Bluecrest - UK Supreme Court Confirms Interpretation of the LLP Salaried Member Rules

The UK Supreme Court has handed down its judgment in HMRC v Bluecrest Capital Management (UK) LLP, dismissing Bluecrest’s appeals. The judgment follows the lower courts’ approach to “disguised salary” (Condition A) but offers a more practical and workable version of the Court of Appeal’s interpretation of significant influence (Condition B).

Firms with members currently relying on Condition B should review their arrangements against the narrower test now confirmed by the Supreme Court, and may need to reassess their position on all three conditions to assure themselves of their members’ position in relation to these rules.

Although this case settles the legal test for Condition B, its application to the facts in Bluecrest has been remitted to the First-Tier Tribunal (FTT). In addition, while these proceedings have been ongoing, related judicial review proceedings have been stayed. These will likely give rise to further developments in due course.

Main Insights

• Legally enforceable rights and duties: Confirming the Court of Appeal’s novel approach to Condition B, influence only qualifies if it can be traced back to the legally enforceable mutual rights and duties of members. Informal, de facto or external influence (however significant in practice) is excluded. That said, contractual influence still needs to be backed up by commercial reality to be “significant”.
• Practical guidance offered on influence: With a focus on certainty for taxpayers and HMRC, the Supreme Court has commented on the correct approach to various matters of practical concern such as delegation, reserved matters, entire agreement clauses and rights to information. The approach is somewhat broader, and more workable, than the position put forward by the Court of Appeal but will still be challenging in many cases.
• Strategic/managerial vs operational influence: Significant influence must be at a strategic or managerial level. Operational or day-to-day management does not suffice. For example, it will be challenging for portfolio managers who do not have other strategic roles to be on the right side of Condition B.
• Condition A: Consistent with all of the lower courts’ decisions, the Supreme Court also found that in looking at whether remuneration varies by reference to the profits of the LLP as a whole, it is insufficient for the LLP’s total profits to simply function as a cap on individual performance-based discretionary awards. A stronger link to LLP profits is needed.

Salaried Members Rules

By way of a brief reminder, in order to be treated as self-employed for tax purposes (i.e., to not be a “salaried member” taxed as an employee), 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 that 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    the LLP and its members do not give the  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.

The Bluecrest case has been concerned with Conditions A and B.

Condition B

The FTT and Upper Tribunal tested Condition B on the basis that de facto influence could form the basis of a member’s significant influence. As such, the tribunals found that portfolio managers with capital allocations of US$100 million or more had significant influence over the LLP’s financial performance and therefore failed Condition B. This approach is broadly in line with HMRC published guidance on the application of Condition B.

The Court of Appeal held that the FTT had erred in law by taking into account informal, de facto influence rather than confining its analysis to influence derived from the legally enforceable rights and duties of members. Being commercially important to the success of the LLP (for example, being a key portfolio manager or revenue generator) does not, of itself, indicate significant influence.

Developing the Court of Appeal’s approach, the Supreme Court has set out the test for influence as follows:

• First, consider what the LLP does in carrying on its business.
• Second, consider whether the member is given a voice in decisions affecting the affairs of the LLP as a whole by virtue of contractual, statutory and/or other legal and equitable rights and duties between members and between a member and the LLP (including from the formal role and responsibilities given to a member that can be traced back to the LLP agreement). The required influence is likely to be strategic or managerial.

A core principle is that the Condition B test is forward-looking and attaches to the role of a member and not the manner in which they perform their job.

In most cases, qualifying influence will be centred on the LLP agreement. Some helpful observations are given that shift the focus from whether an adequate technical link to the LLP agreement can be found, and onto whether there is sufficient influence over matters at an appropriate level:

• Influence only needs to be capable of being traced back to the LLP agreement: it does not need to be set out on its face.
• Influence can derive from delegated (and sub-delegated) authority, or to appointment to a specific role in the LLP. It was noted that this could, in principle, apply to the role of portfolio manager (the appointment to that role itself being ultimately derived from the LLP agreement). However,  it would remain necessary for that qualifying influence to be significant and to be over the broader strategic affairs of the LLP (and not only portfolio management).
• Veto rights or matters being reserved to an individual or a particular sub-set of members does not necessarily exclude other members from having influence.
• There is a distinction between control and influence. It is sufficient to have an ability to influence by having the right to participate in important decisions capable of affecting the affairs of the  LLP or how the affairs of the  LLP are conducted.
• Entire agreement clauses in LLP agreements do not exclude all other potential sources of influence (such as implied terms, common law or equitable rights and duties).

On the scope of influence, the Supreme Court did not go as far as the Court of Appeal to say that influence must always be over the affairs of the  LLP “as a whole”. Instead, it distinguishes high-level or strategic decision-making (which concern the affairs of the  LLP generally, viewed as a whole) from operational responsibility over only part of a business. The former is qualifying influence, whereas the latter is not.

The Supreme Court agreed with the Court of Appeal that to be ”significant”, influence must have “practical and commercial substance in the conduct of those affairs in the real world”. Soft power, shadow influence and performance will not suffice.

For example, in the Bluecrest LLP, members outside the Executive Committee were afforded limited governance and voting rights. Members’ meetings were to be held at least once a year for consultation on strategic matters. Members also had very limited information rights. The division of voting rights meant that a corporate member (100 votes) could always out-vote all individual members (collectively, 82 votes). This arrangement afforded inadequate influence.

Condition A

Bluecrest’s argument that total LLP profits acting as a cap on discretionary profit allocations is sufficient for remuneration to vary by reference to the profits and losses of the LLP as a whole has been rejected at all levels, now including the Supreme Court. In Bluecrest’s case, discretionary profit allocations were calculated as a percentage of the profits of a portfolio manager’s own book. If LLP profits had not been sufficient to meet the calculated allocations, the amounts would have been reduced. The cap was never reached in practice.