Case report: Additional tax payable on profits allocated to corporate partner
In BCM Cayman LP & Anor  TC 07782, the First-tier Tribunal (FTT) found that:
(1)a company was chargeable to corporation tax on profits allocated to it by a partnership via a sub-partnership and that it was not entitled to a trade deduction in respect of interest paid on loans to finance the acquisition of its interest in the partnership; and
(2)individual partners were chargeable to income tax on benefits they received under arrangements which involved the allocation of profits to a corporate partner and the reinvestment of those profits into the partnership by the corporate partner as a capital contribution.
The Cayman Appeals, the PIP Appeals and the IP Appeals concern the profit sharing arrangements of a UK limited partnership (BCM LP) and successor firms. The appeals were heard consecutively.
The Cayman Appeals
Background (paragraphs 8 to 101 of the decision)
The Cayman Appeals are the appeals brought by the Cayman Appellants. The facts agreed by the parties to the case are summarised below.
•In June 2007, BCMC LP, a Caymans Island limited partnership, was formed by BCMCL, a Caymans Island company, RBS and an individual.
•In July 2007, BCMCL purchased a 19% interest in BCM LP, a UK limited partnership carrying on a trade of investment fund management, from Sugarquay, WR and MP in consideration for cash (financed by a loan from RBS) and the issuance of loan notes. BCMCL made a capital contribution to BCMC LP of its interest in BCM LP in consideration for BCMC LP granting it certain partnership interests.
•In June 2008, Fyled replaced RBS in the arrangements.
•In December 2008, the business of BCM LP was transferred as a going concern to BCM LLP.
•In April 2010, a reorganisation was effected under which BCM LLP migrated to Guernsey and a new entity, BCM UK LLP, was incorporated and commenced trading in the UK. BCMC LP became a partner in BCM UK LLP.
•In 2011, BCMCL renegotiated its debt arrangements, redeeming the loan notes and refinancing the remaining balance due to Flyed as part of a new syndicated loan.
•In July 2013, BCMCL refinanced the existing balance on the syndicated loan as part of a new loan facility.
Between July 2007 and July 2013, BCM LP (and successor firms) allocated profits to BCMC LP which in turn allocated profits to BCMCL. BCMCL used those profits to pay interest to the holders of the loan notes and on the RBS/Fyled loan/the syndicated loan.
The Cayman Appellants appealed to the FTT in respect of closure notices issued by HMRC assessing additional profits chargeable to BCMCL. It fell to the FTT to determine a number of issues, referred to as the ‘Profit Allocation Issues’, the ‘Interest Deductibility Issues’ and the ‘Discovery issue’, as set out below.
Profit Allocation Issue 1 (para. 102 to 114)
Is BCMCL liable to corporation tax on all of the profit allocations of BCM LP in respect of the 19% interest in BCM LP purchased in July 2007? In this regard was BCMC LP a partner of BCM LP and, if not, were all the partners of BCMC LP to be treated as partners of BCM LP?
Having regard to the various deeds and agreements, and to Caymans Islands law, the FTT found that BCMC LP could best be described as a ‘sub-partnership’; broadly, a partnership within a partnership. It followed that only BCMCL was a partner in BCM LP (rather than all the partners in BCMC LP) and therefore, that BCMCL was liable for corporation tax on its profit allocations in respect of the 19% interest in BCM LP.
In summary, the FTT rejected the argument put forward by the Cayman Appellants, finding in favour of HMRC.
Profit Allocation Issue 2 (para. 115 to 137)
Did BCMCL’s entitlement to the profits of BCMC LP include those allocated to RBS/Fyled? In this regard:
•What were the “profit-sharing arrangements”, within the meaning of CTA 2009, s. 1262, relevant to BCMC LP?
•In particular, were they confined to the BCMC LP Deed, or did they encompass other contractual agreements and, if so, which other agreements?
Given the FTT’s conclusion with regard to Profit Allocation Issue 1 (above), it was not strictly necessary for the FTT to consider the Profit Allocation Issue 2; however, it did so as the issue was fully argued and in case of any further appeal.
As a matter of Cayman Islands law, the profit sharing agreements were confined to the BCMC LP Deed under which BCMCL’s entitlement to profits of BCMC LP did not include those allocated to RBS/Flyed.
Interest deductibility issue 1 (para. 138 to 161)
Are BCMCL’s interest costs on the RBS loan and the loan notes, entered into by BCMCL to acquire a 19% partnership interest in BCM LP, allowable deductions under CTA 2009 in calculating BCMCL’s chargeable profits for corporation tax purposes? If so, to what extent are they allowable?
It was common ground that BCMCL, as a partner of BCM LP (and successor firms) which carried on its trade through a fixed place of business in the UK, was trading through a UK permanent establishment and that it had no separate or other trading activity in the UK.
As a result, BCMCL was chargeable to UK tax only on those profits specified in CTA 2009, s. 19(3). Therefore, it was necessary to identify BCMCL’s trading profits in accordance with the partnership rules contained in CTA 2009, Part 17 (in particular, CTA 2009, s. 1259) and CTA 2009, s. 380, which concerns the deduction of interest where “a money debt is owed by or to the firm”.
In this case, the interest was not due on a debt owed by a “firm” but by an individual partner, BCMCL, in its own right; therefore, section 380 could not apply and, as there was no mechanism by which BCMCL could claim a deduction for interest on the loan or the loan notes, BCMCL was not entitled to claim a deduction for the interest.
In summary, the FTT rejected the argument put forward by the Cayman Appellants, finding in favour of HMRC.
Interest deducibility issue 2 (para. 162 to 206)
Is the equity and debt structure of BCMCL’s UK PE in any way not representative of a structure that could have been achieved if the parties were operating on an arm’s length basis (i.e. is BCMCL’s UK PE ‘thinly capitalised’) such that the deduction claimed by BCMCL in respect of interest costs on the RBS Loan Facility and the Loan Notes is to be restricted? If so, to what extent is the deduction restricted? In this regard:
(1)Are the conditions of ICTA 1988, Sch. 28AA, para. 1(1) and (2) (since rewritten as TIOPA 2010, s. 147(1)) for the application of the transfer pricing provisions of ICTA 1988, Sch. 28AA (since rewritten as TIOPA 2010, Part 4) satisfied in relation to the RBS Loan Facility and the Loan Notes?
(a)Were the RBS Loan, the Sugarquay Loan, the MP Loan and the WR Loan arm’s length provisions?
(b)Is it necessary that MP or WR be characterised as “enterprises”, for them to be within the scope of Part 4 of TIOPA 2010 and, if so, is such characterisation merited based on the facts of the case?
The FTT having concluded Interest Deductibility issue 1 in favour of HMRC, this issue was academic; however, the FTT addressed the issue in case of any further appeal.
As each of the parties had their own “divergent and differing” interests in the transactions, the transactions were at arms-length and BCMCL was not related to any of RBS, Sugarquay, WR and MP; therefore, the transfer pricing provisions did not apply to the transactions. It was accepted that both the concept of “persons”, as used in the legislation, and “enterprises”, as used in the OECD’s guidelines, includes individuals.
Applying the legislation (ICTA 1988, s. 11AA and Sch. A1 since rewritten as CTA 2009, Pt. 2, ch. 4) and guidance published by the OECD, it was necessary to consider the debt/equity ratio of BCMCL. Having found that the borrowing from RBS and the loan notes were issued on an arm’s length basis, the FTT was unable to find that the UK PE could or would have acted differently or that there would have been any other debt/equity ratio than the one that there was.
Interest Deductibility Issue 3 (para. 207 to 211)
Are the RBS loan and the loan notes to be classified as “trading loan relationships” or “non-trading loan relationships” for the purposes of CTA 2009, Pt. 5? In relation to this, was BCMCL party to the RBS loan and the loan notes for the purposes of a trade it carried on:
(a)at the time of the loans, and
(b)during each accounting period when the loan interest expense was incurred?
CTA 2009, s. 297 provides that, in arriving at its trade profits, a company may deduct debits in respect of a loan relationship entered into for the purposes of that trade. The evidence before the FTT was that BCMCL entered into the financing arrangements in order to acquire an interest in BCM LP; therefore, the loan relationship was not entered into for trade purposes and relief for the interest could not be claimed against trade income. The RBS loan and the loan notes are classed as non-trading loan relationships.
Discovery Issue (para. 212 to 247)
In relation to the Discovery Amendment:
(1)Was the Discovery Amendment validly made under TMA 1970, s. 30B?
(2)If so, were the adjustments made thereunder correct?
HMRC’s adjustments to the 2007–08 and 2008–09 returns were made outside of the usual enquiry window in reliance on its discovery powers under TMA 1970, s. 30B. The onus was on HMRC to prove that the discovery amendments was validly made under section 30B and in particular, that the requirements of section 30B(6) were met; i.e. that at the time the enquiry window closed an officer could not reasonably be expected to have been aware of the actual insufficiency of tax in the return.
For the FTT, the information provided to HMRC, although sufficient to have alerted a hypothetical inspector to make further enquiries, was “not enough of a disclosure in respect of which it would have been reasonable to expect such an officer to be aware of an insufficiency”. The condition in section 30B(6) was met and the discovery assessment was validly made under section 30B(1).
Conclusions (para. 248 to 252)
The Cayman Appeals were dismissed.
The PIP Appeals
Background (para. 253 to 308)
The PIP Appeals are the appeals brought by the PIP Appellants. The PIP is a partner incentivisation scheme under which the profits of BCM LP (and successors) were allocated to, and chargeable to corporation tax in respect of a corporate partner or partners (SCL and Avon). SCL/Avon re-invested the after-tax profits into BCM LP as a capital contribution referred to as “special capital”. Although this reduced the profits available for allocation to the other partners, those partners could be made eligible for consideration for potential discretionary awards of special capital in BCM LP by the corporate partner. In due course, SCL/Avon directed BCM LP to transfer an entitlement to the company’s special capital to the individual partners.
The PIP Appellants appealed to the FTT in respect of closure notices issued by HMRC which:
•in relation to the PIP issue, reduced the profits allocated to Avon and SCL and increased the profits allocated to the individual partners; and
•in relation to the Profit Allocation Issues, reduced the profits allocated to BCMC LP and increased the profits allocated to BCMCL.
PIP issue (para. 308 to 335)
Did the PIP arrangements form part of the “profit-sharing arrangements” of the partnership, within the meaning of ITTOIA 2005, s. 850 and/or CTA 2009, s. 1262? In particular, did the individual partners who participated in the PIP thereby have rights to share in the profits of the partnership and, if so, what is the correct amount of profits to be allocated to them in each year under appeal and/or did SCL and/or Avon have rights to share in the profits of the partnership and, if so, what is the correct amount of profits to be allocated to them in each year under appeal?
The FTT rejected HMRC’s purposive construction of ITTOIA 2005, s. 850, finding that the special capital credited to the individual partners was not in the character of income or a share of profits. The partnership’s profits (i.e. the profits that were agreed to be allocated) were allocated by BCM LP to SCL/Avon and were correctly brought into charge to corporation tax by SCL/Avon.
In summary, the PIP Appellants were successful in their appeal on the PIP Issue.
Profit Allocation Issues 1 and 2 (para. 336)
As Profit Allocation Issues 1 and 2 replicated Profit Allocation Issues 1 and 2 of the Cayman Appeals, it was not necessary to consider the issues further.
Conclusions (para. 337)
The FTT found in favour of the PIP Appellants in relation to the PIP issue and against the PIP Appellants in relation to Profit Allocation Issues 1 and 2.
The IP Appeals
Background (para. 338 to 400)
The IP Appeals are the appeals brought by the IP Appellants. On HMRC’s analysis, should the PIP Appellants be successful in the PIP Appeals, the individual partners would be liable to tax in respect of their awards under the PIP on two alternative bases (the Miscellaneous Income Issue and the Sales of Occupation Income Issue), each of which treats sums received by the Appellants pursuant to the PIP as income.
Miscellaneous Income Issue (para. 401 to 428)
Were sums received by the IP Appellants pursuant to the PIP income or capital for the purposes of the Income Tax Acts? If they were income, were they charged to tax under ITTOIA 2005, s. 687(1)?
For the FTT, the distinction between income which falls within the miscellaneous income charge in ITTOIA 2005, s. 687(1) and that which does not, is whether the receipts are analogous to income or something charged to income elsewhere in the Taxes Acts; put simply, if it was the case that the income was analogous to income or something charged to tax, it was within the charge to tax. Counsel for HMRC had used the example of a present and a bonus. The FTT agreed with HMRC that the awards of special capital were more like bonuses and so were analogous to something taxed by the legislation.
The FTT dismissed the IP Appellants’ appeal.
Sales of Occupation Income Issue (para. 429 to 455)
If the sums received by the IP Appellants pursuant to the PIP were capital, were they charged to income tax under ITA 2007, Pt. 13, ch. 4? In particular:
(1)Was the main object, or one of the main objects, of the transactions or arrangements the avoidance or reduction of the IP Appellants’ liability to income tax?
(2)In respect of each IP Appellant, were the transactions effected, or arrangements made, to exploit the earning capacity of that individual in an occupation? In this regard:
(a)Was the relevant IP Appellant carrying out an “occupation” within the meaning of ITA 2007, s. 777(2), i.e. was the relevant IP Appellant undertaking activities of a kind undertaken in a profession or vocation?
(b)If so, were the transactions effected, or arrangements made, to exploit that Appellant’s earning capacity in the occupation by putting another person in a position to enjoy:
(i)all or part of the income or receipts derived from the individual's activities in the occupation; or
(ii)anything derived directly or indirectly from such income or receipts?
Having decided the Miscellaneous Income Issue in favour of HMRC, the FTT was not required to consider the Sales of Occupation Income Issue; however, it did so in case of a further appeal.
The FTT found in favour of HMRC: first, the “ordinary reasonable” man or woman would regard the term “profession” as including the activities of the IP Appellants and second, although the PIP arrangements clearly had a commercial purpose (the retention and incentivisation of partners), they also had as a main object the avoidance or reduction of liability to income tax.
Conclusions (para. 456 and 457)
The IP Appellants failed on the Miscellaneous Income Issue and their appeals were dismissed. Had the Appellants succeeded on the Miscellaneous Income Issue, they would have failed on the Sales of Occupation Issue.
Summary of conclusions (para. 458)
The Cayman Appeals were dismissed.
The PIP Appeals were allowed.
The IP Appeals were dismissed.
Additional point: redaction of information (Appendix to the decision)
On receipt of the draft decision, the IP Appellants had requested that figures relating to profits allocated to them in the closure notices issued by HMRC be redacted or removed on the basis that this was confidential and sensitive information, relating to named individuals, which was not required for the legal analysis.
The FTT dismissed the application. However, the FTT redacted the figures in case of a further appeal by the IP Appellants which would be rendered nugatory if the figures were published in this decision.
BCMCL: BlueCrest Capital Management Cayman Limited
BCMC LP: BCM Cayman Limited Partnership
BCM LP: BlueCrest Capital Management Limited Partnership
BCM LLP: BlueCrest Capital Management LLP
BCM UK LLP: BlueCrest Capital Management (UK) LLP
LB: Leda Braga
Cayman Appellants: BCMC LP and BCMCL
SD: Simon Dannatt
AD: Andrew Dodd
IP Appellants: LB, SD, AD, MP, JW representative of the larger number of partners who participated in the PIP
MP: Michael Platt
JW: Jonathan Ward
Fyled: Fyled Energy Limited
PIP: Partner Incentivisation Plan
PIP Appellants: BCM LP, BCM LLP and BCM UK LLP
RBS: the Royal Bank of Scotland
Sugarquay: Suguarquay Ltd
This is an epic decision (running to over 200 pages) which touches on many areas of possible interest, including mixed partnerships, transfer pricing, the loan relationship rules, the charge to income tax on miscellaneous income and the anti-avoidance rules designed to catch sales of occupational income.
Significant changes to the rules for the taxation of mixed partnerships were made by FA 2014.
For commentary on mixed partnerships, see In-Depth at ¶289-570ff.
Comment by Stephen Relf, Croner-i tax writer.
 UKFTT 0298 (TC)