In a recent series of cases, HMRC has successfully argued that amounts paid to managers under a remuneration planning arrangement should be subject to income tax as "miscellaneous income". In HMRC v BlueCrest Capital Management LP and other, we now have the Court of Appeal's take on the issue, and it too has supported HMRC's view.
Broadly, under a partner incentivisation plan put in place by the hedge fund BlueCrest, a company was made a partner of the fund management partnership and received profit share that would previously have gone directly to individual partners. The company paid corporation tax on the profits and contributed the net amount back to the partnership as "special capital". Provided certain conditions were met, the company would, in due course, exercise a discretion to re-allocate the special capital to the relevant individuals.
There were commercial reasons for implementing the plan (e.g. it facilitated deferring remuneration), but it was also intended to give rise to a tax benefit, as BlueCrest took the view that the award of special capital to the individuals was not taxable.
Both the First-Tier Tribunal (FTT) and Upper Tribunal (UT) considered that the amount paid to the individual managers should be taxed as "miscellaneous income". The courts have also concluded that the miscellaneous income tax charge applied to very similar special capital schemes in Odey Asset Management LLP v HMRC (FTT) and HFFX LLP and others v HMRC (FTT and UT).
The Court upheld the lower courts' acceptance of HMRC's view that the "special capital" re-allocated to the individual partners should be taxable as miscellaneous income.
In doing so, the Court held that the special capital re-allocation should, despite its name, be seen as income rather than a transfer of partnership capital or assets – pointing to its economic substance, which it considered to be a form of deferred and contingent reward to the participating partners for their work.
The Court also considered that the requirement that the income must arise from an identifiable "source" was satisfied. It agreed with the UT that the source was the exercise by the corporate partner of its discretion to make the awards.
Although the miscellaneous income charge has been on the statute book for a long time, it has generally been considered fairly limited in scope, and, prior to its use to challenge "special capital" planning, not typically employed by HMRC to tax asset manager remuneration. The Court's decision, however, appears to indicate that the necessary conditions for the charge to arise are far easier to satisfy than many previously thought, in particular the "source" requirement.
The "special capital" planning was fairly aggressive from a tax perspective, so the courts' willingness to counter it with the miscellaneous income rules is not entirely surprising. However, fund managers (and others) will be concerned that HMRC will see the special capital cases as a proof of concept for the use of those rules, and could use them to challenge more anodyne arrangements.
Even if BlueCrest does not appeal the decision to the Supreme Court, we may not have come to the end of the story – the Court of Appeal hearing for HFFX is scheduled to be held by July next year and we expect the miscellaneous income point to be raised. However, with all six of the previous tribunal and court decisions having sided with HMRC, taxpayers are unlikely to be particularly optimistic.
