The Commissioners for HMRC v HFFX LLP

For the purposes of the miscellaneous income charge (s.687 ITTOIA) a taxable “source” may arise where a legal framework together with an identifiable decision in the recipient’s favour combine to create the connection between payer and recipient; a contractual or trust-like context plus an exercised discretion can be sufficient to render a receipt income rather than a pure gift, even where no separate enforceable vested right crystallises at the decision point.

The appeals arise from incentivisation arrangements implemented when members of a trading team transferred into an LLP and a corporate member (the Retention Member) received deferred profit allocations under a Capital Allocation Plan (CAP) and later reallocated those amounts as "Special Capital" to individuals. The Upper Tribunal ( [2023] UKUT 00073 (TCC) ) and lower tribunals reached differing conclusions on whether reallocations to individuals gave rise to taxable income under s.687 ITTOIA and whether the initial allocations fell to be treated as allocations to individuals under s.850 ITTOIA. The Court of Appeal, following its reasoning in [2023] EWCA Civ 1481 (BlueCrest CA), treats the s.850 point as resolved in favour of the taxpayers and instead determines that the combination of the Partnership Deed and exercised discretions gives rise to a source within s.687, so the reallocated Special Capital is taxable as miscellaneous income. The court therefore dismissed HMRC's appeal on s.850 and dismissed the individual members' appeal on the miscellaneous income point; the sale-of-occupation issue was not decided.

Held (majority)

1. Outcome: Both HMRC's appeal on the s.850 issue and the individual members' appeal on the miscellaneous income (s.687) issue are dismissed; the sales-of-occupation issue is not decided as unnecessary.
2. Principle on source under s.687: The court endorses the approach in [2023] EWCA Civ 1481 (BlueCrest CA) that a "source" for the purposes of s.687 may be found where an express legal framework coupled with an identifiable decision in the recipient's favour produces the link between payer and recipient. The mere lack of an immediately enforceable vested right does not preclude the existence of a source. (See paras 31–34, 42–46, 62–63.)
3. Application of precedent: Cunard (trustees' exercise of discretion) and Drummond v Collins are applied by analogy: the recipient's title and the new source arise when the relevant discretion is exercised in their favour within the terms of the governing instrument, even where implementation follows. Spritebeam is noted for the proposition that a connection between obligation and recipient can suffice; BlueCrest CA is treated as directly determinative on the analogous facts. (See paras 31–34, 61.)
4. Braganza implication and LLP discretions: The court confirms that the Braganza principle (implied contractual constraint that a discretion be exercised rationally and bona fide) can apply to discretions arising under an LLP partnership deed. The CAP and related letters formed part of the contractual matrix such that GSAM's discretion to reallocate was subject to a requirement of rationality/good faith. Accordingly, the exercise of that discretion in favour of members can found a source. (See paras 35–41, 68–76.)
5. Construction of the Partnership Deed: On construction the CAP and the pro forma letters in Schedules 6 and 7 manifest an incentivisation mechanism: allocations to the Retention Member, reinvestment, and reallocation as Special Capital in the manner described. The context and documentation indicate that GSAM's role was to operate that mechanism and that members had entitlement to be considered and protected by an implied duty in the exercise of GSAM's discretion. The presence of specific powers (eg clause 11.9(B)) and express warnings to members does not negate the implied obligation. (See paras 14–24, 70–76.)
6. Distinguishing voluntary gifts: The court rejects the submission that a source requires a pre-existing enforceable legal right or "possession" of a source by the recipient. Earlier authorities holding that contractual or enforceable claims give rise to assessable income (Brocklesby; Manduca) do not require that conclusion as the only basis for taxability; rather, where an instrument and an exercised discretion combine to produce a payment, that combination can be sufficient to displace the characterisation of a receipt as a mere voluntary gift. (See paras 43–56, 62.)
7. Practical guidance: Where deferred incentivisation operates by allocation to a corporate vehicle and later reallocation to individuals, tribunals and courts must examine the legal architecture and the decision-making mechanism. If the documentation and practice show an identifiable legal framework under which discretions are exercised in the recipient's favour, that reallocation will frequently supply a "source" for s.687. (See paras 57–63, 79.)
8. Final orders: The appeals are dismissed in the terms announced by the court. The sales-of-occupation issue is left undecided as unnecessary to the disposal of the appeals. (See paras 80–81.)

• Court of Appeal (Civil Division) – this judgment dismisses HMRC's appeal on s.850 and dismisses the individual members' appeal on the miscellaneous income issue; sales-of-occupation issue not decided.
• Upper Tribunal (Tax and Chancery Chamber) – decision under appeal: [2023] UKUT 00073 (TCC), which found against HMRC on s.850 and decided the miscellaneous income/sales-of-occupation points against the taxpayers in varying respects; permission decisions and issues identified in that judgment are recorded in the appeal papers.
• First-tier Tribunal – prior findings on the miscellaneous income and sales-of-occupation issues are recorded in the UT decision and were considered on appeal.