Even by the standards of tax cases, the recent case of BlueCrest Capital Management Cayman Limited & others v. HMRC is a difficult read. However, it is worth persevering with, because HMRC has taken the opportunity to test out a number of theories on partnership taxation, with some fairly alarming results for taxpayers.
While the UK tax code is often criticised as being over-complex, the part governing the treatment of partnerships is for the most part simple and brief, often succinctly summarised to the maxim that partnerships are transparent for UK tax purposes. However, the brevity often leaves more questions than answers, and some very strange results can arise, particularly when partnerships are layered on top of one another.
In BlueCrest, HMRC were challenging the treatment of a variety of what can loosely be described as remuneration planning arrangements put in place by a hedge fund for its partners. HMRC argued and won on the following points:
- A partner cannot deal with the beneficial interest in its partnership share for UK tax purposes. One of the taxpayers in the case, a Cayman Islands company, sought to contribute its interest in a partnership to another partnership of which it was the general partner. This was found not to be effective (legally the company remained the relevant partner) and the company remained fully taxable on the partnership income, apparently without the ability to deduct the amount ultimately derived by the other partner in the new partnership, which, again by extension, must have escaped tax altogether (though see 3 below). The outcome may have been different if the new partnership had been a Scottish limited partnership (with legal personality) rather than an English one.
- A non-resident company which acquires an interest in a partnership which is trading in the UK can’t claim relief for the finance costs on any loan it takes out to finance its acquisition but will remain fully taxable on its share of the income, without relief. A UK company in the same position would get relief.
- Distributions of partnership income can be taxable. Prior to this case, I would have said that it is generally accepted that because partnership income is taxed on its partners at the time of receipt (whether or not distributed to them), that distributions from a partnership are a “tax nothing”. In this case the group seems to have adopted the fairly simple expedient of allocating the profits to a UK corporation taxpayer, which contributed the post-tax profits back to the partnership, which then distributed the newly contributed capital to other, individual, partners, who took the position that there was no further tax to pay. The arrangements in this case pre-dated the mixed member rules.
During the hearing, counsel for the taxpayer, Malcolm Gammie QC, accused HMRC of “being prepared to tear up the history of the last 150 years” by advancing its argument at point 2 above. It is certainly the case that when you reduce to the basic principles, as I have done above, the findings are very surprising, all the more so because the way in which the decisions were reached makes it difficult to dismiss them as limited to the individual facts or only applicable in an avoidance situation. The first point also seems to open the door to further planning opportunities.
I expect these issues will be examined further on appeal, but in the meantime, advisers need to take extra care with partnership arrangements. The second point in particular is an inexplicable trap for the unwary.