His Majesty’s Revenue and Customs v BlueCrest Capital Management LP & Ors [2023] EWCA Civ 1481

BlueCrest hedge fund partners participated in a Partner Incentivisation Plan diverting profit shares to a corporate partner, which then re-allocated 'special capital' awards to individuals. The Court of Appeal upheld that profits were validly allocated to the corporate partner under section 850 ITTOIA 2005, but the final awards to individual partners were taxable as miscellaneous income under section 687.

Facts

BlueCrest Capital Management, a major hedge fund business, operated successively through a limited partnership (BCM LP) and two LLPs between 2008 and 2014. In April 2008, it introduced a Partner Incentivisation Plan (‘PIP’) developed by Ernst & Young LLP. Under the PIP, a portion of individual partners’ prospective profit share was instead allocated to an independent corporate partner (initially Special Capital Limited, then Avon). The corporate partner would, after retaining funds for its corporation tax liability, contribute the balance back to the partnership as ‘special capital’, which could later be re-allocated to individual partners as discretionary awards subject to eligibility conditions, including continuing service through deferral periods of six months to three years.

The commercial purposes included retaining and incentivising partners in a competitive market, discouraging excessive risk-taking, and allowing later adjustment for losses. The perceived fiscal benefit was the gap between the 40% marginal income tax rate and the 28% (or, for Avon, effectively 15%) corporation tax rate. The FTT found the PIP had both genuine commercial purposes and tax avoidance as a main object. Approximately 16% of provisional awards (2-3% by value) were never finalised.

Issues

The appeals raised the following issues:

• Primary case (HMRC): Whether, on a realistic application of section 850 ITTOIA 2005, the profit shares allocated to the corporate partner should be treated as the profit shares of the participating individual partners.
• Alternative case (HMRC): If the primary case failed, whether the final PIP awards were taxable in the partners’ hands as miscellaneous income under section 687 ITTOIA 2005, or under the sale of occupational income rules in Chapter 4 of Part 13 ITA 2007.

Arguments

HMRC

HMRC contended that section 850 required a purposive construction and realistic application to the facts, such that ‘profit-sharing arrangements’ encompassed the PIP arrangements as a whole. The corporate partner served only to administer the PIP and was effectively a conduit, with individual partners having an expectation (and contractual right via implied Braganza-type duties) that awards would be made final. HMRC also relied upon RFC 2012 plc v Advocate General for Scotland (Rangers) and Hadlee v Commissioner of Inland Revenue to argue that remuneration paid to a third party for a worker’s benefit remains taxable in the worker’s hands.

Partnerships / Individual Partners

The partnerships argued that the corporate partner was a genuine partner, not a sham, and that the profit allocations to it were properly subject to corporation tax. Section 850 should be applied according to the actual partnership agreements. The PIP awards were transfers of the corporate partner’s own post-tax property (special capital) and not partnership profits. The Ramsay approach could not be used to rewrite the contractual arrangements.

Judgment

Primary case under section 850

The Court of Appeal (Sir Launcelot Henderson giving the leading judgment, with which Falk and Lewison LJJ agreed) dismissed HMRC’s appeal. The Court held that, during the relevant years, the agreed division of trading profits was between the individual partners and the corporate partner in the shares determined by the Board. These were the shares to which they were legally entitled and on which they were taxed. There was no suggestion that the PIP was sham; it had genuine commercial purpose, and its commercial benefits could not have been delivered without the corporate partner mechanism.

The Court held that the Ramsay/purposive approach could not be stretched to treat the corporate partner’s allocated share as simultaneously consisting of disguised profit shares of the individual partners. The unreality of HMRC’s analysis was illustrated by its concession that the corporate partner would not be charged corporation tax if the primary case succeeded. Sir Launcelot Henderson stated that the rate differential between income tax and corporation tax reflects Parliament’s intention, and remedial legislation (as occurred in FA 2014) is the proper remedy.

The Court rejected the subsidiary ground (Ground 2) regarding early PIP rounds where awards crystallised before final accounts were signed off, holding that the underlying allocations had to be respected absent a sham finding. Grounds 3 and 4 (based on Rangers and Hadlee) were also dismissed: those authorities concerned employment income and a different New Zealand statutory regime respectively, neither of which translated into UK partnership taxation, which taxes partners on their agreed shares of partnership profits.

Alternative case under section 687

The Court dismissed the partnerships’ appeal on the section 687 issue. Applying Jones v Leeming [1930] AC 415, a receipt must be of the nature of income and analogous (ejusdem generis) with another head of charge, and must have an identifiable source. The Court held the question of income/capital character is one of law (citing Beauchamp v F W Woolworth Plc [1990] 1 AC 478).

Examining the commercial reality, the Court concluded the final PIP awards constituted deferred and contingent reward to partners for their work, analogous to deferred employment bonuses. The label ‘special capital’ was no more than a label. The eligibility conditions linking awards to continued service confirmed the income character.

On ‘source’, following Cunard’s Trustees v IRC (1946) 27 TC 122 and Spritebeam Ltd v HMRC, the corporate partner’s exercise of discretion (constrained by Braganza duties) constituted a sufficient source. The Court accordingly held the awards taxable under section 687.

Sale of Occupational Income

As HMRC succeeded on section 687, the Court declined to consider the alternative SOI ground and expressly did not endorse the FTT’s or UT’s obiter reasoning on this point.

Implications

The decision confirms that, in the absence of a sham finding, the statutory partnership tax regime in sections 849-850 ITTOIA 2005 (and section 1262 CTA 2009 for corporate partners) respects the actual profit allocations made under partnership agreements, even where the structure has tax mitigation as one of its main purposes. The Ramsay/purposive approach cannot be used to rewrite contractual arrangements between partners where the steps in question have genuine commercial purpose and substance.

The decision draws a clear distinction between UK partnership taxation and the employment income regime considered in Rangers, and the New Zealand regime in Hadlee. The principle that remuneration redirected to a third party remains taxable in the worker’s hands does not transplant into UK partnership taxation, where partners are taxed on agreed profit shares regardless of personal exertion.

However, the case is also significant for HMRC: the section 687 charge provides a fallback where amounts paid under such schemes have the substance of deferred reward for services. The Court confirmed that section 687 retains the scope of the former Case VI of Schedule D, requires the receipt to be of an income nature, analogous to another head of charge, and arising from an identifiable source, and that the exercise of a fettered discretion (subject to Braganza duties) can constitute such a source.

Practically, the case matters to hedge funds, partnerships and LLPs that used similar deferred reward structures prior to the remedial provisions in sections 850C-850E ITTOIA 2005 (introduced by FA 2014). For periods within those reforms, the statutory anti-avoidance regime now applies. The judgment reinforces the importance of legislative intervention rather than judicial reinterpretation in addressing perceived tax mitigation by partnerships.

Verdict: Both appeals dismissed. HMRC’s primary case under section 850 ITTOIA 2005 failed: the profit shares allocated to the corporate partner could not be re-characterised as profit shares of the individual partners. However, HMRC’s alternative case succeeded: the final PIP awards were taxable in the hands of the individual partners as miscellaneous income under section 687 ITTOIA 2005. The Court declined to determine the Sale of Occupational Income issue.

Source: His Majesty's Revenue and Customs v BlueCrest Capital Management LP & Ors [2023] EWCA Civ 1481