BlueCrest Capital Management (UK) LLP v HMRC [2022] UKFTT 204 (TC) is the first case considering the UK salaried members rules under ss 863A – 836G Income Tax (Trading and Other Income) Act 2005 (the “Salaried Members Rules”).

The Salaried Members Rules intend to treat those members of a limited liability partnership (an “LLP”), who are more like employees than partners in a traditional partnership, as employees. Where the Salaried Members Rules apply, a partner in an LLP is treated as an employee of that LLP for the purposes of income tax and National Insurance Contributions, even if the individual partners have already paid income tax on a self-employed basis. In order for the Salaried Members Rules to apply, three statutory conditions ("Conditions A, B and C") must be met. In the current case, only the application of Conditions A and B was disputed.

Condition A would be satisfied if it is reasonable to expect that at least 80% of the amount paid by an LLP to an individual member for that tax year would be “disguised salary.” The definition of disguised salary includes amounts that are variable but vary without reference to the overall amount of the profits or losses of the LLP.

Condition B would be satisfied if the mutual rights and duties of the members of the LLP do not give a member significant influence over the affairs of the LLP.

This case concerns a UK hedge fund LLP (“BlueCrest LLP”) which undertakes two activities: (i) providing investment advice as a sub-investment manager; and (ii) providing “back-office” services to other members of its group. There are two main categories of members – portfolio managers and non-portfolio managers. Non-portfolio managers include infrastructure members and other front-office members who are very experienced in research and technology and without their own discretionary portfolios. The First-tier Tribunal (the “FTT”) had to decide (i) whether the remuneration paid to BlueCrest LLP’s members was variable with reference to the overall amount of BlueCrest LLP’s profits or losses and therefore whether Condition A was met; and (ii) whether BlueCrest LLP’s portfolio managers and non-portfolio managers exercised significant influence over BlueCrest LLP’s affairs and therefore whether Condition B was met.

Condition A – Variability

The FTT held that, even though there is no need for the individual members’ remuneration to “track” the LLP’s overall profits and losses in order to fall outside Condition A, there must be a link between an individual’s remuneration and the overall profits and losses. 

In order to establish such a link, it is not enough to rely solely on the fact that the individual members’ remunerations are abated if there is not enough accounting profit to distribute the total remuneration. This is because one cannot distribute more than the accounting profits dictate. Condition A looks at the criteria that must be met when determining how those profits are to be shared. If they are shared in such a way that they vary by reference to those profits, Condition A is not met. Therefore, losses and risks that either theoretically or actually have affected the accounting profit are not taken into account again when considering the basis of the distribution of that profit.

In the current case, it is the “discretionary allocation” (i.e., the member’s “bonus”) that was in dispute.  

Even though whether and how much discretionary allocations are paid out is in the discretion of the remuneration committee (and therefore the overall profits of the partnership may have been taken into account by the remuneration committee), the evidence showed that this discretion in respect of the portfolio manager’s bonus is fettered by the terms of the variable remuneration or award methodology agreed when a portfolio manager joins BlueCrest LLP, or as part of the terms of his or her ongoing membership of BlueCrest LLP. For portfolio managers, this makes clear that the methodology is essentially a proportion (say, 20%) of the individual’s profit and loss account (as opposed to BlueCrest LLP’s overall profits and losses). Therefore, the evidence showed that the portfolio managers at least had a legitimate expectation that, provided there are sufficient overall profits of BlueCrest LLP to meet this quasi-contractual promise, his or her variable remuneration will be computed in that way and a discretionary allocation made accordingly. The FTT found that the individual’s profit and loss account is a reflection of the individual member’s individual performance, but not the overall profits of the partnership.

In relation to the “discretionary allocation” of the non-portfolio managers, there was no evidence showing that the allocations have been made by reference to the overall profits and losses of the partnership. The financial performance of BlueCrest LLP is taken into account when calculating the variable remuneration pool before being allocated to department heads. The department heads then take into account, when computing an individual non-portfolio manager member’s discretionary allocation, the individual’s performance, and current market rates utilising market benchmark surveys and recent hire information. The FTT held that the evidence does not demonstrate a link between the variable remuneration and the profits of the partnership. The FTT appreciated that the variable remuneration calculation for non-portfolio managers takes into account BlueCrest LLP’s financial performance, but that is very different from demonstrating a link to that calculation and BlueCrest LLP’s profits.

Based on the above, the FTT held that Condition A was met in this case.

Condition B – Significant Influence

The FTT held that Condition B can include direct financial influence (in the context of the portfolio managers) and is not limited to managerial influence. Significant influence can be over one or more aspects of the affairs of the partnership and need not be over the affairs of the partnership as a whole.

Therefore, the starting point for this analysis must be a consideration of what the affairs of the partnership are. In other words, what does the partnership do? Significant influence can be over one or more aspects of those affairs. Also, the FTT noted that the role of a partner in a traditional partnership is to “find, mind and grind.” In other words, a traditional partner is expected to go out and find work, supervise others to undertake it and to do the work themselves. The extent to which each function will be carried out depends on the role of the partner, his or her particular qualities and the nature of the partnership. These functions are not limited to making management decisions, but to contributing to the success of the partnership.

In the current case, the FTT found that BlueCrest LLP undertakes two activities: (i) providing investment advice as a sub-investment manager; and (ii) providing “back-office” services to other members of its group.

In relation to the portfolio managers, the FTT found that portfolio managers, as a class, could potentially exercise influence over BlueCrest LLP’s affairs by reason of the investment activity undertaken by these portfolio managers. These portfolio managers are allocated capital, and the way in which they invest that capital is a matter for individual discretion. They take key investment decisions on a daily basis, and their main, if not sole, purpose is to make money for BlueCrest LLP. This is BlueCrest LLP’s core activity.

In determining whether each individual portfolio manager in fact has significant influence, BlueCrest LLP’s counsel identified, and the FTT agreed, that portfolio managers managing portfolios of $100 million or more would have significant influence. The evidence in this case showed that these portfolio managers are recognized as individuals of high standing whose opinions carry weight and to whom other people would listen. The FTT noted that more senior partners are likely to be more experienced, not just about the marketplace but the firm itself, and thus carry more weight and respect in managerial and operational discussions.

In relation to the non-portfolio managers, the FTT found that Condition B can include operational influence.

However, in relation to the back-office services provided by the non-portfolio manager members internally to the portfolio managers within BlueCrest LLP, the FTT found that it cannot tell from the evidence whether any individual has played a significant part in any decisions made by the operational committees. Then the FTT went on to say that the activities undertaken by the non-portfolio manager members of the operational committees are not, in its experience, ones which would have necessarily been undertaken by partners in a traditional partnership. They could equally (and, given the specialist nature of the operational activities, such as risk, HR, finance, tax, perhaps more appropriately) be undertaken by employees who specialize in those areas. The FTT also found that these non-portfolio manager members seemed to have contributed indirectly to the operational activities undertaken by the portfolio managers, and therefore any such “influence” is exercised at second hand and is not significant in any event.

In relation to the back-office services provided by the non-portfolio manager members to other members of BlueCrest LLP’s group, the FTT had heard no evidence of the time spent by the individuals on external services or any particular projects on which those providing the external services worked. Neither had the FTT heard any evidence as to the qualitative nature of those services over and above the general statements of the broad strands of activities undertaken by the departments and their heads. The FTT noted that this evidence went nowhere near explaining how the services provided by those individuals or by their departments directly contribute to the external services, and that those providing them exercised significant influence over their provision. As a result, the FTT was unable to determine what financial or other contributions were made by the non-portfolio managers to the provision of the external services provided by BlueCrest LLP to other members of its group and which comprise a significant element of its overall activities.

The FTT reached the conclusion that no non-portfolio manager exercised significant influence over BlueCrest LLP’s affairs.

Conclusion

Although the operation of each LLP will be slightly different, the FTT − in this case, at least − rejected HMRC’s narrow interpretation of “significant influence” and held that “significant influence” need not be managerial or extend to every aspect of the LLP’s business.

As seen above, the decisions reached by the FTT were very fact-sensitive, having taken into account an extensive amount of evidence in establishing the exact operations of BlueCrest LLP’s business. Therefore, one should keep evidence to support claims of significant influence or that remuneration is truly variable by reference to the overall profits or losses of the LLP.

The FTT reached its conclusion that non-portfolio managers had not exercised significant influence over BlueCrest LLP’s affairs mainly based on the lack of evidence that the non-portfolio managers (i) directly exercised significant influence on BlueCrest LLP’s investment activities and (ii) exercised significant influence on BlueCrest LLP’s back-office services provided to other members of BlueCrest LLP’s group. However, at the same time, the FTT noted that, in its experience, these non-portfolio managers are more akin to specialist employees than to traditional partners who “find, mind and grind.” Therefore, it remains to be seen whether, when given more evidence of direct significant influence exercised by non-portfolio managers, a court could be persuaded that non-portfolio managers exercise significant influence.