, but the deal struck with the owners was that they would do so, and become employees, partly in consideration of being granted options to become shareholders. The original options were by reason of the employments even if it was equally true that the original employments were by reason of the CLM Owners agreeing to the individuals having the opportunity to become shareholders.

In 1995, the CLM owners wanted to sell their remaining shares to the other members but, after negotiation with the other members, sold the shares back to the company itself for £3 per share. The other parties agreed between them that the company would then issue the same number of shares to the remaining shareholders (Messrs Wells and Maynard, Questor and certain other employees) at the same price, but part-paid as to only 25p per share. As a result, Messrs Wells and Maynard acquired in total more than 50% of the issued share capital and control of the company.

In relation to this fourth tranche of shares, the Tribunal held that:

• as the right or opportunity to acquire the shares was made available to all shareholders and resulted in other shareholders acquiring shares on the same terms, albeit in different proportions, it was not tenable to characterise that right or opportunity as having been made available “by reason of employment” per s421B(1) : it was available because they were shareholders and their employment had nothing to do with it;
• the right or opportunity for Messrs Wells and Maynard to acquire the shares was made available by the CLM Owners as part of their decision to sell their remaining shares to the existing shareholders and the company merely fulfilled that opportunity. It was not linked to their continuing employment, therefore s421B(3) did not apply and the shares were not acquired as ERS.

Whilst, as a matter of simple fairness, this may appear to be the “right” answer, and consistent with what should have been the decision in Vermilion, it is difficult to reconcile with the approach taken by Lord Hodge. As in Vermilion, what was acquired (here, shares, in Vermilion the share option) was actually provided by the company itself. That – according to Lord Hodge – avoided the need for an enquiry into causation: the company “conferred” (to use his word) the opportunity for the individual to acquire the option, and therefore s471(3), the equivalent of s421B(3), applied and the acquisition had to be regarded as made by reason of employment.

Why did the Tribunal feel able to ignore the approach of Lord Hodge and instead look behind the question of “who conferred the benefit?” to see “who made available the right or opportunity for the shares to be acquired?”. It is to be hoped that this Tribunal decision points up a “chink in the armor” of HMRC seeking to avoid the need for any enquiry as to who provided the right or opportunity, as opposed to asking who transferred the shares or granted the option. The approach of the Tribunal would appear to be more consistent with the clear intention of the legislation than was the line taken by Lord Hodge.

The circumstances of the fourth acquisition pre-dated s421D ITEPA (“replacement” and “additional” shares). Nevertheless, one point made by HMRC was that, if an employee has acquired shares as ERS, any further shares acquired are to be regarded as ERS if the reason why the opportunity to acquire the further shares was made available was the existing holding of ERS. The Court of Appeal, in Charman v HMRC ([2022] STC 157) had rejected the idea that such a causal link was broken by the fact that the shares were, on the same occasion, offered to non-employees (see Charman at [52]). The Tribunal in Coopervision gave no explanation for side-stepping this reasoning, appearing to differentiate on the basis that the fourth tranche of shares acquired were part of an exiting member’s holding offered to all other shareholders on the same terms.

Of course, had the shares been made available by connected controlling shareholders, the position would have been squarely within s421B(3), but the CLM Owners had, by 1995, then reduced their holding to below a controlling interest.

The decision of the Tribunal has “muddied the waters” and made it all the more difficult to advise as whether on any given set of facts the shares acquired are, or were, ERS.

It is surely also wrong in principle that a question of whether ERS charges arise should be dependent upon circumstances over 25 years ago. Perhaps the government should consider waiving the ERS-specific charges if the shares have been held by the same individual, or “associated persons” for at least, say, 21 years.