Upper Tribunal agrees with HMRC in mixed member partnership tax rules case

In Mark Benedict Holden v HMRC and HMRC v The Boston Consulting Group UK LLP and others [2026] UKUT 00025 (TCC), the Upper Tribunal (UT) considered the application of the mixed member partnership tax rules (the MMRs) and largely agreed with HMRC, holding that 'capital interests' issued to managing directors and partners (MDPs) of The Boston Consulting Group UK LLP (UK LLP), were taxable as income rather than as capital gains.

Background

UK LLP is part of a privately-owned corporate group headed by The Boston Consulting Group Inc (BCG Inc) (together referred to as BCG). The case concerned on BCG's global long-term incentive scheme (LTCV) which was designed to give the MDPs a stake in the firm's future growth.

It was decided that UK LLP would be the vehicle for the BCG business in the UK. The rights attaching to the LTCV and relating to the MDPs, were set out under three Limited Liability Partnership Agreements (LLPAs), the key terms of which were:

• the MDPs were allocated LTCV units which were described as Capital Interests and allocated initially upon appointment and subsequently based on seniority and length of service;
• the MDPs were entitled or required to sell their LTCV interests to a BCG entity;
• the LTCV was funded by UK LLP making a retention of 18% of its profits in each period, which was allocated to BCG Inc for accounting purposes but to BCG Ltd for tax purposes, as a corporate member of the UK LLP; and
• when an MDP sold their Capital Interest to BCG Ltd, it would use funds it had or receive a capital injection from BCG Inc or an intragroup loan, to pay the MDP for the Capital Interest.

MDPs accounted for tax on their Capital Interest in the years that they received payments from a sale of their Capital Interest, on the basis that the payments were not profits received from UK LLP, but rather capital receipts. The Capital Interests were also treated by the MDPs as shares in the capital of UK LLP and they claimed Entrepreneurs' Relief (now Business Asset Disposal Relief) in respect of them.

HMRC disagreed with this treatment and amended UK LLP's Partnership Statement for the relevant years and issued certain MDPs with discovery assessments under section 29, Taxes Management Act 1970 (TMA).

UK LLP and 63 MDPs appealed to the First-tier Tribunal (FTT). The case proceeded with UK LLP and five MDPs as lead appellants.

FTT decision

The effect of the FTT's decision was that the UK LLP succeeded in its appeal on the substantive issues concerning the treatment of payments made in respect of the Capital Interests. With regard to the MDPs, although the FTT found that the payments were taxable as miscellaneous income in the hands of the MDPs, all lead appellants, other than Mr Holden, succeeded on their procedural challenges.

The FTT determined that:

1. The Capital Interests were not interests in the capital of UK LLP or a share of its assets.
2. The MMRs in section 850, Income Tax (Trading and Other Income) Act 2005 (ITTOIA), did not apply.
3. No amounts were to be reallocated to the MDPs under section 850, ITTOIA.
4. The sums paid to the MDPs in respect of their Capital Interests were subject to income tax as miscellaneous income under section 687, ITTOIA.
5. If, contrary to its other findings, the sums paid to the MDPs in respect of their Capital Interests were capital in nature, those sums were taxable as the sale of occupational income under Chapter 3, Part 13, Income Tax Act 2007.
6. A number of appeals made on the basis that HMRC's assessments were procedurally defective and invalid were allowed, and others were dismissed. 

Both HMRC and Mr Holden appealed to the UT.

UT decision 

Although, the UT upheld the FTT's decision in part, the effect of its decision was that UK LLP failed in its appeal on the substantive issues concerning the tax treatment of the Capital Interests. 

The main issues considered by the UT were:

1. Whether the FTT was wrong to hold that the Capital Interests were not interests in the capital of the UK LLP (the Capital Issue).
2. Whether the FTT was wrong to decide that the MMRs did not apply, and if it was, what was a 'just and reasonable' re-allocation to the MDP (the MMR Issue).
3. If the MMRs did not apply, whether the sums paid to the MDPs were taxable as miscellaneous income (the Miscellaneous Income Issue) or as proceeds from the sale of occupational income (the Occupational Income Issue).
4. In relation to certain assessments on the MDPs and the 2016/17 partnership return filed by the UK LLP, whether HMRC had shown that there had been carelessness within the meaning of the relevant statutory provisions and whether HMRC had shown, in relation to the 2015/16 partnership return filed by the UK LLP, that the hypothetical officer requirement under section 30B(6)(a), TMA, was satisfied (the Procedural Issues). 

The Capital Issue

The UT agreed with the FTT that the payments made under the relevant provisions of the LLPAs were not payments for an interest in capital or in goodwill and they were also not a payment to buy-out a right created under the relevant provisions of the LLPA, because the price paid bore no relationship to the value of that right. Accordingly, there was no sale of a capital interest under the LLPAs.  

The MMR Issue

The UT disagreed with the FTT on this issue and held that the MMRs did apply for the years 2014/15 through to 2016/17.

In reaching its conclusion, the UT held that the LCTV payouts qualified as 'deferred profit'. The UT considered that because the financial benefit was received by MDPs only on sale of the Capital Interests, it was inherently deferred even if not tied to a specific earlier-year entitlement. Deferred profits were included in the corporate member's profit share. The UT commented that the statutory test relied on broad assumptions based on a relatively high-level analysis and that, in this case, it was reasonable to assume that if profits had been allocated to BCG Ltd for tax purposes and BCG Ltd was expected to pay for the MDPs' Capital Interests, then the MDPs' deferred profits had been included in BCG Ltd's profit shares.

The MDPs had the power to enjoy BCG Ltd's profit share. In the view of the UT, as the retained profits were allocated to BCG Ltd for tax purposes to fund the future cost of buying back these interests (and because the MDPs did in fact receive their payments from BCG Ltd) it was clear that the MDPs were able to benefit from BCG's share of the profits. The UT agreed with the FTT that it was reasonable to conclude that BCG Ltd's profit share was linked to the MDPs’ ability to benefit from it. 

The counterfactual test, applicable to both Conditions X and Y for the purposes of the standard profit-allocation rules in sections 848 to 850, ITTOIA, supported HMRC. The UT held that, absent the arrangements under the LTCV, it was reasonable to suppose that the MDPs’ profit shares would have been higher.

The Miscellaneous Income Issue and Occupational Income Issue

For the years 2012/13 and 2013/14, the UT agreed with the FTT that the payments received were taxable as miscellaneous income under section 687, ITTOIA. The position was different for the later years because the MDPs were taxable under the MMRs (as explained above in relation to the MMR Issue). 

In the view of the UT, the Occupational Income Issue was not relevant as it only needed to be considered if the UT found that the Capital Interests were capital in nature. However, the UT went on to consider the issue and concluded that if it was wrong in relation to its findings relating to the MMRs and/or the miscellaneous income provisions, the sale of occupation income provisions would have applied.  

The Procedural Issues

The UT considered various assessments relating to UK LLP and specific MDPs across different tax years. The below summary does not set these out in full and focuses on the key Procedural Issues only. In this regard, the UT:

(1)  Upheld the FTT's finding that UK LLP was careless when it decided that payments made on the sale of the Capital Interests were capital in nature because it had failed to take adequate professional advice. 

(2)  Agreed with HMRC, that in taking advice from PwC about the arrangements, including in particular, the Capital Interests, UK LLP was acting on its own behalf and on behalf of the MDPs. 

(3)  Concluded that there was a tax loss because the MDPs treated payments in their self-assessment returns as capital when it should have been treated as income and the UK LLP's carelessness caused the loss of tax. 

(4)  Concluded that, with regard to UK LLP, the hypothetical officer test was met for the tax year 2016/17, so that HMRC's assessment, even though outside of the 'enquiry window', was valid. Accordingly, for the purposes of section 29, TMA, the hypothetical officer could not have been reasonably expected, on the basis of the information made available to them before that time, to be aware that there were profits that had not been included in the return or that insufficient profits had been included in the return.  

Comment

This decision is significant for professional service firms, particularly those using corporate members in partnership structures. Such firms should review their remuneration arrangements and consider the potential application of the MMRs in light of the interpretation of the relevant legislation adopted by the UT in this case.  

The UT's conclusions on the Procedural Issues are also worthy of note, highlighting that taking independent tax advice on its own is not always sufficient to avoid a finding of carelessness for the purposes of extended time limit assessments, if the written advice received is inadequate. 

Given the importance of the legislation considered in this case and the wider implications for other taxpayers, it will be interesting to see if the decision is appealed to the Court of Appeal. 

The decision can be viewed here.