Walewski - Mixed partnership rules mean profit can be reallocated for whole period of account

In Nicholas Walewski v HMRC [2021] UKUT 0133 (TCC), the Upper Tribunal (UT) held that the mixed partnership rules in section 850C, Income Tax (Trading and Other Income) Act 2005 (ITTOIA) can operate to reallocate profits for any period during which an individual and a body corporate are partners in a partnership, regardless of whether they both remain partners for the whole period.

Background

Mr Nicholas Walewski (the taxpayer), and Walewski Ltd (W Ltd), were  members of two limited liability partnerships (the LLPs) at various (not entirely overlapping) points during the tax year 2014/15.  W Ltd was a company of which the taxpayer was the sole director and sole employee.  HMRC charged the taxpayer to income tax for the tax year 2014/15 on the basis that his profit share from the LLPs should be increased (under section 850C, ITTOIA) by reference to the entirety of the profit shares originally allocated to W Ltd, and issued closure notices to this effect.

The taxpayer appealed the closure notices to the First-tier Tribunal (FTT), contending that the profits attributed to W Ltd should not be allocated to him because they had been earned by W Ltd as a corporate member.    

The FTT dismissed the taxpayer's appeal, holding that the profits had not been earned by W Ltd, but had been allocated to it because the taxpayer had the ability to enjoy those profits via an offshore trust to which W Ltd paid its profits and of which the taxpayer's children were beneficiaries.  

The taxpayer appealed to the UT, relying on the following grounds:

(i) profits could not be reallocated to W Ltd under section 850C, ITTOIA, for the period of time that it was not a member of the LLPs; and 

(ii) if (as the FTT held) he had played a single role for the benefit of W Ltd and both LLPs, the FTT had been wrong to allocate all of the profits allocated to W Ltd to him for the relevant period.

Legislation

Section 850(1), ITTOIA, provides that a partner's share of a firm's profit or loss is determined for income tax purposes in accordance with the firm's profit sharing arrangements for the period.  This is subject to sections 850A to 850D, ITTOIA.

Section 850C provides (broadly) that if, for a period of account, an individual has the power to enjoy a corporate partner's profit share, that profit share exceeds an appropriate 'notional profit', it is reasonable to suppose that all or part of the corporate partner's profit share is attributable to the individual's power to enjoy, and the individual's profit share and relevant tax amount are lower than they would have been absent this power, then the individual's profit share is increased by so much of the corporate member's share as is attributable to the individual's deferred profit or power to enjoy. 

UT decision

The appeal was dismissed.

In delivering its decision, the UT noted that there was no necessary correlation between a partner's profit share and the time that he had spent as a partner in a partnership.  Reading words into the statute to require this would, in the UT's view, open the way to a clear ability to divert partnership profits and undermine the purpose of section 850C by allowing partners to time their entry into and departure from partnerships and would 'involve doing violence to the clear language' of the statute.  The taxpayer's first ground of appeal therefore failed.

In relation to the second ground, as W Ltd was a corporate alter ego of the taxpayer, the UT saw no reason to displace the FTT's findings.  The UT viewed the second ground as a challenge to the findings of fact made by the FTT as to whether the statutory requirements of section 850C had been met, or to its determination as to what constituted a 'just and reasonable' reallocation of profits, and neither could amount to an error of law. The second ground of appeal therefore also failed.

Comment

The UT has applied a strict interpretation to the wording of section 850C and was firmly of the view that the alternative interpretation relied upon by the taxpayer was incorrect.  The language used in its decision is unusually strong, even in an anti-avoidance context.  Given that the mixed partnership rules are designed to counter tax planning, and that it is possible for a partner to receive a profit allocation even if he or it resigns from the partnership part-way through a year, the outcome of this appeal is not surprising.  This decision will encourage HMRC to use the mixed partnership rules when challenging corporate member planning. 

The decision can be viewed here.