Supreme Court decides the LLP salaried member rules - but sends BlueCrest back to the First-tier Tax Tribunal

The Supreme Court has handed down its long-awaited decision in HMRC v BlueCrest Capital Management (UK) LLP, dismissing the taxpayer's appeal and providing the fullest judicial guidance to date on the salaried member rules that determine whether an individual member of an LLP is taxed as an employee or as a partner. 

The decision upholds HMRC's position on both of the conditions in dispute, refines the legal test for "significant influence" first articulated by the Court of Appeal, and sends the case back to the First-tier Tribunal for a third round of fact-finding.

For any business operating through an LLP - asset managers, professional practices, and other partnerships alike - this decision has immediate relevance to how membership terms, governance frameworks, and delegated authority are structured, and to how existing membership populations should be reviewed against the salaried member rules.

Background

The salaried member rules, introduced in the Finance Act 2014, treat an individual LLP member as an employee for tax and NICs purposes if three conditions are all met. If any one condition is failed, the member retains partner (self-employed) status. Only two of the three conditions were in issue in BlueCrest.

• Condition A - met if at least 80% of a member's expected remuneration is, in substance, "disguised salary": fixed, or variable but not linked to the LLP's overall profits or losses.
• Condition B - met if the member does not have "significant influence" over the affairs of the LLP, by virtue of the mutual rights and duties of the members and the LLP.

HMRC had assessed BlueCrest for some £197m in PAYE and NICs across five tax years, on the basis that all but four members of BlueCrest's original executive committee met both conditions and should therefore be taxed as employees.

Condition A: the profits cap argument fails

BlueCrest's portfolio managers and desk heads were remunerated substantially by reference to the profits generated by their own capital allocation, not by reference to BlueCrest's overall profitability. BlueCrest argued that Condition A was nonetheless failed, because its policy was to scale back discretionary allocations if the LLP's total profits were insufficient to cover them - meaning the payments were, at least potentially, linked to overall profits after all.

The Supreme Court has rejected that argument, agreeing with the First-tier Tribunal, Upper Tribunal, and Court of Appeal below. A cap derived from the LLP's overall profits is not the same as remuneration that varies by reference to those profits. The purpose of Condition A is to distinguish typical partner remuneration (a share of the firm's profits) from typical employee remuneration (individual or team performance pay, however structured); a mere backstop cap does not achieve that link. 

Condition B: the test for “significant influence”

The more consequential part of the decision concerns Condition B, where the Supreme Court has significantly eased the decision of the Court of Appeal on the sources from which influence can (or cannot) be derived, but has affirmed that it must ultimately derive from the constitutional framework of the LLP and must be influence over the affairs of the LLP as a whole.

Source of influence 

Until the Court of Appeal's decision, it had been common ground between HMRC and taxpayers that "significant influence" was assessed by looking at the influence a member actually had in practice, whether or not that influence derived from any legally enforceable source. The Court of Appeal rejected that approach, essentially holding that the influence had to be found in the LLP agreement itself. The Court of Appeal had further held that where there was a “whole agreement” clause that effectively made the LLP agreement the sole reliable source of those mutual rights and duties. 

The Supreme Court, while expressing agreement with the Court of Appeal, effectively overruled this part of the judgment (they might prefer to say “clarified”). They held that legally enforceable rights and duties can also arise from terms implied into the LLP agreement, from common law or equitable rights and duties, and from authority delegated under the governance framework the agreement establishes - including delegation to committees, sub-committees, or to individuals by virtue of a specific role or appointment (such as a portfolio manager mandate), provided that role can ultimately be traced back to the LLP agreement itself. Importantly, they also expressly held that an "entire agreement" clause in the LLP agreement does not exclude these other sources.

Type of influence

The influence we are looking for must in fact derive from those legally enforceable rights once they have been identified. Influence generated by a member's strong personal performance, seniority, reputation, client relationships, or financial contribution to the LLP's profits - as opposed to influence conferred by an enforceable right or duty - is excluded, however real that influence may be in practice. The Court found that the First-tier Tribunal had wrongly treated evidence of this kind of de facto, performance-based influence as sufficient in itself, and identified this as the key material error of law in its original decision.

For example, a seat on the management board will give a person that legally enforceable influence. The fact that someone is a star performer who may be listened to in practice, but who does not have that management board seat, will mean they do not have significant influence.

Influence over the LLP's affairs “as a whole”

The Supreme Court also addressed how much of the LLP's affairs a member's influence must extend to. It rejected the taxpayer's argument that significant influence over an important part of the business - such as core investment decision-making - is enough without a broader managerial or strategic role. Significant influence must be influence over the LLP's affairs viewed as a whole, and is likely to require some form of participation in managerial or strategic-level decision-making, rather than day-to-day operational decisions within a particular part of the business, however important that part may be to profitability (although the Court did allow for exceptions to this on a case-by-case examination of the facts).

The Supreme Court also helpfully defined “significant” as meaning influence that has a commercial and practical substance, but clearly falling short of control i.e. you must have enough power to be genuinely listened to, but you needn’t have enough power to ensure you always get your way. 

The Supreme Court also helpfully confirmed that a governance structure that reserves certain decisions to a particular member (for example, a corporate investor with a veto over specified matters) does not prevent the remaining members from having significant influence over the LLP's affairs more broadly - just as a shareholder veto in a company does not negate the board's control of that company's affairs.

Outcome and next steps

The question of which BlueCrest members, if any, had significant influence over the LLP's affairs has been remitted to the First-tier Tribunal for reconsideration, on the existing evidence, applying the test as now clarified by the Supreme Court. 

The decision gives considerably more clarity on Condition B than has existed at any point since the salaried member rules were introduced, but it also confirms a narrower test than many taxpayers had been operating. In particular, while the decision is consistent with HMRC’s guidance that the influence must be over the affairs of the LLP as a whole, it contradicts clear statements in that guidance that influence can be de facto and derived from what happens in practice. That guidance is now clearly wrong in law and so will need to be updated, but it remains to be seen what approach they will take to the past. 

There will be a question as to whether taxpayers can hold HMRC to that guidance in respect of past periods on the basis of a legitimate expectation – this is an uncertain area of the law and whether it will need to be opened up will depend on HMRC’s approach. It is to be hoped that they will, as with their updates to the guidance for Condition C (which was not discussed in the BlueCrest case), engage with stakeholders to seek a balanced position. 

What this means in practice

Reliance on de facto or informal influence to keep members outside the salaried member rules is no longer viable. What matters is the enforceable governance framework - the LLP agreement, any implied terms, and any delegated authority genuinely traceable back to it.

LLPs should therefore review membership terms and governance documents to identify precisely what rights and authority each category of member holds, and whether those rights extend to managerial or strategic participation in the LLP's affairs as a whole, rather than operational responsibility for a discrete part of the business.

Delegation frameworks and committee structures can be a legitimate source of qualifying influence, but only where they can be traced back to the LLP agreement.

Where the influence that members exercise is at present derived from implied terms or delegation from management structures that has not been formally documented, LLPs should consider formalising those arrangements. 

Naturally, if you would like to discuss any aspect of this decision or how it affects your business or structure, please get in touch with your usual Macfarlanes contact.