UK Supreme Court upholds narrow interpretation of 'significant influence' in the LLP salaried members rules

The UK Supreme Court on 1 July released its decision in the case of BlueCrest Capital Management (UK) LLP, ruling in favour of HMRC and supporting the Court of Appeal's narrow interpretation of what constitutes "significant influence" for the purposes of condition B of the salaried members rules. 

The court also rejected BlueCrest's argument that condition A, which looks at whether a member's remuneration is a "disguised salary", was not satisfied, upholding the lower courts' findings that it was met. Condition C was not an issue in this case.

The Supreme Court, in its HMRC v BlueCrest Capital Management judgment, upheld the Court of Appeal's order remitting the question of whether condition B was satisfied to the First-tier Tribunal (FTT), to be reconsidered in accordance with the narrower interpretation of condition B confirmed by both the Supreme Court and the Court of Appeal.

Salaried members rules

The salaried members rules were introduced to tackle the perceived problem of disguised employment relationships through limited liability partnership (LLP) membership, by removing the presumption of self-employment for certain LLP members.

The rules set out three conditions, which if all are met, treat an individual member of an LLP as an employee for employment tax purposes. LLP profit shares and drawings are taxed via Pay As You Earn,  and attract an employer's National Insurance contributions cost, and carried interest returns paid to the relevant LLP member may also be taxed as employment income. 

• Condition A. It is reasonable to expect that at least 80% of the member's remuneration is "disguised remuneration"; that is, fixed, or if variable, varied without reference to the profits or losses of the LLP. 
• Condition B. The mutual rights and duties of the members of the LLP and of the partnership and its members do not give the member significant influence over the affairs of the partnership. 
• Condition C. The member's capital contribution to the LLP is less than 25% of the disguised salary.

Condition A: disguised remuneration

The court upheld the decisions of each of the lower courts in determining that condition A was satisfied. BlueCrest argued that, although its members' remuneration consisted of discretionary allocations calculated primarily with reference to their individual investment portfolio performance rather than overall profits, the LLP's total profits for a year served as a cap on aggregate discretionary allocations for that year, such that they would have been reduced if profits fell short; although this had never occurred. 

On that basis, BlueCrest contended that the allocations varied by reference to the LLP's total profits, and condition A was therefore not met. The court disagreed, commenting that BlueCrest's interpretation was "so divorced…from an ordinary reading of its language that it must be rejected". 

Condition B: significant influence over the affairs of the partnership

The more significant part of the court's decision arose in relation to condition B.

The court upheld the Court of Appeal ruling that the FTT and Upper Tribunal (UT) erred in law when accepting a wider construction of condition B. Both the FTT and UT had held that significant influence could include not only rights provided for in the LLP agreement but also any de facto or wider practical arrangements and, in addition, could include influence over part of the business. The court agreed with the Court of Appeal that this was not the correct approach and that the lower courts had hardly addressed the terms of the LLP agreement. 

The court broke down condition B, which requires that, "the mutual rights and duties of the members of the limited liability partnership, and of the partnership and its members, do not give [a member] significant influence over the affairs of the partnership" into three parts.

Mutual rights and duties

The court held that the "mutual rights and duties" of the members, and of the partnership and its members, were the legally enforceable rights and duties conferred by the contractual and statutory framework governing the operation of the partnership. The court agreed with the Court of Appeal that influence is excluded if it cannot be traced back to such a framework. Influence derived from informal, de facto or external arrangements should not qualify. 

Qualifying influence would not include any that arose due to strong performance in the role, a high financial contribution to the profits of the LLP, or personal qualities or relationships with clients or other members. The court drew the distinction between what is in effect the scope of the role, and the performance in that role. 

The court further held that, where there is a written agreement governing the operation of the LLP, that agreement will be the starting point, described by the court as the "ultimate source", for identifying the mutual rights and duties of the LLP and its members. However, the source of qualifying influence is not limited solely to the LLP agreement, the court noted, and may also derive from rights delegated under that agreement or from a member's appointment to a specific role within the LLP.

Significant influence

Whether the legally enforceable rights and duties derived from the governance instruments, delegated authority or from holding a specific role in the LLP give the member the necessary "significant influence" over the affairs of the LLP is the central question arising from condition B.

The court held that "influence" means the power or ability to affect something; it does not mean control. The right to participate in important decisions capable of affecting the affairs of the partnership (whether through a meaningful right to vote or other rights) would be sufficient. The requirement for this effect to be "significant" is that it must add some intensity to the strength of the influence. The court agreed with the Court of Appeal's characterisation of "significant" as requiring “a degree of influence…which has practical and commercial substance in the conduct of those affairs in the real world."

Partnership affairs

The qualifying influence must be exerted over the "affairs of the partnership". The court held that this is construed broadly; it means the affairs of the partnership generally, viewed as a whole. While the court noted that this is likely to focus on "managerial" or "strategic" decision-making, it does not necessarily have to be and would depend on the precise circumstances. Participation in decision-making at board or strategic or management level is likely to qualify, whereas day to day decision making on an operational level may not.

The court also rejected the idea that reserved powers in an LLP agreement vested in, for example, one member would preclude any other member from having significant influence. 

Osborne Clarke comment

With the Supreme Court endorsing the Court of Appeal's narrow interpretation of condition B and rejecting the wider construction adopted by the FTT and the UT, it is important for LLPs to review any arrangements that rely on falling outside of the salaried members rules by failing condition B in particular. In light of the court's judgment, this will require each member's significant influence to be properly embedded in the LLP agreement or other formal governance arrangements.

The court's clarification that qualifying influence is not limited to the express terms of the LLP agreement, but may also derive from delegated authority or appointment to a specific role, is a welcome development in the context of a narrowed interpretation of significant influence for these purposes. It means that clearly documented delegated authority arrangements could become increasingly important. 

The court's confirmation that reserved powers vested in one member do not necessarily preclude others from having significant influence may also be a helpful finding, particularly in relation to the practical split of responsibilities between LLP members.

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