Supreme Court confirms tax treatment of deferred partner remuneration

Overview

The Supreme Court recently delivered its judgment in HMRC v HFFX LLP; Atkins and others v HMRC [2026] UKSC 17. The decision considers the income tax treatment of deferred partnership profit sharing arrangements operated by a limited liability partnership (LLP) and, in particular, the interaction between the partnership profit allocation rules and the residual income tax charge on income not otherwise charged (often referred to as the “miscellaneous income” charge).

HMRC failed in its argument that the profits allocated to the corporate member should be taxed on the individual members under the profit allocation rules but succeeded on its alternative argument that the amounts should be taxed on the individuals as miscellaneous income. The ultimate result was, therefore, that the deferred profit-sharing arrangements did not operate as intended and this will be considered a practical win for HMRC.

Whilst the judgment is important for partnerships and LLPs using similar profit-sharing structures, although the introduction of the mixed member rules in 2014 means that this is generally now a historic issue. However, the Supreme Court’s reasoning on the miscellaneous income charge will have continuing relevance for determining when various types of payments or allocations should be subject to tax under these sweep-up provisions.

Background to HFFX

The case concerned HFFX LLP (HFFX), a foreign exchange trading business. HFFX operated a “Capital Allocation Plan” under which part of the profits that might otherwise have been allocated to individual members was instead allocated to a corporate member, GSA Member Limited (GSAM). Those amounts were then invested and, subject to discretionary decisions and other conditions, could later be reallocated to individual members as “Special Capital”.

The intended tax effect was that amounts allocated to GSAM would be taxed at the corporation tax rate rather than as income of the individual members at income tax rates, and that later reallocations of Special Capital would not give rise to an income tax charge. The Supreme Court was asked to consider two principal issues:

1. HMRC’s appeal on the profit allocation issue (i.e. whether the profits allocated to GSAM represented profit shares of the individual members). If correct, the effect would have been to tax the individual members on those amounts in accordance with HFFX’s profit-sharing arrangements.
2. The individual members’ appeal on the miscellaneous income issue. The miscellaneous income provisions charge tax on “income” from any “source” that is not taxed under another part of the tax legislation. The individual members argued that the deferred amounts did not have a sufficient “source” to fall under this charging provision.

The profit allocation issue

The Supreme Court held that the relevant provision requires the allocation of partnership profits for income tax purposes to be determined by reference to the partners’ rights to share in profits during the relevant period of account.

In the Court’s view, the relevant profit-sharing arrangements must make it possible to identify whether any part of the partnership’s profit for the period is definitively attributable to the partner, and in what amount. That required a contractual right, existing during the relevant period, to share in the partnership profits.

On the facts, the individual members had no contractual right during the relevant period to receive the amounts allocated to GSAM. They had the benefit of a deferred remuneration mechanism under which recommendations could be made, and discretionary decisions could later be taken, but that was not the same as a present contractual right to share in the relevant profits of HFFX.

The Court rejected HMRC’s wider purposive argument that the commercial reality was that the individual members received sums reflecting their contribution to the business. The fact that a structure has a tax avoidance objective does not, by itself, allow the statutory concept of a partner’s right to share in profits to be rewritten.

Accordingly, on the profit allocation issue, the Court found that the deferred amounts should not, under general partnership taxation principles, be allocated to and constitute taxable income of the individual members. It is however important to note that following the introduction of the mixed member rules it is likely that similar structures would now result in profits being reallocated to the individual members under these provisions.

The miscellaneous income issue

Although HMRC failed in relation to the profit allocation issue, the individual members were unsuccessful in overturning the lower courts’ conclusions on the miscellaneous income issue.

The individual members accepted that the deferred amounts were income. The dispute was whether there was a sufficient source for that income to be within the miscellaneous income provisions. The Court held that there was. The source was found in the individual members’ rights under the LLP deed, combined with the decisions taken in their favour to reallocate Special Capital.

It was important that the payments were not purely voluntary. The relevant discretionary powers were exercised within a legal framework, the decision-makers had to exercise their discretion rationally and for the purposes for which it was conferred.

The Court considered earlier authorities on discretionary payments and concluded that, where there is an identifiable reason for an income payment framed by powers and obligations arising from a legal instrument, that can constitute a relevant source. The source did not have to be something separately “possessed” by the taxpayer.

Key takeaways

Whilst the introduction of the mixed member rules means that the profit allocation issue is now less relevant in tax planning arrangements involving corporate members, the decision contains several wider points of interest for partnerships, LLPs and tax advisers. The Supreme Court’s reasoning reinforces the importance of the legal rights created by partnership and LLP agreements and provides further guidance on the scope of the miscellaneous income provisions.

• Contractual rights remain central to determining how partnership profits are taxed.
• The Court rejected HMRC’s argument that commercial reality should override the legal effect of the LLP agreement.
• Similar arrangements would now be likely to be affected by the mixed member rules.
• The miscellaneous income analysis is likely to be the more significant practical outcome of the decision.
• The judgment may have implications beyond partnership structures where income does not fall neatly within another charging provision.

There are numerous other situations where income does not neatly fit into an explicit charge to tax and where the miscellaneous income provisions may provide a suitable charging fallback. Examples include cryptoassets, voluntary receipts and a range of tax avoidance structures. We therefore expect increasing litigation and growing jurisprudence in this area as HMRC seeks to apply the provisions more widely to ensure that income receipts of various types are duly subject to tax.

If you would like to discuss the implications of the HFFX decision, or the tax treatment of partnership and LLP remuneration arrangements more generally, please contact our tax and partnership specialists.