30 Jan 2024

BlueCrest: careful what you wish for?

Insights, Publications

The arrangement implemented by BlueCrest Capital Management, on which the Court of Appeal ruled in [2023] EWCA Civ 1481, has been overtaken by legislation as long ago as 2014.  But (as well as reminding us of how long it may take to bring a case to court) the decision warns us again that planning aimed at reducing tax can have the opposite effect.

BlueCrest is and was a private investment firm.  It was run as a partnership.  It was decided that a part of each partner’s annual share of profit should initially be allocated only provisionally, with allocation being finally confirmed only some time later if specified conditions were met.  Meanwhile the profit was allocated to a ‘Partner Incentivisation Plan’ (‘PIP’).  This was ‘to incentivise the partners to remain with BlueCrest, in a highly competitive market, for periods of between six months and three years; to discourage excessive risk-taking; and to permit account to be taken of the partners’ subsequent performance before awards under the PIP were finalised.’  An impeccably commercial motivation, as HMRC fully accepted.

The mechanism by which the PIP operated was to allocate the relevant shares of profit to a corporate member of the partnership created for the purpose, which then applied those amounts to subscribe for ‘special partnership capital’. In due course, if the relevant conditions were met (as they were for some 84% of the awards covering about 97% of the value) the relevant slice of ‘special partnership capital’ was transferred by the corporate member to the relevant partner.

Tax returns were filed on the basis that the corporate member was liable to tax on the share of profit allocated to it, and that any subsequent allocation of ‘special partnership capital’ was tax-free.  HMRC demurred.

The law says that a partner’s share of a partnership’s taxable profits for a period is determined by reference to the rights of the partner to share in the (actual, commercial) profits for the period.

HMRC’s main argument was that on a purposive construction of the legislation, the partner’s ‘share of profit’ for a period included the amount allocated provisionally (regardless of whether that amount was subsequently forfeited or was followed by an allocation of ‘special partnership capital’).  The taxpayers argued that it was not possible to go behind the allocation of profit to the corporate member:  the subsequent award of ‘special partnership capital’ was simply not a share of trading profit.

The Court of Appeal upheld the decision of the Upper Tribunal in favour of the taxpayer: ‘It seems to me impossible to escape the conclusion that, during the years when the PIP operated, the agreed division of the trading profits of the relevant partnership was between the individual partners and the corporate partner, in the shares finally determined by the Board.’  HMRC’s argument involved an impossible rewriting of the contractual position.

But what about the tax treatment of the subsequent supposedly tax-free allocation of ‘special partnership capital’?  HMRC argued that, even if the awards were not a share of trading profit share, they were nonetheless taxable under the ‘sweeping-up’ provision (ITTOIA s687(1)) as ‘income from any source that is not charged to income tax under or as a result of any other provision of this Act or any other Act’.

That required it to be shown both that the award had the nature of ‘income’ and that it arose from a ‘source’.

The Court of Appeal agreed that both requirements were met.

As regards ‘income’: If the partnership was the tree, the deferred PIP award was part of the fruit which the partner derived from his membership of the partnership and his exertions on its behalf during the relevant accounting period.

As regards ‘source’: I therefore see no difficulty in holding that a source for the final PIP awards may be found in the exercise by the corporate partner of its discretion whether or not to follow the recommendations of the Board.

The unfortunate outcome thus seems to have been that the total tax payable was more than if BlueCrest had simply acquiesced in HMRC’s main argument, or if the arrangement had involved the corporate member’s distributing to partners via some form of equity participation rather than making the aspirationally-tax-free ‘special partnership capital’ allocation.  As it was, the corporate member will have suffered corporation tax on the allocation of profit and the individual allocatee will have suffered income tax at full rates on the subsequent PIP award.

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