Nicholas Walewski v The Commissioners for HMRC

This appeal concerns the interpretation and application of the “mixed partnership” rules contained in sections 850C to 850E of the Income Tax (Trading and Other Income) Act 2005 (“ITTOIA”). A mixed partnership arises where a partnership includes at least one individual partner and one non-individual partner, such as a limited company or other corporate entity.

The partnership rules include section 850C. One effect of this provision is to enable the Commissioners for Her Majesty’s Revenue and Customs (“HMRC”) to increase the profit share of an individual partner who has the power to enjoy the profit share of the corporate partner, if other conditions are satisfied. In these circumstances, HMRC is required to reallocate so much of the profit share of the corporate partner to the individual partner’s power to enjoy to the extent this is just and reasonable. 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, benefitting from the rate of corporation tax which is lower than the higher or additional rate of income tax.

In this case, Mr Walewski (or the “Appellant”) and Walewski Limited (“W Ltd”) were both partners in two LLP partnerships: Alken Asset Management LLP (“AAM”) and Alken Finance LLP (“AF”). The Appellant was an individual partner and W Ltd was a non-individual or corporate partner. W Ltd was a UK company of which the Appellant was a sole director and employee. Partners of the LLPs in this case are also referred to as members.

HMRC charged the Appellant to income tax for the 2014-15 tax year under section 850C ITTOIA on the basis that the Appellant’s profit share from AAM and AF should be increased by reference to the whole of the profit shares which had originally been allocated to W Ltd.

The assessments were made by HMRC under section 850C ITTOIA by way of two closure notices, each dated 31 March 2017, in which the partnership statements of the LLPs were amended with the result that:

£18,088,195 of profits from AAM were reallocated to the Appellant giving rise to total profits chargeable to income tax in his hands of £18,103,962; and

£1,372,510 of profits from AF were reallocated to the Appellant giving rise to total profits chargeable to income tax in his hands of £1,434,315.

The Appellant appealed the amendments in the closure notices to the First-tier Tribunal (“FTT”). He contended that the additional profits of the two partnerships, amounting to £19,460,705, should not be re-allocated to him because they were earned by W Ltd as a corporate partner and not by him in his capacity as an individual partner in AAM or AF. The majority of these profits were allocated to W Ltd from AAM. The remaining, much smaller amount (£1,372,510), was allocated to W Ltd from AF.

The FTT dismissed the Appellant’s appeal in a decision released on 30 January 2020. An amended decision was released on 21 April 2020 (the “Decision”). The FTT found that the profit share from the partnerships was not earned by W Ltd but was allocated to W Ltd because of the Appellant’s ability to enjoy those profits via an offshore trust to which W Ltd paid its profits and of which the Appellant’s children were beneficiaries. It found that the whole of W Ltd’s profit share was attributable to the Appellant’s power to enjoy its profits and that it was just and reasonable to reallocate all of W Ltd’s profits to the Appellant.

The Appellant sought to appeal the Decision to the Upper Tribunal on two grounds. On 21 April 2020, the FTT granted the Appellant permission to appeal on the first ground of appeal. On 22 May 2020 the Upper Tribunal granted the Appellant permission to appeal on the second ground.

The first ground of appeal (“Ground 1”) is that, to the extent W Ltd’s profit share was attributable to the period of time when the Appellant was not a partner of AAM (which was between August and November 2014), the profits could not have been reallocated to him. It was submitted that the FTT erred in finding that section 850C ITTOIA could apply to such a time period.

The second ground of appeal (“Ground 2”) is premised on the FTT’s findings at [170] to [172] of the Decision that the Appellant’s work for W Ltd, AAM and AF was fungible, he was playing only a single role for the benefit of all three entities, and there was “no commercial, physical or temporal separation of [the Appellant’s] activities”. The Appellant submits that the inevitable consequence of these findings is that the FTT erred in allocating all of W Ltd’s profits to the Appellant for the relevant period. There should have been an equal division of W Ltd’s profits (excluding the amounts which could not be reallocated in any case).

We consider these grounds of appeal in turn below, in Sections D and E. Before we do so, however, it is necessary to set out the relevant statutory provisions (which we do in Section B) and explain how those provisions were applied by HMRC and found to apply by the FTT (which we do in Section C). In a number of respects, the Appellant accepted the approach of HMRC as considered by the FTT (or at least did not seek to appeal the FTT’s decision in these respects), but it is nevertheless necessary to understand the overall approach in order properly to understand Ground 1 and Ground 2.

The profits or losses of an LLP that carries on a business with a view to profit are allocated between the partners according to their agreed partnership interests. Section 849 ITTOIA sets out the basic rule for calculating a partnership’s profit or losses: where, for any period in which a UK resident partner in the trading partnership is chargeable to income tax, the profits and losses of the trade are calculated as if the partnership were a UK resident individual.

Section 850(1) ITTOIA provides that, for any period of account, a partner’s share of a profit or loss of a trade carried on by a firm is determined for income tax purposes in accordance with the firm’s profit-sharing arrangements during that period. Section 850(2) defines “profit-sharing arrangements” as “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”.

Section 850 is expressly made subject to “sections 850A to 850D”. For the purposes of this appeal, the critical section is section 850C, although the parties did make reference to a number of other provisions of ITTOIA. So far as is material, section 850C provides:

The Appellant contended that, to the extent that W Ltd’s profit share was attributable to the period of time when the Appellant himself was not a partner of AAM, the profits of W Ltd earned during that period could not be reallocated to him as a matter of statutory construction. Essentially, the contention was that, on a proper analysis of section 850C, the power to reallocate profit share to the Appellant could only arise in respect of a time period during which he (and W Ltd) were both partners of AAM.

Paragraph 11 of the Appellant’s written submissions put the point thus:

The difficulty with this contention is that is assumes a direct correlation between a person’s status as partner and the allocation to that person of the profits in the partnership. In short, the underlying assumption is that there is a direct relationship between the time spent by a person as a partner and the profit share accruing to that partner.

There is, we consider, no such correlation. Indeed, that was demonstrated by the various different measures that Mr Soares, on behalf of the Appellant, articulated as to how the profits of AAM might be split as between the Appellant and W Ltd based purely on their time of service as partners during the relevant accounting period.

We consider that there is no necessary correlation between profit share and time served, and that – absent very clear wording in the statute – the proposition advanced by Mr Soares is an untenable one. Indeed, it would open the way to a clear ability to divert partnership profits and undermine the purpose of section 850C by appropriately timing the entry and exit of partners.

We accordingly reject Ground 1. It represents both a misunderstanding and misinterpretation of section 850C, is contrary to the clear language of the provision, not supported by any authority and inconsistent with the statutory scheme under section 850C. More specifically:

The construction contended for would involve doing violence to the clear language of section 850C and/or inserting further words. On its face, section 850C does not have the meaning for which the Appellant contends.

Section 850C applies “for a period of account” (see subsection (1)(a)). Absent any words of limitation, it applies if the various conditions are met at any point in the period of account. As a matter of construction, there is no requirement that A be a partner for more than a moment of time within the relevant period of account for the purposes of section 850C, so long as A receives a share of some profit (see subsection (1)(a)(ii)).

This is consistent with the scheme of the legislation: section 850(1) (allocating a firm’s share of profits (or losses) between partners) is subject to section 850C. Section 850A applies for a “period of account”. It is therefore consistent for section 850C to apply for that same period of account, in this case from 6 April 2014 until the dissolution of the partnership on 29 November 2014.

This approach is also consistent with the scheme of section 850C itself, which is concerned with the inappropriate diversion of profit shares. The intended purpose of the section is to reallocate profits of a partnership to an individual partner where the requirements of the section are met, and to impose additional requirements not present in the statutory wording and not necessary for its operation is not permissible.

Mr Soares also submitted that the FTT erred at [213] to [216] of the Decision in not exercising its discretion to reduce the reallocation of the profit share in respect of the four months that the Appellant was not a partner in AAM. He submitted that the FTT might have apportioned this on a time basis – reducing the reallocation by 50% because he was a partner for four months and a non-partner for four months. Alternatively, he suggested that the reallocation should be apportioned according to the proportion of turnover generated by AAM in the period while the Appellant was a partner.

We are satisfied that this aspect of Ground 1 is no more than a challenge to the FTT’s findings and a submission that the FTT erred in determining it just and reasonable to increase the Appellant’s profit to the full extent of W Ltd’s profits. This, as it seems to us, is an impermissible attempt to argue primary points of discretion, and absent a contention that the FTT erred as a matter of law, the FTT’s Decision must stand. Having rejected the error of law contended for by the Appellant – namely that the FTT had misconstrued section 850C in the manner we have described – we consider that the Appellant has not articulated, in Ground 1, any further basis for contending that the FTT had erred as a matter of law.

The basis upon which Ground 2 was articulated rested upon the FTT’s “overall conclusion” at [170] to [172] of the Decision that the Appellant’s services to AAM, AF and W Ltd were “fungible”.

It is appropriate to set out the relevant paragraphs of the Decision:

On behalf of the Appellant it was submitted that, given that the FTT found the Appellant was playing a single role for the benefit of all three entities, it had accepted that the Appellant was providing half of his time or half of his services through W Ltd to the partnerships and their clients. W Ltd had, therefore, earned that half of its profit share from the partnerships as a corporate partner. The increase in the Appellant’s profit share should take account of the time and services the Appellant provided through W Ltd to the partnerships and their clients.

We confess that we have some difficulty in seeing the error of law alleged by the Appellant in Ground 2. It is trite that the terms of a decision or judgment should not be read as if a statute, and – particularly where an appeal is confined to points of law – an appellate court must be particularly careful when considering the manner in which the court below has expressed itself. Here, quite clearly, the FTT was holding that the manner in which Mr Walewski provided his services was utterly fluid and essentially unknowable. The fact is that W Ltd was nothing more than a corporate alter ego to Mr Walewski and it seems to us that the conclusion reached by the FTT is entirely consistent with that finding.

In short, we are satisfied that Ground 2 is nothing more than a challenge either to the factual findings of the FTT as to whether the statutory requirements were satisfied or to its determination as to what was “just and reasonable” on the facts it had found. Neither, as it seems to us, can amount to an error of law, whether as articulated in Ground 2 or otherwise.

The FTT properly and carefully followed each stage in the series of statutory requirements imposed by section 850C and, where in dispute, made findings that these statutory requirements were satisfied. Its findings on each requirement, including on the extent of W Ltd’s excess profits, were rational and available to it to make on the evidence it received. We are satisfied that the findings were neither perverse nor irrational. There is no sustainable challenge that can be made to any of the factual findings or inferences that could be drawn from them.

Likewise it cannot be said that the FTT’s determination as to what was “just and reasonable” for the purposes of section 850C(4) was “plainly wrong”. While this is not an exercise of judicial discretion but a judicial determination, we should not interfere with it unless we are satisfied that the high hurdle expounded in Piglowska v. Piglowski, [1999] 1WLR 1360 is met.

In this case, the FTT came to three key conclusions when determining that section 850C(3) was satisfied and when considering the application of section 850C(4):

Each of W Ltd, AAM and AF were creatures of the Appellant who controlled them: Decision at [198].

None of the profits allocated to W Ltd can be said to have been earned by that entity through the Appellant’s activities or services provided as an employee (Decision at [200] and [202]). In other words, all of its profits were excess profits.

All of W Ltd’s profits were attributable to the Appellant’s power to enjoy (Decision at [205]).

Each of the three key conclusions, and the factual findings supporting them, were rational and available to the FTT on the evidence it received, and we see no basis for challenging the FTT’s conclusions in this regard. Accordingly, we reject Ground 2.

For the reasons we have given, Grounds 1 and 2 both fail and this appeal must be dismissed. HMRC did file a respondent’s notice, but given the nature of our conclusions in relation to Grounds 1 and 2 it is unnecessary to consider this further.