Upper Tribunal Backs HMRC In Mixed Member Rules Case

In a significant ruling for professional services firms and other partnerships, the Upper Tribunal has sided with HMRC in Holden v HMRC / HMRC v The Boston Consulting Group UK LLP [2026] UKUT 25 (TCC), expanding the reach of the "mixed member" partnership tax rules (the "MMRs").

Unless overturned on appeal, the decision could have far‑reaching implications for partnership remuneration structures since, as explained below, the decision may leave individual partners exposed to tax on profits that they did not (and were never intended to) receive in the year in which they arose. Indeed, the decision indicates that even where there is a substantial commercial rationale sitting behind the structuring of an incentive scheme, this may carry little weight in determining the application of the MMRs.

Professional partnerships with corporate members should review their remuneration structures – however commercially justified – in light of the ruling, to determine whether they are at risk of a mechanistic application of the MMRs.

Background

The MMRs

The MMRs – contained in section 850C ITTOIA 2005 — were introduced to counter tax advantages that could arise from individual partners shifting their share of partnership profits to a company (or other non‑individual) member that pays a lower rate of tax.

Where the rules apply, they require profits of a corporate member to be re-allocated "back" to the relevant individual partner(s) (who will then be subject to income tax on those profits).

For the MMRs to apply, two threshold conditions must be met:

• First, the partnership must have made a profit in the relevant tax year.
• Second, the individual partner in question must themselves have a profit (or, at least, not a loss) under the standard profit‑allocation rules in sections 848 to 850 ITTOIA 2005.

If those threshold conditions are met, one of two further conditions (Conditions X and Y) must then be satisfied for reallocation to be required under the MMRs:

• Condition X is that it is "reasonable to suppose" that amounts representing the individual partner's "deferred profit" are included in the corporate member's profit share.
• Condition Y is that the corporate member's profit share exceeds its "appropriate notional profit"; the individual has the "power to enjoy" the corporate member's profit share; and it is "reasonable to suppose" that the whole or part of the corporate member's profit share was attributable to the individual's power to enjoy.

The final element of both Conditions is that it is reasonable to suppose that both the individual's profit share, and the overall tax that would be chargeable in respect of the individual's and the corporate member's profit shares, are lower than they otherwise would have been. (This was referred to as the "counterfactual test" in the Upper Tribunal decision.)

BCG's Long‑Term Incentive Structure

At the centre of the dispute was Boston Consulting Group's ("BCG's") global long‑term incentive scheme (abbreviated as "LTCV") which was designed to give managing directors and partners ("MDPs") a stake in the firm's future growth.

The scheme was implemented in the UK after BCG restructured in 2011, transferring its UK business (carried on until then by BCG Ltd, which had operated the LTCV in a different form) into a new LLP (in which BCG Ltd became a corporate member). Under the LLP agreement:

• The MDPs were allocated LTCV units labelled "Capital Interests". MDPs received initial allocations upon appointment and subsequent allocations based on seniority and length of service.
• At certain points in the course of their service as MDPs, the MDPs were entitled/required to sell their LTCV interests to a BCG entity (usually BCG Ltd).
• The LTCV was funded by the LLP making a retention of 18% of its profits in each period ("Retained Profits"), which was allocated for accounting purposes to BCG Inc (the US parent, which could also use the Retained Profits to fund the worldwide business), but for tax purposes it was allocated to BCG Ltd as a corporate member of the LLP.
• When an MDP sold their Capital Interest to BCG Ltd, BCG Ltd would use such funds as it had, or would 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 Interests in the years that they received payments from a sale of Capital Interests, on the basis that the payments were not profits received from the LLP, but rather capital receipts from the disposal. The Capital Interests were also treated by the MDPs as shares in the capital of the LLP and they therefore claimed Entrepreneurs' Relief on them.

HMRC's Challenge

At various points throughout 2018 to 2021 inclusive, HMRC opened enquiries into the LLP's partnership returns and the personal tax returns of MDPs for the years 2012/13 to 2016/17.

• In respect of all tax years, HMRC made amendments and assessments on the basis that the disposals of Capital Interests (i) gave rise to miscellaneous income under s. 687 of ITTOIA 2005, or (ii) were proceeds from the sale of occupational income under Chapter 3 of Part 13 of ITA 2007 (the "Capital/Income Decisions").
• In respect of the tax years from 2014/15, which was the first tax year in which the MMRs applied, HMRC also made amendments/assessments on the basis that the profits allocated in the partnership tax return to BCG Ltd should be reallocated to (and taxed as income in the hands of) the MDPs under the MMRs (the "MMR Decisions").

As well as appealing against the technical bases of these amendments/assessments (ie, the Capital/Income and MMR Decisions), the LLPs and MDPs challenged the procedural validity of HMRC's actions.

The appeals against the Capital/Income Decisions were decided against the taxpayer appellant in both the F-tT and the Upper Tribunal. Whilst they take up a significant proportion of the Upper Tribunal decision, they are relatively fact-specific, and the technical ground that they cover has been traversed before. This note therefore focusses on the MMR Decisions.

Decision on the MMRs

The F-tT had previously ruled that, although BCG Ltd's profit shares involved deferred profit and also exceeded the appropriate notional return (with the MDPs having power to enjoy the relevant profits), the MDPs' own profit shares had not been reduced as a result – meaning the MMRs did not apply. The Upper Tribunal disagreed.

In reaching that conclusion (and in rejecting the taxpayers' appeal against the F-tT's position), the Upper Tribunal made the following key findings.

• LTCV payouts qualified as "deferred profit". The Upper Tribunal rejected BCG's arguments that (a) Capital Interests conferred an immediate benefit (hence were not a deferral of anything), and (b) the later benefit derived from the Capital Interests rather than any deferred entitlement. Instead, the Upper Tribunal held 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 Upper Tribunal rejected the taxpayers' contentions that any deferred profits had not been included in BCG Ltd's profit share since, the taxpayers argued, the Retained Profits were neither (a) retained on BCG Ltd's balance sheet; nor (b) set aside for the particular purpose of paying for the MDP's Capital Interests (which could be funded from other sources). The Upper Tribunal held that the statutory test relied on broad assumptions based on 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.
• MDPs had the "power to enjoy" BCG Ltd's profit share. The taxpayers sought to argue that the concept of "power to enjoy" was intended to be narrower than suggested by the F-tT, demonstrated by the fact it was drafted more narrowly that the "power to enjoy" rules in the Transfer of Assets Abroad regime. The Upper Tribunal rejected this comparison, saying that no supporting guidance or legal authority had been adduced. Further, the Upper Tribunal rejected the argument that the payments made to MDPs were not funded from BCG Ltd's profit share (because, the taxpayers argued, the money could have come from other parts of the group and BCG Ltd was not the only entity that could have bought the MDPs' Capital Interests). The Upper Tribunal said that because 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 Upper Tribunal also endorsed the F-tT's finding that it was reasonable to conclude that BCG Ltd's profit share was linked to the MDPs' ability to benefit from it. The Upper Tribunal dismissed the argument that the Retained Profits would have been retained by BCG in any event, saying this did not undermine the conclusion that it was connected to the LTCV. It also rejected an argument from the taxpayers based on the fact that the profit split mirrored the position before the restructuring, noting that the introduction of the Capital Interests meant the situations were not comparable. (Although the taxpayers also did not agree with the F-tT's decision that BCG Ltd's profit share exceeded its "appropriate notional profit", they chose not to argue the point in the Upper Tribunal but purported to preserve their position on the matter should the case reach the Court of Appeal. The Upper Tribunal criticised this approach and indicated that whether they could raise this issue in the Court of Appeal was a matter for that court.)
• The counterfactual test (applicable to both Conditions X and Y) favoured HMRC. The Upper Tribunal held that, absent the arrangements under the LTCV, it was reasonable to suppose that the MDPs' profit shares would have been higher. The Upper Tribunal disagreed with the F-tT's incorporation of the commercial context (viz, the global application of the LTCV and the fact that individuals would never have stood to receive the Retained Profits in the years they arose however the LTCV was implemented). Instead, the Upper Tribunal applied the standard profit allocation rules in ss. 848–850 ITTOIA 2005 to a counterfactual in which there was no LTCV at all – in which case, the Upper Tribunal said, the only reasonable assumption was that the relevant profits would have been allocated among the MDPs (whose respective shares thereof were to be calculated by reference to their Capital Interests).

Comment on the MMR Decision

If the Upper Tribunal's decision is correct, the MMRs appear to apply such that individual members will be subject to income tax on any profits allocated to a corporate member which the individual partners might later benefit from, in the year those profits arise, even though the individuals do not receive and cannot use those profits. This can be seen from the Upper Tribunal:

• focussing (almost solely) on future benefit when construing "deferred profit" in Condition X (without reference to rights in the year when the profits arose); and
• rejecting a true counterfactual test at any stage (relying instead on assumptions made more or less in the abstract).

That approach appears, effectively, to eliminate the relevance of Condition Y in cases where the individual partner stands to benefit from the corporate member's profits in future (because any such case would always be caught by Condition X). That would appear to cut across the terms of Condition Y, which expressly include cases of future benefit in the definition of the power to enjoy – an inclusion that is not inconsequential, given it indicates that such future benefits only fall within the mischief of the MMRs if it is also the case that the profits were not appropriately allocated to the corporate member in the first place.

If, however, "deferred profit" were construed as requiring the deferral of a current entitlement (as well as the receipt of a benefit in future), that would bring out a clear and rational distinction between the conditions. If the individual has given up a current entitlement, that suffices to attribute the profits to the individual, so it is logical that Condition X does not consider whether it was appropriate for them to be allocated to the corporate member. On the other hand, if the individual has not given up a current entitlement, then it is logical to first inquire whether the profits were appropriately allocated to the corporate member, and only if that was not so to attribute them to the individual.

Whilst not the focus of this note, the Upper Tribunal's decisions on the procedural issues in this case are also notable. Of general relevance, the Upper Tribunal's decision highlights that the taking of independent tax advice will not suffice to avoid a finding of carelessness for the purposes of extended time limit assessments, if the written advice received is deemed to be inadequate. Similarly, if advice received indicates that a point is potentially contentious, the Tribunal may take the view that the taxpayer should additionally have obtained an opinion from tax counsel in order to avoid a finding of carelessness by not doing so.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.