The Supreme Court on the UK’s Salaried Members Rules

The UK Supreme Court has dismissed the appeal by BlueCrest Capital Management (UK) LLP (“BlueCrest”) as regards the salaried members rules (and, in particular, as regards the application of Conditions A and B of those rules, as outlined below)¹.

The Salaried Members Rules – A Self-standing Test

The salaried members rules (found at sections 863A to 863G of ITTOIA 2005) will deem an individual member to be employed by his or her LLP for income tax and national insurance purposes if all of Conditions A to C are met. In essence, the three conditions are:

• Condition A: It is reasonable to expect that at least 80% of the LLP member’s remuneration for the performance of his or her services for the LLP is “disguised salary” (i.e., it is (a) fixed, or (b) variable, but without reference to the overall amount of the LLP’s profits or losses, or (c) will not, in practice, be affected by the overall amount of those profits or losses).
• Condition B: The member’s mutual rights and duties do not give them significant influence over the affairs of the LLP.
• Condition C: The member’s capital contribution to the LLP is less than 25% of “the disguised salary”.

Only if all of the above Conditions are met in relation to a particular member of an LLP will the salaried members rules apply and the member taxed accordingly. In other words, failing any one of the Conditions is enough to fall outside of the rules. 

Background

BlueCrest is a UK LLP that acts as sub-investment manager to a group of hedge funds. For the 2014 to 2019 tax years, HMRC determined that all but four of BlueCrest’s members (its original executive committee) met Conditions A to C and issued PAYE determinations of approximately £142 million and a Class 1 NICs decision of approximately £55.3 million in respect of the other members. BlueCrest’s individual members included portfolio managers and desk heads who took significant investment decisions but had only a limited formal role in the LLP’s governance, which was vested in its board and an executive committee.

BlueCrest appealed HMRC’s determination, arguing that certain of its members failed either or both of Conditions A and B. The First-tier Tribunal (“FTT”) held that all relevant members met Condition A, but that portfolio managers with capital allocations of at least $100 million and desk heads failed Condition B because they had significant influence over BlueCrest’s affairs, and the Upper Tribunal upheld that decision. The Court of Appeal agreed on Condition A but held that the tribunals had wrongly taken into account members’ informal, or de facto, influence when assessing Condition B, and remitted that issue for reconsideration by the FTT. BlueCrest appealed to the Supreme Court.

Condition B – Significant Influence

The Supreme Court held that qualifying influence for Condition B must derive from a member’s legally enforceable mutual rights and duties under the contractual and statutory framework governing the LLP, including rights traceable to the LLP agreement through delegated authority or appointment to a specific role. Informal or de facto influence arising from a member’s personal qualities, performance or business relationships does not qualify, even where that influence is real and/or significant in commercial terms.

The Supreme Court found that the words, “affairs of the partnership”, relevant to Condition B, carry their widest meaning, but the requisite influence must be exercised over those affairs viewed as a whole and is likely to be managerial or strategic in nature; day-to-day operational decision-making in relation to only part of the business will not suffice, even where that part is core to the LLP’s business. The Supreme Court also held, in the context of significant influence, that whilst “significant” does not mean control, it does mean influence which has commercial substance “in the real world”.

Applying these principles, the Supreme Court held that the First-tier Tribunal had erred by focusing on the portfolio managers’ and desk heads’ informal influence, derived from their personal qualities, performance and day-to-day investment activity, rather than examining the rights and duties conferred on them by BlueCrest’s LLP agreement, under which management and control was vested in the board and executive committee and individual members’ governance rights were minimal. The Supreme Court upheld the Court of Appeal’s decision to remit the Condition B issue to the FTT for reconsideration on the correct legal basis.

Condition A – disguised salary

BlueCrest argued that the discretionary allocations paid to portfolio managers and desk heads fell outside “disguised salary” because they were capped, in aggregate, by BlueCrest’s total profits for the relevant year, meaning, in effect, that they were varied with reference to the overall amount of the profits or losses of the LLP (and that, as such, Condition A could not be met).

The Supreme Court rejected this argument. Instead, it held that Condition A is designed to distinguish between remuneration that is typical of a partner, whose reward reflects a share of the firm’s overall profits, and remuneration that is typical of an employee. It held that a discretionary allocation calculated by reference to an individual’s or a team’s own profits, subject only to an overall cap based on the LLP’s total profits, was not enough to fail Condition A, notwithstanding that BlueCrest’s reading of the Condition found some support in a literal interpretation of the legislation. The Supreme Court accordingly upheld the tribunals’ and the Court of Appeal’s conclusion that all of the relevant members met Condition A.

It seems likely that, even if the remuneration of the BlueCrest partners had been found to be varied with reference to the overall amount of the profits of the LLP (paragraph (b) of Condition A), such remuneration could still have been disguised salary on the basis that it was not in practice affected by the overall amount of the LLP profits (paragraph (c) of Condition A) although this point was not directly addressed by the Supreme Court.

Takeaways

BlueCrest is a big win for HMRC on the meaning of “significant influence”: LLPs cannot rely on a member’s de facto or informal influence, however real in commercial terms, to keep that member outside the salaried members rules, and must instead look to the rights and duties conferred by the LLP agreement and other enforceable sources.

LLPs whose members hold significant operational responsibility but limited constitutional governance rights should revisit their LLP agreements and governance arrangements in light of this decision, as HMRC is expected to increase scrutiny of compliance with the salaried members rules following this judgment.

The decision also confirms that discretionary remuneration calculated by reference to an individual’s own performance will generally constitute disguised salary for Condition A purposes, even where subject to a firm-wide cap. It reconfirms that a “top down” approach to allocation of profits (which starts with the firm’s total profits) is likely to be safer than a “bottom up” approach (which starts with individual performance).