Mixed Membership Partnerships: A Salient Reminder

Two differently constituted First-tier tribunals (FTTs) recently decided that amounts allocated to a corporate member of a limited liability partnership (LLP) were individually subject to income tax under the “miscellaneous income” provisions in Income Tax (Trading and Other Income) 2005 (ITTOIA 2005) section 687. While these historical remuneration arrangements have subsequently been targeted by the mixed membership partnership rules in ITTOIA 2005 sections 850C-850E (and the taxation of fund managers has been the subject of wider taxation reform), the FTT decisions in Odey Asset Management LLP and others v HMRC [2021] UKFTT 0031 (TC) and HFFX LLP and others and Badzyan v HMRC [2021] UKFFTT 0036 (TC) serve as a salient reminder that HMRC continues to look closely at remuneration arrangements in the funds industry, including on an historical basis and notwithstanding any possible regulatory and commercial justifications.

Both cases were factually similar in that the LLPs were involved in fund management and had established deferred remuneration arrangements. Under these arrangements, profits otherwise allocable to individual members of the LLP were instead allocated to a corporate member of the LLP. The corporate member subsequently contributed amounts to the LLP as “special capital” and permitted the individual members to withdraw the funds over the following two to three years.

The amounts allocated to the corporate members were subject to corporation tax. However, it was argued by the taxpayers that the individual members were not subject to any further taxation upon either the allocation or the eventual receipt of the amounts otherwise deferred. The FTT held in each case that the amounts were subject to income tax in the hands of the individual members in the year of receipt under the “miscellaneous income” provisions in ITTOIA 2005, section 687 (and were not subject to income tax in the year of allocation under ITTOIA 2005, section 850).

For the purposes of ITTOIA 2005, section 687, the FTT held that the amounts had a “source” with a sufficient connection to the individual members, notwithstanding that reallocation of the amounts to the individual members did not arise under contract. In both cases, the taxpayers also noted that the deferral of remuneration was required by the Financial Services Authority (as it was at the time) so as to align certain remuneration components with the longer-term interests of the business.

It is also worth noting that the FTT in HFFX held that, in the alternative, the amounts would be taxable under Income Tax Act 2007, Part 13, Chapter 4 being an anti-avoidance provision that subjects capital sums from the sale of occupational income to income tax where there is a main object of avoiding or reducing income tax liability. The FTT in Odey concluded that these provisions would not apply.

While the decisions of the FTT ensured that individual members who did not receive a deferred remuneration component (for example, individual members who left the fund) were not subject to tax on amounts allocated but never received, the decisions in Odey and HFFX do raise the possibility for such historical arrangements to give rise to double taxation under both corporate tax and income tax provisions.

 

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