The Boston Consulting Group UK LLP & Ors v The Commissioners for HMRC

Furthermore, the evidence of Mr Holden explains that for accounting purposes the UK LLP is treated as having the benefit of the services provided by the UK MDPs. The fair value of the Capital Interests is fixed at the date they are acquired by the MDPs and a debit is recognised equal to that value as calculated by applying Black-Scholes. Such amounts are categorised as “members’ remuneration” even though in practice no amount will be paid by the UK LLP to the MDPs in respect of their Capital Interests. That amount is therefore recognised as an expense in the UK LLP’s profit and loss account. However, it is the profit for the financial year before members’ remuneration and profit shares which is used as the starting point for determining the profits of the UK LLP to be allocated amongst its members for income tax and corporation tax purposes.

On disposal of the Capital Interests the price paid by BCG Ltd under the disposal provisions is recognised for accounting purposes by the UK LLP as a capital contribution made to it by BCG Ltd on the basis that the UK LLP is treated as having the benefit of the services provided by the MDPs and the Capital Interests are treated as connected to the provision of those services by them.

In the accounts of BCG Ltd it was stated:

“The ultimate parent company allows participants in BCG LLP to be granted interest rights over its shares. The accounts for the plan as a cash settled share-based payment under FRS 20 because the obligation to settle the award resides with BCG Ltd.

There are no share-based payment expenses recorded as the employees are not providing services to the company, instead the fair value of the services provided are recorded against investment in BCG LLP with the corresponding liability recorded within [the] company at each reporting period end. The fair value is measure[d] by the use of the Black-Scholes pricing model….

[ the Capital Interest scheme] … is akin to a share-based payment scheme. ”

The evidence of Mr Holden explained that while BCG Ltd is required to recognise a debit on the allocation of Capital Interests to MDPs it is also required to determine the fair value of those interests at each balance sheet date. Again, as the UK LLP is treated as having the benefit of the services provided by the MDP and the Capital Interests are connected to the provision of those services, the amounts which BCG Ltd recognises are treated as adjusting its investment in the UK LLP. If the value of a Capital Interest increases following acquisition by a MDP, BCG Ltd will be required to recognise that increase in liability at each subsequent balance sheet date in the investment in the UK LLP.

PwC explained in correspondence with HMRC that the following factors led to the MDPs’ Capital Interests being included in the accounts as liabilities of BCG Ltd:

BCG Ltd does not obtain a deduction in calculating its profits for UK corporation tax purposes in respect of the accounting debits which it is required to recognise in connection with the Capital Interests.

UK MDPs were not required to pay to acquire their Capital Interests, and therefore they would not make an overall loss in respect of their Capital Interests, if the value of the BCG Inc shares fell during the period in which the UK MDPs held their Capital Interests to below the share value as at the date of acquisition. Economically, this put the UK MDPs in largely the same position they had been in before the LLP Conversion, in which the funds required to purchase BCG Inc shares were advanced to them by way of a loan, with the creditor’s recourse under that loan being limited to the UK MDP’s LTCV investment.

However, once the value of their Capital Interests increased (by virtue of the increase in value of the BCG Inc Shares), the MDPs were at risk of losing some or all of that increase in value if the UK LLP or BCG Ltd became insolvent, or if the value of the BCG Inc shares fell. That again is economically the same as with the BCG Inc shareholding structure.

If the MDPs were receiving interests in the goodwill of the UK LLP as the Appellants maintain we would expect those interests to have some value on their grant. Instead, the Capital Interests were said to have no value on grant because they were solely linked to the increase in value from that point of the BCG Inc shares (although we would note that we would expect the Capital Interests to have some “hope” value in the context of the successful BCG Group).

Similarly, in a normal arrangement in which partners share the value of the capital of the partnership, the introduction of a new partner would be expected to have some impact on the value of the interests held by the existing partners. Those interests may not decrease in value if the business is growing, but the basic premise exists that the division of the capital between x partners is now a division between x+1 partners. That is not the case here. The MDPs’ interests are solely dependent upon the changing value of the BCG Inc shares between the grant of the interest and its disposal.

So far as BCG Ltd is concerned it held an interest in the capital of the UK LLP which remained constantly shown as owning 100% of the UK LLP (99.9% directly and the remainder through another group member, BCG UK1 Ltd) despite the fact the MDPs are said to have been holding Capital Interests in the partnership. However, PwC have explained that this was required under the applicable Financial Reporting Standard because BCG Ltd held the majority (in fact all) of the votes.

The total value of the Capital Interests could potentially exceed the fair market value of the UK LLP. There is no cap on the value and indeed no direct link. Although the evidence from Mr Holden was that the values were regularly reviewed by the business to ensure that the value of the Capital Interests did not exceed the value of the UK LLP, there is no evidence as to what would happen in such a situation. Such a review and action would not be necessary if those interests were in fact interests in the capital of the UK LLP. The limitation would be self-fulfilling.

If the profits of BCG Ltd were insufficient to fund purchases of the Capital Interests the evidence of Mr Holden is that BCG Ltd would be put in funds by way of capital injection from BCG Inc or from intragroup borrowing.

Clearly arrangements under which a formula price is paid on disposal of members interests where that formula is not linked to the value of the business itself is unusual. The fact that the interest has no value on grant would tend to lead us away from the conclusion that the Capital Interests were in fact interests in the partnership itself.

Mr Holden said that the intended effect of the Capital Interest rights was that a portion of the entitlement to share in the assets of the UK LLP was, in effect, transferred out of BCG Ltd’s residual share of the capital and into the hands of the relevant MDP. While this may be so in funding terms as a result of the 18% margin being used to fund the purchases of Capital Interests, we find little basis to conclude that BCG Ltd had transferred any rights in the capital of the UK LLP itself.

Although PwC stated in their advice in 2010 that the membership of the UK LLP would provide a substantial incentive for the partners in comparison to their previous position where they did not have a material equity stake in either BCG Inc or the UK business, in fact the UK LLP arrangements resulted in the real equity stake remaining that in BCG Inc. as before as a result of the form of the formula price payable for the Capital Interests. PwC had been envisaging a somewhat different structure in which the partners very clearly had the sort of rights as partners in a limited partnership which would normally be seen in professional partnerships.

Given all the elements of the LLPAs and the Capital Interests we have described we have concluded that:

We consider that the fact that BCG Ltd would not be required to pay for the Capital Interests where the UK LLP was insolvent does not in itself alter our conclusion as to whether the Capital Interests were in fact interests in the capital (goodwill) of the UK LLP. The insolvency provisions simply meant that the MDPs could not profit from good results in the worldwide group in circumstances where the UK business had gone bust but that is no more than a contractual term of the rights to payment on “sale” of the Capital Interests.

Given our findings we conclude that the Capital Interests were not interests in the capital of the UK LLP or a share in its assets. Indeed, the Capital Interest holders had no right as Capital Interest holders as against the UK LLP itself (in contrast to a capital contribution right). Their rights were against BCG Ltd to be paid an amount at a future date calculated by reference to the increase (if any) in the value of BCG Inc. As HMRC submitted, the incorporation of this right under the LLPAs means that the right is part of each MDP’s “interest in the UK LLP” in the broadest Reinhard v Ondra sense, but that does not make them a right in the goodwill, the capital or any other asset in the UK LLP itself. That conclusion reflects the very flexibility of LLP agreements. We recognise that this does not reflect the evidence of Mr Holden as to the intended effect of the rights, but given the conclusions we have reached we are unable to accept his interpretation of those rights.

We also recognise that on an MDP leaving a document was prepared which recorded that the MDP assigned all rights under the Capital Interests to BCG Ltd. The “purchase price” was the amount calculated under the LLPA provisions (but was not paid to the departing MDP for a year in order that there could be set off under anti-competitor penalty provisions – see paragraph 143 below). Although the document appears on its face to suggest a sale of an interest in the UK LLP we have concluded that the substance of the Capital Interests is that they are rights against BCG Ltd to payment. While the drafting of the assignment or sale documents would be consistent with a sale of an asset in the UK LLP itself, those documents do not alter the underlying nature of the Capital Interests. The word “sale” must therefore be interpreted in that context. We therefore use the word “sale” in this decision in quotation marks.

Mr Grodzinski submits that the effect of s863(1)(c) ITTOIA and s59A(1)(a) TCGA is that the members are treated as holding the assets of the partnership for income and capital gains tax purposes and therefore even if the interests of its MDPs were not properly to be regarded for general purposes as direct interests in the capital of the UK LLP they are treated as direct interests in the assets of the UK LLP for tax purposes.

We return to this argument later, but would note that at most it is an overriding “fiction” for tax purposes which treats membership of the partnership as meaning that the partner holds a share in the assets of it, reflecting the transparent treatment of partnerships for tax purposes. It does not override the proper analysis of the nature of the Capital Interests. It is accepted (and indeed relied upon) by the Appellants that in the context of an LLP as a matter of general law there is total flexibility regarding the terms of the LLP agreement as to ownership of the assets.

We now turn to consider whether the Capital Interests should be regarded as part of the MDPs’ remuneration or compensation for services.

The following factors weigh in favour of concluding that the Capital Interests operated to give the MDPs part of their reward for services:

We recognise that by 2012 new partner presentations were excluding the LTCV from illustrations of total compensation. However, we read this in the context of the presentation overall which explains BCG’s compensation and equity framework as being made up of two components: a global performance evaluation system and a profit sharing and distribution model. Within that it is stated that there are five structural components of the model including the LTCV and a bonus scheme. The LTCV is specifically addressed and described as having three basic objectives: to provide a long-term mechanism linked to BCG’s performance; to incentivise high performing partners to remain with BCG; and to strengthen and increase the stability of BCG’s capital base. The presentation however, is high level covering the LTCV in varying forms globally. It describes the partners as purchasing an initial interest, whereas in the UK the Capital Interests were not purchased by the partners. We therefore consider that its value in accurately identifying the role of the Capital Interests is limited.

Mr Holden’s oral evidence at the hearing in re-examination was that the Capital Interests were nothing to do with compensation and were a separate investment as part of the business’ working capital. However, Mr Holden has been intimately involved with the litigation of this dispute and is fully aware of the case which the Appellants seek to present. We have therefore considered his evidence in the context of the various items we have identified in the evidence leading to the conclusion that the Capital Interests were part of the MDPs compensation package. Moreover, the fact that the Capital Interests (just as the predecessor structure of the LTCV in the UK) gave the MDPs a form of equity style investment in the business was particularly focused on by Mr Grodzinski at the hearing. We accept that the Capital Interests operated in that way by reference to the increase in value of the BCG Inc shares, but that in itself is not determinative of the question of whether the interests were part of the MDPs’ overall compensation.

We have therefore concluded that considering the evidence overall and, in particular, the factors identified above, the Capital Interests should be found to have been part of the overall package of remuneration provided to senior personnel for the services they provided to the organisation.

On 20 May 2013, HMRC published a consultation document entitled “Partnerships: A review of two aspects of the tax rules” setting out proposals for what became the “mixed member rules” or “MMRs”.

Given the perceived risk of tax costs arising from the proposals it was decided that BCG Ltd would purchase all the UK MDPs’ Capital Interests with effect from 31 March 2014.

With effect from 31 March 2014, each of the UK MDPs sold their entire Capital Interest in UK LLP to BCG Ltd, in accordance with the terms of the LLPA (the March 2014 Disposal). Each of Mark Benedict Holden (BH), Afonso Nascimento (AN) and Thomas Garside (TG), being the individual Appellants who were UK MDPs as at that date, was required to reinvest the proceeds which they received as part of the March 2014 Disposal (less an amount retained to satisfy the estimated tax liability arising to each individual on that disposal) as a capital contribution to UK LLP.

BCG Ltd funded the purchase by way of intra-group borrowing.

The contribution of the proceeds from the disposal as capital was to ensure that the MDPs concerned did not realise cash as a result of the disposal and therefore were not in a better position than non-UK MDPs participating in the LTCV.

Aside from the acquisitions of Capital Interests on 1 April 2011 and between 1 December 2014 and 1 January 2015, and the disposals of Capital Interests on 31 March 2014, as described above, during the Relevant Period, the Individual Lead Appellants participated in further acquisitions and / or disposals of Capital Interests, as follows:

Between 1 December 2014 and 1 January 2015, each of the UK MDPs was granted a new Capital Interest in UK LLP. The members of UK LLP also entered into an amended and restated LLPA (the 2014 LLPA) with effect from 1 December 2014.

Once the view was formed that the MMRs should not apply to the UK LTCV, in December 2014 and January 2015, UK MDPs were granted new Capital Interests under the LLPAs. The size of the Capital Interest which each UK MDP acquired at that date was intended to be equivalent to the size of the Capital Interest which that UK MDP had held prior to the March 2014 Disposals, but taking into account the amount which had been realised by that UK MDP via the March 2014 Disposal (with some further adjustments, to ensure the size of those Capital Interests remained consistent with the LTCV Policy; for example, where a UK MDP had increased in seniority prior to the reintroduction of the Capital Interests).

By way of illustration, using one Appellant, AN, as an example:

The result was that for the MDPs participating in the 2014 disposal the change in value of the BCG Inc shares had been locked in at the point of that disposal as it had been converted to a capital contribution in the UK LLP.

The trigger for restructuring the LTCV in the UK was a concern regarding US tax changes potentially causing US tax deductions no longer to be available as well as sensitivity to UK tax law changes indicating an increased scrutiny of executive share based programmes.

The perceived tax risks particularly focused in 2010 on the possible introduction of changes to employment-related securities rules where shares are provided to employees through share options where the shares have no rights or limited rights over the value of the company at the time at which the options are granted but have rights over all subsequent growth from that time onwards. The consultation which was being considered at the time explained that the aim of the provisions was to ensure that employment income from employment-related securities would be subject to income tax and National Insurance Contributions. The evidence of Mr Holden is that simply re-implementing the previous LTCV programme in the UK as before was considered to carry that income tax and National Insurance risk.

Therefore the restructuring from the BCG Inc share structure was driven by the desire to avoid the effect of expected changes in both the US and the UK. On a worldwide basis BCG sought to obtain capital gains tax treatment for the LTCV programme where possible.

In considering what alternative structure could be used BCG was receiving advice that it was still normal and acceptable for individuals who are part owners of private businesses to hold interests in them which would be subject to capital gains tax rather than income tax on disposals, consistent with the treatment that individuals disposing of their BCG Inc shares had obtained. Therefore BCG looked to find a new structure replicating that capital gains tax result, although it was recognised that the corporation tax deduction which BCG Ltd had claimed in respect of the pre-February 2010 LTCV programme was unlikely to be obtained.

Internal BCG documents show that the LTCV had four basic objectives: to provide a long-term reward mechanism linked to BCG’s performance; to incentivise high performing partners to remain with BCG; to strengthen and increase the stability of BCG’s capital base; and to provide tax advantages where possible.

Indeed, the tax advantages of the UK LLP structure were a key feature of its adoption as shown by the following evidence in particular:

We recognise that there were tax disadvantages to the structure for non-UK domiciled MDPs. We recognise also that there were other non-tax benefits identified with the UK LLP structure. A presentation to the BCG audit committee identified the benefits of the UK LLP as being: greater competitive remuneration incentives, through capital interests, to enhance recruitment and retention of MDPs; the fact that partners in UK LLP are not protected by employment law; a tax effective reward system that aligns the MDP and BCG interests; social tax savings; a deferral of tax which enhanced working capital; and the potential to realise the entrepreneurs’ relief benefit. Using the UK LLP was also identified as offering the opportunity to ensure that the MDPs did not obtain minority shareholders rights. The UK LLP could be structured with no voting rights given to the MDPs.

Recognising that there were other elements of the UK LLP/Capital Interest structure which made it attractive to BCG and that for the non UK domiciled MDPs there were disadvantages compared to the previous BCG Inc share structure, we are however, clear that avoiding income tax on the LTCV was one of the main objects of the restructuring. The UK LLP structure using the Capital Interests was seen as a way to achieve that. We are also clear that the capital gains tax treatment and the potential tax and social security savings to both BCG and the individuals was a main object of the use of the UK LLP and the Capital Interests.

BCG obtained the following written advice from third party advisors in relation to the transactions described above:

In addition to the advice described above, in respect of each tax year within the Relevant Period, each UK (including the individual Appellants) was provided with a letter of advicefrom PwC, setting out how PwC considered that that UK MDP should report the various amounts arising to that UK MDP out of his or her relationships with BCG in his or her UK self-assessment return for that year (the PwC Advice Letters). Where a UK MDP disposed of his or her Capital Interest in the year in question, the PwC Advice Letter sent to that UK MDP for the relevant year advised that UK MDP to report that disposal on the UK MDP’s self-assessment return as a disposal of a capital asset (and, for certain of those UK MDPs, to claim entrepreneurs’ relief in respect of that disposal, and to include a “white space” disclosure in their self-assessment return in respect of such claim). PwC was engaged to provide these letters by BCG and not by the individual UK MDPs themselves.

The Feasibility Report prepared by PwC in 2010 was based on a structure of the Capital Interests as providing MDPs with interests in the value of the UK LLP itself and not the value of BCG Inc’s shares. The report also contemplated a structure where the MDPs purchased the Capital Interests – contributing capital for an interest in the capital of the UK LLP. That purchased interest in the capital could then be structured such that it gave a right to be paid an amount equal to the change in value of the BCG Inc shares (as before). However, it was noted that there was a potential problem if the value of UK LLP did not increase as fast as the increase in the value of BCG Inc shares. In that case, it was suggested that income interests could be allocated that gave the MDP the same rights as BCG Inc equity would have delivered, albeit as income not capital.

The advice was therefore predicated on the value of the Capital Interests reflecting the value of the UK LLP which is significantly different to the structure put in place. Indeed, Mr Holden wrote to colleagues in relation to the PwC report saying “This last point is the crux, if the LLP does not grow revenue then the capital interests don't grow in value.”

The March 2011 letter of advice from PwC was written by PWC in the USA addressed to BCG Inc. By that stage the structure did not involve the MDPs paying for the Capital Interests and those Interests would be realised by an MDP generally after 20 years or on retirement for a value determined by reference to the difference in the value of BCG Inc shares between allocation of the Capital Interests and their assignment to BCG Ltd. However, the structure PwC advised upon also:

The evidence from Mr Holden was that there would have been conversations about the structure and differences between what had been assumed by PwC and what was to be implemented. He also thought that PwC had decided that it was not in fact necessary to check that the value of the Capital Interests did not exceed the value of the UK LLP. Mr Grodzinski referred to emails in 2010 referring to the need for a significant amount of detailed work to be done before an informed decision can be made about the appropriateness of the structure and raising the possibility of seeking a second opinion from the law firm, Norton Rose. The timetable shows a series of meetings over the course of four days in November 2010 to discuss the structure with PwC and internally. However, these meetings and comments pre-dated the PwC advice. No further written evidence has been provided and Mr Holden recognised that given the passage of time it was difficult to remember just what was said at the time.

The chief financial officer at the time identified that the structure had the sense of being too good to be true saying: “Anytime we can take old comp and make it new capital gain….my radar goes on high alert. And then my follow up question is that if it really works, why didn't we do it with all of their comp?” She wanted to follow up the PwC letter with a phone call to understand the level of risk.

Notably, the March 2011 letter of advice was stated not to be an opinion about the tax consequences of the transactions. In our experience it would be standard practice for an opinion to be obtained in such situations setting out identified risks. That opinion may use “should” wording rather than the more definite “would” but would give the client the clear identification of the extent of risk of challenge to the tax treatment of such a structure. The need for such an opinion is particularly strong where the chief financial officer has identified a concern with the structure and advice.

We do not find Mr Holden’s general assertions that there would have been some conversations to be sufficient to show that an opinion addressing the differences in structure between the PWC March 2011 letter and that implemented was in fact obtained.

In relation to 2014/2015 onwards the application of s850C ITTOIA needed to be addressed. Concern about the impact of the new mixed member partnership rules had prompted the disposal of Capital Interests by the UK MDPs in March 2014. There is reference in the evidence to the business working with multiple external advisers to analyse the draft rules. However, there is little evidence beyond that showing what those multiple external advisers said save for the evidence of advice from PWC and a very generalised level of evidence from Mr Holden.

Before moving forward to implement that structure again PwC wrote a report in June 2014 in which it was stated that:

“PwC believe that the proposed changes to the LTCV will segregate the profits that are subject to tax on the partners and any gain realised on the growth in value of the LTCV. However to gain further comfort on [how] the likely interpretation of the tax tribunal’s and courts would apply the “reasonable suppose” test we would recommend that BCG seek specialist counsel’s opinion before implementing the new LTCV in the UK.”

One element seen as key to the operation of the UK LLP outside s850C ITTOIA was that BCG Ltd would not use “warehoused profits” to pay MDPs for their Capital Interests.

PwC identified a potential issue for the structure in connection with the uncertainty surrounding the application of Condition Y in s850C ITTOIA. They advised that the “power to enjoy” condition in Condition Y (see later in this decision) would be met. PwC then set out several pages of detailed analysis about the interpretation of the provision in Condition Y which addresses whether it is reasonable to suppose that the individual partner’s profit share is lower than it would have been absent the Capital Interests. The analysis makes clear that this is not a straightforward question to answer. Reference is made to several HMRC guidance examples and concludes that there remains a risk that Condition Y would be satisfied. PWC then recommended that tax counsel’s opinion should be sought. No such opinion was in fact obtained.

In mid to late 2014 EY were engaged by BCG to consider options for re-introducing the LTCV for MDPs including the Capital Interests. EY provided a note of advice in draft form. A finalised version of that note has not been provided and given the fact that Mr Holden told us that BCG relied on the EY note as well as the PwC advice it is somewhat surprising that a final version was not obtained. Furthermore, the advice obtained was limited to a few briefly stated conclusions with little underling analysis. Without any explanation of the factors considered in relation to the Capital Interests EY simply state that as the UK LLP is transparent, they would argue that the LTCV is treated as a disposal of goodwill on sale. The tax risks associated with the MMRs are dealt with in one short paragraph concluding that EY would “argue” that the rules would not apply primarily because of the “defence” that the LTCV is mandatory and has no effect on the level of the UK LLP partnership profits which accrue to the partners.

In using the words “argue” and “defence” the reader is put on notice that this is a potentially contentious area. Yet EY were not asked to provide a fuller analysis of the risks or even to finalise the draft.

In relation to the individual Appellants, a letter from PwC advised them as to what entries and figures to include in their tax returns. Each letter would include an appendix which was said to detail instructions on how to enter the individual’s BCG income onto their tax return. The individuals were told that if they had a tax adviser they should pass those instructions onto them. Where Capital Interests were sold there was a section under the heading of “details of chargeable assets disposed of and gains and losses” which described the sale of a Capital Interest and the “disposal proceeds” resulting therefrom.

We find that the MDPs relied on the advice contained in the PwC letters in order to work out how to report their partnership income and the proceeds from “sale” of the Capital Interests.

Some of the individual Appellants also engaged agents who filed their returns on their behalf. There is no evidence that any of the agents acting on those individuals’ behalf took a different view to that stated in the PWC advice letters.

In March 2012 the Budget set out the reduction in the top rate of income tax from 50% to 45% with effect from the tax year beginning 6 April 2013.

An internal memorandum was produced by BCG’s UK tax department which noted that due to the early announcement of the tax rate changes it was widely anticipated that businesses would react and large payments such as bonuses or equity awards would be postponed until the 2013/2014 tax year or later. It was further noted that there were no measures introduced in the budget or subsequently to restrict any such deferrals and UK Treasury forecasts had modelled the tax impact of expected forestalling. It was therefore proposed that the UK LLP profit allocations should not include lump sum distributions payable in May and December 2013, but instead they should be allocated at the same time as the 2014 distributions in the 2013/2014 tax year. It was noted that this proposal had been discussed with PwC who were comfortable with the position and the income tax savings for MDPs would be around £600,000. PwC later prepared the 2012/2013 tax return on behalf of the UK LLP on the basis of a valid deferral.

As explained earlier the profit allocation made in the summer of each year would generally run on the basis of one quarter from the year just ended and three quarters from the expected results of the current year.

In May and June 2013, prior to the decision of the Remuneration Committee regarding the allocation of UK LLP’s profits for the year ended 31 March 2013, it was decided that the MDPs would not receive any allocation of UK LLP profits for the year ended 31 March 2013 in respect of their PD and OPB (and associated PSRF) (see paragraph 52 above) for the 2012 calendar year. That amount (less the portion of that amount which had already been allocated to the UK MDPs out of UK LLP’s profits for the year ended 31 March 2012) was instead allocated to those MDPs out of UK LLP’s profits for the year ended 31 March 2014 by a decision of the Remuneration Committee for that year, made in July 2014. All of the profits for the year ended 31 March 2013 were taken into account by BCG Ltd as profits to which it was entitled.

While it was expected in mid-2013 that the allocation of UK LLP’s profits for the year ended 31 March 2014 would be made in such a way as to deliver to the UK MDPs an amount in respect of their 2012 PD and OPB (and associated PSRF), to the extent not already received out of UK LLP’s profits for the year ended 31 March 2012, it was not intended that the MDPs would have any right to that amount, unless (and until) that amount was allocated to them by the remuneration committee in July 2014. Indeed, the terms of the LLPA made clear that MDPs had no right to share in profits until an allocation was made.

Provisions in the LLPAs (set out above) made clear that if the drawings exceeded the profit allocation the MDP would be required to repay the difference.

When the proposal was discussed within BCG it was stated that it was anticipated that the UK LLP’s profits would be more than sufficient to cover the increased MDP profit allocations in 2013/14, with approximately £10-15m being the remaining profit for BCG Ltd.

The allocation deferral had no impact on the amount of PD and OPB which each MDP received in cash in 2012; or the time at which that amount was paid to the UK MDP. Amounts were paid to the MDPs by way of partners’ drawings, instead of by way of profit allocation and those drawings were then set against the amounts of profit allocated for the financial year ended 31 March 2014.

For the reasons we have set out earlier we have decided that it is relevant for the issue raised by HMRC regarding the process for allocation of the UK LLP’s profits to be addressed.

The LLPA 2011 stated that the extent of each Member’s interest in the profit of the UK LLP for any financial year shall be determined and notified to each Member by the Remuneration Committee. (In 2014 the committee changed to the profit allocation committee but the provisions remained essentially the same.)

In addition, the agreements provided that the Distribution Account of each Member would be adjusted to reflect the profit allocated to that member and the drawings and distributions paid to that Member. Profit allocated by the Remuneration Committee to a member was to be credited to that Member’s Distribution Account.

However, there was no notification of allocation of profits to BCG Ltd by the Remuneration Committee. Yet despite this apparent omission, apart from the amounts allocated to MDPs as their profit shares, all profits have been treated by the Appellants as allocated to BCG Ltd. The evidence of Mr Holden confirms that BCG has operated on the basis that the amount left after allocation to the MDPs is treated as allocated to BCG Ltd without a separate resolution allocating that residual profit to the company. Notification of allocations was made by the Remuneration Committee/Profit Allocation Committee to individual MDPs and the same “back office” system ensured that the accounts of BCG Ltd took into account its receipt of the residual profit. The accounts have reflected this and BCG Ltd has paid Corporation tax on its allocation. The monies have been used for a variety of purposes by BCG Ltd and no MDP has ever challenged the operation of the UK LLP in this way.

From the perspective of BCG it is clear from the documents considering the possibility of conversion operating through an LLP that it was intended that residual profit (after allocation to MDPs) would be received by BCG Ltd.

It was also made clear in communications with the UK MDP’s prior to the transfer to the LLP structure that those MDP’s would receive an allocation of the UK LLP’s profits the extent of which would be determined in accordance with the Framework. There is no evidence to suggest that the MDPs or BCG Ltd contemplated that the MDPs would be entitled to the entirety of the profits.

However, there is an entire agreement clause which stated:

The practical implementation did not reflect the requirement of the LLPAs for the Remuneration Committee to notify each Member of their entitlement. Under the terms of the LLPAs alone, without that notification a Member had no entitlement. However, the members of the UK LLP all acted on the basis that BCG Ltd was entitled to the residual profit.

The tax computations of the UK LLP for 2011/2012 to 2013/2014 did not mention the Capital Interests. They were mentioned in the notes to the accounts for those years.

On 17 and 19 January 2018 an HMRC officer opened enquiries into two individual MDPs in relation to their tax returns for the year 2015/2016. Those queries were raised regarding the disposals of Capital Interests. At the same time disposals of Capital Interests by those MDPs had also been identified by the officer as having taken place in 2013/2014. The matter was then handed to Mr Taylor.

Mr Taylor identified that around 40 MDPs had disposed of Capital Interests in 2013/2014 and had claimed entrepreneurs’ relief. He noted that most of them had not included any acquisition costs for the Capital Interests and had stated in their returns:

“I hereby claim Entrepreneurs Relief… on the sale of an interest in UK LLP on 31 March 2014. I sold x Class D shares in BCG Inc.”

Mr Taylor then reviewed UK LLP’s partnership tax computations for 2011/2012 - 2013/2014 and found no reference to the Capital Interests. However, the UK LLP’s accounts for the accounting periods ended 31 March 2012, 31 March 2013 and 31 March 2014 made reference to what was described as a “Capital Interests Scheme” in the notes describing them as follows:

“partners in the LLP are granted interest rights in UK LLP. The value of the rights is tracked with reference to the value of BCG Inc shares. This is akin to a share-based payment scheme. The LLP accounts for the plan as an equity settled share-based payment under FRS 20 because the obligation to settle the award resides with another group company, BCG Ltd.

The fair value of the services received from participants in exchange for the share interest awards is recognised as an expense over the vesting period (if any). The fair value is measured by the use of the Black-Scholes option pricing model.

The BCG Ltd accounts for the same periods included consistent notes about the Capital Interests. The investments note within the accounts stated that BCG Ltd owned 99.9% of UK LLP and the remaining 0.01% was owned by BCG UK 1 Limited.

Given the descriptions in the accounts, the fact that the individuals had been granted the rights for no consideration, the fact that BCG Ltd was receiving a significant portion of the UK LLP profits and the fact that a new tranche of Capital Interests was granted within nine months of the declared disposals on 31 March 2014, Mr Taylor thought it likely that the Capital Interests were in effect a share-based incentivisation/remuneration scheme for individuals.

Mr Taylor consequently concluded that the proceeds of the Capital Interests may be taxable under the profit sharing rules of s850 ITTOIA, the miscellaneous income rule in s687 ITTOIA or the provisions of ss773-778 ITA 2007. He considered that he had made a valid discovery on 16 February 2018 because it appeared that the profits allocated to the MDPs were too low or the amounts assessed in their individual self-assessment returns were insufficient.

He then issued the s30B TMA discovery amendments to UK LLP on 23 February 2018 in relation to the 2013/2014 return. On the same day he issued s29 TMA discovery assessments to 38 MDPs for 2013/2014.

On 19 April 2018 Mr Taylor met with representatives of PwC who were representing UK LLP. Meeting notes show that HMRC was told that following conversion to an LLP Capital Interests were allocated in the UK LLP. PwC explained that the value of the Capital Interests in the UK LLP was based on the value of shares in BCG Inc. HMRC noted that on the face of it the value of the Capital Interests in the UK LLP would be different to the value of shares in BCG Inc and commented that the economics of the Capital Interests were considered to be same as the economics of the BCG Inc shares. HMRC noted that there were concerns that the Capital Interests were possibly replicating an incentive scheme resulting in income being converted into capital. PwC explained the intention that MDPs held the Capital Interests until retirement or leaving BCG and noted the announcement of the MMRs had triggered disposals in 2014. MDPs then reacquired interests when the legislation was passed. A list of outstanding points/enquiries was identified which included:

PwC responded on 18 June 2018 and 31 July 2018. The responses included a copy of the 2014 LLPA and an explanation of its key terms and a schedule showing for each MDP the Capital Interests held from the inception of the UK LLP to 5 April 2014 inclusive. It did not include a schedule for the Capital Interests held after that date.

On 6 September 2018 Mr Taylor spoke with PwC representatives explaining that HMRC continued to believe that there had been an underpayment of tax relating to the Capital Interests and intended to raise additional discovery assessments for nine individual members listed in a schedule of pre-April 2014 Capital Interests who had not previously been assessed.

In an email dated 7 September 2018 HMRC requested further information, commenting that it would appear to be the case that profit entitlements of the individual members are deferred in favour of the corporate member until the agreed encashment date. Comments regarding this suggestion were requested.

On 17 September 2018 and 27 September 2018 Mr Taylor indicated in telephone calls that additional discovery amendments were to be issued imminently.

On 15 October 2018 Mr Taylor emailed PwC explaining that it was understood that at least some of the MDPs continued to hold equity interests in BCG Inc. It was commented that the concerns in respect of the draft MMRs would not be expected to be negated if the partners of the UK LLP continued to hold equity stakes in the corporate group where they continued to have an indirect power to enjoy profits allocated to the corporate member of the UK LLP. Therefore the reason for re-acquiring the Capital Interests in March 2014 was still not understood. Further explanation was sought.

On 9 November 2018 PwC provided further information and documents including a schedule of the grants of Capital Interests granted post-April 2014. The information and documents also included a slide deck explaining profit allocation methodology, written resolutions of the Remuneration Committee, profit allocation statements and PwC’s letter of advice dated March 2011. Mr Taylor says that it was upon reviewing this document that he discovered the value of the Capital Interests allocated to each individual which he believes should have been treated as share-based payments, or that amounts of individual members’ profit entitlements had been deferred to the corporate member or that the individual members could potentially have the power to enjoy amounts allocated to the corporate member.

During a telephone call between Mr Taylor and PwC on 12 December 2018 it was agreed that Mr Taylor would issue a further request for information to seek to address HMRC’s concerns that there had been an underpayment of tax.

On 10 January 2019 Mr Taylor wrote to PwC stating that he continued to believe that HMRC had made a discovery in respect of there being a shortfall in tax paid resulting from the transactions surrounding the Capital Interests. It was noted that detailed information had been provided but further clarifications were sought. In the letter Mr Taylor set out a summary of the concerns regarding the Capital Interests:

In addition, the 10 January 2019 letter included an unusually long schedule of information and documents sought by HMRC.

On 25 February 2019 PwC responded in detail in a 23 page letter.

On 8 March 2019 HMRC issued further discovery assessments to 9 individual MDPs.

On 29 March 2019 a s30B amendment was issued to UK LLP in respect of 2012/2013 and 2014/2015 on the basis of allocation of profits under s850 and/or s850C.

The s30B amendment issued to UK LLP did not encompass any amendment required to reflect HMRC’s current position that the deferral of profit allocation to MDPs in 2012/2013 to 2013/2014 was not valid.

Mr Taylor has confirmed in his Witness Statement that there were a number of items of correspondence exchanged between August 2020 and February 2021 but no further information was provided that changed his opinion as the tax consequences of the arrangements which he had formed from his initial review of the UK LLP accounts.

We conclude that:

The parties have agreed that the appeals raise the following issues.

Whether (and, if so, the extent to which) the arrangements concerning the Capital Interests form part of the “profit sharing arrangements” of UK LLP for the purposes of section 850 ITTOIA; and, if so, how the UK MDPs’ and BCG Ltd’s allocation of UK LLP profits for income or corporation tax purposes in each of the years within the Relevant Period should be adjusted to take into account those arrangements.

Whether the disposal by the UK MDPs of their Capital Interests should be treated as giving rise to income, subject to UK income tax under section 687 ITTOIA, rather than as the disposal of a capital asset, potentially subject to UK capital gains tax.

Whether disposals by the UK MDPs of their Capital Interests should be treated as giving rise to amounts chargeable to income tax under Chapter 4, Part 13 of the Income Tax Act 2007.

Whether the UK MDPs’ allocations of UK LLP profit for the 2012/2013 year should be increased to include a portion of the profits included in those UK MDPs’ UK LLP profit allocations, as returned, for the 2013/14 year.

Whether section 850C ITTOIA applies in respect of the allocation of UK LLP’s profits between the UK MDPs and BCG Ltd for each of the financial years ended 5 April 2015, 5 April 2016 and 5 April 2017.

If the disposal by the UK MDPs of their Capital Interests is treated as a disposal of a capital asset, potentially subject to UK capital gains tax, whether those disposals are disposals of the whole or part of a business owned by the relevant UK Partner, for the purposes of Chapter 3 Part V of the Taxation of Chargeable Gains Act 1992. However, HMRC have conceded that if sales of the Capital Interests are correctly taxed as disposals of capital assets, Entrepreneurs’ Relief is available.

In relation to the assessments raised by HMRC against each of the individual Appellants pursuant to section 29 TMA (the Discovery Assessments), whether the conditions in section 29 TMA are met in respect of those Discovery Assessments.

In relation to the amendments made by HMRC to the partnership statements of UK LLP pursuant to section 30B TMA (the Partnership Amendments):

Whether the Discovery Assessments represent the appropriate means of effecting changes to the allocation of UK LLP's profits for the financial years to which they relate (and, if so, what is the correct interaction between the Discovery Assessments raised for a particular year and the Partnership Amendment made to UK LLP's partnership statement for its accounting period ending during that year).

Whether the scope of any "discovery" giving rise to the Partnership Amendments for 2012/13 and 2013/14 (and, as a result, the scope of those Partnership Amendments and of the Appeals against those Partnership Amendments) is sufficiently broad as to encompass the issue described in paragraph 227 above.

In relation to each of the Discovery Assessments issued:

In relation to each of the Partnership Amendments to UK LLP's partnership statements for 2012/2013 and 2015/16, respectively, if HMRC has identified correctly a "loss of tax" within sections 30B(1)(a) to 30B(1)(c) TMA in respect of the relevant partnership statement, whether that loss of tax was brought about carelessly or deliberately by UK LLP’s representative partner, or any person acting on his behalf, for the purposes of section 36 TMA.

Although the burden of proof is on HMRC to show that the assessments and amendments were validly issued, that involves at least in part a consideration of whether HMRC has shown that the taxpayers were careless when completing their returns. Clearly if the proper tax treatment of the payments is as declared by the taxpayers they cannot have been careless. We therefore consider the substantive issues first.

We heard extensive submissions from both parties and only summarise key points in this decision in the context of each issue.

Before analysing the issues one by one we comment on three cases to which much reference was made in the hearing: HMRC v BlueCrest Capital Management LLP and ors [2022] STC 1696, Odey Asset Management LLP and ors v HMRC [2021] UKFTT 31 and HFFX LLP and ors v HMRC [2023] UKUT 00073 (TC).

The cases concern the tax treatment of another LLP structure and as the parties have acknowledged there are notable differences between the structure in those cases and the structure in this. In particular, in this case once Capital Interests are awarded to an MDP there are no bad leaver/forfeiture provisions although the penalty provisions have substantially the same effect. The MDP can count on being able to realise value from the Capital Interests so long as the value of the shares in BCG Inc increases over the time and the UK LLP does not become insolvent. The LLP structure here is also much longer term: in the other cases the participants could access the value after a period of varying between six months and three years. In addition, and importantly, the other cases:

However, the cases have been relied upon by the parties in various contexts and we address the principles derived from the Upper Tribunal decisions in HFFX and BlueCrest in particular in the context of this decision, while recognising that the decisions were based upon notably different facts.

Section 848 ITTOIA provides that:

“unless otherwise indicated (whether expressly or by implication), a firm is not to be regarded for income tax purposes as an entity separate and distinct from the partners”.

Section 850 ITTOIA currently provides as follows:

These sections together mean that the partners are taxed on the amounts of profits or losses allocated to them by the profit sharing arrangements of the firm.

In the Relevant Periods s850(1) was subject only to s850A and s850B in 2012/2013 and 2013/2014. Neither s850A nor s850B is relevant in this case.

From 2014/2015 s850 was also subject to s850C. These rules are therefore relevant for the tax years 2014/2015, 2015/2016 and 2016/2017.

Section 850C is the section which was introduced to counter manipulation of profit sharing arrangements by taxpayers in the context of mixed member partnerships – where there are one or more individual partners and one or more non individual partners. Section 850C requires three cumulative conditions set out in s850C(1) to be met. It is accepted that the first two are met by virtue of “A” (being an MDP) being treated under s849 as having been allocated a profit from the UK LLP; and “B” (being BCG Ltd) also being treated under s849 and s850 as having been allocated a profit from the UK LLP.

The dispute in this case focusses on Section 850C requiring that one of two conditions – Condition X and Condition Y – is met.

Section 850C(2) states:

Section 850C(3) states so far as relevant that:

Where either Condition X or Y is met then:

Section 850C(8) defines “A’s deferred profit”:

"The appropriate notional profit" is defined by s850C(10) as the sum of the appropriate notional return on capital and the appropriate notional consideration for services.

"The appropriate notional return on capital" is defined in s850C(11):

Section 108 ITA provides:

Section 850C(18) provides that A has the power to enjoy B's profit share if:

Those conditions are provided so far as relevant by subsection (20) as follows:

The UK LLP relies upon the flexibility provided by the LLP Act. The rights of a member are determined by the LLPA. Reliance is placed on the description of the nature of the members’ interests provided by Warren J in Reinhard v Ondra LLP and others [2016] 2 BCLC 571. In this case the Capital Interests are the MDPs’ share of the goodwill of the UK LLP.

Although members do not have any direct legal or beneficial entitlement to the assets of an LLP the position is modified for tax purposes in relation to LLPs that are carrying on a trade or business with a view to profit. Section 836(1)(c) ITTOIA and s.1273(1)(c) of the Corporation Tax Act 2009 state that the property of an LLP is treated as “held by the members as partnership property”. For capital gains tax purposes s.59A(1)(a) TCGA provides that the property of an LLP is treated as “held by its members and partners”. Therefore even if the interests of the MDPs were not properly to be regarded as direct interests in the capital of an LLP they are treated as direct interests in the assets for tax purposes.

Reliance is placed on the cases of HMRC v BlueCrest Capital Management LLP and ors [2022] STC 1696, Odey Asset Management LLP and ors v HMRC [2021] UKFTT 31 and HFFX LLP and ors v HMRC [2023] UKUT 00073 (TC).

The key determining facts are those relating to the rights of the members to share in profits in the relevant period of account as determined under the relevant LLPA. Importantly in this case the payments are made by one member of the UK LLP - BCG Ltd - to another member - the UK MDP - in consideration for the acquisition of an asset, i.e. the Capital Interest.

HMRC rely on the case of Morgan and Self v HMRC [2009] SFTD 160, but the fact that it was concluded that payments made to partners leaving the firm were payments out of profits does not mean that payments to departing partners are always to be regarded as such. Furthermore, an acquisition of an asset is no less an acquisition because it occurs where an individual ceases to be a member of the UK LLP and in this case, as regards the March 2014 disposals, the UK MDPs who sold their Capital Interests were not departing members.

The UK LLP does not provide a mechanism for enabling the gratuitous or disguised transmission of profits from BCG Ltd to the UK MDPs. The fact that BCG Ltd may use money generated from profits that have accrued to it under the terms of the LLPA to acquire Capital Interests does not transform the receipt by the member of the consideration he receives for their “sale” into a share of the profits of the LLP. BCG Ltd is only one of the entities able under the terms of the LLPA to acquire the Capital Interests as BCG Ltd can designate that another person shall purchase the Capital Interests. Accordingly, sums that are not derived from BCG Ltd’s share of the profits may also be used to acquire the Capital Interests. The value of the Capital Interests is not directly related either to the profitability of the UK business or to BCG Ltd’s profit share. The value of the Capital Interests may rise or fall in value unlike an allocation of profits. BCG Ltd is not a mere conduit. It was not inserted into an existing partnership or LLP to perform a conduit function. It owned the whole of BCG’s UK business before it transferred that business to the UK LLP. Following the LLP conversion no change was made to the way that the Framework was applied to the UK MDPs and BCG Ltd continued to receive (in substance) the entirety of the profits from the UK business net of UK MDP remuneration (albeit as a share of the profits of the UK LLP rather than employment income). The profits are not legally or in practice held for the UK MDPs’ benefit by BCG Ltd. They were available for distribution to, or use by, BCG group entities as and when required and have in fact been distributed to and/or used by BCG Ltd and other group entities before, during and after the Relevant Period.

In relation to the provisions of s850C:

Each individual’s LTCV entitlement can be calculated year by year and reflects a right against BCG Ltd. Unlike the corporate member in BlueCrest the obligations on BCG Ltd on purchasing the Capital Interests and the rights of the individuals are absolute in this case. BCG Ltd was required to make the payments (or direct someone else to) when the conditions were met with no exercise of discretion. BCG Ltd was a mere conduit for the LTCV, being allocated sums purely to satisfy its obligations under the LLPA and accordingly the Capital Interests should be considered part of the profit sharing arrangements of the UK LLP in line with the description of such a “conduit” in BlueCrest. Rights under the LTCV were fixed once and granted. There were no provisions for “bad leavers” to lose their Capital Interests. A significant sum (18% of margin according to the Framework) was to be retained separately to any profits paid out via the Framework to fund the LTCV and therefore a significant part of BCG Ltd’s entitlement was given to it for this funding.

If it is accepted that the disposal of the Capital Interest represents the sale of a valuable asset to BCG Ltd then it follows that year-on-year that asset has had its value increased. As the asset is, in substance, a right to a sum of money from BCG Ltd and BCG Ltd is put in funds to meet that liability, it makes sense to treat that as an allocation in favour of the individual MDP.

From 2014/2015 all of BCG Ltd’s allocation would be treated as allocated to the individuals by s850C ITTOIA which was introduced to enable HMRC to reallocate profits from corporate partners to individuals where a corporate partner was either obtaining an excessive proportion or the structure was being used to confer benefits on the individuals out of the company’s profit share.

Condition X applies because sums intended to fund the LTCV are an individual’s “deferred profit” within s850C(8) as the payment made under the LLPAs is a benefit which is deferred according to conditions as to exit or long service. It is clear from the Framework that the LTCV is one of the benefits enjoyed by the partners, albeit a long term equity benefit.

Given that part of the reason for making allocations to BCG Ltd is to fund the LTCV, if there were no LTCV then the individuals would, in general, receive higher profit shares each year. Furthermore, as the Framework shows that 18% is used to fund the LTCV rather than form part of the profit pool to which the compensation pillars applied, the pool would have been larger and profit shares would be larger without the LTCV.

In relation to Condition Y the amount contributed as capital by BCG Ltd is the amount recorded as its capital contribution, i.e. £5.7 million in 2011 and the value of approximately £3.5 million of the lease it transferred in 2013 making a total of a little under £9.3 million. Evidence from Mr Holden regarding the value of the business is not admissible as he was not put forward as a valuation expert. Furthermore, the Appellants have not until now challenged their own valuation in the accounts. The capital contribution of BCG Ltd is therefore very limited. The individuals had power to enjoy BCG Ltd’s profit share as defined in s850C.

The LLPAs expressly provide for what both parties accept are profit sharing arrangements. Those non-contentious arrangements are found in the terms of the LLPAs setting out that the extent of each Member’s interest in the profit of the UK LLP in any financial year would be determined and notified to each Member by the Remuneration Committee (and later the profit allocation committee). The allocation of profits to the MDPs reflected the four compensation components of the Framework.

The contentious matter concerns the Capital Interests which HMRC maintain should be taken into account as taxable income of the MDPs by virtue of forming part of the profit sharing arrangements of the UK LLP, either on the basis of the application of the general profit sharing rules for partnerships contained in s850 ITTOIA, or the special rules for mixed partnerships contained in s850C ITTOIA.

We consider that as a matter of general principle the Capital Interests should not be treated as part of the allocation of profit of the UK LLP under s850 for the following reasons:

Our conclusion is reinforced by the approach taken in BlueCrest and HFFX. Those cases involved partnerships where the corporate partner was awarded a portion of the partnership’s profits on a discretionary basis and used those profits to make discretionary awards of “special capital” to the individual partners. There was therefore a closer connection between the partnership profits and the “capital” provided to the individual partners than in this case. Yet the Upper Tribunal were satisfied in each case that the special capital allocation did not form part of the partnerships’ profit allocation. Here there is no allocation of some or all of BCG Ltd’s allocation of profit of the UK LLP to some category of interest/capital in the UK LLP. It is even further removed from a profit-sharing arrangement than the situation in BlueCrest and HFFX. To conclude that the Capital Interests form part of the profit sharing arrangements of the UK LLP would involve rewriting the contractual arrangements between the parties in such a way as the Upper Tribunal in BlueCrest decided was outwith even the most purposive construction of s850.

We recognise that the 18% margin was retained on the UK LLP’s balance sheet and that amount was treated as allocated to BCG Ltd for tax purposes, but there was no requirement to set money aside from BCG Ltd’s profit allocation or indeed even to use these retained funds. The MDPs could not make any claim against that retention. We therefore conclude that this funding system does not alter our conclusion about the application of s850.

We now turn to consider whether the provisions in s850C altered this conclusion. Those provisions only apply for the tax years 2014/2015, 2015/2016 and 2016/2017 from the Relevant Periods.

The matter in dispute is whether Condition X or Y is met.

Before setting out our specific conclusions regarding the Conditions we note the guidance provided by the Upper Tribunal in the case of Walewski v HMRC [2021] STC 1749 where the role of s850C was set out as follows:

“…the purpose of the rule is to prevent individual partners making arrangements which seek to accumulate profits in a corporate partner at a lower tax rate - for example, benefiting from the rate of corporation tax which is lower than the higher or additional rate of income tax.”

We agree with Mr Grodzinski that the context of the UK LLP is relevant. The Framework was in place for many years before the conversion to the LLP structure. It is part of a global remuneration and incentivisation programme operated by BCG, which, as we have found, also operates to contribute to the working capital base of BCG’s global business.

The evidence also shows that the conversion to the LLP structure was not driven by the existence of a lower corporation tax rate in the UK for BCG Ltd. Instead, it was initially prompted by US tax concerns. The structure involving the UK LLP was then seen to offer potential incentivisation advantages by providing a corporate structure akin to other professional firms, but was also importantly seen as a way of achieving tax advantages in social tax savings as well as the potential significant benefit of capital gains tax treatment combined with entrepreneurs’ relief for the individuals and potential business property relief for inheritance tax.

Benefiting from a lower corporation tax rate is only one example of the type of arrangements which Walewski describes as being the target of s850C. However the core element of the purpose of the rule is to prevent individual partners making arrangements which seek to accumulate profits in a corporate partner. It is with this purpose in mind that we address the Conditions.

Condition X

“Condition X is that it is reasonable to suppose that—

(a)

amounts representing A's deferred profit (see subsection (8)) are included in B's profit share, and

(b)

in consequence, both A's profit share and the relevant tax amount (see subsection (9)) are lower than they would otherwise have been.”

At the heart of this Condition is the concept of deferral of profit by “A” i.e. the MDPs. “A’s deferred profit” is defined by s850C(8), in essence, as “remuneration, benefits, or returns, the provision of which to A has been deferred”.

We consider that the use of the terminology “remuneration, benefits, or returns” shows a clear purpose of casting the net widely and in consequence we are satisfied that the Capital Interests fall within that description. The UK MDPs are entitled to receive the amount provided for under the LLPAs on their “sale” of the Capital Interests. We consider that is a “benefit or return” in its broadest sense. Mr Grodzinski submits that the MDPs receive the market value of the Capital Interests but they have paid nothing for them and we have found as a fact that the Capital Interests are similar to an employee share scheme in providing the recipient with a stake in the business and at the same time providing the recipient with a potential benefit/return if the business prospers.

We must then consider whether the provision of that “remuneration benefit or return” reflected by the Capital Interests is deferred.

Mr Grodzinski submits that something which is deferred is something to which the person would otherwise be entitled, but which is postponed. However, we consider that “deferral” should be given its ordinary meaning. The Oxford English Dictionary defines “defer” as:

“put off to a later time; postpone.”

We are satisfied that the provision of the remuneration benefit or return encapsulated within the Capital Interests is deferred applying this ordinary simple definition of the term. There is no requirement that there is an entitlement which is crystallised prior to the deferral. Mr Chacko conceded that this was not a case such as seen in Odey and HFFX where profits otherwise payable to a member are deferred. However, he maintained that s850C(8)(a) is still met. We agree. The wording of that subsection applies not only to a deferral of a profit share but also more widely given the extended meaning of “deferred profit”. The benefit deferred in this case is the value received by MDPs from the realisation of the Capital Interests.

Furthermore, s850C(8)(a) provides that the deferral may be “pending the meeting of any conditions (including conditions which and may never be met) or otherwise”. Therefore the fact that the value of the Capital Interests may increase, decrease, fluctuate, or disappear prior to their “sale” does not undermine the conclusion that there is a deferral.

The next question is whether the amounts representing the deferred profit are included in B’s (i.e. BCG Ltd’s) profit share. We are clear that it is important to recognise that the question here is focusing on whether an amount representing the deferred remuneration, benefit or return is included in BCG Ltd’s profit share.

18% of the group’s “adjusted margin” on a global basis is retained within the BCG group in order to fund the LTCVs. Quite how the adjusted margin precisely relates to the accounting profit is not addressed in the evidence but that does not matter. The important fact is that that a portion of the UK LLP’s profits are set aside and are not available to be allocated by the Remuneration Committee. For tax purposes all of the profits are allocated each year under s850 and this amount is therefore allocated for those purposes to BCG Ltd. Therefore the 18% which is considered to provide for the liabilities arising on the “sale” of the Capital Interests is included in BCG Ltd’s profit share for tax purposes. The fact that BCG Ltd does not then warehouse the 18% does not affect the underlying point that an amount which is seen to represent the potential liability under the terms of the Capital Interests is allocated to BCG Ltd.

We therefore conclude that “amounts representing the deferred profit are included in BCG Ltd’s profit share.” We consider that the provision was drafted widely as shown by the definition of deferred profit addressed above and consistent with that approach is the use of the word “representing”. The 18% margin represented the expected liability to pay MDPs for their Capital Interests; i.e. the deferred profit; and the margin amount was included in BCG Ltd’s profit share.

We now turn to the final part of Condition X which requires that “in consequence” of the amount representing the MDP’s deferred profit being included in BCG Ltd’s profit share, both the MDP’s profit share and the relevant tax amount are lower than they would otherwise have been. In this regard we take into account the following factors in particular:

Therefore we conclude that even though an amount representing the deferred profit was included in BCG Ltd’s profit share this did not mean that the MDPs’ profit share was reduced.

The result is that Condition X does not apply.

The “appropriate notional profit” is defined in s850C(11) – (13). In short, it is a return calculated on the basis of an amount of money equal to B’s (BCG Ltd’s) contribution to the UK LLP at a commercial rate of interest.

The contribution to the UK LLP is determined by applying the rules set out in s108 ITA as amended by s850C(14). The parties agree that the amount contributed as capital by BCG Ltd is the amount reflecting its contribution of the business to the UK LLP in 2011 together with the value of the lease it transferred in 2013. The parties do not agree on how the value of the business contribution is calculated. In short, HMRC says that the amount recorded as BCG Ltd’s capital contribution in the accounts i.e. its net book value of £5.7 million is the value of its contribution of the business to the UK LLP; whereas the Appellants maintain that the initial contribution of the business should be valued according to market value and the increase in the value of the business should be taken into account on an annual basis.

We agree with the Appellants that the determination of whether Condition Y is satisfied must take place for each period of account. This reflects the fact that the starting point for the partnership taxation in s849 refers to the profits or losses of the trade being calculated for any period of account and s850C(1) itself starts by considering whether the three requirements in s850C(1) (including the requirement that either Condition X or condition Y is met) are met “for a period of account”. The appropriate notional return calculation must then also take place for each relevant period of account (s850C(11)). This is a natural consequence of considering the return provided by a commercial rate of interest given that interest rates will generally be expected to change.

However, that in itself does not mean that “B’s contribution to the firm” i.e. BCG Ltd’s contribution to the UK LLP should be revalued each year. The rules for determining the value of that contribution are set out in an amended version of s108 ITA. The annual calculation will reflect additional contributions such as the transfer of the lease.

The parties dispute what amount should be taken into account under s108(2) as “the amount which BCG Ltd has contributed to the UK LLP as capital”.

HMRC rely upon the cases of Hamilton and Kinneil and Papat to say that the amount contributed as capital by BCG Ltd is the amount recorded as its capital contribution. We note that this contradicts HMRC’s stated position in the Partnership Tax Manual where it is stated that if a member has contributed an asset the capital contribution is the market value at the time of transfer even where the capital account of the partner is credited with the amount reflecting historic cost rather than market value. However, HMRC’s manuals are not law. They set out HMRC’s opinion and therefore must be viewed as no more than that.

The case of Papat concerned the situation where two individuals entered into a partnership in each case contributing unequal amounts of cash. The question was whether the profit realised on a sale, after dissolution, of the assets of the partnership was divisible equally between the partners (pursuant to the provisions of the Partnership Act 1890) or in shares corresponding to their respective shares of the capital of the partnership as at the date of dissolution. The court held that there was a distinction to be made between capital of the partnership and its assets and Nourse LJ refers to a previous decision of his in Reed v Young (1983) 59 TC 196 stating that:

“Each contribution must be of a fixed amount. If it is in cash, it speaks for itself. If it is in-kind it must be valued at a stated amount.”

Hamilton and Kinneil was a decision of the Upper Tribunal considering other tax rules affecting limited liability partnerships dealing with loss relief which could be claimed by a corporate limited partner. The provisions (in s118ZC ICTA 1988) state that a member’s contribution to a trade is the greater of: (a) the amount subscribed by it, and (b) the amount of its liability on a winding up. The amount subscribed is stated to be the amount which it has contributed to the limited liability partnership as capital, less so much of that amount as it is or may be entitled to draw out or received back or which may be entitled to require another person to reimburse to it. Therefore the case specifically addresses the concept of an amount contributed to a limited partnership. However, the case concerned a situation where the partner contributed cash and therefore the issue before this tribunal was not at large, although statements made by the Upper Tribunal serve to inform the approach we should take.

The Upper Tribunal considered the requirement under the Limited Partnerships Act 1907 for limited partners to contribute a sum or sums as capital or property valued at a stated amount which would be reflected in the capital account of the limited partner. While there was no such requirement under the LLP Act the Upper Tribunal stated that:

“where contributions are in fact made and are credited to the capital accounts of members, there is capital of the LLP just as much as there is capital in the case of a limited partnership. The asserted differences between an LLP and limited partnership in relation to capital do not require, in my view, fundamentally different approaches to be taken to the concept of “contribution”.”

The Upper Tribunal went on to consider the amount subscribed and in particular the legislative requirement to consider the amount contributed as capital. In doing so the Upper Tribunal considered that subscription was “the transfer of assets, usually money but sometimes assets valued at a stated amount” in return for an interest in the LLP at [34].

We consider that this reference to the valuation at a stated amount reflects the fact that what is being considered is the “capital contribution” to the LLP. The term is specifically addressing the value in the LLP’s capital. In that sense we agree with HMRC that as identified in Papat there is a difference between the capital of an LLP and its assets. Therefore it is necessary to look to the accounts and the amounts shown in the capital of the UK LLP as the amount contributed by BCG Ltd.

In each period of account the capital contribution of BCG Ltd should be identified. In 2013 its capital contribution increased when it contributed the leasehold property and this is reflected in the UK LLP’s accounts.

Consequently we conclude that the amount which BCG Ltd has contributed to the UK LLP as capital is £9.3m.

Mr Grodzinski submits that we should consider the overall substance and purpose of the provisions contained in s850C and so, for example, regard unrealised capital profit as additional capital contribution. While we recognise that a purposive approach should be taken to legislative interpretation where the wording is unclear we consider it to be beyond the scope of such an approach to read into the words “capital contribution” items which go beyond amounts recognised in the accounts as capital contributed by a member.

It is not disputed that BCG Ltd’s share of the profit exceeded the appropriate notional profit when an amount of only £9.3 million is treated as its capital contribution.

We therefore must then consider whether the UK MDPs have the “power to enjoy” BCG Ltd’s profit share.

Section 850C(18) provides that A has the power to enjoy B’s profit share if:

“(c)

any of the enjoyment conditions (see subsection (20)) is met in relation to B’s profit share or any part of B’s profit share.”

In this regard HMRC has relied upon s850C(20)(c) which applies where:

“(c)

A receives or is entitled to receive at any time any benefit provided or to be provided (directly or indirectly) out of B's profit share or the part.”

HMRC says that the Capital Interests accrue as liabilities of BCG Ltd and therefore whether or not it actually uses its current profits to pay them out, profit allocations to BCG Ltd support its ability to meet its obligations at least indirectly and enure for the benefit of the individuals.

The UK MDPs are entitled to receive the amount provided for under the LLPAs on their “sale” of the Capital Interests. We consider that is a “benefit” in its broadest sense for the same reasons that we concluded it is a “benefit or return” for Condition X, Mr Grodzinski submits that the MDPs receive the market value of the Capital Interests on grant, but we have found as a fact that the Capital Interests are similar to an employee share scheme in providing the recipient with a stake in the business and at the same time providing the recipient with a potential benefit if the business prospers.

That benefit is provided by the “sale” of the Capital Interests to BCG Ltd or another person nominated by BCG Ltd. Whether or not the purchase is by BCG Ltd itself (and in fact the evidence is that it would be expected that BCG Ltd would be the purchaser) the 18% margin is allocated to BCG Ltd as part of the worldwide retention to fund the purchase of LTCV interests. The wording of s850C(20)(c ) is widely drawn referring to benefits provided directly or indirectly out of B’s share or any part of B’s profit share. We consider that “profit share” for these purposes is interpreted by reference to the profits allocated to each partner under s850. The amount retained is treated as profit allocated to BCG Ltd. The expectation is that the 18% amount will provide the funds needed by BCG Ltd when the benefit is paid to MDPs on the “sale” of their Capital Interests. We therefore consider that in the ordinary course the expectation of the parties is that the “benefit” will be provided out of that retention of profits allocated to BCG Ltd.

It is then finally necessary to consider s850C(3)(c). We consider that it is “reasonable to suppose” that part of BCG Ltd’s profit share is attributable to the MDPs’ “power to enjoy” (as that term is defined in the legislation) given the retention and allocation of the 18% amount to BCG Ltd to fund the future purchase of the Capital Interests. In other words the MDPs receive a benefit at a time after generation of the profits which benefit is paid out of BCG Ltd’s profit share.

In addition, there is also the requirement that the MDP’s profit share and the relevant tax amount are lower than they would have been in the absence of the MDPs’ power to enjoy. Notably the wording in Condition Y is wider than Condition X. Condition X requires that it is reasonable to suppose that in consequence of amounts representing the MDPs’ deferred profit being included in BCG Ltd’s profit share, the MDPs’ profit share and relevant tax amount are lower than they would otherwise have been. The “in consequence” linkage is not included in Condition Y, which is therefore a provision of wider scope.

However, the requirement that the MDP’s profit share and relevant tax amount are lower than they would otherwise have been clearly begs the question as to what the comparison should be made just as in the case of considering s850C(2)(b) for Condition X? If the MDPs did not have the power to enjoy a benefit out of BCG Ltd’s profit share on the “sale” of the Capital Interests, would their profit share otherwise have been higher?

For the same reasons as we have found in considering the application of s850C(2)(b) above we conclude that in the context of Condition Y the MDP’s profit share and the relevant tax amount are not lower than they would have been in the absence of the MDP’s power to enjoy.

Accordingly even if we conclude that the “power to enjoy” condition is satisfied under s850C(20)(c), the arrangements do not meet the requirement of s850C(3)(c)(ii). Therefore Condition Y is not met.

Consequently the arrangements do not fall within s850C.

We address this issue first. It is a discrete issue concerning the allocation of the profits rather than the taxation of the Capital Interests.

We have found that the implementation of the LLPAs did not reflect their terms; in particular under those terms no Member was entitled to share in profits until the Remuneration Committee allocated the profits to them. Yet BCG Ltd was treated in its accounts and by all involved as being entitled to the residue of the profits after the allocation to the MDPs without any decision being made by the Remuneration Committee to that effect.

HMRC accept that it was (prior to the LLPAs) intended and expected that residual profits would be allocated to BCG Ltd but that was not achieved in practise. It is submitted that pre-contractual negotiations are not part of the matrix of fact for construing the LLP Agreements. Although the residual profits were treated as having been made available to BCG Ltd the amount was not drawn down but left with the UK LLP as a balance on its balance sheet. The fact that the accounts of the UK LLP and BCG Ltd reflect the allocation of profit to BCG Ltd cannot be determinative as they are not part of the profit sharing arrangements.

Mr Grodzinski submitted that even if HMRC were right about the need for the Remuneration Committee to allocate profit to a Member, that was done in relation to the MDPs. There is no mechanism to deem that to be increased. The LLPAs did not require a formal resolution – simply notification. The “notification” effectively happened within BCG not least by virtue of Mr Holden being a member of the Remuneration Committee and a director of BCG Ltd. There was a consistent pattern of behaviour and therefore even if the LLPAs were construed such that under their terms the required notification had not taken place for BCG Ltd to have been entitled to the residue of the profits, there was variation by conduct of the LLPAs.

The relevant provision at the heart of this issue is that contained in s850 ITTOIA. What were the “profit sharing arrangements”? The statutory definition tells us that they are: “the rights of the partners to share in the profits of the trade and the liabilities of the partners to share in the losses of the trade”.

If we follow HMRC’s analysis the only profits to which the MDPs had a right to receive were those allocated to them by the Remuneration Committee. That leaves the residue unallocated – yet s850 works on the basis of allocation of all of the profits.

The section refers to “profit sharing arrangements”. Arrangements is a broad term which can encompass more than simply a partnership agreement. We are satisfied that the arrangements overall – including the parties’ understanding and expectations must be taken into account in that context. We recognise that the LLPAs stated that they set out the entire agreement between the parties but the conduct of the parties effectively meant that no actual notification by the Remuneration Committee was required in order for BCG Ltd to be treated by all involved as entitled to the residue of the profits.

As a result, we conclude that the rights to profits under the profit sharing arrangements for the MDPs were solely to the amounts allocated to them by the Remuneration Committee and BCG Ltd had a right to the residue. The fact that the profit to which it was entitled was not paid out to it but set against other balances or left as an outstanding debt owed to BCG Ltd does not alter the existence of that right.

Section 687 ITTOIA states that:

“(1)

Income tax is charged… on income from any source that is not charged income tax under or as a result of any other provision of this Act or any other Act.”

The parties agree that this charge was historically found under the previous Schedular system in Schedule D Case VI and that the jurisprudence relating to that charge remains relevant. In particular, they agree that we should have regard to the principles set out in Kerrison v HMRC [2019] 4WLR at [68] and therefore agree that for a receipt to be chargeable on this basis:

Mr Grodzinski argued that the Capital Interests should be treated in the same way as an individual buying a share in a general partnership. However, our findings of fact earlier in this decision detract from that conclusion. We agree with HMRC that the fact that the rights are described as “capital” in the LLPAs is not itself determinative. Instead, we have considered the true nature of the rights and we have not accepted that they are in any real sense interests in the goodwill or other assets of the UK LLP.

Furthermore, we do not accept Mr Grodzinski’s argument that the effect of the partnership being transparent for tax purposes is that the MDPs are treated as owning the capital of the UK LLP such that any payment made in relation to the “sale” of the Capital Interests cannot be income in nature. That transparency rule does not override the need when applying s687 to determine the nature of the payment received by the MDPs. Furthermore, we are also satisfied that the realisation of value in relation to the Capital Interests does not involve the disposal of any interest in the UK LLP or its assets as the money is paid by BCG Ltd.

Turning to the Kerrison principles in turn, we start with considering whether the payments made on “sale” of the Capital Interests have the nature of “annual profits”. Mr Grodzinski relied on the case of Moss EmpiresLimited v IRC [1937] AC 785 to submit that this requirement was not met, referring, in particular, to the judgement of Lord Maugham who stated that in determining whether the payments in that case were “annual payments” the word “annual” must be taken to have the quality of being recurrent or being capable of recurrence. That decision was considering whether or not sums paid fell within the term “annual payment” where it was used in the context of a legislative provision (in r.21 of the Income Tax Act 1918) referring to “payment of any interest of money, annuity or other annual payment, etc. “. Lord Maugham’s stated that:

“ in r.21”annual” must be taken to have, like interest on money or an annuity, the quality of being recurrent or being capable of recurrence.” (Underlining added.)

It is clear therefore that this decision was focused upon the context of the use of the word “annual”. We do not consider it undermines the principle set out in Kerrison, relying upon the decision in Ryall v Hoare 8 TC 521, that the receipt must be capable of being “calculated in any one year”. It is not necessary for the income to recur every year (Leeming v Jones (Inspector of Taxes) 15TC 333).

In BlueCrest in the Upper Tribunal it was accepted by the taxpayer that the receipts in question were annual profits, but in that case the deferral period of the awards was six months, one year, two years or three years to ensure that should a partner leave they would automatically breach the eligibility criteria or forfeit the possibility of an award being made final. We are therefore clear that the facts in BlueCrest are fundamentally different.

Turning instead to Ryall v Hoare Rowlatt J considered various options for the meaning of the word and concluded that the word meant “calculated in any one year”. In that sense payment received on “sale” of the Capital Interests would be “annual”. Consequently, the first of the criteria is satisfied.

This leads us to the second of the Kerrison principles at the heart of this case which is whether the payment on “sale” of the Capital Interests was income in nature. We refer to our findings made earlier as to the nature of the Capital Interests and, in particular, the following:

We therefore consider that these factors lead to the conclusion that the payments received on “sale” of the Capital Interests were income in nature. The fact that there is what is described in documents as a “sale” of the Capital Interests to produce the payment does not outweigh these considerations.

In considering whether the payments are analogous to the other cases in Schedule D the decision in BlueCrest sets out relevant principles. The Upper Tribunal referred in particular to the decision in Manduca v Revenue and Customs Comrs [2015] UKUT 262. Mr Grodzinski submitted that Manduca is not an appropriate authority given that it was considering the situation of employees, but this was specifically acknowledged in BlueCrest where it was noted that the payments in that case were not paid pursuant to a contract of employment but were considered to be a reward for services. The Upper Tribunal identified specifically that the FTT had found that the scheme in that case was intended to reward individual partners for their contribution to the success of the partnership because of the services they provided and to incentivise them for the future. As a result the Upper Tribunal concluded that the FTT was entitled to find that those services were eiusdem generis with the services listed within the other cases in Schedule D (see [117]).

Given our findings referred to above we similarly conclude that the payments are in substance analogous to other amounts taxable under Schedule D.

It is clear that the payment is made to each MDP and is theirs.

That leaves the matter of the source of the income.

HMRC submit the rights under the LLPAs are the rights in respect of which the payment under the Capital Interest arises. We agree. The source of the income is the terms of the LLPA which sets out the terms of the Capital Interests and the ability to access those terms is rooted in the individual’s service with BCG in the context of the remuneration/ reward/ incentivisation programme operated by the group as a whole.

We respectfully agree with the FTT in the case of Versteegh Ltd v HMRC [2014] SFTD 547 at [126] that for there to be a source the recipient does not need to have a right, still less an enforceable right, to the payment before it is made. Indeed, that is reinforced by the Upper Tribunal decision in Spritebeam Ltd v Revenue and Customs Comrs [2015] UKUT 75 as noted by the Upper Tribunal in BlueCrest at [124].

The source of the payments is the terms on which the Capital Interests are allocated under the LLPAs. That is where the obligation to purchase the Capital Interests and make the payment is found. And there is a sufficient link between that source and the MDPs.

Mr Grodzinski submits that there is only one source of income here which is the trade of the LLP and that is “exhausted” by the profit sharing arrangements under the LLPAs. Mr Baldry submits that such an approach was rejected by the Upper Tribunal in BlueCrest. Indeed, we are clear that the source is not the underlying business of the UK LLP or profits of the UK LLP. We have already found that the Capital Interests are not part of some profit sharing arrangements. They stand outside the business and profits of the UK LLP. Just as the Upper Tribunal noted in BlueCrest that the taxpayer could not have it both ways in arguing that the payments made there were not part of the profit sharing and at the same time arguing that the LLP’s trade was the source of the payments; so the Appellants here cannot have it both ways.

Our conclusion therefore is that s687 applies to the payments made on the “sale” of the Capital Interests. That conclusion means that we would dismiss the individuals’ appeals (subject to our conclusions about the validity of the assessments to which we turn later). However, as the issue was fully argued we also address the application of the “sale” of occupational income provisions.

If we are incorrect in concluding that s687 applies to the payments we must consider the application of the legislation contained in Chapter 3 of Part 13 ITA.

Section 773 ITA provides as follows:

Section 775(b) ITA provides that Chapter 4, Part 13 ITA has effect subject to any other provision of the Tax Acts treating income as belonging to a particular person. Section 776 ITA imposes a charge on the full amount of income treated as arising in the tax year. The person liable for any tax charged is the individual to whom the income is treated as arising.

Section 777 ITA provides that three conditions must apply, for the charge to arise, as follows:

Section 774 ITA defines what is meant by “occupation”.

Section 777(6) explains that:

Section 777(7) defines "capital amount" as:

“an amount in money or money's worth which does not fall to be included in a calculation of income for purposes of the Tax Acts otherwise than as a result of) this Chapter”

Section 773(2)(b) makes clear that tax avoidance is the focus of these provisions which only apply if the avoidance or reduction of liability to income tax was the main object, or one of the main objects of the transactions or arrangements.

Where the requirements are satisfied, s.778 applies. It provides as follows:

An exemption to the application of the provisions is provided in Section 784 ITA which provides (so far as relevant) as follows:

The Appellants submit that s784 applies to exempt their situation as the sale of the Capital Interests is the sale of an asset representing the MDP’s share in the UK LLP and/or goodwill and the UK LLP was carrying on a profession. Mr Baldry submits that the MDPs are receiving money because of their position as members of the UK LLP holding the Capital Interests, but they are not selling assets of the UK LLP or a share of it. Furthermore, he submits that s784(4) restricts the application of this exemption to the UK LLP as the value received for the Capital Interests is attributable to the growth in value of BCG Inc’s shares and not the LLP. The fact that the MDP received no payment if the UK LLP is insolvent does not alter that conclusion. Mr Grodzinski relies on the core analysis that the Capital Interests give the MDPs a share in the capital of the UK LLP. In relation to s784(4) he submits that there is nothing impermissible in using a metric such as the formula for the sale price of the Capital Interests to work out the value of the members’ shares in the goodwill. Furthermore, the clear purpose of the going concern condition is to recognise the difference between selling interests in going concerns and selling an individual’s future earnings.

It is not disputed that the UK LLP carries on a profession. We have addressed the arguments regarding the Capital Interests being interests in the goodwill of the UK LLP and have explained earlier why we do not accept that analysis. However, in any event we consider that the going concern condition referred to in s784(4) is not satisfied as the value of the Capital Interests is not attributable to the value of the profession as a going concern. Those words clearly refer to the profession carried on by the LLP as opposed to a wider valuation of the group overall. As we have explained earlier, the value of the UK LLP can fall while at the same time the value of the Capital Interests increases.

We therefore turn to consider the general anti avoidance rules set out above.

The first point of dispute in the provisions concerns the application of Condition B.

In BlueCrest the Upper Tribunal held that Condition B was satisfied. However, in that case the scheme which was operated had been found to have replaced the profit allocations which had been made to individual partners to reward their performance. That is notably different to the facts in this case where the Capital Interests replace the BCG Inc shares rather than previous profit allocations.

Mr Grodzinski submits that the facts are similar to those which led the FTT in the case of Odey to accept that Condition B was not satisfied. However, given that the discussion in that case regarding Condition B was obiter dicta and the conclusions are inconsistent with those in the Upper Tribunal in both BlueCrest and HFFX concerning essentially the same structure as in Odey, we do not adopt the reasoning there.

HMRC submit that the UK LLP’s income came solely from the personal exertions of the MDPs and fellow employees. Some at least of those profits arising from the activities of the MDPs were allocated to BCG Ltd. Mr Grodzinski submits that the Condition is not satisfied because prior to the conversion to the UK LLP it was BCG Ltd which generated and received the income from the business in the UK. Following the conversion to the UK LLP structure BCG Ltd put the MDPs in the position to directly receive income derived from their activities as members of the UK LLP. The MDPs did not become entitled to less income by becoming members of the UK LLP or because of the implementation of the Capital Interests. Moreover, the anti-avoidance provisions are designed to apply to schemes in which individuals sell their earning potential in exchange for capital payments and there was no such sale by the MDPs of their earnings potential to BCG Ltd.

We recognise the target of the anti-avoidance rules when introduced. While that is, of course, of particular relevance in applying a purposive interpretation of the legislation it is also well recognised that widely drawn anti-avoidance provisions often capture more than the original schemes for which they were drafted. We must apply the legislation as drafted and it is drafted very widely with a limitation being provided by the tax avoidance purpose rule.

Arrangements were made (the UK LLP and the terms of the LLPAs) which meant that BCG Ltd was put in a position to enjoy part of the income or receipts derived from the MDPs’ activities in the occupation. That is sufficient for Condition B to be satisfied. The Condition does not envisage the sort of comparison to the circumstances before the LLP Conversion which Mr Grodzinski refers to.

Condition C is satisfied given that consideration of the application of this section only arises where s687 is found not to have applied.

However, the provisions only apply if the avoidance or reduction of liability to income tax was the main object, or one of the main objects of the transactions or arrangements. Mr Grodzinski referred us to the case of Euromoney v HMRC [2022] STC 1457 and the need to consider the purpose of the totality of the scheme or arrangements.

In considering the totality of the arrangements in this case we take into account the following findings in particular:

Obtaining capital gains tax treatment was a desired object of the implementation of the LTCV programme wherever possible and simply using the BCG Inc shares again was seen as being prone to the risk of income tax treatment. The UK LLP structure enabled the other commercial objectives regarding incentivisation and strengthening of the capital base to be achieved as well but those were also obtained by the previous share structure. The UK LLP offered non income tax advantages connected to self-employment status and the added potential benefit of entrepreneurs’ relief, but that was in the context of the underpinning object of achieving capital gains tax rather than income tax treatment if possible. BCG had gone to some lengths to ensure that the previous structure remained outside the income tax treatment resulting from the employment related securities rules. Indeed, we would go so far as to say that if the UK LLP structure was one which led to income tax treatment of the LTCV and there was another commercially acceptable structure which provided capital gains tax treatment the UK LLP structure would have been rejected given the worldwide aim of capital gains tax treatment where possible.

We therefore conclude that the avoidance or reduction of liability to income tax was the main object, or one of the main objects of the transactions or arrangements when considered overall. (The avoidance of National Insurance contributions was also a main object but that is in addition to the conclusion that the avoidance of income tax was a main object.)

We have not received submissions from the Appellants regarding s778. For the avoidance of doubt we are satisfied that the capital amount obtained on “sale” of the Capital Interests does not consist of property which derives substantially the whole of its value from the individual's activities.

We therefore conclude that disposals by the UK MDPs of their Capital Interests should be treated as giving rise to amounts chargeable to income tax under Chapter 4, Part 13 ITA if the charge in s687 ITTOIA does not apply.

HMRC say that the MDPs received the amounts via partners’ drawings and simply calling it an allocation for a later period without any change whatsoever in the receipts by the MDPs cannot change the tax position. HMRC recognises that there was some risk that the deferred allocation of profit would not be made (if for example, profits were then insufficient) but say that everyone worked on the basis that in the ordinary course the MDPs would be allocated their shares of the profit for the year ended 31 March 2013 and which they had already received via drawings.

The Appellants say the question is when the right to the profit share arose, by reference to the terms of the LLPA 2011 and the decisions made by the UK LLP’s Remuneration Committee, in accordance with the terms of the LLPA 2011 for the tax years 2012/13 and 2013/14.

Section 5 of ITTOIA 2005 provides that income tax is charged on the profits of a trade, profession or vocation. Limited liability partnerships are transparent for tax purposes such that the LLP is not a separate taxable entity (s848 ITTOIA).

Section 849 of ITTOIA 2005 makes provision for the way in which a partnership's trading profits are to be calculated:

As a consequence of the tax transparency of a LLP, the profits of the trade carried on by a limited liability partnership are divided among their members who pay tax. Once those profits have been calculated, they must be allocated to the partners or members for tax purposes.

For the tax year ended 5 April 2013 s850 of ITTOIA 2005 provided (so far as relevant) as follows:

The deferral issue resulting from the steps taken to defer allocation of profits to MDPs until the summer of 2014 therefore turns upon the application of s850 in particular. We must decide what the profit sharing arrangements were for the tax years 2012/2013 and 2013/2014. In particular, we must decide whether the purported deferral of the allocation of profits to the MDPs from the financial year ended 31 March 2013 to the financial year ended 31 March 2014 was effective.

In this regard we agree with Mr Grodzinski that HMRC’s case has been somewhat inconsistent. HMRC say that the lack of a Remuneration Committee resolution allocating profits to BCG Ltd means that BCG Ltd was not in fact allocated profits. However, in the context of the deferral HMRC say that despite the fact that there was no Remuneration Committee allocation of profits to the MDPs for the year ended 31 March 2013 the MDPs should be treated as entitled to those profits which were later allocated to them.

We do not agree with HMRC’s submissions on this point. There was no allocation to the MDPs and without such allocation there was no entitlement. In contrast to the situation concerning the lack of notification of allocation to BCG Ltd addressed earlier the understanding of the parties was not that there had been an allocation to the MDPs which was just not notified. Indeed, HMRC recognise there was no right to the amounts before allocation – just an expectation and understanding that in the ordinary course the allocation would be made. There were payments made as drawings but that does not alter the conclusion – it is a fundamental of partnership taxation that partners are not taxed on the basis of payments made to them but on the basis of the sharing of the profits agreed between them. The terms of the LLPAs made it clear that if the profits in fact were lower than the profits allocated to an MDP the difference was repayable by the MDP.

In relation to the individual Appellants it is necessary to move to consider the procedural issues now that we have concluded that there were substantive errors in their returns.

Given our conclusions about the UK LLP’s appeals the issues regarding the validity of the discovery amendments fall away. However, given the nature of this case we have decided that we should address the validity of the discovery amendments assuming that the UK LLP is not successful in relation to the substantive issues considered above.

Section 12AA TMA provides for HMRC to require a partnership return to be submitted:

Section 12AB sets out what must be included in the partnership return:

Section 8(1B) TMA then provides for each partner to include their relevant share of the income or losses etc in their own tax return:

“(1B) In the case of a person who carries on a trade, profession, or business in partnership with one or more other persons, a return under this section shall include each amount which, in any relevant statement, is stated to be equal to his share of any income, loss, tax, credit or charge for the period in respect of which the statement is made.”

Section 30B TMA provided as follows in the relevant years:

In this case HMRC do not allege that the inaccuracies were deliberate.

The two conditions in subsection (5) and (6) are referred to by us as the “carelessness condition” and the “hypothetical officer condition”. HMRC v Hicks [2020] STC 254 makes clear that carelessness can take the form of omissions as well as positive acts.

Section 118(5) TMA provides that for the purposes of the TMA, a loss of tax is brought about ‘carelessly’ by a person: “if the person fails to take reasonable care to avoid bringing about that loss or situation”.

In Atherton v Revenue and Customs Commissioners [2019] UKUT 41 (TCC) the Upper Tribunal said at [37]:

“The reasonable care which should be taken by a taxpayer is assessed by reference to a prudent and reasonable taxpayer in the position of the taxpayer in question.”

Furthermore, the Upper Tribunal went on to say at [61-62]:

“Accordingly, the relevant question is not that which would arise under the general law, nor whether the tax return was carelessly submitted, but whether the taxpayer and those acting on his behalf took reasonable care to avoid creating the insufficiency in the assessment.

[62] When the question is asked in that way, the answer becomes clear. The duty of the taxpayer is to take reasonable care to avoid bringing about an insufficiency and if he does not do so then the insufficiency is brought about carelessly. “

The case of Hicks and Anderson v HMRC [2017] SFTD 100 makes clear that what the reasonable and prudent taxpayer would do is not assessed in a vacuum but by reference to the actual circumstances of the taxpayer in question.

In relation to the hypothetical officer test s30B(7) TMA imports a modified version of s29(6) and (7) TMA as follows:

“(6)

For the purposes of subsection (5) above, information is made available to an officer of the Board if—

(a)

it is contained in the representative partner’s partnership return in respect of the relevant year of assessment (the return), or in any accounts, statements or documents accompanying the return;

…

(c)

it is contained in any documents, accounts or particulars which, for the purposes of any enquires into the return or any such claim by an officer of the Board, are produced or furnished by the representative partner to the officer; or

(d)

it is information the existence of which, and the relevance of which as regards the situation mentioned in subsection (1) above—

(i)

could reasonably be expected to be inferred by an officer of the Board from information falling within paragraphs (a) to (c) above; or

(ii)

are notified in writing by the representative partner to an officer of the Board.

(7)

In subsection (6) above—

(a)

any reference to the representative partner's partnership return in respect of the relevant year of assessment includes—

(i)

a reference to any return of his under that section for either of the two immediately preceding year of assessments;

(ii)

[omitted pursuant to s. 30B(7)(c)]; and (b) any reference in paragraphs (b) to (d) to the representative partner includes a reference to a person acting on his behalf.”

Mr Grodzinski submits that s30B TMA is not capable of allowing HMRC to vary the allocation of profits as between the partners. HMRC do not claim that the profits included in the UK LLP’s partnership statement for any of the tax years are in any way insufficient. Even if that is correct (which is disputed), there are simply no profits which ought to have been included in the partnership statement which have been omitted from it. The reference in s.30B(1) to profits not being included in the partnership statement is to the income which under s.12AB(1)(a) must be included in the partnership statement, namely, the income from each source which has accrued to the partnership for the period in question. All of that income has been included in the relevant partnership statements.

Furthermore, s30B makes no provision for an adjustment mechanism to allow for the fact that if one partner’s allocation of profit is increased the profit of the other partner or partners needs to be decreased. Section 30B TMA does not refer to “share” in contrast to s12AB(1)(a) and (1)(b). Further support for the Appellant’s position is provided by the heading of s30B TMA itself. Therefore the s30B TMA amendments are invalid.

The fact that the result may be a lacuna in the tax rules does not in itself mean that the legislation should be interpreted to say what is not written. In Hamilton and Kinneil Warrne J at [61] noted that “sometimes, it has to be accepted, statutory provisions do not always precisely hit the target at which they are aimed, or, if they do hit the target, there is unforeseen collateral damage”.

Mr Chacko submits that the partnership statement includes amounts for income allocated to each partner. The purpose of the partnership return is “for the purpose of facilitating the establishment of…” (a) “the amount in which each partner chargeable to income tax… is so chargeable” and (b) “the amount each partner chargeable to corporation tax… is so chargeable”. Section 12AB states that the partnership return must include a statement which includes identification of the share each partner’s income or loss. Each partner will then include their respective share in their own tax return pursuant to s8(1) TMA

It would be extraordinary if pursuant to s30B, (the power to make amendments to that return after the one-year enquiry window has closed), HMRC could not change the amounts to which any given partner is chargeable to income tax unless they changed the amount of income received by the partnership as a whole. The Appellants’ construction leaves the rules in disarray: HMRC would need to raise discovery assessments against each individual who had been allocated too little, with no apparent means of correcting the position for the individuals who had been allocated too much (and had paid too much tax).

There are three FTT decisions to which we have been referred on this issue: Albermarle, Odey and HFFX. However, Albemarle considered a different point as to whether a 30B amendment could be used to apply a loss to partnership profits. The remaining two decisions reach opposite conclusions, but Odey does so relying upon Albermarle which, as said, is on a different point. We respectfully agree with the approach of Judge Fairpo in HFFX namely that:

“262.

The legislation clearly defines "profits" in s30B(9) TMA 1970 as being both "income" for the purposes of income tax and "profits as computed for the purposes of [corporation] tax".

263.

Section 30B(1)(b) applies where “an amount” of profit included in the statement is insufficient, not “the amount”. I consider the definition of “profits” in s30B(9) means that no additional words are required to read into s30B(1)(b) the ability for HMRC to make an amendment where the partnership statements includes an amount of income as calculated for the purposes of income tax which has been found to be insufficient. It does not require that the total profit of the partnership has been found to be insufficient.”

We go further in reaching this conclusion addressing points raised before us. Section 12AB requires each partner’s share of the income to be stated in the partnership statement which forms part of the required return. Section 30B(1) then addresses the position of a discovery of insufficient profits (defined as set out by Judge Fairpo) as regards a partnership statement. The officer may then “make good the deficiency”. A purposive reading of these words enables us to conclude that “making good” the deficiency is wide enough to encapsulate both increasing the amount of “profit” share of partner A and decreasing the “profit” share of partner B. This reading does not require us to go beyond the words of the legislation in order to conclude that an adjustment mechanism is contained within s30B TMA.

The structure of the TMA partnership tax provisions is not left with the lacuna HMRC have identified as existing under the Appellant’s approach; i.e. the need for HMRC to raise discovery assessments against each individual who had been allocated too little, with no apparent means of correcting the position for the individuals who had been allocated too much (and had paid too much tax).

We therefore conclude that s30B can be used to make amendments to the allocation of profit between partners as well as amendments of the overall profit.

We have decided that the deferral of profits from 2012/2013 to 2013/2014 was validly made. That disposes of the issue as to whether the discovery amendments can permit assessment on the basis of the deferral issue in 2012/2013 rather other than that of the discovery itself which was concerning the treatment of the Capital Interests and the allocation of profits between the MDPs and the UK LLP for tax purposes. To the extent that this issue needs to be addressed on any onward appeal, the relevant facts have been set out by us.

The Discovery Amendments for 2012/13 (issued on 29 March 2019) and 2015/16 (issued on 26 March 2021), can only be valid if HMRC can show that the UK LLP (by its representative partner), or a person acting on its behalf, was careless. That is because for those two tax years, HMRC need to rely on the extended time limits in s.36(1) TMA.

In addition, for the tax years 2013/14, 2014/15 and 2016/17, HMRC would also have to show carelessness, unless the “hypothetical officer” test was met for those years.

The first question is what is the situation said to have been brought about carelessly by the representative partner or a person acting on his behalf (s30B(5))? There are various potential answers:

In relation to the profit sharing rules, HMRC’s case that there was carelessness turns upon the steps taken to implement the Capital Interests and the advice received in relation thereto. HMRC submit that the level of care taken fell below the reasonable standard for a large business with access to tax expertise given that the arrangements involve very large sums of money, the UK LLP was aware that the structure was a means of saving very substantial income tax, the structure was perceived internally as a means of converting income to capital with serious tax risk and the arrangements involve the insertion of complicated and contrived provisions into the LLPA. The analysis in the PwC reports is high level without detailed consideration of whether, in light of the terms of the Capital Interests, they are actually capital assets. Neither report considers whether the Capital Interests should be viewed as a vehicle for income benefits.

For 2014/2015 onwards HMRC submit that the advice from PwC was that there was doubt about the application of s850C and counsel’s advice should be obtained which BCG failed to obtain. HMRC submits that was therefore careless. The analysis in the EY draft advice is minimal and was never finalised. It did not provide an adequate second opinion.

The Appellants submit that the UK LLP always took advice, carefully considered that advice and then followed it, having reasonably considered it appropriate to do so.

We consider that the following facts lead to a conclusion of carelessness by the UK LLP/the representative partner of the UK LLP:

We do not consider that the evidence of obtaining advice by the business is sufficient to counter the evidence that the UK LLP was careless. The advice from PwC was predicated upon different structural elements to those involved with the actual operation of the Capital Interests. The advice obtained from both PwC and EY was lacking in depth and quality given the concerns raised by senior management in BCG and by the adviser, PwC, themselves. We conclude that the level of care taken in this respect was not in line with what would be expected of a prudent and reasonable taxpayer in the position of the UK LLP.

Mr Grodzinski submitted that there must be a causal connection between the carelessness and the insufficiency in the tax assessments or returns. He submits that HMRC must provide evidence to prove that if the UK LLP had not been careless it would have allocated the profits correctly under the profit sharing rules relying upon cases such as Anderson v HMRC [2016] UKFTT 335 and HMRC v Bella Figura [2020] STC 922.

HMRC submit that the answer is provided by s118(5) TMA which states:

“For the purposes of this Act a loss of tax or a situation is brought about carelessly by a person if the person fails to take reasonable care to avoid bringing about that loss or situation”.

We agree that we should apply the approach as set out in the Upper Tribunal case of Atherton v HMRC [2019] STC 575. There the Upper Tribunal specifically referred to s118(5) TMA and said at [61]:

“… The relevant question is… Whether the taxpayer and those acting on his behalf took reasonable care to avoid creating the insufficiency in the assessment.

62 … The duty of the taxpayer is to take reasonable care to avoid bringing about an insufficiency and if he does not do so then the insufficiency is brought about carelessly.”

On the assumption that there was an insufficiency as a result of the application of the profit sharing rules we are satisfied that the UK LLP did not take reasonable care to avoid bringing that about given the findings we have made and conclusions we have reached above.

None of the Upper Tribunal authorities to which we were referred suggest that there is some requirement that HMRC procure expert evidence to show that if, in this case, the UK LLP had obtained counsel’s opinion, that opinion would have concluded that the profit sharing legislation requires a different allocation of profits in the tax returns.

In relation to the omission of notification by the Remuneration Committee to BCG Ltd, HMRC say that if they are correct that no allocations were properly made to BCG Ltd then the filing of partnership returns which recorded such allocations, despite the Profit Allocation (or Remuneration) Committee not having made the appropriate resolutions, was careless.

We have found that the allocations were properly made and therefore this issue falls away. However, even if that conclusion were to be incorrect we do not consider that filing on the basis of the assumption that the residual profits should be treated as allocated to BCG Ltd was careless. The substantive law in issue on this point depends upon the meaning of “profit sharing arrangements”. It was the understanding of all involved that BCG Ltd was entitled to the residue and filing on that basis was a reasonable result. As we have identified, there is a good argument that the term “profit sharing arrangements” should be considered beyond merely the terms of the LLPAs. We therefore conclude that a prudent and reasonable taxpayer in the position of the UK LLP would not be expected to do more to clarify or check the position before filing the partnership return on the basis of the profit sharing as understood by all involved.

In relation to the deferral of profit allocation to the MDPs in 2012/2013 to 2013/2014, (assuming for these purposes that this was not effective), we are satisfied that the UK LLP was not careless. HMRC say that it was not reasonable to take this course of action without external advice. We do not agree. This is the sort of matter about which we would expect the internal department of a large corporate such as BCG, to be well qualified to take a view. In fact, the evidence shows that the internal tax department produced a memorandum considering matters such as UK Treasury forecasts which had modelled the tax impact of expected forestalling, and this memorandum was produced after obtaining advice from PwC that the deferral should work. We consider that was in line with what would be expected of a prudent and reasonable taxpayer in the position of the UK LLP.

This test is only relevant where HMRC raised the discovery amendment within four years as otherwise HMRC need to establish carelessness and if carelessness is established there is no need also to satisfy this test. The relevant tax returns are therefore the UK LLP returns for the tax years 2013/2014, 2014/2015 and 2016/2017.

The parties agree that the focus of this test is on the quality of the taxpayer’s disclosure and whether it clearly alerts the hypothetical officer to the insufficiency in the assessment or return (Sanderson v HMRC [2016] 4 WLR 67).

The Appellants submit that it is for HMRC to discharge the burden which rests on them by showing in respect of each of the relevant tax returns what information was available to the hypothetical officer and then to explain why that was insufficient. In making this assessment Mr Taylor is a useful comparator taking account of what he in fact knew in the earlier years. It is recognised that where the law is complex even adequate disclosure by the taxpayer may not make it reasonable for the officer to have discovered the insufficiency on the basis of the information disclosed at the time. Sanderson makes clear that the purpose of the hypothetical officer conditions is to test the adequacy of the taxpayer’s disclosure.

HMRC say that the Capital Interest structure was complex and was not one that HMRC could have inferred the detail of from the material supplied.

The first issue is the time at which the hypothetical officer test is applied. The enquiry time limits for the relevant tax returns expired on 20 December 2015 (for 2013/2014), 23 December 2016 (for 2014/2015) and 15 January 2019 (for 2016/2017).

We are satisfied that the evidence shows that the hypothetical officer test was met in relation to the two earlier tax years and indeed in the hearing Ms Lemos conceded that the Appellants were content not to press their case in relation to those earlier years.

The situation is not so clear in relation to the tax return for 2016/2017. We have set out earlier the progress of the enquiries and the information provided to Mr Taylor at various times. HMRC submitted at the hearing that it was not until Mr Holden’s witness statement was provided together with the exhibit of the Framework that they had sufficient information for the assessments to be made. In particular, it had been difficult to understand how the LTCV related to other elements of the MDPs’ compensation.

In this regard Mr Baldry submitted that the question is not whether the hypothetical officer was in the position to make the assessment made by the actual officer but whether the hypothetical officer could assess the actual insufficiency of tax. In particular, he submitted that it was only when the Witness Statement and Framework documentation were provided that HMRC knew how the Capital Interests were funded such that a hypothetical officer could identify an actual insufficiency by reference to s850C.

We agree that Sanderson drew a clear distinction between the actual officer and the hypothetical officer stating at [17[:

“… What the hypothetical officer must have been reasonably expected to be aware of is an actual insufficiency.”

Our decision about the hypothetical officer test turns on what the hypothetical officer needed to know in order to make the assessment. We have found that the UK LLP’s appeal is successful. Were this to be wrong the profit sharing rules would have applied. In that regard we agree with Mr Baldry that the hypothetical officer could not have reasonably been expected on the basis of the information made available to him before January 2019 to have been aware of the way in which sums were put aside to fund future purchases of the Capital Interests. That would be a key element of any charge under the profit sharing rules and the MMRs. Consequently, the hypothetical officer test would have been met if HMRC had succeeded in relation to the substantive issues underpinning the discovery amendment made in relation to the 2016/2017 return.

We therefore conclude that the discovery amendment made in relation to 2016/2017 would have been validly made.

Mr Grodzinski submits that if we decide that adjustments to the amounts of profits allocated to the MDP’s are appropriate under s850 and/or s850C ITTOIA and the correct procedural approach is by making discovery amendments under s30B TMA, it is not then open to HMRC to seek to assess profits that ought to have been allocated those individuals via discovery assessments made under s29 TMA.

Given our conclusions that adjustments to the amounts of profits were not required that issue falls away. However, we would comment that we see no restriction in the legislation which would prevent HMRC from issuing both the discovery amendments under s30B and the discovery assessments under s29 TMA. Clearly, as a matter of first principle, HMRC cannot tax the same income in the hands of the individuals twice. Therefore as a practical matter if the profits were to be reallocated to the MDPs we would expect that the discovery assessments raised to tax the allocation of profits would fall away. Indeed, HMRC has said that if the Appellants are correct that s30B cannot be used to adjust the profit shares between partners, HMRC would then rely on the s29 discovery assessments against those partners that deal with tax on the s850 / s850C basis (rather than on receipt of the price of a Capital Interest). Those s29 assessments were raised in case s30B could not be used, unlike the other s29 assessments which were raised in respect of receipt of the proceeds on the “sale” of the Capital Interests. If s30B can be used to adjust profit shares, then those (non-receipt) s29 assessments fall away.

We now move on to consider the validity of the discovery assessments otherwise. This is of particular relevance for the assessments raised to deal with the treatment of disposals of the Capital Interests, but we have addressed the validity of all of the s29 TMA assessments below.

The discovery assessment legislation in s29 TMA which is in substantially the same terms as s30B TMA states, so far as relevant:

“Assessment where loss of tax discovered.

(I)

If an officer of the Board or the Board discover, as regards any person (the taxpayer) and a year of assessment —

(a)

that any income, unauthorised payments under section 208 of the Finance Act 2004 or surchargeable unauthorised payments under section 209 of that Act or relevant lump sum death benefit under section 217(2) of that Act which ought to have been assessed to income tax, or chargeable gains which ought to have been assessed to capital gains tax have not been assessed, or

(b)

that an assessment to tax is or has become insufficient, or

…the officer or, as the case may be, the Board may, subject to subsections (2) and (3) below, make an assessment in the amount, or the further amount, which ought in his or their opinion to be charged in order to make good to the Crown the loss of tax.

(3)

Where the taxpayer has made and delivered a return under section 8 or 8A of this Act in respect of the relevant year of assessment, he shall not be assessed under subsection (1) above—

(a)

in respect of the year of assessment mentioned in that subsection; and

(b)

... in the same capacity as that in which he made and delivered the return,

unless one of the two conditions mentioned below is fulfilled.

(4)

The first condition is that the situation mentioned in subsection (1) above was brought about carelessly or deliberately by the taxpayer or a person acting on his behalf.

(5)

The second condition is that at the time when an officer of the Board—

(a)

ceased to be entitled to give notice of his intention to enquire into the taxpayer's return under section 8 or 8A of his Act in respect of the relevant year of assessment

…the officer could not have been reasonably expected, on the basis of the information made available to him before that time, to be aware of the situation mentioned in subsection (1) above.

(6)

For the purposes of subsection (5) above, information is made available to an officer of the Board if—

(a)

it is contained in the taxpayer's return under section 8 or 8A of this Act in respect of the relevant year of assessment (the return), or in any accounts, statements or documents accompanying the return;

(b)

it is contained in any claim made as regards the relevant year of assessment by the taxpayer acting in the same capacity as that in which he made the return, or in any accounts, statements or documents accompanying any such claim;

(c)

it is contained in any documents, accounts or particulars which, for the purposes of any enquires into the return or any such claim by an officer of the Board, are produced or furnished by the taxpayer to the officer ; or

(d)

it is information the existence of which, and the relevance of which as regards the situation mentioned in subsection (1) above—

(i)

could reasonably be expected to be inferred by an officer of the Board from information falling within paragraphs (a) to (c) above; or

(ii)are notified in writing by the taxpayer to an officer of the Board.”

HMRC submits that the UK LLP instructed PwC on the individual’s behalf to advise them how to fill out their returns. Therefore carelessness by the UK LLP can be attributed to those individuals, applying Hicks.

We therefore start by considering whether the UK LLP was “a person acting on behalf” of the individual Appellants.

Section 29(4) TMA applies where, in this case, an assessment to tax is or has become insufficient and that was “brought about carelessly by the taxpayer or a person acting on his behalf”. In Hicks at [122] the Upper Tribunal said:

The UK LLP obtained external advice from PwC as to the tax position of the individual Appellants. However, the UK LLP did not represent the individual Appellants. It merely arranged for advice to be provided to the taxpayers. We consider that this is too far removed to fall within the types of active engagement described in Hicks as falling within the term “acting on his behalf”. HMRC have not argued that PwC was careless.

Again the only relevant assessments are those issued in relation to the tax years 2013/2014 and 2016/17 for the same reasons as explained for the UK LLP’s returns (i.e. HMRC need to show carelessness for the other periods).

The enquiry window in respect of MDPs’ self-assessment tax returns for 2013/2014 expired on 15 December 2015. The hypothetical officer would have had little if any information regarding the Capital Interests by 15 December 2015. Ms Lemos recognised the difficulties in her concession.

The enquiry window in respect of MDP’s self-assessment tax returns for 2016/2017 expired on 31 January 2019. The assessments were issued on 26 March 2021. The burden of proof to show the hypothetical officer test is met rests on HMRC. HMRC has done remarkably little to make their case in relation to this part of the appeals in relation to the assessments applying to the disposals of Capital Interests in particular. In their Statement of Case HMRC state that the Appellants have not explained what information was provided which would have made clear to HMRC that the receipts were income. Clearly this is failing to recognise where the burden of proof lies. In Mr Baldry’s skeleton argument it is simply stated that the explanations provided before 31 January 2019 were not sufficient for the hypothetical officer to be alerted to the understatement. At the hearing Mr Baldry focused on the application of the test to the assessments raised on the basis of the allocation of profit rules and the lack of information regarding the retention of funds by BCG Ltd for the LTCV.

We agree with Mr Grodzinski that it is not enough for HMRC to merely assert that the test is met without proper reference to, and analysis of, the relevant documents. There is very little engagement in HMRC’s case with the position regarding the “disposal” assessments.

However, for the avoidance of doubt we conclude that the evidence before us shows that the hypothetical officer test would not have been met in relation to the 2016/2017 discovery assessments raised in relation to disposals of the Capital Interests. Therefore those assessments were not validly made. By that stage (i.e. 31 January 2019) the hypothetical officer would have had the following information as found earlier:

We therefore conclude that by 31 January 2019 the hypothetical officer would have had such information that he could have been reasonably expected to have been aware of the actual insufficiency of tax in the relevant MDPs’ self-assessment returns relating to the disposals of the Capital Interests. Consequently, HMRC have not shown that the hypothetical officer test is met in relation to those 2016/2017 discovery assessments.

In relation to the discovery assessments raised in relation to the allocation of profit (assuming that both s850 or s850C apply and the adjustment is not correctly dealt with by the amendments under s30B TMA) we conclude that our conclusions regarding the hypothetical officer in the context of the s30B TMA amendments apply equally here. Therefore the discovery assessments in relation to profit allocation made in relation to 2016/2017 would have been validly made.

We therefore conclude as follows:

This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The application must be received by this Tribunal not later than 56 days after this decision is sent to that party. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.