In HFFX LLP & Ors v HMRC [2021] TC8023, the First Tier Tribunal found that a LLP scheme to reallocate profits via a corporate vehicle using allocations of special capital failed to work and those allocations were chargeable to Income Tax on individual partners.

HMRC raised Discovery assessments over a number of years into the HFFX Limited Liability Partnership (LLP) and member returns seeking to tax allocations of Special Capital contributed by a corporate member and withdrawn by individual members of LLP.  HMRC raised these assessments in a number of different ways which are highlighted in the facts of the case which are as follows:

  • GS restructured the way that certain employees were engaged.
  • The employees becoming members of HFFX LLP and provided services to GS.
  • HFFX LLP also had a corporate member, GSAM which was independent of the individual members.
  • HFFX received 50% of the profits generated for GS by its members.
  • The profits of the LLP were subject to a 'Capital Allocation Plan' (CAP) whereby:
    • HFFX was forced to pay 50% of the profits made to GSAM (Issue 1: Should amounts paid to GSAM under the CAP be treated as partnership profits of the individual members?)
    • The profits paid to GSAM were recommended for future allocation to individual members of the LLP by its designated member.
    • The balance of profits of HFFX was allocated by the managing partners to the individual members.
    • GSAM invested its profits in funds ran by GS after settling its liabilities, including tax.
    • One, two and three years after the recommended allocations were made, the investments made by GSAM were sold and the proceeds injected into HFFX as 'Special Capital'.
    • GSAM provided its discretion to HFFX to allow individual members to withdraw the Special Capital from the LLP largely in line with the recommended allocations made (Issue 2: Should amounts of Special Capital allocated to individuals be treated as miscellaneous income? Or as an alternative Issue 3: Is the allocation of Special Capital taxed on the basis of the provisional sale of occupational income regime?)
  • HMRC issued various discovery assessments (Issue 4 and 5 - were discovery assessments valid and not stale)
  • The Appellants appealed those assessments.

Issue 1: Should amounts paid to GSAM under the CAP be treated as partnership profits of the individual members?

The FTT concluded that the recommended future allocation of the profits allocated to GSAM should not be reallocated to the individual members as:

  • There was no guarantee the amounts will be paid in full, or at all, to the individual members.
  • Amounts paid to individual members could be, and were, varied when compared to the recommended allocation.
  • Amounts were withheld at behest of GS.
  • Amounts legally became the property of GSAM rather than the individual members.
  • A discretionary right to a future distribution of profits cannot be a right to a share in the profits of the LLP at the point the profits are allocated. It is only when that discretion is exercised that a taxable amount can be determined
  • The members did not direct a portion of their profit share to GSAM, that was outside their control.
  • The right to request alternative remuneration, receiving a deferred bonus in the form of deferred shares rather than profits in the form of the CAP, was exactly that, a request, rather than a right to an allocation of profit.

As this issue was found for the taxpayer, their appeals against the assessments raised by HMRC seeking tax in this way were allowed.

Issue 2: Should amounts of Special Capital allocated to individuals be treated as miscellaneous income?

HMRC argued that if the amounts allocated to GSAM were a profit share of GSAM (if Issue 1 does not subject the profits to tax in the hands of the individual members) then when Special Capital is allocated to the individual members it should be taxed under the miscellaneous income provisions.

The miscellaneous income anti-avoidance provisions are a catch-all to tax income from 'any source' that is not otherwise charged to tax.

The FTT concluded that the miscellaneous income provisions applied to the reallocation of Special Capital as:

  • The CAP was set up as a deferred bonus scheme to comply with regulatory requirements.
  • The discretionary reallocation of Special Capital was to reward individual members for their performance and to incentivise behaviour.
  • The discretion exercised by GSAM to reallocate Special Capital was in accordance with the HFFX LLP deed which provided a link between the reallocation of capital and the members' rights and obligations.
  • This link meant that there was a 'source' for the purposes of the miscellaneous income provisions.

Issue 3: Is the allocation of Special Capital taxed on the basis of the provisional sale of occupational income regime?

The FTT considered the application of the sale of occupational income provisions despite the miscellaneous income provisions being applicable and taxing the amounts reallocated.

These provisions apply if transactions are put in place to exploit the earning capacity of an individual undertaking an occupation the main object, or one of the main objects, of which is to reduce liability to Income Tax.

The FTT considered that these provisions would apply to the allocation of Special Capital as:

  • The activities undertaken by the appellants were an occupation 'of a kind undertaken in a profession'.
  • While there were commercial reasons for the CAP, the managing member considered alternative arrangements carried an unfair tax position and this played a substantial part in choosing the CAP as a remuneration strategy.
  • While a taxpayer is entitled to choose how to structure their affairs, it was considered that the arrangements were intended to lead to a significant tax reduction for the individual members and that this was one of the main objects of the implementation.

Issue 4:  Were discovery assessments valid?

While the FTT finding Issue 1 for the taxpayer rendered the associated discovery assessments invalid, the FTT considered the arguments in respect of their validity. The FTT:

  • Dismissed the taxpayers' argument that there could not be an insufficiency of tax if the total profits of the LLP were unchanged (as all of the profits of the LLP had been subject to tax).
  • Found that, the insufficiency of tax was at the level of the individual member, so a discovery assessment could change the allocation of profit between members.

Issue 5: Whether discovery assessments were stale.

This covered the discovery assessments raised taxing the reallocations of Special Capital in the way considered in Issue 2.

The FTT concluded that the discovery assessments had not become stale and invalid as:

  • The fact that HMRC had reached a view on cases with similar circumstances did not mean that they could reach a conclusion without analysis of the requested information and documentation of this case.
  • HMRC should have sufficient time to consider all of the information put to them before making the decision.
  • Continued correspondence between HMRC and the taxpayer indicated that HMRC considered that further information could become available.
  • HMRC were pursuing their enquiry and had not been inactive.

Useful guides on this topic

Discovery Assessments: At a glance
What is a Discovery Assessment? When can HMRC make a Discovery? What are the time limits for Discovery Assessment?

Discovery Assessments
When can HMRC issue an assessment outside of the normal statutory time limits? What conditions must be met? What are your rights of appeal and defences?

Sale of occupational income: anti-avoidance
When is there a sale of occupational income?  How is it taxed?

Partnerships with mixed membership
What is a mixed-member partnership?  How are the profits of a mixed-member partnership taxed?

External links

HFFX LLP & Ors v HMRC [2021] TC8023


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