Bluecrest - Court of Appeal Narrows “Significant Influence” Test for LLP Salaried Member Rules

The Court of Appeal has taken an unexpectedly narrow and highly consequential interpretation of the significant influence test (Condition B) of the LLP salaried member rules in HMRC v Bluecrest Capital Management (UK) LLP. The judgment may have significant adverse consequences for many LLPs and their members currently relying on Condition B.

In summary:

• At least one of the three conditions in the salaried member rules must be “failed” for an LLP member to be respected as self-employed (and not a “salaried member”, treated as an employee for UK tax purposes).
• One of the conditions, Condition B, is that the member does not have significant influence over the affairs of the LLP. In other words, a member will not be a salaried member if they do have significant influence over the affairs of the LLP.
• The lower courts (and, in some respects, HMRC) previously took the view that de facto influence over part of a business (for example, a portfolio manager having actual financial influence) could, depending on the precise facts of the case, qualify as significant influence.
• The Court of Appeal has overturned the decisions of the First Tier Tribunal¹ and Upper Tribunal², surprisingly ordering the case to be remitted to the First Tier Tribunal to be decided again based on the Court of Appeal’s interpretation of the legislation. It has determined that:

o Influence must derive from, and have its source in, the legally enforceable mutual rights and duties of LLP members (i.e., pursuant only to statutory rights and/or contractual rights via the LLP agreement) (“qualifying influence”); and

o The significance of that “qualifying influence” can nevertheless be assessed by reference to de facto influence, which is otherwise “non-qualifying influence”.

• In another reversal of the decision of the lower courts, the Court of Appeal stated that significant influence must be over the affairs (wider than just the business) of the LLP as a whole and not in part i.e. those responsible for decision-making at an overall strategic level.
  
  
• In the light of this judgment, LLPs and their members relying on Condition B should ensure that their governance arrangements are clearly enshrined in their LLP deeds and may wish revisit salaried member analyses to ensure that members are being taxed appropriately under the salaried member rules. However, it is likely that Bluecrest will seek to appeal to the Supreme Court, in addition to the case being sent back to the First Tier Tribunal, so certainty in this area is unlikely to be forthcoming for some time.

Salaried Member Rules

Somewhat counterintuitively, in order to be treated as self-employed for tax purposes (i.e., to not be a “salaried member”), an LLP member must fail at least one of three conditions:

Condition A is that it is reasonable to expect that at least 80 percent of amounts allocated to an individual are “disguised salary”. “Disguised salary” is remuneration which is (i) fixed; (ii) variable without reference to the overall profits/losses of the LLP as a whole; or (iii) not in practice affected by the overall profits/losses of the LLP.

Condition B is that the mutual rights and duties of LLP members and the LLP and its members do not give the LLP member “significant influence” over the affairs of the LLP.

Condition C is that the LLP member’s capital contribution is less than 25 percent of the expected “disguised salary” payable for the tax year.

Significant Influence (Condition B)

It has long been HMRC’s practice that the applicable LLP agreement is the starting point for an analysis of significant influence. However, it was accepted that the practical operation of the LLP also plays a part in deciding whether an LLP member fails Condition B.

Although this was common ground between Bluecrest and HMRC, the Court of Appeal decided that the parties and the lower courts had failed to appreciate that it is, specifically, the “mutual rights and duties” of LLP members that must confer significant influence under the rules. Influence must therefore derive only from the legally enforceable statutory or contractual framework governing the rights and duties of members – most commonly, the LLP agreement (or in the absence of one, the default rules in the Limited Liability Partnerships Act 2000). It was found to be unhelpful that Bluecrest’s LLP agreement contained an entire agreement clause which prevented verbal or implied agreements outside the LLP agreement itself from having legal enforceability.

The Court found that practice (the “facts on the ground”) could nevertheless inform the analysis whether the influence was “significant”. Following the judgment, there is therefore now a two-stage test for significant influence:

1. Does the member have influence over the affairs of the LLP, as a whole, which derives from the legally enforceable mutual rights and duties of the LLP members (“qualifying influence”)?

2. Is that influence significant, having regard to qualifying influence but also other factors such as the practical operation of the LLP and third parties (“non-qualifying influence”)?

In another reversal of the decision of the lower courts, the Court of Appeal stated that significant influence must be over the affairs (wider than just the business) of the LLP as a whole and not in part. It therefore appears that other activities seen as capable, in isolation, of giving rise to significant influence by the Upper Tribunal, such as financial and operational clout, may no longer be sufficient. It remains to be seen to what extent such factors may nevertheless inform the wider “significance” analysis if they contribute to influence over the LLP as a whole. Condition B therefore remains a highly fact-specific analysis.

As in the lower courts, the Court of Appeal declined to put a particular gloss on the meaning of “significant”, while noting that this means “more than insignificant, and which has practical and commercial substance in the conduct of those affairs in the real world”.

To give a practical example of the impact of this decision, the Upper Tribunal held that Bluecrest members who were portfolio managers managing US$100m or more had significant influence over the affairs of the LLP by virtue of the financial significance of such books to the LLP’s business. In contrast, per the Court of Appeal, such members do not have significant influence since their influence is not “qualifying influence” nor over the affairs of the LLP as a whole.

Comment

The Court of Appeal’s judgment is an unexpected and very significant departure from both HMRC's published interpretation and the market’s approach to Condition B to date, and from the broader interpretation endorsed by the lower courts. The emphasis on “mutual rights and duties” ascertained only by contractual agreement or legislation represents a fundamental change to the approach to influence which may be impossible to square with market practice as to the day-to-day management and business of asset management LLPs and the typical drafting of LLP agreements. The judgment will be hugely concerning to many LLPs and their members and, understandably, taxpayers will be confused as to how it can possibly be that the court has determined that the significant influence test is even narrower than HMRC’s narrowest interpretation.

Those who were hoping for greater certainty following this chapter of the Bluecrest case will be disappointed. Instead, there remains uncertainty for taxpayers seeking to rely on Condition B pending the First Tier Tribunal’s application of the Court of Appeal’s interpretation to the facts, and Bluecrest’s presumed appeal to the Supreme Court. A judicial review by Bluecrest also remains stayed while these proceedings continue. A final outcome should not be expected any time soon!

Whilst it may be premature to amend existing arrangements in the light of this decision, LLP businesses with members relying on Condition B may wish to revisit their LLP agreements to ensure that governance practices are enshrined (for example with respect to the role of the managing member or management committee) as legally binding arrangements. They may also wish to look again at Conditions A and C.

In view of this narrower interpretation of Condition B, where increased reliance is placed on Conditions A and/or C, it is important to bear in mind HMRC’s ongoing review of the controversial changes to its Condition C guidance published in February 2024 which suggest that a member will be unable to rely on Condition C if, for example, annual adjustments are made to the member’s capital contribution in order to continue to meet the 25 percent threshold as the member’s remuneration changes.