The Court of Appeal (CoA) ruled that an enforceable right to the relevant payment is not needed for it to fall within income taxable under Section 687 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA 2005).
Background:
This case concerns appeals by both HMRC and individual members of the relevant partnership relating to incentivisation arrangements, whereby profits were initially allocated to a corporate member with subsequent ‘special capital’ allocations being made by the individual members.
The incentivisation arrangements were put in place in October 2020 when GSA, an investment management business, transferred its high-frequency foreign currency trading team to a limited liability partnership HFFX LLP. As a result of the restructuring, members of the team who were made members of HFFX became treated, for tax purposes, as self-employed partners rather than as employees. Their overall 'pay-out' from profits earned for GSA was subsequently increased, with a substantial portion deferred via a 'Capital Allocation Plan' (CAP).
The issues in the appeal included whether the allocation of profits to a corporate member of HFFX LLP should be considered an allocation to individual members under Section 850 of ITTOIA 2005 and whether the reallocation of 'Special Capital' to individual members constituted taxable income. Both the First-tier Tribunal (FTT) and the Upper Tribunal (UT) had previously found against HMRC.
Decision:
The Court of Appeal needed to determine whether the profits should be taxed as income for individual members. The Court dismissed HMRC’s appeal, rejecting the argument that the profit allocation to the corporate member ought to be considered an allocation to the individual members under Section 850 of the ITTOIA 2005. The Court based its reasoning on the decision in BlueCrest Capital Management LP [2023] which was determinative of this issue in favour of the partnership. The Court confirmed the tax treatment in favour of HFFX LLP.
The CoA also dismissed the individual members’ appeals against the decision that the allocations of ‘special capital’ were taxable as miscellaneous income under Section 687 ITTOIA 2005. For the CoA, the case was materially indistinguishable from BlueCrest Capital and the decisions taken by the corporate member in favour of the individual members regarding allocation of ‘special capital’ in combination with their rights under the partnership deed were capable of amounting to a source from which the receipt of the ‘special capital’ was derived. Such receipts were, therefore, taxable as miscellaneous income.
Implications:
This judgement confirms the outcome in BlueCrest Capital and that the profit allocation was not to be considered as allocated to the corporate members for the purpose of Section 850 of the Income Tax (Trading and Other Income) Act 2005. It also makes it clear that special capital can be taxable as miscellaneous income. It is very important to ensure that you understand all the aspects before agreeing on an incentivisation arrangement which could result in higher taxation.