Taxation of UK LLP Members

Summary

The Supreme Court has dismissed BlueCrest’s appeal on the UK’s salaried members rules for LLPs. The decision is unlikely to surprise taxpayers following last year’s Court of Appeal judgment. HMRC succeeded on both Condition A (disguised salary) and Condition B (significant influence). The question whether particular BlueCrest members satisfy Condition B will now return to the First-tier Tribunal, applying the legal test laid down by the appellate courts.

The judgment’s broader significance lies in the Supreme Court’s development of the analysis of Condition B. It confirms that the enquiry is not simply whether a member exercises significant influence, but first whether that influence derives from the legally enforceable rights and duties of the LLP and its members, and only then whether that legally derived influence is sufficiently significant.

The decision also carries wider import. It illustrates both the courts’ preference for objective statutory tests capable of prospective application and the limits of relying on HMRC guidance where that guidance proves inconsistent with the legislation.

Background

Members of UK LLPs are generally treated as partners, rather than employees, for UK income tax and national insurance contribution purposes.

The salaried members rules were introduced in 2014 in response to concerns that LLP structures were being used to avoid employer National Insurance contributions by admitting individuals as LLP members who, in substance, had employee-like relationships with the LLP.

The rules apply only where all three statutory conditions are met:

• Condition A – at least 80% of the member’s expected remuneration is “disguised salary”;
• Condition B – the member does not have significant influence over the affairs of the LLP; and
• Condition C – the member’s capital contribution is less than 25% of expected disguised salary.

The three conditions were intended collectively to capture the principal characteristics traditionally associated with partnership: participation in profits, contribution of capital and participation in management. A member remains taxed as a partner if any one of those conditions is not satisfied.

The BlueCrest Litigation

The appeal in summary

There was no dispute that Condition C was satisfied.

Condition A

BlueCrest argued that remuneration paid to portfolio managers and desk heads was sufficiently linked to the LLP’s overall profits because the LLP’s total profits operated as a cap on the discretionary allocations ultimately payable. The First-tier Tribunal, Upper Tribunal, Court of Appeal and Supreme Court all rejected that argument. The courts held that remuneration calculated principally by reference to an individual’s own performance, or that of the individual’s desk, rather than by reference to the overall profits of the LLP, remained disguised salary notwithstanding the existence of an overall profit cap.

Condition B

The litigation followed a more interesting course. The First-tier Tribunal concluded that certain desk heads and senior portfolio managers exercised significant influence because, viewed realistically, they had substantial influence over BlueCrest’s business. The Upper Tribunal agreed.

Importantly, both HMRC and BlueCrest accepted before those tribunals that the relevant influence did not need to derive from the LLP’s constitutional arrangements. HMRC’s published guidance likewise directed taxpayers to consider not only the LLP agreement but also how the LLP operated in practice.

The Court of Appeal rejected that common ground. It held that only influence deriving from the mutual rights and duties of the LLP and its members could satisfy Condition B and remitted the case to the First-tier Tribunal to apply that legal test. The Supreme Court has now affirmed that approach while substantially developing the framework for analysing Condition B.

The judicial review

BlueCrest has also brought judicial review proceedings challenging HMRC’s application of the salaried members rules. Those proceedings were stayed pending the outcome of the tax appeal. Following the Supreme Court’s judgment, it must now be expected that the judicial review will resume. Depending on the issues that remain in dispute, the proceedings may provide further guidance on the extent to which taxpayers can rely on published HMRC guidance where that guidance is subsequently found not to reflect the legislation.

The Supreme Court judgment in detail

A two-step analysis for Condition B

The Supreme Court’s principal contribution is not the outcome of the appeal but its analytical framework.

Condition B[1] asks whether the mutual rights and duties of the LLP and its members give a member significant influence over the affairs of the LLP. The judgment makes clear that Condition B requires two distinct enquiries. The first is whether the member’s influence derives from the legally enforceable rights and duties governing the LLP and its members. Only if that question is answered affirmatively does the second question arise: whether that legally derived influence is sufficiently significant.

The Supreme Court has therefore distinguished between the source of a member’s influence and the extent of that influence. Commercial importance alone cannot satisfy the first stage. However, once the source of the influence has been identified, the practical exercise of that “qualifying influence” must be analysed to determine whether it is sufficiently significant.

The Supreme Court helpfully clarified that legally derived influence is not confined to powers expressly contained in the LLP agreement itself. It may arise through delegated authority, committee appointments or formal governance arrangements, provided those arrangements ultimately derive from the LLP agreement or another legal source.

Why did the Court reach that conclusion?

The judgment is notable because Condition B itself does not expressly refer to “legally enforceable” rights and duties.

The Supreme Court reached that conclusion by reading Condition B in its statutory context, particularly section 5 of the Limited Liability Partnerships Act 2000, which uses substantially similar language when describing the mutual rights and duties of LLP members.

The Court was also strongly influenced by the need for certainty. The salaried members rules are intended to operate prospectively. A test rooted in legally identifiable governance rights provides a more objective framework capable of prospective application than one based on identifying who carries a more nebulous concept of influence within a business.

Takeaways

Beyond BlueCrest: HMRC guidance and the wider lesson for UK taxpayers

In recent years, UK tax legislation has increasingly been drafted in broad, principles-based terms, leaving many questions of practical application to HMRC guidance.

HMRC’s published guidance on Condition B directed taxpayers to examine not only the LLP agreement but also how the LLP operated in practice. Both HMRC and BlueCrest adopted that analytical framework throughout much of the litigation. The Court of Appeal nevertheless concluded that the guidance did not reflect the legislation, and the Supreme Court has now confirmed that conclusion.

The lesson extends well beyond the salaried members rules. Where UK taxpayers implement transactions or structures in reliance on published HMRC guidance, they should consider recording that reliance contemporaneously – for example in board minutes or equivalent governance records. Although HMRC guidance cannot alter the meaning of the legislation, evidence of reliance may become important if HMRC later departs from its published position or if judicial review proceedings become necessary.

Practical implications for LLPs

Many LLPs that rely on members failing Condition B will have been reviewing their governance arrangements since the Court of Appeal’s decision. The Supreme Court’s judgment does not fundamentally change the direction of travel, but it provides a clearer analytical framework and greater certainty as to the issues that LLPs should address.

In particular, LLPs should review their constitutional documents and governance arrangements with the following points in mind:

• The legal source of members’ influence. The Supreme Court has confirmed that the relevant influence for Condition B must derive from legally enforceable rights and duties. LLPs should therefore review their LLP agreements and other governance documents to identify the legal source of each member’s authority. Where reliance is placed on Condition B, the LLP agreement should clearly identify the roles, responsibilities and decision-making powers that are said to give members significant influence.
• Delegated authority. The judgment makes clear that qualifying influence need not be expressly set out in the LLP agreement itself. It may arise through delegated authority or formal appointments made pursuant to powers contained in the LLP agreement. LLPs should therefore review board delegations, committee terms of reference, role descriptions and appointment documents to ensure that delegated authority is clearly documented and capable of being traced back to the LLP agreement or another legal source.
• Reserved powers. Many LLPs that form part of wider groups reserve strategic decisions or veto rights to a corporate member or parent entity. The Supreme Court helpfully confirmed that significant influence over the affairs of an LLP can “accommodate the existence of reserved powers.” Nevertheless, LLPs should consider whether extensive reserved matters, or the ability of a corporate member to make key decisions unilaterally, effectively deprive individual members of significant influence.
• Boards and executive committees. The governance structure adopted by an LLP is likely to assume greater importance following BlueCrest. Where day-to-day management and strategic decision-making are concentrated in a board or executive committee, members outside those bodies may find it more difficult to demonstrate significant influence. That does not mean that only board or committee members can satisfy Condition B. However, LLPs should consider whether the legal basis on which other members participate in decisions affecting the LLP as a whole is sufficiently clear.
• Influence over the affairs of the LLP as a whole. The Supreme Court confirmed that Condition B is concerned with influence over the affairs of the LLP viewed holistically, rather than operational responsibility for a particular business line or function. LLPs should therefore consider whether members participate in decisions affecting the business of the LLP generally, rather than merely exercising authority within their own practice area, portfolio or operational function.
• Different categories of members. LLPs with a clear distinction between senior and junior members should not assume that the same analysis will apply across the membership. Senior members may participate in governance or strategic decision-making in ways that junior members do not. Equally, LLPs with a large number of members may find it more difficult to demonstrate that each member has significant influence over the affairs of the LLP as a whole. The analysis should therefore be undertaken on a member-by-member basis rather than assuming that one conclusion applies across the partnership.

Conclusion

BlueCrest establishes a two-step analysis for Condition B. A member must first be able to point to legally conferred rights and duties that give rise to influence. That “qualifying influence” must then be sufficiently significant. Commercial importance, however real, cannot supply the first requirement, although it may be relevant when assessing the second.

The judgment also carries two broader lessons.

First, it is a reminder that HMRC guidance, while often an indispensable aid to understanding and applying complex tax legislation, is not law. Taxpayers should continue to have regard to published guidance, but where significant amounts are at stake they should also test that guidance against the statutory language and record contemporaneously where they have relied upon it. BlueCrest demonstrates that even long-standing HMRC guidance, accepted by both HMRC and taxpayers, may ultimately be held not to reflect the legislation.

Secondly, the case illustrates the willingness of the appellate courts to develop their own analysis of tax legislation rather than confining themselves to the competing arguments advanced by the parties. The decisive step in the litigation – the distinction between the legal source of a member’s influence and whether that influence is sufficiently significant – did not originate in the parties’ submissions before the tribunals, but in the Court of Appeal’s own analysis, subsequently developed by the Supreme Court. The decision is therefore a reminder that, in tax litigation, courts may adopt interpretive approaches that differ materially from those advanced by either HMRC or the taxpayer.