Upper Tribunal clarifies application of Mixed Member Rules in Boston Consulting Group

The Upper Tribunal has overturned a decision of the First-tier Tax Tribunal (FTT) by concluding that the Mixed Member Rules (MMRs) applied to profit sharing arrangements operated by the Boston Consulting Group. 

The Upper Tribunal took a broad approach to the so-called ‘counterfactual tests’, which consider what the position would have been in the absence of the arrangements allocating profit to a corporate member. This interpretation expands the potential reach of the MMRs by holding that it does not matter if an alternative structure would have been implemented to achieve similar commercial outcomes. Rather, the question is whether the profit share of individual members would have been higher had the arrangements in question not been implemented.

The Upper Tribunal also overturned elements of the decision made by the FTT in relation to a number of procedural challenges successfully pursued by the taxpayers. In particular, the Upper Tribunal found that HMRC could use their extended time limits to issue discovery assessments on the basis that: (i) the LLP had been careless in failing to obtain adequate professional advice on the tax treatment of the Capital Interests; and (ii) this carelessness could be attributed to the individual members – even though they were not personally at fault – because the LLP had acted on their behalf by instructing advisers to provide guidance on completing their tax returns.

What are the Mixed Member Rules? 

The MMRs were introduced from 6 April 2014 and potentially apply to all partnerships and LLPs with both individual members and a corporate member. They were designed to prevent tax planning whereby profits would be allocated to a corporate member (which would benefit from the lower corporation tax rates) rather than to individual members (who would be subject to the higher income tax rates). 

The MMRs will apply where (i) there is an allocation of profit to a corporate member; and (ii) one of either two conditions are satisfied:

• “Condition X” is satisfied if it is reasonable to suppose that the profits allocated to the corporate member represent a deferred profit of the individual member and, as a consequence, the individual member’s profit share and the relevant tax amount are lower than they would otherwise have been.

• “Condition Y” is satisfied if:

  • The corporate member’s profit share exceeds the ‘appropriate notional profit’;

  • The individual member has the ‘power to enjoy’ the corporate member’s profit share;

  • It is reasonable to suppose that the corporate member’s profit share is, at least in part, attributable to the individual member’s power to enjoy it; and

  • It is reasonable to suppose that as a consequence of the individual member’s power to enjoy, the individual member’s profit share and the relevant tax amount are lower than they would otherwise have been.

Where the MMRs apply, the individual’s profit share is increased by such amount of the corporate member’s profit share as is reasonably attributable to the individual’s deferred profit or power to enjoy.

Background 

In 2011, Boston Consulting Group (BCG) restructured its UK operations. BCG Ltd, the subsidiary carrying out BCG’s UK business, contributed its business to The Boston Consulting Group UK LLP (the UK LLP). The senior employees (or ‘Managing Directors and Partners’, MDPs) of BCG Ltd, as well as BCG Ltd itself, became members of the UK LLP. 

As part of a global reward framework, the MDPs were given ‘Capital Interests’ and payments were made in respect of these Capital Interests upon long service or retirement. It was intended that the Capital Interests would be regarded as capital assets in the UK LLP, so that payments would be taxed under the capital gains tax regime rather than as income.

HMRC disagreed with this tax treatment, arguing that the amounts paid in respect of the Capital Interests were income (rather than capital) in nature. HMRC’s position was that the amounts paid in respect of the Capital Interests represented income that needed to be reallocated from the corporate member in accordance with the UK LLPs’ ‘profit sharing arrangements’, or in accordance with the MMRs (for the tax years 2014/15 onwards). HMRC’s alternative position was the income amounts were taxable under either the miscellaneous income provision or the sale of occupational income provisions. HMRC therefore made various amendments to the UK LLP’s partnership returns and issued a series of discovery assessment against the MDPs, which were then appealed by the UK LLP and MDPs.

The UK LLP and the MDPs were largely successful before the FTT. The FTT agreed with HMRC that the Capital Interests were not interests in the capital of the UK LLP, but disagreed that the amounts could be reallocated under s.850 ITTOIA or pursuant to the MMRs. While the FTT did find that the Capital Interests were subject to be taxed as miscellaneous income (or, in the alternative, under the sale of occupational income provisions), the FTT also found that all but one of the MDPs’ discovery assessments were invalidly issued on procedural grounds. 

Both the taxpayers and HMRC appealed various aspects of the FTT’s decision.

The Upper Tribunal’s decision 

Practical implications

This decision carries significant practical implications for taxpayers operating mixed member partnership structures.

The Upper Tribunal’s broad interpretation of the counterfactual tests means that there is limited scope for taxpayers to argue that an alternative commercial arrangement would have been put into place in the absence of the arrangements being challenged. From the Upper Tribunal’s perspective, the question is simply whether, if the individual partner's deferred profit had not been allocated to the corporate member, it would have been allocated to that individual partner (to which the answer will almost invariably be yes).

The procedural elements of the decision reinforce the importance of obtaining comprehensive, detailed professional advice before implementing bespoke remuneration or profit-sharing arrangements. Taxpayers will not be able to protect themselves against allegations of carelessness simply because they have taken advice if that advice is inadequate, or if the advice recommends that further legal advice be taken and this recommendation is not followed.

The decision also expands the circumstances when a person will be acting on another person’s behalf for the purposes of attributing carelessness. An LLP that engages advisers to provide instructions to members on how to prepare their self-assessment returns will be treated as acting on behalf of those members. This significantly extends HMRC's ability to rely on extended time limits for discovery assessments where the LLP (rather than the individual member) was careless.