In Nicholas Walewski v HMRC [2020] TC7554, the First Tier Tribunal dismissed an appeal against a reallocation of the profits of mixed-member LLPs to an individual partner. There was no evidence the profit allocations were for any reason other than the individual’s power to enjoy them.
Since April 2014 anti-avoidance rules have applied to individual partners who are members of mixed partnerships. They deal with situations where individual partners use flexible profit or loss-sharing arrangements to obtain a tax advantage.
The excess profits allocation rule applies if a mixed partnership makes a taxable profit and either of the following conditions apply:
- Condition X: the profits represent the deferred profit of an individual partner (A), or
- condition Y: B's profit-share exceeds the appropriate notional profit. An individual partner, A meets the power to enjoy condition, in relation to any element of the profit share allocated to the non-individual partner (B), and
- as a result, an individual member’s profit share and their relevant tax amount are lower than they would have been had the profits been allocated to them, rather than to the non-individual.
Mr Waleswki (“Mr W”), an investment adviser, was a partner in two LLP’s; Alken Asset Management LLP (“AAM”) and Alken Finance LLP (“AF”).
- He was a director of Walewski Limited (“WL”), a UK company indirectly owned by an offshore trust for the benefit of his children but from which he could not benefit.
- WL was a partner in AAM and AF, WL having taken over AAM’s interest in AF in 2011.
- Mr W was the only employee of WL, for a contractual salary of £200,000 per year.
- The AAM partnership deed allowed 99.9% of the profits to be allocated to WL.
- The AF partnership deed showed 99.9% of the profits as being due to AAM. This was transferred to WL in 2011.
- In August 2014 WL purchased his capital in AAM. He briefly became an employee of AAM.
- In November 2014 both LLPs were incorporated; he was a director of both new companies.
HMRC assessed Mr Walewski as having £18,088,195 of profits from AAM and £1,372,510 of profits from AF which had been allocated to WL for the 2014/15 tax year.
The FTT dismissed Mr W’s appeal. The only point of contention, it said, was whether Mr W had met the second limb of condition Y.
- The question was, if W Ltd’s profit allocation could not be explained by Mr W’s earning power as its employee, what alternative reasonable explanation was there for the profits being allocated to WL, other than Mr W’s power to enjoy them?
The tribunal found that the profit allocations exceeded both what would be an appropriate notional consideration for Mr W’s services through WL and what would be an appropriate notional return on WL’s capital in the partnerships.
- There was no evidence WL earned the profits allocated to it by AAM and AF by reason of Mr W’s activities for their clients. Neither did the entities, clients, or Mr W himself, ever distinguished a separation of activities between any of the three different entities.
- There was a conflict between his employment contracts for WL and AAM, both obliging him to work full time.
- For each partnership, WL’s capital stood at just £0.5m and an appropriate return was 5%.
As Mr W could not provide any other reasonable explanation for the profits being paid to WL by AAM and AF, the FTT found that the only explanation was that the profits were allocated to WL due to Mr W’s power to enjoy them through the trust for his children.
The tribunal considered whether there should be any time apportionment of the profits to account for Mr W ceasing to be a partner in AAM part way through the period. It concluded that this was not reasonable; most of the profits were earned whilst he remained a partner. They did, however, allow an adjustment to be made for return on capital for the relevant period, at 5%.
Given the amounts involved, we anticipate that the taxpayer may look to appeal to the Upper Tribunal.
Links to our guides
Partnerships with mixed membership
Partnerships: tax planning guides
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