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Tribunal publishes first detailed decision on salaried members rules

Overview

The salaried members rules were introduced in 2014 to counter situations where UK limited liability partnerships (LLPs) were avoiding employment taxes by making junior workers members (rather than employees) without bearing the risks, rewards and responsibilities typically associated with partnership. Under the rules, members of an LLP are treated as  employees for tax purposes, unless one of three exclusions apply. However, until now, we have not had a court decision considering their application in detail. This is important as, in the absence of judicial consideration, businesses have had only HMRC's guidance to go on when considering the rules and, unsurprisingly, this takes the view that the exclusions should be interpreted narrowly. 

The First-tier tribunal (FTT) has just published its decision in Bluecrest Capital Management (UK) LLP v HMRC, the first case to look in detail at the salaried member rules.   

Background

Bluecrest was a UK LLP that provided investment management and certain other back-office services.  It had various individual members, some of whom were fund managers or traders (Managers) and some of whom carried out other functions (non-Managers).  Managers were given capital to invest on behalf of clients, with more senior members being given larger amounts.  HMRC challenged, under the salaried members rules, the position of both Managers and non-Managers.

Disguised salary

A key element of the member's remuneration took the form of a "discretionary allocation".  One of the exclusions from the salaried members rules is, broadly, that more than 20% of the individual's pay is not "disguised salary".  The concept of disguised salary is getting at amounts that look like the reward of an employee rather than a true partner (i.e. a part owner of the business).  Amounts that are variable by reference to the overall profits or losses of the LLP are not, therefore, disguised salary. The Managers' discretionary allocation was a percentage of the profit they made on their individual portfolio less costs and HMRC successfully argued that, as it was based on the individual's personal performance (and not that of the LLP as a whole), it was disguised salary.  However, HMRC may consider that their victory on this point came at a cost.  The FTT's view was that the fact that the allocation would only be paid if the LLP had enough overall profits to pay it was not enough to satisfy the link between the allocation and overall LLP profits and losses, but it made clear that the threshold for the link to profits is a "low one". 

HMRC succeeded in relation to the non-Managers on the basis that the non-Managers had not produced enough evidence to satisfy the burden of proof that their discretionary allocation was calculated by reference to the overall profitability of the LLP.

Significant influence

A further exclusion from the rules is if the member has "significant influence over the affairs of the partnership".  HMRC argued that this required managerial influence over all the affairs of the LLP, but the FTT disagreed.  Essentially, the FTT took the view that, as the purpose of the rules is to distinguish between individuals who would have been partners in a traditional partnership and those who are effectively employees, the question is whether the relevant individual has traditional partner-like influence.  This is not confined to managerial influence and does not need to extend to the whole business.  This was good news for some of the senior Managers as, on the facts, the FTT considered that those allocated at least $100m to invest and desk heads had influence akin to that of a partner in a traditional partnership. 

In relation to the non-Managers, the FTT held that Bluecrest had not established on the balance of probabilities that they had significant influence.  Here, the FTT seemed more sympathetic towards individuals profitably supplying back-office functions to other members of the Bluecrest group than to those carrying out internal back-office functions for the LLP itself.  This was on the basis that the roles undertaken by those in the latter category were not those which would necessarily have been undertaken by partners in a traditional partnership.  The FTT indicated that the high profitability of the intra-group supplies could mean that those involved in them had significant influence (as financial contribution was expressly said to be relevant), albeit not enough evidence was produced on the point to discharge the burden of proof. 

Those carrying out internal back office functions may be disappointed by this element of the decision and hope that a future court takes a slightly more nuanced approach - having regard to the particular sector in which the LLP operates.  For example, heads of certain back office functions (e.g. risk and finance) may be more likely to have partner equivalent status in asset management houses than other businesses.

The targeted anti-avoidance rule

The salaried members rules contain a provision which requires that arrangements that have a main purpose of avoiding them are to be disregarded.  In 2014, shortly before the rules were introduced, Bluecrest took the view that they would not apply to discretionary allocations provided that they would not be paid out if LLP overall did not have enough profits.  To ensure that this would be the case, the board of the LLP passed resolutions preventing discretionary allocations exceeding relevant available profits.  As discussed, above, the FTT disagreed that capping allocations by reference to available profits prevented them from being disguised salary.  However, in case it was wrong on that point it considered whether the anti-avoidance provision would prevent the 2014 arrangements from having effect, and held that they would.  

The judgment on this point is very brief, but raises the question of what level of restructuring to fall within one of the exclusions the courts would respect as not triggering the anti-avoidance rule.  In their guidance, HMRC accept that a genuine and long-term restructuring that causes an individual fall within one or more of the exclusions is not problematic.  It appears that HMRC did not think that the 2014 arrangements were substantive enough, and, on the facts, that is understandable.  However, it would have been helpful if the FTT had explained why, if the arrangements had had the effect of making member's pay truly variable, they would have been disregarded and, more generally, the parameters of the anti-avoidance rule.

Further thoughts

The decision contains a helpful first judicial insight into how a number of the provisions of the salaried members rules should be interpreted and, on the whole, is favourable for taxpayers.   

In the context of significant influence, the focus on whether an individual is carrying out the sort of activities that a partner in a traditional partnership would carry out, is noticeably different from HMRC's current narrower and more literal approach which looks at the LLP in isolation.  That being said, at this stage, taxpayers may be wary of taking positions different from that set out in HMRC's guidance given that FTT decisions are not binding precedent (and this one may be appealed).  

In addition, for those looking to rely on either the "significant influence" or "non-disguised salary" exclusions, the decision shows the need to have appropriate evidence for each member.  

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