HMRC has become increasingly assertive in seeking to apply income tax charges to returns that LLP members have viewed as capital or non-taxable in nature. This approach looks set to continue following last week's decision in The Boston Consulting Group (BCG) in which the Upper Tribunal (UT) held that a variety of anti-avoidance rules applied to a long-service remuneration scheme.
In BCG, individual members of an LLP were awarded special "interests" in the LLP which, broadly, on the occurrence of specified events (linked to long-service), would be sold to BCG Ltd (a corporate member of the LLP) for a price based on the value of shares in the global parent company (Boston Consulting Group Inc). Each year, 18% of the LLP's profits were allocated to BCG Ltd to fund the payments. The intention was that the eventual sale of the interests would be treated as a capital disposal (and benefit from entrepreneurs' relief).
In the First-tier Tribunal (FTT), HMRC had failed in its argument that the mixed member partnership (MMP) rules should apply to subject the individual members to income tax on the 18% profit share allocated each year to BCG Ltd. However, the FTT held that the individuals were subject to income tax on the payments made on the eventual sale of the interests under the "miscellaneous income" tax charge, or, if it were wrong on that, under the sales of occupation income anti-avoidance rules.
The UT, essentially, held that, given the very limited rights attaching to the special LLP interests, their sale was not a capital transaction. It then went on to consider the MMP rules.
For the MMP rules to apply, broadly, either the corporate member must have received an individual member's "deferred profit" or the individual must have the "power to enjoy" the corporate member's profit share. The UT (following the FTT) gave these conditions a wide (i.e. HMRC-friendly) reading, and concluded that they were both met. However, crucially, unlike the FTT, it held that a further requirement, the "counterfactual test", was satisfied.
The "counterfactual test", broadly, requires that it is reasonable to suppose that by virtue of the individual's deferred profit being allocated to the corporate member or the individual's "power to enjoy", both (i) the individual's profit share, and (ii) the individual's and corporate member's aggregate tax liability, are less than they otherwise would have been.
In essence, the FTT had held that, as the remuneration structure was part of a global Boston Consulting Group programme that was implemented (in different ways) worldwide, even if the specific LLP arrangements had not existed, the individuals would still not have received the 18%. Instead, a different commercially-similar structure would have been implemented. Therefore, the counterfactual test was not met. However, the UT took a different approach.
The UT held that it was not right to speculate on how the global business would have implemented the remuneration structure in the UK differently. Rather, all the LLP's profits have to be allocated somewhere, and if the 18% had not been allocated to BCG Ltd, it is reasonable to assume that it would have been allocated to the individuals.
For good measure, the UT confirmed that the miscellaneous income tax charge applied to payments received in tax years before the MMR rules were introduced, and that if it were wrong in relation to the MMP rules and/or miscellaneous income rules, the sales of occupation income rules would apply.
We are increasingly seeing HMRC invoke a variety of potential tax charges when attacking the capital or non-taxable treatment of LLP member returns. In this regard, it has had notable recent court success in applying the, previously rarely-used, miscellaneous income tax charge in a series of cases involving a fairly aggressive "special capital" remuneration structure used by hedge funds. In those cases, the courts (where they considered the point), generally, also had sympathy for alternative HMRC arguments based on the use of the sale of occupation income rules. The arrangements in BCG were, arguably, less aggressive and so HMRC will be heartened by the UT's agreement that both those tax charges applied. On top of that, HMRC will be pleased by UT's interpretation of the "counterfactual test", which increases the scope of the MMP rules.
That being said, the story may not be over. A Supreme Court decision in HFFX (one of the special capital cases) is due soon (although a taxpayer victory would be a surprise) and BCG may well be appealed.
