BlueCrest is and was a
private investment firm. It was run as a partnership. It was
decided that a part of each partner’s annual share of profit should initially
be allocated only provisionally, with allocation being finally confirmed only
some time later if specified conditions were met. Meanwhile the profit
was allocated to a ‘Partner Incentivisation Plan’ (‘PIP’). This was ‘to incentivise the partners to remain
with BlueCrest, in a highly competitive market, for periods of between six
months and three years; to discourage excessive risk-taking; and to permit
account to be taken of the partners’ subsequent performance before awards under
the PIP were finalised.’ An impeccably commercial motivation,
as HMRC fully accepted.
The mechanism by which the
PIP operated was to allocate the relevant shares of profit to a corporate
member of the partnership created for the purpose, which then applied those
amounts to subscribe for ‘special partnership capital’. In due course, if the
relevant conditions were met (as they were for some 84% of the awards covering
about 97% of the value) the relevant slice of ‘special partnership capital’ was
transferred by the corporate member to the relevant partner.
Tax returns were filed on the basis that the corporate member was liable to tax on the share of profit allocated to it, and that any subsequent allocation of ‘special partnership capital’ was tax-free. HMRC demurred.
The law says that a partner’s share of a partnership’s taxable profits for a period is determined by reference to the rights of the partner to share in the (actual, commercial) profits for the period.
HMRC’s main argument was that
on a purposive construction of the legislation, the partner’s ‘share of profit’
for a period included the amount allocated provisionally (regardless of whether
that amount was subsequently forfeited or was followed by an allocation of
‘special partnership capital’). The taxpayers argued that it was not
possible to go behind the allocation of profit to the corporate member: the subsequent award of ‘special partnership capital’ was simply not a share of
trading profit.
The Court of Appeal upheld
the decision of the Upper Tribunal in favour of the taxpayer: ‘It seems to me impossible to escape
the conclusion that, during the years when the PIP operated, the agreed
division of the trading profits of the relevant partnership was between the
individual partners and the corporate partner, in the shares finally determined
by the Board.’ HMRC’s argument involved an impossible
rewriting of the contractual position.
But what about the tax treatment of the subsequent supposedly tax-free allocation of ‘special partnership capital’?
HMRC argued that, even if the awards were not a
share of trading profit share, they were nonetheless taxable under the
‘sweeping-up’ provision (ITTOIA 2005 s 687(1)) as ‘income
from any source that is not charged to income tax under or as a result of any
other provision of this Act or any other Act’.
That required it to be shown
both that the award had the nature of ‘income’ and that it arose from a
‘source’.
The Court of Appeal agreed
that both requirements were met.
As regards ‘income’: If the partnership was the tree, the
deferred PIP award was part of the fruit which the partner derived from his
membership of the partnership and his exertions on its behalf during the
relevant accounting period.
As regards ‘source’: I therefore see no difficulty in
holding that a source for the final PIP awards may be found in the exercise by
the corporate partner of its discretion whether or not to follow the
recommendations of the Board.
The unfortunate outcome thus
seems to have been that the total tax payable was more than if BlueCrest had
simply acquiesced in HMRC’s main argument, or if the arrangement had involved
the corporate member’s distributing to partners via some form of equity
participation rather than making the aspirationally-tax-free ‘special
partnership capital’ allocation. As it was, the corporate member will
have suffered corporation tax on the allocation of profit and the individual
allocatee will have suffered income tax at full rates on the subsequent PIP
award.
BlueCrest is and was a
private investment firm. It was run as a partnership. It was
decided that a part of each partner’s annual share of profit should initially
be allocated only provisionally, with allocation being finally confirmed only
some time later if specified conditions were met. Meanwhile the profit
was allocated to a ‘Partner Incentivisation Plan’ (‘PIP’). This was ‘to incentivise the partners to remain
with BlueCrest, in a highly competitive market, for periods of between six
months and three years; to discourage excessive risk-taking; and to permit
account to be taken of the partners’ subsequent performance before awards under
the PIP were finalised.’ An impeccably commercial motivation,
as HMRC fully accepted.
The mechanism by which the
PIP operated was to allocate the relevant shares of profit to a corporate
member of the partnership created for the purpose, which then applied those
amounts to subscribe for ‘special partnership capital’. In due course, if the
relevant conditions were met (as they were for some 84% of the awards covering
about 97% of the value) the relevant slice of ‘special partnership capital’ was
transferred by the corporate member to the relevant partner.
Tax returns were filed on the basis that the corporate member was liable to tax on the share of profit allocated to it, and that any subsequent allocation of ‘special partnership capital’ was tax-free. HMRC demurred.
The law says that a partner’s share of a partnership’s taxable profits for a period is determined by reference to the rights of the partner to share in the (actual, commercial) profits for the period.
HMRC’s main argument was that
on a purposive construction of the legislation, the partner’s ‘share of profit’
for a period included the amount allocated provisionally (regardless of whether
that amount was subsequently forfeited or was followed by an allocation of
‘special partnership capital’). The taxpayers argued that it was not
possible to go behind the allocation of profit to the corporate member: the subsequent award of ‘special partnership capital’ was simply not a share of
trading profit.
The Court of Appeal upheld
the decision of the Upper Tribunal in favour of the taxpayer: ‘It seems to me impossible to escape
the conclusion that, during the years when the PIP operated, the agreed
division of the trading profits of the relevant partnership was between the
individual partners and the corporate partner, in the shares finally determined
by the Board.’ HMRC’s argument involved an impossible
rewriting of the contractual position.
But what about the tax treatment of the subsequent supposedly tax-free allocation of ‘special partnership capital’?
HMRC argued that, even if the awards were not a
share of trading profit share, they were nonetheless taxable under the
‘sweeping-up’ provision (ITTOIA 2005 s 687(1)) as ‘income
from any source that is not charged to income tax under or as a result of any
other provision of this Act or any other Act’.
That required it to be shown
both that the award had the nature of ‘income’ and that it arose from a
‘source’.
The Court of Appeal agreed
that both requirements were met.
As regards ‘income’: If the partnership was the tree, the
deferred PIP award was part of the fruit which the partner derived from his
membership of the partnership and his exertions on its behalf during the
relevant accounting period.
As regards ‘source’: I therefore see no difficulty in
holding that a source for the final PIP awards may be found in the exercise by
the corporate partner of its discretion whether or not to follow the
recommendations of the Board.
The unfortunate outcome thus
seems to have been that the total tax payable was more than if BlueCrest had
simply acquiesced in HMRC’s main argument, or if the arrangement had involved
the corporate member’s distributing to partners via some form of equity
participation rather than making the aspirationally-tax-free ‘special
partnership capital’ allocation. As it was, the corporate member will
have suffered corporation tax on the allocation of profit and the individual
allocatee will have suffered income tax at full rates on the subsequent PIP
award.
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