UK Supreme Court Releases BlueCrest Decision Affecting Asset Managers and Other UK LLPs

The UK Supreme Court’s decision in BlueCrest, released on 1 July, represents the long-awaited conclusion regarding the application of the UK salaried member rules (the “SMR”). It was specifically given in the context of the asset management industry but has wider ranging implications for all businesses structured as UK limited liability partnerships (“LLPs”).

The Salaried Member Rules

Introduced in 2014, the SMR set out three conditions which, if met, will result in a member of a UK LLP being treated for UK tax purposes as an employee rather than as self-employed:

• Condition A is met if, at the relevant time, at least 80% of the relevant member’s drawings over the reference period are expected to represent “disguised salary”. Disguised salary for these purposes, includes amounts which do not vary by reference to the overall profits or losses of the LLP.
• Condition B is met if the mutual rights and duties of the LLP member do not give the member significant influence over the affairs of the LLP.
• Condition C is met if, at the relevant time, the member’s capital contribution to the LLP represents less than 25% of their disguised salary.

If any one of these conditions is failed, the member will be treated as a self-employed member of the LLP. However, if all three conditions are met, the LLP would become liable to pay employer National Insurance contributions (currently at a rate of 15%) on the drawings of so-called salaried members. This alone could result in a significant unexpected tax liability for the LLP. In addition, the LLP and its members could potentially become subject to additional tax liabilities in relation to their carried interest awards falling unexpectedly within the scope of the employment-related securities rules.

It is therefore vital that asset managers and other business established in the form of UK LLPs take advice to determine whether any of their members would be treated as salaried members for UK tax purposes, particularly in view of this latest decision, which marks a departure from both previously established practice and HMRC’s current guidance on the SMR.

The Decision

In BlueCrest, the decision primarily focused on the interpretation of Condition B and determining when an LLP member should be considered to have “significant influence” over the affairs of an LLP.

In the BlueCrest case, the taxpayer argued that, in determining whether or not an LLP member had significant influence, regard should be had not only to the LLP agreement, but also to the way in which the LLP operated in practice. The effect of this was to widen the ambit of members with significant influence for the purposes of Condition B to include not only those in whom significant influence was vested under the terms of the LLP agreement (such as the executive committee and those to whom it had specifically delegated certain tasks), but also to portfolio managers who were influential by virtue of the amount of revenue they generated for the firm.

However, the Supreme Court rejected this interpretation of Condition B and instead specifically held that “a member’s influence (even if significant) on the profitability of the business … cannot translate into significant influence over the affairs of the LLP taken generally.” Rather, it was found that, for the purposes of Condition B, “influence [is] founded in the legally binding constitutional framework of the partnership and that influence from other sources, including de facto influence exercised by its members and others should not qualify.” Additionally, “the relevant right or duty may not be found expressly on the face of the LLP agreement itself, [but needs to] ultimately be traced back to that agreement.”

The Court further found that the relevant influence to be considered should be participation in decision-making at a board or strategic/management level rather than day-to-day decision-making on a purely operational level.

In reaching their decision in BlueCrest, the Supreme Court attached significant weight to the fact that the LLP agreement made it clear that the rights of individual members to participate in the governance of the LLP were minimal and members only had very limited rights to vote on matters affecting the business.

It should be noted that the decision also reiterated that for the purposes of Condition A, any profit allocations which are variable otherwise than by reference to the overall profits of the LLP nevertheless constitute disguised salary. Confirming that profit allocations should be made on a top-down basis (i.e., the starting point is the overall profits of the LLP) rather than a bottom-up basis (i.e., starting with the profits brought in by the particular member).

Impact of the Decision

The effect of the decision in BlueCrest is that asset managers and other businesses structured as UK LLPs should review their LLP agreements and reassess whether or not their members should be treated as salaried members based on this new, narrower interpretation of Condition B and the meaning of significant influence. Businesses may also wish to review their profit allocation keys to ensure that they are not inadvertently rendering significant portions of a member’s LLP drawings as disguised salary.