Legal development

UK Court of Appeal extends application of salaried member rules

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    What you need to know

    The Court of Appeal's decision in BlueCrest has clarified the test for Condition B under the "salaried members" legislation, which determines whether members of LLPs should be treated as employees for tax purposes. 

    Condition B provides that, where the member has "significant influence" over the affairs of the LLP, the member will remain treated as self-employed for tax purposes and therefore not subject to PAYE or NICs. The Court of Appeal's formulation of this test considerably narrows the scope of what constitutes significant influence, emphasising that this influence must stem from the mutual rights and duties outlined in the LLP Agreement or other legally enforceable documents. The Court referred to this as "qualifying influence". Once it has been established that a member has "qualifying influence", it must be considered whether such qualifying influence is, in fact, significant.

    This more restricted test for Condition B could potentially bring many LLP members into the scope of employee taxation. 

    What you need to do

    • Review LLP Agreements to ensure that they clearly and accurately outline the mutual rights and duties of members and update these if necessary to reflect the actual influence and responsibilities of members.  This will be crucial in determining whether members have significant influence over the LLP's affairs and, if so, how and where they exercise that significant influence.
    • Consider whether the influence of an existing member is over the affairs of the LLP as a whole.  This judgment indicates that HMRC published guidance as to which influence is important may not properly reflect the test as understood by the Court of Appeal and greater consideration should be given to the extent to which the individual has influence over the management of strategic issues (such as business strategy and the business plan, financial management, HR issues and general board level decisions). 
    • Depending on the nature of the LLPs activities, our experience is that the amount of strategic governance required to monitor the LLP's activity can vary from entity to entity and demonstrating significant influence in entities that do not require a high level of governance may become more of a challenge.
    • Assess existing member roles and responsibilities to determine if their influence is derived from the LLP Agreement and whether their existing tax treatment is in accordance with the Court of Appeal's statement of the test. Conditions A and C may become more relevant if there is new doubt on the applicability of Condition B.
    • Take advice if there is doubt that existing members relying on Condition B may not be able to do so, now its scope has narrowed. Redesignating members' employment status may have repercussions for prior tax years which should also be considered carefully.
    • Monitor further developments on the salaried members legislation; BlueCrest may well decide to appeal this decision to the Supreme Court (there is nearly £200m of tax at stake) and further guidance is awaited from HMRC as to the application of anti-avoidance rules to Condition C where additional capital contributions are made during the life of the LLP to ensure that the Condition is not met. 

    The "salaried members" legislation

    The salaried members legislation was introduced in 2014 to prevent the avoidance of income tax and national insurance contributions by disguising employment relationships within LLPs.  

    It operates to treat LLP members who are, in effect, providing services on terms similar to employment as employees for tax purposes if three conditions are met:

    Condition A it is reasonable to expect that at least 80% of the amount to be paid by an LLP to an individual member is disguised salary i.e. the amount payable is (a) fixed, (b) variable but not by reference to the overall amount of the profits or losses of the LLP, or (c) is not in practice affected by the overall amount of those profits and losses; and

    Condition B the mutual rights and duties of the members of the LLP, and of the LLP and its' members, do not give M significant influence over the affairs of the LLP; and

    Condition C the individual member's level of capital contribution to the LLP is less than 25% of the amount of the disguised salary it is reasonable to expect the member to receive in respect of the individual's services for the LLP during the tax year in question.

    Organisation and governance of BlueCrest LLP

    BlueCrest LLP provides investment management and back-office services to other group entities. 

    The members of BlueCrest were characterised as Portfolio Managers or Non-portfolio Managers; the former comprised the discretionary traders who were allocated amounts of capital for investment and/or the "desk heads" overseeing these managers, and the latter were those providing support or back-office services such as legal, compliance or technology and senior researchers. A number of the Portfolio Managers had a minimum of $100m of capital to invest.

    Tribunals' view of Condition B

    The First-tier and Upper Tribunals both found that the reference to influence "over the affairs of the partnership" did not need to be to the entirety of the affairs of the partnership but could be restricted to influence over particular aspects or departments. 

    Similarly, "influence" was not restricted to managerial influence but could include influence in terms of operational, managerial and financial performance and/or responsibility, depending on the facts of the case. 

    Specifically here, the First-tier and Upper Tribunals concluded that the Portfolio Managers with an allocated amount of capital to invest of over $100m had the requisite significant influence over the affairs of the partnership as, in practice, they directly and significantly influenced BlueCrest’s investment activities. These individuals therefore failed Condition B, thus avoiding salaried member status.

    Court of Appeal decision on "significant influence"

    The Court of Appeal took a very different approach from the Tribunals in a number of ways:

    • Most importantly, the CA disagreed that significant influence over the affairs of the LLP could be derived from practical arrangements and de facto influence.  It determined that the influence must be derived from the legally enforceable mutual rights and duties specified in the LLP Agreement or other legally binding documents.

    The CA termed this influence "qualifying influence" but, although the exercise of de facto influence would not qualify, the CA reasoned that "it's nature and extent may well be relevant to the separate question of whether the qualifying influence of an individual member is "significant".

    • The CA also considered that the requirement that the influence be exerted "over the affairs of the partnership" implied the affairs of the partnership generally, viewed as a whole and in the wider context of the BlueCrest group. Influence over a smaller part of the business may therefore not suffice. 

    Similarly, the CA appeared to reject the Tribunals' approach that operational and/or financial influence was relevant, noting that the focus should be on "decision-making at a strategic level, rather than on how individual members perform their duties in conducting the [b]usiness".

    • Finally, the CA usefully gave some guidance on the threshold for "significant", taking the view that "the shade of meaning contemplated is 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."

    This decision underscores the importance of having clear, legally enforceable documentation outlining the roles and responsibilities of LLP members. While potentially making it harder to demonstrate that an individual has significant influence, it does arguably brings more clarity to how Condition B is to be applied.  

    This decision also raises an interesting question as to whether this 'form over substance' approach, combined with the new guidance on the meaning of "significant", might work to the benefit of certain LLPs. 

    The information provided is not intended to be a comprehensive review of all developments in the law and practice, or to cover all aspects of those referred to.
    Readers should take legal advice before applying it to specific issues or transactions.