In its recent judgment in HMRC v BlueCrest Capital Management (UK) LLP, the Court of Appeal has overturned the decisions of the lower tribunals and supported HMRC's narrow interpretation of "significant influence". In doing so, the Court introduced a new focus on the source of a member's influence, holding that the only influence that counts is that derived from legal rights and duties. In addition, the Court appeared to support HMRC's view that the scope of significant influence is limited to strategic influence over the affairs of the LLP generally.
Key takeaways
- The salaried members rules do not apply unless "Condition B" is met. The Court's judgment markedly reduces the circumstances in which a member will be considered to have sufficient influence so that Condition B is not met.
- There is now a two-stage test for assessing whether Condition B is met: (i) to what extent does the relevant member's influence derive from legal rights and duties of the members? and (ii) is their influence that derives from those rights and duties "significant"?
- Firms that rely on failing Condition B to prevent the salaried members rules applying should revisit their LLP deeds to ensure significant influence is properly embedded in the legal rights and duties of the members and may need to reflect on whether their current payroll processes are aligned with the principles coming out of the Court's judgment.
- Taxpayers will be disappointed that the Court took a narrow view of when influence is "significant" – focusing on decision-making at strategic level and holding that influence must be exerted over the affairs of the LLP generally. This seems to be in line with HMRC's longstanding view which had been firmly rejected by the lower tribunals.
In light of this decision, we will be hosting webinars analysing where we are now on the salaried members rules and the use of LLPs generally and considering whether the LLP is the right model for your business and the practicalities of converting to a corporate. To register your interest for the webinars please complete the form at the bottom of this page.
Background
The salaried members rules
Under the salaried members rules, members of an LLP are treated as employees for tax purposes if three conditions (A to C) are all met. A key consequence of an individual being a salaried member is that employer NICs / social security become payable (by the LLP) on the profits allocated to them. The rate is currently 13.8% and is set to increase to 15% from 6 April 2025 – the cost of the salaried member rules applying can, therefore, be substantial.
The three conditions, all of which must be met for the salaried members rules to apply, are broadly:
Condition A - it is reasonable to expect that at least 80% of the individual's total remuneration is "disguised salary" (basically, it is fixed or does not vary by reference to the LLP's overall profits or losses);
Condition B - the mutual rights and duties of the members of the LLP do not give the individual significant influence over the affairs of the partnership; and
Condition C - the individual's capital contribution to the LLP is less than 25% of their expected "disguised salary" for the tax year.
The Court of Appeal considered both the first two conditions but focused on Condition B.
Condition C was not in point in BlueCrest, as both parties agreed it was met. However, its scope is currently the subject of some controversy as, in February 2024, HMRC changed its published guidance to say that "topping up" capital contributions to ensure that Condition C continues to be failed is caught by a targeted anti-avoidance rule that, essentially, causes any arrangements to be disregarded that have a main purpose of preventing the salaried member rules from applying. Following a backlash from businesses, HMRC is in the process of undertaking an internal review of its position.
The facts of BlueCrest
Bluecrest was a UK LLP that provided investment management and certain back-office services. It had various individual members, some of whom were fund managers or traders (Portfolio Managers) and some of whom carried out other functions (Non-Portfolio Managers). Most Portfolio Managers were given capital to invest on behalf of clients, with more senior members being given larger amounts. For Portfolio Managers, the discretionary allocation was a percentage of the profit they made on their individual portfolio less costs, whereas for the Non-Portfolio Managers the methodology for determining the allocation was more nebulous and less formulaic.
Both the First-tier Tribunal and Upper Tribunal had found that:
- the discretionary allocations were disguised salary for all the relevant members, such that Condition A was met; but
- certain of the senior Portfolio Managers (those allocated at least $100m to invest and desk heads) had significant influence, such that Condition B was failed and, accordingly, the salaried members rules did not apply to those senior managers.
Importantly, in relation to Condition B, the tribunals disagreed with HMRC's approach that "significant influence" required managerial influence over all the affairs of the LLP.
HMRC appealed the Upper Tribunal's significant influence finding in relation to the senior Portfolio Managers and desk heads and BlueCrest cross-appealed the disguised salary finding in relation to those individuals.
Significant influence
It has been HMRC's longstanding view that when identifying whether a member has "significant influence" it is important to look at not only the written LLP agreement but also how the LLP operates in practice. Both parties, HMRC and BlueCrest, were happy for this approach to be taken, and the lower tribunals duly followed it.
However, the Court of Appeal focused on the wording of Condition B and held that influence is only relevant if it derives from, and has its source in, the legally enforceable mutual rights and duties of the members of the LLP as conferred by the statutory and contractual framework which governs its operation. Although, the Court found that this sort of influence, which it referred to as "qualifying influence", is the only basis on which a member can meet Condition B, it considered that other influence ("non-qualifying influence"), including that of third parties, may be highly material in deciding whether a person's qualifying influence is "significant".
The Court also briefly discussed the scope of "significant influence", taking the view that:
- the influence must be exerted over the affairs of the partnership generally, viewed as a whole and in the wider context of the BlueCrest group. In a reversal of the decision of the lower tribunals, this would seem to exclude influence over a part of the business. In addition, the Court observed that "affairs" is wider than the term "business.
- a focus on decision-making at a strategic level, rather than on how individual members perform their duties in conducting the LLP's business accords better with the basic purpose of Condition B. Although not stated expressly, this would also seem to reverse the lower tribunals' position that other forms of influence, including financial and operational, can qualify.
Although the above two points are extremely relevant to Condition B, the Court's analysis relating to them was very limited, with these issues not being the focus of its decision.
The Court also gave a limited steer on the level of influence needed to count as "significant", indicating that it requires "a degree of influence over the partnership's affairs which is more than insignificant, and which has practical and commercial substance in the conduct of those affairs in the real world".
Having held that the Upper Tribunal had erred in law as to the true construction of Condition B, the Court of Appeal sent the case back to the First-tier Tribunal for reconsideration using the correct legal principles.
Disguised Salary
The Court upheld the approach of the lower tribunals in rejecting BlueCrest's argument that the fact that discretionary allocations might have to be repaid if there were insufficient LLP profits meant that they were sufficiently linked to the LLP's profitability to avoid being disguised salary.
Comment
The Court of Appeal's view that significant influence is limited to strategic influence over the affairs of the LLP generally appears to be in line with HMRC's longstanding view of Condition B reflected in its published guidance. This will be a disappointment for taxpayers, after the lower tribunals' broader view of what can amount to significant influence.
The focus on the requirement for significant influence to be grounded in the legal rights and duties of members is, however, new and was only reluctantly adopted by HMRC after the Court had raised it. This may reflect a concern of HMRC that taxpayers will seek to argue that having formal legal rights is sufficient to give a member significant influence even if it does not necessarily reflect the way in which actual (de facto) influence is exercised.
A key question for taxpayers will be whether the Court's decision will be appealed to the Supreme Court. Given the amounts at stake (approximately £200m) and the strong decisions at tribunal levels in favour of a wider interpretation of significant influence, it would not be surprising if BlueCrest sought permission to appeal (and it has 28 days to do so).
However, for the time being, given the need (as a result of the Court of Appeal's decision) for "qualifying influence", firms that rely on failing Condition B to prevent the salaried members rules applying should revisit their LLP deeds to ensure significant influence is properly embedded in the legal rights and duties of the members. In addition, these firm may need to reflect on whether their current payroll processes are aligned with the principles coming out of the Court's judgment
The Court's narrow interpretation of Condition B, will also impact firms that have failure of that condition as their 'back up' or secondary argument, other than for the most senior individuals. The judgment puts more pressure on those firms' primary argument that Condition A (disguised salary) or C (capital contribution) are failed. In particular, for firms that have historically relied on condition C, it increases the importance of HMRC's internal review of its controversial guidance changes on 'top up' contributions. We still have no date on when HMRC will release its review findings.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
