Commissioners for His Majesty's Revenue and Customs v HFFX LLP

Factual and Procedural Background

This Supreme Court judgment concerns the UK income tax treatment of deferred remuneration and profit-allocation arrangements implemented by a foreign exchange trading limited liability partnership, Company A. Two appeals were heard together: (i) an appeal by Agency A regarding the allocation of Company A’s partnership profits for income tax purposes under section 850 of the Income Tax (Trading and Other Income) Act 2005 (“ITTOIA”); and (ii) an appeal by Individual Members of Company A regarding whether amounts they received under a deferred remuneration mechanism were taxable as income under section 687 of ITTOIA, or (if not) under Chapter 4 of Part 13 of the Income Tax Act 2007 (“ITA 2007”).

Company A was created in 2010 within Company B’s wider business. The team’s remuneration historically included a discretionary profit-share. Following the establishment of Company A, a deferred remuneration structure—the “Capital Allocation Plan” (“CAP”)—was implemented via an LLP deed dated 28 October 2010. Under the CAP, a significant proportion of profits that might otherwise have been allocated to participating individuals was allocated instead to a corporate member, Company E. Company E invested the funds and later, in tranches, contributed proceeds as “Special Capital” to Company A, which Company E then could reallocate to individual members, enabling withdrawals. The CAP had commercial purposes (retention and incentivisation), and it was found as a fact (not contested on appeal) that avoidance or reduction of tax was one of its main objects.

At first instance, the First-tier Tribunal (Judge Fairpo) rejected Agency A’s section 850 case but upheld taxability under section 687 and under the ITA 2007 “sales of occupation income” regime. The Upper Tribunal (Judge Mellor and Judge Raghavan) dismissed both sides’ appeals, relying substantially on BlueCrest authorities. The Court of Appeal (Judge Falk, with agreement of Judge Asplin and Judge Whipple) dismissed both appeals. In the Supreme Court, Judge Sales gave the judgment (with whom Judge Lloyd-Jones, Judge Hamblen, Judge Burrows, and Judge Rose agreed).

Legal Issues Presented

1. Whether amounts allocated to Company E (a corporate member of Company A) should nevertheless be treated as the Individual Members’ profit shares “in accordance with the firm’s profit-sharing arrangements” under section 850 of ITTOIA.
2. Whether amounts received by Individual Members through reallocations of “Special Capital” under the CAP are taxable as income under section 687 of ITTOIA, including whether the receipts arose from an identifiable “source”.
3. If section 687 does not apply, whether the receipts are deemed income under Chapter 4 of Part 13 of ITA 2007 (“sales of occupation income”), including whether the members’ activities were “of a kind undertaken in a profession or vocation” and whether “Condition B” can apply to profit-allocation arrangements within a partnership/LLP (not determined due to the section 687 conclusion).

Arguments of the Parties

Agency A’s Arguments

• Section 850 (ITTOIA): The allocations to Company E should be treated, in substance, as allocations to the Individual Members, reflecting their work and the commercial reality of the arrangements; the rights within the LLP deed to be considered for allocations were said to be sufficient for section 850; the discretion involved was not “unfettered” because it was constrained by Braganza-type duties.
• Section 687 (ITTOIA): The deferred payments were income linked to the members’ work and behaviour incentives; the payments were not gratuitous because the discretion was constrained by legal duties, providing a sufficient connection to a source.
• ITA 2007 (Chapter 4, Part 13): If section 850 did not apply and profits were genuinely allocated to the corporate member, the arrangements exploited the earning capacity of individuals by placing another person in a position to enjoy income derived from their activities; “profession”/“vocation” should not be interpreted narrowly.

Company A and the Individual Members’ Arguments

• Section 850 (ITTOIA): The LLP deed meant the Individual Members had no contractual entitlement in the relevant accounting periods to share in profits allocated to Company E; they had only a right to be considered under a discretionary mechanism; therefore section 850 did not apply.
• Section 687 (ITTOIA): The payments were said to be “purely voluntary” because Company E had “absolute discretion” whether to reallocate Special Capital; a mere right to be considered was argued to be insufficient to constitute a “source”, relying on Drummond v Collins (as deployed in argument in the tribunals and appellate courts).
• ITA 2007 (Chapter 4, Part 13): The members contended their activities were not of a kind undertaken in a profession or vocation, characterising them instead as trading/commercial activities; they also challenged findings said to be irrational in an Edwards v Bairstow sense (though certain objections, including the “main object” tax avoidance point, were not pursued by the time the case reached the Supreme Court).
• New Supreme Court point: A further argument was advanced that section 575 of ITTOIA gave priority to taxing the receipts (if from a trade) under Part 2 rather than under section 687 in Part 5.

Table of Precedents Cited

Court's Reasoning and Analysis

Section 850 (ITTOIA): The Court held that section 850 is concerned with translating partnership trading profits and losses for a given period of account into taxable income (or losses) of the partners for that same period, by reference to the firm’s “profit-sharing arrangements during that period.” Reading subsection (1) with subsection (2)’s definition (“the rights of the partners to share in the profits”), the Court concluded that section 850 requires that, in the relevant period, the partner has a contractual right subsisting during that period to share in the profits (or losses) that are to be treated as their income (or losses) for that period. This construction was reinforced by the surrounding statutory scheme treating partnerships/LLPs as transparent for income tax purposes and requiring certainty in allocating the entire taxable profits among partners in the accounting period.

On the CAP’s facts, the Individual Members had no contractual right during the relevant accounting periods to receive the sums allocated to Company E. Those profits were genuinely allocated to Company E in its own right; later reallocations depended on a separate discretionary process. Accordingly, section 850 did not convert later deferred remuneration into the Individual Members’ income for the earlier profit periods. The Court rejected Agency A’s attempt to broaden the meaning of “rights” under section 850 by an abstract appeal to statutory “purpose” or “commercial reality,” holding that the purpose of section 850 is primarily identified from its language and context: allocation according to contractual rights in the period, not an after-the-event reconstruction of economic outcomes. The CAP had a genuine commercial purpose, and there was no justification (on these facts) for disregarding it under a Ramsay-type approach.

Section 687 (ITTOIA): The Court accepted that section 687 is a residual charging provision intended to replicate the scope of the former Case VI of Schedule D. The only live question was whether the deferred receipts had an identifiable “source.” It was common ground that the payments were not purely voluntary because the discretion to reallocate was constrained by Braganza-type duties. The Court held that where a payment is made as income pursuant to the joint operation of (i) a legal instrument conferring a structured discretionary power and associated rights (including rights to be properly considered) and (ii) the actual exercise of that discretion in the recipient’s favour, that combination can constitute an identifiable “source” for section 687 purposes. The Court rejected the submission that the “source” must be something “possessed” by the taxpayer, finding no textual basis for importing such a limitation into section 687 and noting that earlier authorities treated discretionary decisions under legal frameworks as capable of constituting a source.

New section 575 point: The Court permitted a new argument that section 575 prioritised Part 2 (trading receipts) over Part 5 (including section 687), but rejected it. The Court agreed with reasoning that the “source” of the deferred receipts was the discretionary decision under the CAP framework (a separate stage), not the underlying trade of Company A; therefore, section 575 did not displace section 687.

ITA 2007 Chapter 4 (sales of occupation income): Because section 687 applied, it was unnecessary and inappropriate to determine the ITA 2007 issue, particularly given the absence of full appellate analysis on that topic. The Court expressly stated it should not be taken to endorse or disapprove the Upper Tribunal’s reasoning on this regime.

Holding and Implications

Holding: DISMISSED (both appeals). The Court dismissed Agency A’s appeal on section 850 ITTOIA and dismissed the Individual Members’ appeal on section 687 ITTOIA.

Implications: The immediate effect is that profits allocated to the corporate member under the CAP were not re-characterised as the Individual Members’ profit shares for the relevant accounting periods under section 850; however, the sums actually received by the Individual Members by way of Special Capital reallocations were taxable as income under section 687 because they arose from an identifiable source (their rights under the legal framework combined with discretionary decisions made in their favour). The Court made no determinative ruling on Chapter 4 of Part 13 of ITA 2007, and stated no new precedent on that regime; the decision’s direct consequence is confined to the tax treatment of these arrangements under sections 850 and 687 on the facts found.