Tax planning structures designed to defer partner remuneration must now be carefully re-examined following a definitive ruling on how discretionary payments are handled by HMRC.
Background:
The dispute arose from a Capital Allocation Plan, or CAP, implemented by HFFX, a limited liability partnership (LLP) within the GSA investment management business. Led by managing member Mr. Alexander Gerko, HFFX’s individual members designed high-frequency FOREX trading software. Under the plan, a portion of partnership profits was allocated to a corporate member, GSA Member Ltd, which invested the funds for three years before contributing the proceeds back to HFFX as "special capital".
This special capital was then reallocated to individual members according to Mr Gerko’s recommendations. Crucially, GSA Member Ltd retained absolute discretion over these reallocations, subject only to the rationality principles established in Braganza v BP Shipping Ltd [2015].
Individual members received "indicative letters" detailing potential awards, although payments ultimately depended on performance and remaining with the firm. The arrangement aimed to ensure that profits were initially taxed at corporate rates, while subsequent payouts to individuals were expected to escape income tax entirely. HMRC challenged this notion, seeking to tax the indicative allocations upfront as partnership profits under Section 850 (s850) of the Income Tax (Trading and Other Income) Act (ITTOIA) 2005, or to tax the final receipts as miscellaneous income under s687. The First-tier Tribunal, Upper Tribunal (UT), and Court of Appeal (CoA) all held that s850 did not apply to the indicative allocations of special capital. HMRC appealed this judgement.
Decision:
The Supreme Court has unanimously dismissed both appeals, delivering a nuanced judgement that carefully dissected the mechanics of ITTOIA 2005. Regarding HMRC’s appeal under s850, the Court held that for a partner’s share of profits to be taxable during a specific period, the partnership arrangements must grant that partner a definitive, subsisting contractual right to those profits during that timeframe. Because GSA Member Ltd possessed a genuine, legally enforceable discretion to withhold or vary the allocations, the individual members had no contractual right to the money when the indicative letters were issued. Consequently, s850 did not apply to the initial allocations.
However, the Supreme Court also dismissed the individual members' appeal regarding s687. The taxpayers had argued that the final payouts were purely voluntary, discretionary receipts that lacked a legal "source," rendering them non-taxable. The Court rejected this narrow view, clarifying that a "source of income" for the purposes of miscellaneous income does not require a strict contract; rather, it requires a sufficient connecting factor between the income and the recipient, and an activity can constitute a source. The Court concluded that the highly structured decision-making process under the partnership deed, governed by Braganza duties, served as the precise source of the deferred income. Therefore, the receipts were rendered fully taxable as miscellaneous income.
Implications:
This ruling brings profound clarity to how deferred compensation and discretionary bonus schemes will be treated for tax purposes moving forward, and the lessons are pivotal for any business operating as a partnership or LLP.
First, the decision confirms that you cannot have your cake and eat it too. If an arrangement successfully uses a corporate partner's discretion to defer or avoid immediate partnership profit tax, then the law will catch those funds on the back-end when they are ultimately distributed to individuals. The Court has effectively closed the door on using elaborate discretionary structures to turn regular, hard-earned professional income into tax-free windfalls.
Second, the judgement represents a sea change in how we define taxable income. Even if a payment is technically discretionary and not guaranteed by a contract, it can still be taxed if it comes from a structured corporate scheme or an employment-like relationship. If a payout is linked to your ongoing work, performance, and institutional rules, the tax authority will look past the "voluntary" label and treat it as a taxable source of income.
Finally, anyone currently utilising or considering corporate partner structures to manage remuneration must urgently review their partnership deeds. While these structures may still offer commercial benefits, such as locking in key talent over a three-year vesting period, the anticipated tax advantages may no longer exist. If you are part of a firm utilising deferred capital allocation plans, it is highly recommended to seek professional legal counsel to assess your exposure and align your compensation strategies with this definitive precedent.
