Tax and the City - March 2014

Tax and the City briefing
for March
SPEED READ HMRC’s guidance on the new salaried
member rules for LLPs creates nearly as much
uncertainty as it dispels. The ‘Working Wheels’ scheme,
which saw taxpayers seeking to deduct a £5m fee for
borrowing £7,500, is given short shrift by the FTT. Some
taxpayer wins outside the marketed scheme arena
underline the neutrality of the purposive construction
principle and indicate that HMRC cannot always have its
cake and eat it.
Helen Lethaby has been a tax partner at Freshfields
Bruckhaus Deringer for eight years. She has experience
across the corporate tax spectrum, with a particular
emphasis on tax structured finance, leasing and funds
structuring, and advises a number of clients in the
banking and asset management sector. Email:
[email protected]; tel: 020 7427 3506.
Limited liability partnerships:
salaried members
It is now less than a month until the start
of the new tax year and many LLPs will be
finalising arrangements designed to ensure
that members currently taxed as partners do
not get recharacterised as employees under the
new rules on salaried members (effective from
6 April 2014). ‘Salaried member’ status will
attach to an individual who meets each of the
following three conditions: 80% or more of his
remuneration is ‘disguised salary’ (a fixed amount
or a variable bonus which is not dependent on
overall firm performance); he does not have
‘significant influence’ over the firm’s affairs; and
his contributed capital, broadly as measured at the
start of a tax year, is less than 25% of his expected
disguised salary for that tax year. So not meeting
any one of these conditions is a good thing – it
means the individual continues to be respected as
a self-employed partner.
The pressure points will be different depending
on what sort of business the LLP is carrying on. The
position of, say, a small London-based adviser to
an affiliated US private equity fund manager will
be different from that of a large law or accountancy
firm. The revised guidance and numerous examples
published on 21 February (see
d7jmX) do not make for an entirely coherent
message and are by turns helpful and unhelpful.
The guidance indicates that any method used
for calculating an individual member’s percentage
entitlement of firm profits (the ‘cake’), including
where for example an individual’s allocation of
units or points reflects to some extent personal
or divisional performance, should not cause the
disguised salary condition to be met, provided that
the remuneration will nevertheless still fluctuate
depending on the actual size of the overall cake.
This may enable a number of professional firms
with quasi ‘eat what you kill’ arrangements to
conclude that their members fall on the right side of
the line.
Whilst the guidance helpfully confirms that
this principle holds true even if profits are highly
predictable and do not vary much from year to
year, it also clearly states that calculating a UK
LLP’s profits on a cost-plus basis (our London-based
adviser to a US PE house) will nevertheless result
in all members receiving disguised salary. HMRC’s
view is that this is the tail wagging the dog: the size
of the cake is determined by the remuneration due
to be paid to the members (remuneration invariably
being the biggest component of ‘cost’), rather than
members’ remuneration being dependent upon how
big the cake is.
Members of smaller firms falling at the costplus fence for the purposes of the disguised salary
condition may however be able to argue that they
have the requisite significant influence to fail the
second condition. The revised guidance sticks to
HMRC’s previous line that this requires a member
to have a say in formulating the firm’s overall
strategy, although it is not easy to reconcile this
with one of the examples given. X, a member of
an LLP carrying on a regulated asset management
business, holds controlled function CF4 (partner
function) for Financial Conduct Authority
purposes. This is a status which HMRC does
not regard as conclusive evidence of significant
influence, c.f. CF3 (chief executive function) and
CF8 (apportionment and oversight function). X
also has investment decision-making responsibility
in respect of one of the funds under management.
Despite the fact that X does not sit on the LLP’s
management committee, X is nevertheless to be
regarded as having significant influence.
In practice, given the uncertainties and
judgment calls involved in applying the other two
tests, many firms will want to ensure that their
members fall the right side of the line by relying
on the 25% capital contribution test. There will
be a grace period – three months from 6 April for
existing members; two months for new members
admitted after the rules come into effect – in which
members can contribute the required capital,
although it will be necessary for members to
give undertakings to inject the capital in order
to benefit from this. HMRC appears to accept
that, even if a member would not be making a
capital contribution or would be contributing a
smaller amount but for the new rules, these are not
sufficient grounds for invoking the targeted antiavoidance rule (TAAR) – if a member has chosen
to avoid employee status by genuinely accepting the
risks that go along with being a partner, then that is
not avoidance.
However, the capital must be permanent
(i.e. non-withdrawable whilst a member), genuinely
at risk and required as working capital in the
business. Advisers are generally taking the view
that, if the capital is serving as a cash buffer for
regulatory capital purposes, HMRC should accept
that this is ‘good’ capital for tax purposes, although
this point is not addressed in the guidance.
Furthermore, if the capital is debt-funded, then ~ 14 March 2014
– to avoid triggering the TAAR – the loan must
be full recourse to, and any interest costs must be
borne by, the individual, and the funding must not
derive from the firm’s own resources. The guidance
indicates that funds will derive from the firm where
the loan is made ‘as part of an arrangement where
there is to be a reduction in the firm’s indebtedness
to the bank’. This is currently causing some concern
where a firm’s relationship bank has been lined
up to provide the loans to members and where,
for a number of reasons (including anti-money
laundering requirements), the capital contribution
will go straight into the firm’s bank account and
have the automatic effect (if the firm is overdrawn)
of reducing the firm’s indebtedness to the bank.
Express confirmation is awaited from HMRC that
this is not of itself a problem, provided that the
capital contributions have no impact on the firm’s
borrowing limits or its ability to redraw.
The 25% capital test is a prescriptive one. Whilst
this makes it relatively easy to satisfy, the flipside
is that if a member is required to withdraw capital
to deal with an emergency and this takes his
percentage below 25%, then (depending on whether
or not he satisfies the other tests) he may switch to
employee status.
Revised legislation and explanatory notes were
published on 7 March, incorporating changes
flagged in the 21 February document.
‘Working Wheels’
Fund managers putting capital at risk to avoid
salaried member status seems sensible. Fund
managers – or for that matter Radio 1 DJs or
racehorse owners – posing as used car salesmen to
avoid paying tax seems rather extreme.
According to an HMRC press release dated 21
February and issued following its win in the test
case Flanagan and Others v HMRC [2014] UKFTT
175 (TC), the ‘Working Wheels’ scheme was
marketed to 450 fund managers, celebrities and
other high net worth individuals between 2006 and
The facts in Flanagan were complex but, in
essence, involved the taxpayer borrowing £7,500
and purportedly investing it in a second hand car
business, with a view to the client being regarded as
a ‘trader’. The taxpayer also stock borrowed and lent
on £7,500 worth of loan notes in a BVI company
and, as part of those arrangements, was required to
make a ‘manufactured overseas dividend’ of nearly
£5m – being a multiple (81,111) of the £60 interest
payment on the notes (‘overseas dividend’ for
these purposes including overseas interest). Statute
provided that, where the amount of a manufactured
overseas dividend exceeded the amount of the
actual overseas dividend which it represented, the
excess was to be regarded as a separate fee. The
scheme relied on this deemed fee being regarded
as a trading deduction – a cost to the taxpayer in
raising finance for his business.
The First-tier Tribunal (FTT) did not consider
the taxpayer to be trading, nor did it accept that
14 March 2014 ~
the £5m payment was a manufactured overseas
dividend: whilst the statute allowed that a
manufactured payment may exceed the underlying
payment which it represents and accordingly
did not presuppose that the amounts had to be
equivalent, there was an upper limit to the disparity
in value between the two payments beyond which it
could not be said that one was representative of the
other – and the difference in value between £60 and
£5m was simply too great.
One might have thought there was also an
upper limit to the credulity of most taxpayers, but
apparently not.
The revised guidance published on
21 February does not make for an
entirely coherent message and is by
turns helpful and unhelpful
Purposive construction: a neutral
The FTT’s decision in RKW Ltd v HMRC
[2014] UKFTT 151 (TC) serves as another
reminder to HMRC that, outside the arena of
marketed schemes, purposive construction can
work against them as much as for them.
The case concerned the application of the
‘loans to participators’ rules, which are designed
to prevent the participators (typically, the
shareholders) in a ‘close company’ from enjoying
the income of the company tax-free in the form of
indefinite loans, and which operate by imposing a
tax charge on the company when it makes a loan
or advance to a participator or when a participator
incurs a debt to the company (with relief available
when the loan is repaid). The FTT held that,
construing the rules purposively, they did not
apply in circumstances where new shares were
subscribed on deferred payment terms, i.e. where
the subscriber was not in any sense enjoying any
pre-existing resources of the company.
This can be contrasted with the outcome in
Aspect Capital Ltd v HMRC [2014] UKUT 0081, in
which the Upper Tribunal held that funds provided
by a close company in order to enable employees to
purchase existing shares from an employee benefit
trust did amount to a loan which triggered the loans
to participator rules.
As expected, the Supreme Court has also found
in favour of the taxpayer in HMRC v Forde and
McHugh Ltd [2014] UKSC 14, holding that an
employer contribution to a funded unapproved
retirement benefits scheme was not a payment
of ‘earnings’ attracting national insurance
contributions, for reasons largely to do with
common sense. According to Lord Hodge, the
person to ask about such matters is no longer the
man on the Clapham omnibus, but the ‘ordinary
man on the underground’.
For related
reading, visit
guidance on the
draft ‘salaried
members’ rules
(George Bull &
Malcolm Cook, 7.3.14)
Cases: Flanagan and
two others v HMRC
Mayes and the
limits to a purposive
(John Tallon, 21.4.11)