Large LLPs ‘likely to be concerned’ by decision broadening scope of anti-avoidance tax rules

Hatice Ismail, a funds tax expert at Pinsent Masons, was commenting after the Court of Appeal published its decision in a case involving anti-avoidance tax rules applicable to LLPs. Overturning previous tribunal decisions, the court upheld HMRC’s appeal that the rules apply, determining that condition B – the “significant influence” test should be interpreted narrowly – ultimately broadening the scope of the rules.

Where the rules apply, affected LLP members are considered to be employees for tax purposes and therefore, should be paid through the PAYE system with income tax and National Insurance contributions (NICs) deducted prior to payment. The LLP is also required to pay employer NICs – currently at 13.8%, but increasing to 15% from April – on payments to those members. Generally, LLP members are paid on a self-employed basis and employer NICs are not payable, so falling within the rules could be costly for an LLP.

The rules apply to an LLP member where three conditions are met: that it is reasonable to expect that at least 80% of the individual’s total remuneration should be deemed to be “disguised salary” (‘condition A’); that the individual doesn’t have significant influence over the affairs of the partnership (‘condition B’); and that the individual’s capital contribution to the partnership is less than 25% of their expected “disguised salary” (‘condition C’).

The appeal concerned condition B. The court held that whether an individual has a “significant influence” over the affairs of the partnership should be narrowly interpreted and must derive from the legal rights and duties of members conferred by the statutory and contractual framework governing the operation of the LLP – primarily, the partnership agreement. The court also held that the scope of significant influence should be limited to strategic influence over the “affairs of the partnership” generally and viewed as a whole – with the affairs of the partnership in this context being wider than only the business of the partnership.

Ismail said “By focusing on the source of the members’ influence, most commonly the partnership agreement – the court had narrowed the interpretation of condition B. Any LLPs that currently rely on members “failing” condition B to fall outside of the salaried members rules need to carefully consider the scope of the legal rights, powers and duties documented in their partnership agreements to check that they reflect the ability of members to exercise significant influence over the partnership’s affairs as a whole as interpreted by the court, whilst taking care to ensure that what is documented is appropriate, not artificial.”

In the case, Bluecrest Capital Management provided investment management services, whilst also delivering back-office services to entities across the Bluecrest group. Broadly, Bluecrest’s individual members consisted of portfolio managers who ran the investment portfolios and non-portfolio managers who performed the other services. Most portfolio managers were allocated varying amounts of capital, to invest at their discretion on behalf of clients, whilst non-portfolio managers did not receive capital allocations.

Portfolio managers were paid by way of a discretionary allocation based on a percentage of profits made on their individual investment portfolios. A different payment mechanism was used for the non-portfolio managers. It was accepted as fact that condition C was met. The court held that the discretionary allocations to all relevant members were disguised salary and therefore condition A was also met, resulting in the application of the salaried members rules turning on whether condition B was met. On the basis of its narrow interpretation of condition B, the court held that all but four of the individual members fell within the rules and should be taxed as employees, with employer NICs due by the LLP on payments to those members.

The outcome for Bluecrest is currently unclear. The Court of Appeal held that the case should be remitted back to the First-Tier Tribunal for re-hearing using the court’s narrow interpretation of the “significant influence” test. It is also possible that Bluecrest will seek permission to appeal to the Supreme Court to overturn the decision entirely.

Tax disputes expert Steven Porter of Pinsent Masons said, “Given the amount of tax involved – estimated at approximately £200m – it wouldn’t be unsurprising if Bluecrest decided to appeal. In the meantime, there will be many LLPs facing significant uncertainty about the extent to which the rules may apply to members. HMRC has already raised a large number of enquiries on this very issue and this decision will no doubt embolden HMRC to progress these further. Any firm with such an enquiry, or concerns they may receive one, should seek professional advice.”