BlueCrest Capital Management is a very large international hedge fund. In 2020, it succeeded before the First-tier Tribunal (‘FTT’) in a case concerning the tax treatment of its profit-sharing arrangements in years up to 2013/14.
From 6 April 2014, the law on the taxation of LLPs changed very significantly with the introduction of the legislation on ‘salaried members’ of LLPs. And BlueCrest has been back before the FTT in [2022] UKFTT 204 (TC) arguing with HMRC about the application of the new rules. And, again, it has been (mostly) victorious – so far, at least.
A member of an LLP is caught by the new rules (and so treated for tax purposes as an employee of the LLP) if and only if three specified conditions (styled Conditions A, B and C) are all met. Before the FTT it was agreed that Condition C was met; but Conditions A and B were both in dispute. The FTT succinctly summarised them as follows:
‘Condition A is met if at the relevant time it is reasonable to expect that at least 80% of the amount paid by an LLP to an individual member is disguised salary. That includes amounts which are variable but vary without reference to the overall amount of the profits or losses of the LLP, or are not, in practice, affected by the overall amount of those profits and losses. Condition B is met if the mutual rights and duties of the members of the LLP do not give a member significant influence over the affairs of the LLP.’
Remuneration of members included
- A ‘priority distribution’ of a fixed amount (agreed to be ‘disguised salary’)
- A discretionary allocation of profit (accounting in every case for the bulk of the profit share)
- A share, allocated by reference to ‘income points’, of what was left after distributing the above (agreed not to be ‘disguised salary’)
The battleground was therefore the treatment of the discretionary allocation. If it wasn’t ‘disguised salary’ Condition A wasn’t met and BlueCrest was home and dry.
Some members were directly responsible for managing investment portfolios (‘portfolio managers’); others contributed to the success of the LLP in other ways (‘non-portfolio managers’).
For portfolio managers, the discretionary allocation of profit was based on the performance of the portfolio he or she managed, by reference to a formula agreed with the manager on joining the LLP (though there was debate as to whether the agreement conferred a legal entitlement). Of course, if the overall profit of the LLP were insufficient to cover all the proposed discretionary allocations, they would need to be reduced. But that did not, in the FTT’s view, mean ‘that the allocations are, essentially, variable and are computed by reference to, that overall profit.’ Rather, the allocations varied not by reference to the LLP profit but by reference to each manager’s individual performance: they were ‘disguised salary’.
For non-portfolio managers, discretionary allocation of profit was ‘less formulaic and more nebulous than that for the portfolio managers’ but there was ‘no evidence that either during the iterative process of establishing the preliminary discretionary allocation, nor during the process of the Board approving it and thus making it final, that the profits of the appellant were taken into account, other than to the extent that the Board was fettered by the accounting profits which had been reported for the relevant financial year.’ So, again, this was ‘disguised salary’.
However, that wasn’t an end to it. What about Condition B? Here it gets even more interesting.
In line with their published guidance, HMRC took the view that ‘significant influence’ means significant managerial influence – and furthermore, significant managerial influence over the affairs of the LLP as a whole rather than some aspects. HMRC considered that a member who generated a lot of income for the LLP would have ‘significance influence’ only if the financial contribution was reflected in what HMRC called ‘managerial clout’.
Not so, said the FTT. What the legislation as a whole is getting at is ‘to distinguish between members whose position is like that of a partner in a traditional partnership with those who are playing the role of employees.’ And in the context of Condition B, that requires examination of ‘the ongoing contribution, from an operational perspective, which a partner would make to that traditional partnership’s business.’ That, said the FTT, ‘extends well beyond solely managerial influence, and into the other aspects of a partner’s activities in a traditional partnership.’
On that basis, the FTT accepted that portfolio managers with a ‘capital allocation’ (roughly, funds under management) of $100 million or more (which in practice meant most members who were portfolio managers) would have the necessary ‘significant influence’. Non-portfolio managers, on the other hand, may have ‘assisted the portfolio managers to exercise their significant influence both collectively and individually’ but did not do so directly. Such ‘influence’ at second hand was not enough.
Thus, while both portfolio managers and non-portfolio managers met Condition A as being remunerated as to at least 80% with ‘disguised remuneration’, most of the portfolio managers did not meet Condition B and were therefore not caught by the ‘salaried members’ rules.
The amounts involved were substantial (National Insurance Contributions in dispute exceeded £55m); and the principles are novel. This case will surely go further.
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