The recent First Tier Tribunal (FTT) decision in BlueCrest Capital Management (UK) LLP v HMRC (29 June 2022) is the first time that the UK Employee Member Rules (the Rules) have been made into account in the context of an asset management limited liability company (LLP). BlueCrest is engaged in the provision of hedge fund investment management services. In summary, the FTT found that some of the members of BlueCrest who were responsible for managing large investment portfolios had “significant influence” over the affairs of the LLP, whether or not that financial influence amounted to managerial influence over the entire LLP business, such that these members were not salaried members (but other members who were not engaged in portfolio management did not have significant influence at these purposes, as explained below).
The decision on the significant influence requirement for portfolio managers will be welcomed by asset management firms LLP. However, HMRC is widely expected to appeal the decision, particularly as it appears to be at odds with HMRC’s approach, as set out in HMRC’s Partnership Handbook, that only members involved in the high-level management of an LLP should be treated as having significant influence over its affairs.
Employee Member Rules Overview
The Rules effectively treat an individual member of a UK LLP as an employee for UK income tax purposes, unless the LLP member passes one of the three tests set out in the Rules. They are intended to apply to LLP members who are more akin to employees than traditional partners in a partnership. When an LLP member is treated as an employee for these purposes, it means, among other things, that:
the LLP is required to account for employees’ income tax and National Insurance (NIC) contributions via PAYE against their remuneration;
employer NICs are payable by the LLP; and
any title acquired by the person as a result of their alleged employment with the LLP may fall within the scope of the UK employment title rules.
For an LLP member not to be treated as a salaried member, they must meet at least one of the following conditions (although the Rules are actually designed around the “breach” of a condition phrased in the sense opposite):
Condition A – it is reasonable to expect that less than 80% of the total amount to be paid by the LLP to the member in the following tax year will be “disguised wages”, which includes both fixed amounts and variable amounts if this is the case. the amounts vary without taking into account the overall profitability of the LLP;
Condition B – the LLP member has “significant influence” over the affairs of the LLP; Where
Condition C – the LLP member makes a sufficient capital contribution to the LLP (roughly 25% of their disguised salary).
The BlueCrest decision considered Condition A and Condition B.
Condition A – Variable compensation
This condition requires a forward-looking assessment at the beginning of the relevant period to determine whether it is reasonable to expect that less than 80% of the member’s remuneration will be fixed or, if variable, vary without reference to profits or aggregate losses of the LLP or, in practice, will not be affected by the aggregate amount of such profits or losses.
Members of BlueCrest LLP who were responsible for portfolio management received discretionary allocations which were calculated, in aggregate, by reference to the performance of the individual portfolios for which they were responsible. Discretionary allocations for other LLP members (not responsible for portfolio management) were not calculated by reference to a measure of profitability and were based on individual performance measures. The FTT considered that it was necessary for there to be a demonstrable link between the profits of the LLP, on the one hand, and the basis for calculating the variable remuneration, on the other hand, although the impossibility of demonstrate that there was such a link was set low. Nevertheless, the FTT considered that there was insufficient evidence of such a link in the evidence in this case.
In particular, BlueCrest had modified its formal compensation policy applicable to members involved in portfolio management at the beginning of 2014, just before the implementation of the Rules. It had added a clause stating that each member’s additional compensation would be reduced if the LLP’s overall profits were insufficient to pay all portfolio managers the amounts calculated on the basis of the individual portfolio performance formula. The FTT considered that this reduction clause was not sufficient to mean that the variable remuneration was not a “disguised salary” since it simply indicated what would happen in any partnership and that there was no proof that variable remuneration has ever been reduced because of this clause. .
The FTT also considered whether the anti-avoidance provision of the Rules should apply to the policy change. The anti-avoidance provision states that any arrangement whose primary purpose is to ensure that the Rules do not apply to an individual should be disregarded when determining whether the Rules apply. The FTT said (although not directly relevant to the decision) that if the change in the terms of the policy meant that the variable pay was not disguised pay, the anti-avoidance provision would have applied so that the change would have been ignored. In this case, changing the terms of BlueCrest’s compensation policy was not sufficient to allow BlueCrest to pass the disguised salary test, so the decision on this point was not material to the decision of the FTT. . Notably, HMRC made this point despite guidance issued by HMRC which states that HMRC would not consider that the anti-avoidance rule should apply to “genuine and long-term restructuring which results in an individual failing to comply with a or more of the conditions” in the Rules.
Condition B – Significant influence
In order not to be a salaried member under this test, the mutual rights and duties of members of the LLP must give the member concerned significant influence over the affairs of the LLP.
Regarding the assessment of significant influence of an LLP member, BlueCrest argued that financial influence as well as management influence should be considered. HMRC’s position was that only management influence on the general affairs of the LLP should be considered. The FTT agreed with BlueCrest and concluded that there was no justification for limiting significant influence to managerial influence and that it was not necessarily necessary to have significant influence over business. of the LLP as a whole, but that financial influence or managerial influence could override an aspect of the LLP’s business.
With respect to the members of the Portfolio Manager LLP, the FTT found that they made key investment decisions on a daily basis and that their primary function was to generate income by engaging in the core business of the LLP and, as such, they wielded significant influence over the affairs of the LLP. In addition, they were found to be operationally involved in the type of activities that a partner in a traditional partnership would have undertaken, including recruiting, identifying and exploiting new business opportunities. and relationship management. In light of this, some of the members of the portfolio manager LLP were found to have significant influence (and therefore were properly treated as self-employed for UK tax purposes).
Conversely, infrastructure LLP members (involved in business support activities rather than portfolio management activities) were found to have no significant influence (based on which was demonstrated by the evidence provided) and the FTT considered that the activities they carried out (legal, risk, HR, finance, taxation, etc.) were not those which would generally have been carried out by the associates of a traditional partnership, but rather those that would be taken care of by specialized collaborators. It was held that, although they indirectly contributed to the operations of the LLP and assisted the portfolio managers in exercising their significant influence, they did not themselves exercise significant influence over the affairs of the LLP, which means that they should be treated as employees for UK tax purposes. purposes.
This ruling as to the scope of significant influence will be welcomed by the UK asset management industry, but as noted above, HMRC should appeal as it gives a significantly broader interpretation of Condition B than guidelines published by HMRC.
© 2022 Proskauer Rose LLP. National Law Review, Volume XII, Number 196