BlueCrest in the Supreme Court – why it matters for LLPs

Last week the Supreme Court released its decision in HMRC v BlueCrest Capital Management (UK) LLP.  This is a significant decision in relation to the salaried members rules and provides more clarity on how the ‘significant influence’ condition (Condition B) under those rules should be applied.   The Supreme Court dismissed the taxpayer’s appeal and found in favour of HMRC in analysing what constitutes ‘significant influence’ for these purposes.

Salaried Members Rules

The salaried members rules are a set of anti-avoidance provisions which, broadly, seek to tax LLP members as employees in respect of amounts received from the LLP where three conditions are met:

• Condition A:  It is reasonable to expect that at least 80% of the total amount payable to the member is fixed, or does not vary by reference to the overall amount of the LLP’s profits or losses (referred to as ‘disguised salary’)
• Condition B: The mutual rights and duties of the members of the LLP do not give the member significant influence over the affairs of the LLP
• Condition C: The member's contribution to the LLP is less than 25% of the total amount of the disguised salary expected to be payable to that member.

All three conditions need to be met for the salaried members rules to apply so if any one of these is failed, for example if the member does have significant influence over the affairs of the LLP, the rules will not bite.

BlueCrest

The Supreme Court decision considered both Condition A and Condition B in relation to payments to BlueCrest’s members. The most important part of the decision was in relation to Condition B and whether certain portfolio managers had significant influence over the affairs of the LLP.

BlueCrest argued that many of its portfolio managers should not be treated as salaried members because they exercised enormous responsibility over investment decisions and the deployment of very substantial capital. The lower tribunals had accepted that, on that basis, some of those individuals did exercise significant influence over the LLP’s affairs and therefore failed Condition B.  The Court of Appeal disagreed and held that for influence to be relevant for the purposes of Condition B, it had to have its source in the LLP agreement itself and should be over the affairs of the LLP as a whole.

The Supreme Court broadly agreed with the Court of Appeal but its judgement has provided some more guidance around how Condition B should be applied and crucially held that influence does not need to come strictly from the terms of the LLP agreement itself.

The Supreme Court's approach 

The judgment establishes some key principles in determining what influence is relevant for the purposes of Condition B.

• The source of the influence matters

  The Court held that influence must be capable of being traced back to an identifiable legal source, typically the LLP agreement or powers delegated pursuant to that agreement, for example to a committee. This is a slightly broader interpretation than the approach taken by the Court of Appeal and the Supreme Court recognised that legally enforceable rights deriving from implied terms in the LLP agreement or common law can also be relevant. 

  Influence that arises simply because an individual is commercially important, generates significant profits or manages large teams is not enough. 

• The influence must relate to the LLP's affairs as a whole

  The Court emphasised that Condition B is concerned with influence over the affairs of the LLP itself, rather than influence over a particular business line, trading desk or portfolio. 

  Although the Court did not create a rigid test, the judgment suggests that the type of influence likely to satisfy Condition B is influence at a strategic or governance level. This could be participation in management committees, influence over firm-wide policy decisions, voting rights on key matters or other constitutional powers affecting how the LLP is run. 

• Significant influence falls short of control

  The Supreme Court confirmed that a member does not need to have control for their influence to be significant.  It is sufficient that their influence has real world practical and commercial substance and that they have the right to participate in important decisions of the LLP.

  Helpfully, the Supreme Court also confirmed that negative control, i.e. a veto right held by one member, will not prevent other members having significant influence.

What does this mean for LLPs?

The decision means that LLPs can no longer rely on pure commercial or informal influence to fail Condition B and therefore prevent the salaried members rules from applying.     Senior individuals who run teams or generate substantial revenue but cannot trace their influence back to legally enforceable rights are unlikely to have significant influence for the purposes of the salaried members rules. 

The practical consequence is that LLPs will need to look much more closely at their governance documents and ask:

• What legal rights do members actually have?
• Do particular members genuinely participate in, and influence, the affairs of the LLP as a whole?
• Can that influence be traced back to the LLP agreement or related constitutional arrangements? 

LLPs that have historically relied on Condition B may want to revisit their LLP agreements, governance structures and committee arrangements and consider whether any de facto influence currently held by members over the LLP should be formally documented.

Conclusion

The key take aways from the Supreme Court decision are that, when considering whether a member has significant influence over the affairs of an LLP: 

• the focus should be on the strategic overall influence on the LLP’s affairs as a whole;
• the relevant influence must stem from legally recognised membership rights; and
• simply pointing to the commercial importance of a partner's role will not be enough.

HMRC will be pleased with the outcome of the Supreme Court decision and its focus on overall strategic influence as the relevant test for Condition B.  However, there is also some good news for taxpayers in the form of the loosening of the Court of Appeal's strict view that rights relevant for Condition B must come from the LLP agreement itself. 

For LLPs, including professional firms and asset managers, the case is likely to trigger a fresh review of partnership structures, governance documents and salaried member analyses.