Tax

It can often come as a surprise that granting an option can trigger a UK tax charge for a UK grantor. “But how?”, is often the question. A quirky provision of the UK tax code (section 144, Taxation of Chargeable Gains Act 1992 (“section 144”)) results in a grantor being treated as having disposed of an asset upon the grant of the option. “But what asset has been disposed of?”, comes an exasperated reply. The fiction is that the UK grantor has disposed of a right to acquire or dispose of whatever asset forms the subject matter of the option.  The good news is that on exercise of the option any charge arising on grant should be unwound – although this is not always the case.

Background

Notwithstanding the statutory position in respect of section 144, where it applies is clear:

1. where an option is granted by a UK grantor that grantor is treated as having disposed of an asset
2. as the grantor is unlikely to have a tax basis in the asset being disposed of a chargeable gain may arise on either the consideration paid for the grant or, in some cases, the market value of the option; and
3. if the option is subsequently exercised, any section 144 charge arising on grant should be unwound.

That all seems quite simple. However, in practice, it is anything but! The extent of any section 144 charge is highly fact specific; equally the mechanic for unwinding any section 144 charge on exercise is not always obvious, including where exercise occurs more than two years after the end of the accounting period in which the option was granted.

In practice, section 144 comes up more than may be expected. For instance, options may be issued as part of a corporate sales process or as part of security arrangements in banking / financing transactions.  Often we see “options” which may be labelled as something different –  warrants in restructuring or SPAC transactions are an obvious example.

When is an option not an option? – M Krishnamohan and another v HMRC

With that background, let’s turn to the recent decision of the UK First Tier Tax Tribunal (the “FTT”) in M Krishnamohan and another v HMRC.  In that case the FTT found for the taxpayers, holding that, despite the relevant agreement being labelled as an “option”, no option had been granted on this occasion.

Facts

The taxpayers wished to expand their property portfolio and entered into a number of agreements each entitled “option agreement” with a third party finance provider (the “TPFP”).  Under each of those agreements the taxpayers purportedly conferred an option on the TPFP to acquire certain of their portfolio of properties in exchange for the financing. However, the TPFP could only exercise the rights conferred by those agreements following the lapse of a 12-month option period if the taxpayers had not repaid certain amounts to the TPFP within that period. In other words, if the taxpayers paid the relevant amounts to the TPFP within the requisite period the rights would fall away.

The taxpayers repaid the required amounts to the TPFP within the requisite period with the result that the options were not (and were not capable of being) exercised by the TPFP.

HMRC argued that the agreements amounted to the grant of options within the scope of section 144 resulting in a UK tax charge. Conversely the taxpayers argued that the agreements (despite their title) did not amount to the grant of options for the purposes of section 144.

Decision

As mentioned above, the FTT found in favour of the taxpayers.

“Option” is not exhaustively defined in the legislation and the FTT looked at case law as well as referring to HMRC guidance. Despite the title of the agreements, the FTT found that the agreements did not grant an option to the TPFP within the meaning of section 144. The effect of the contractual language was that the taxpayers agreed to grant an option to the TPFP in 12 months’ time if, and only if, certain defined circumstances came to pass, with those circumstances (namely non-repayment of the relevant amounts) within the control of the taxpayers.

The FTT distinguished this situation from a scenario where an option was granted but not immediately exercisable. Although the FTT accepted that an option does not need to be immediately exercisable to trigger a section 144 charge, where the grant is dependent on a subsequent event, the FTT considered it relevant in deciding whether an option had been granted to look at whether the grantor can control the events which must occur for the grantee to have the relevant choice (i.e. to exercise or not exercise the option).  Here the FTT found that the taxpayers had control over those events.  Accordingly, the FTT found that no options were granted by the taxpayers pursuant to the agreements.

Final remarks

The Krishnamohan case highlights the importance of ensuring that section 144 has been appropriately considered as part of complex commercial arrangements. Where it is potentially in play taxpayers will need to be mindful of the arrangements and think through at least the following points:

1. What are the terms of the arrangements – has an “option” actually been granted? 
2. Could a right embedded in a wider instrument amount to an “option”?
3. Has a UK tax resident person granted the option?
4. Where the grantor is a company, what is the accounting treatment of the option – for instance, is the option accounted for as a derivative falling within the derivative contracts regime?
5. What consideration was paid for the grant of the option?
6. Do the market value rules apply so as to deem the consideration received by the grantor to be the market value of the option?
7. What is the exercise period (and is there a mandatory exercise / lapse)?
8. Are there any exceptions available to the section 144 charge?
9. Are any losses available to shelter any section 144 charge?