Revenue And Customs v NCL Investments Ltd & Anor

Factual and Procedural Background

The appeal concerns whether debits to the profit and loss accounts of certain taxpayer companies, arising from the grant of employee share options by trustees of an employee benefit scheme, are deductible for corporation tax purposes. The taxpayer companies are wholly-owned subsidiaries of Company A, which established an employee benefit trust (EBT) that granted options to employees allowing acquisition of shares in the holding company. The First-tier Tribunal (FTT) allowed the taxpayers' appeals against closure notices disallowing these deductions. The Upper Tribunal (UT) dismissed the appeal of the Revenue and Customs Commissioners (HMRC), who now appeal to this court with permission granted.

The options represented contractual rights against the EBT trustee, did not confer proprietary rights over shares, and were treated as equity-settled under international accounting standards. The taxpayers accounted for the options as an expense reflecting the fair value of the options, recognised under IFRS 2, though no actual cash outflow occurred. The taxpayers treated the cost as part of employee remuneration, and the grant of options was reflected in their statutory accounts prepared under IFRS, complying with generally accepted accounting practice (GAAP).

The main legal issues concern the interpretation and application of sections 46, 48, 54, and 1290 of the Corporation Tax Act 2009 (the 2009 Act), relating to whether the debits are deductible expenses, their purpose, their capital or revenue nature, and the operation of restrictions on deductions for employee benefit contributions.

Legal Issues Presented

1. Whether the debits to the profit and loss accounts, required by GAAP for the grant of employee share options, constitute allowable deductions in computing profits for corporation tax purposes.
2. Whether such debits qualify as "expenses" and are "incurred" wholly and exclusively for the purposes of the taxpayers' trades under sections 46, 48, and 54 of the 2009 Act.
3. Whether the debits represent items of a capital nature under section 53(1) of the 2009 Act, thus disallowing deductions.
4. Whether section 1290 of the 2009 Act applies to restrict or defer deductions for the employee benefit contributions represented by the grant of options.

Arguments of the Parties

Appellant's Arguments (HMRC)

• The debits required by IFRS 2 do not constitute deductible expenses as they do not reflect actual or prospective outgoings by the taxpayers.
• The word "incurred" in section 54(1)(a) requires that expenses reflect an actual or prospective outgoing, which these accounting debits do not.
• The debits are items of a capital nature because the corresponding credits represent capital contributions from the holding company.
• The grant of options falls within the scope of section 1290, which restricts deductions for employee benefit contributions, as the shares held or acquired by the trustee may be used under an employee benefit scheme.
• Reliance on the decision in Lowry v Consolidated African Selection Trust to argue that the accounting debits do not reflect true expenses.
• Support from the obiter views in Ingenious Games LLP v HMRC concerning the "incurred" requirement and economic burden.

Appellee's Arguments (Taxpayers)

• The debits are properly recognised expenses under GAAP, specifically IFRS 2, reflecting consumption of employee services.
• The word "incurred" in section 54 does not impose an additional requirement beyond the recognition of expenses under GAAP.
• The debits are wholly and exclusively for the purposes of the taxpayers' trades as they represent remuneration of employees.
• The debits represent revenue items, not capital, as they reflect the consumption of employee services, not capital contributions.
• Section 1290 does not apply because the options granted are contractual rights, not property held under the employee benefit scheme, and the acquisition of shares by the trustee to satisfy options is not the provision of qualifying benefits.
• Accounting treatment and expert evidence support the taxpayers' method of recognising expenses and the related recharge arrangements.

Table of Precedents Cited

Court's Reasoning and Analysis

The court first analysed the accounting treatment under IFRS 2, which requires recognition of an expense reflecting the fair value of share options granted to employees, even though no cash outflow occurs. This accounting debit is mandated by GAAP and was properly reflected by the taxpayers.

Under section 46(1) of the 2009 Act, profits must be calculated according to GAAP, subject to adjustments authorised by law. Section 48 defines receipts and expenses as items brought into account as credits or debits, without requiring actual payment or receipt. The court found that the debits in question are expenses under these provisions.

The court rejected HMRC's argument that the word "incurred" in section 54(1)(a) requires an actual or prospective outgoing beyond the accounting debit. The court held that "incurred" operates as a participle linked to "expenses" and does not impose an additional requirement beyond the recognition of the debit under GAAP. The court emphasised the statutory context and the structure of the legislation, noting that section 54 restricts deductions but does not override the definitional effect of sections 46 and 48.

Regarding the purpose requirement under section 54(1)(a), the court accepted the FTT's finding that the grant of options was wholly and exclusively for the purposes of the taxpayers' trades, as part of employee remuneration to enable profitable trading. The subjective purpose of the taxpayers in making the debits was thus satisfied.

On the capital issue, the court found that the debits represent revenue expenses reflecting consumption of employee services, not capital items, despite corresponding capital contributions recorded in the balance sheets. The nature of the transactions underlying the debits was determinative.

Concerning section 1290, which restricts deductions for employee benefit contributions, the court agreed with the FTT that the grant of options did not constitute an "employee benefit contribution" within the meaning of the section. The options were contractual rights granted by the trustee and not property held under the employee benefit scheme. The acquisition of shares by the trustee to satisfy options was not the provision of qualifying benefits triggering restriction or deferral under section 1290.

Overall, the court upheld the reasoning of the FTT and UT, rejecting HMRC's statutory interpretations and submissions.

Holding and Implications

The court DISMISSED the appeal by HMRC.

The debits to the profit and loss accounts required by IFRS 2 for the grant of employee share options are deductible expenses for corporation tax purposes under sections 46, 48, and 54 of the Corporation Tax Act 2009. They are incurred wholly and exclusively for the purposes of the taxpayers' trades and are revenue, not capital, items. Section 1290 does not restrict or defer these deductions.

The decision directly affects the parties by affirming the deductibility of these accounting debits but does not establish new precedent beyond confirming the proper application of the relevant statutory provisions in this context.