The Government has published a consultation on a legislative solution for double tax issues which can arise where UK resident individuals hold interests in US limited liability companies (LLCs). It proposes to treat LLCs which are transparent for US tax purposes (and other similar entities) as transparent for UK tax purposes too, where the LLC interests are held by individuals. The consultation closes on 31 July.
The issue: LLCs are a common ownership vehicle in the US. The default US tax position is that LLCs are ‘transparent’ meaning an LLC’s profits are taxed in the hands of its members as they arise. The issue stems from whether a US LLC should be treated as transparent or opaque for UK tax purposes.
If LLCs are transparent for UK purposes, then a UK resident LLC member should in principle be entitled to credit any US tax paid on their LLC profit share against their UK tax liability on the same profit (whether income or capital gains). However, if LLCs are treated as opaque for UK purposes, the UK tax system essentially regards LLC distributions as dividends. So the US and the UK would tax different amounts – the underlying items of LLC profit in the US, and the dividend in the UK. This mismatch creates the potential for double tax, as neither the US/UK DTT nor UK domestic law offer a clear route to a credit.
In 2015, the Supreme Court concluded in Anson v HMRC [2015] UKSC 44 that a Delaware LLC’s profits arose directly to the members at the point credited to their LLC capital accounts (rather than on distribution). The UK and the US were therefore taxing the same amounts, and double tax relief should be available.
HMRC issued guidance in both 2015 and 2023 saying, in effect, that Anson was limited to its specific facts, and that LLC profits should generally be taxed at the point of distribution for UK purposes. The 2023 guidance represented a considerable hardening of HMRC’s position, going so far as to say that HMRC would investigate taxpayers who adopt a contrary position.
This produces a mismatch which can prevent credits from being available in either jurisdiction, resulting in significant double taxation. The consultation paper cites effective tax rates as high as 75%.
This has placed taxpayers in an impossible position between following Anson (risking HMRC challenge) and following HMRC’s guidance (risking double tax).
The consultation proposals: The core proposal is that legislation would be introduced which deems US LLCs transparent for UK purposes automatically if they meet certain criteria, broadly that (1) the LLC is taxed on a transparent basis in the US; and (2) it is neither UK tax resident, nor trading in the UK through a UK permanent establishment. The rule would only apply to individuals, not corporate LLC members (framed as minimising disruption to corporate groups).
While the automatic deeming rule appears to be intended as a helpful measure, it will be important to consider situations where an ability to elect into or out of transparency would be preferred. Although the focus is on US LLCs, the legislative solution would also extend to other non-UK entities with the same mismatch.
The automatic transparency rule would deem individual members of LLCs which carry on a trade or business to be partners in a partnership for UK tax purposes. For LLCs with a single member, the member would be treated as a sole trader (for a trading LLC) or holding assets on their own account (for investment LLCs). This opens up access to certain allowances and reliefs.
Key points:
Only prospective application? The consultation describes transparent treatment as applying ‘prospectively’ but does not indicate how prior tax years should be addressed. Many taxpayers will have filed on the basis of Anson, while others followed HMRC’s guidance – raising the question whether the proposals effectively put Anson on a legislative footing. The consultation offers no solution to address these uncertainties. This will be an issue of central importance, particularly for taxpayers with active HMRC enquiries.
Transitional rules: clarity will be needed as to transitional rules for situations where an LLC moves from opaque to transparent treatment (due to the proposed deeming rule) or vice versa, for example the treatment of unrealised gains accrued during the ‘opaque period’ (where taxpayers have adopted the approach in HMRC’s guidance), the base cost of assets for CGT purposes going forward, and profits allocated (but not yet distributed) to members before the transition date.
Whilst there are a number of important points that will need to be addressed, a carefully considered and properly designed legislative solution has the potential to resolve the problem definitively for the future.
Home >Articles > Solving the LLC double taxation problem
Solving the LLC double taxation problem
A welcome consultation.
The Government has published a consultation on a legislative solution for double tax issues which can arise where UK resident individuals hold interests in US limited liability companies (LLCs). It proposes to treat LLCs which are transparent for US tax purposes (and other similar entities) as transparent for UK tax purposes too, where the LLC interests are held by individuals. The consultation closes on 31 July.
The issue: LLCs are a common ownership vehicle in the US. The default US tax position is that LLCs are ‘transparent’ meaning an LLC’s profits are taxed in the hands of its members as they arise. The issue stems from whether a US LLC should be treated as transparent or opaque for UK tax purposes.
If LLCs are transparent for UK purposes, then a UK resident LLC member should in principle be entitled to credit any US tax paid on their LLC profit share against their UK tax liability on the same profit (whether income or capital gains). However, if LLCs are treated as opaque for UK purposes, the UK tax system essentially regards LLC distributions as dividends. So the US and the UK would tax different amounts – the underlying items of LLC profit in the US, and the dividend in the UK. This mismatch creates the potential for double tax, as neither the US/UK DTT nor UK domestic law offer a clear route to a credit.
In 2015, the Supreme Court concluded in Anson v HMRC [2015] UKSC 44 that a Delaware LLC’s profits arose directly to the members at the point credited to their LLC capital accounts (rather than on distribution). The UK and the US were therefore taxing the same amounts, and double tax relief should be available.
HMRC issued guidance in both 2015 and 2023 saying, in effect, that Anson was limited to its specific facts, and that LLC profits should generally be taxed at the point of distribution for UK purposes. The 2023 guidance represented a considerable hardening of HMRC’s position, going so far as to say that HMRC would investigate taxpayers who adopt a contrary position.
This produces a mismatch which can prevent credits from being available in either jurisdiction, resulting in significant double taxation. The consultation paper cites effective tax rates as high as 75%.
This has placed taxpayers in an impossible position between following Anson (risking HMRC challenge) and following HMRC’s guidance (risking double tax).
The consultation proposals: The core proposal is that legislation would be introduced which deems US LLCs transparent for UK purposes automatically if they meet certain criteria, broadly that (1) the LLC is taxed on a transparent basis in the US; and (2) it is neither UK tax resident, nor trading in the UK through a UK permanent establishment. The rule would only apply to individuals, not corporate LLC members (framed as minimising disruption to corporate groups).
While the automatic deeming rule appears to be intended as a helpful measure, it will be important to consider situations where an ability to elect into or out of transparency would be preferred. Although the focus is on US LLCs, the legislative solution would also extend to other non-UK entities with the same mismatch.
The automatic transparency rule would deem individual members of LLCs which carry on a trade or business to be partners in a partnership for UK tax purposes. For LLCs with a single member, the member would be treated as a sole trader (for a trading LLC) or holding assets on their own account (for investment LLCs). This opens up access to certain allowances and reliefs.
Key points:
Only prospective application? The consultation describes transparent treatment as applying ‘prospectively’ but does not indicate how prior tax years should be addressed. Many taxpayers will have filed on the basis of Anson, while others followed HMRC’s guidance – raising the question whether the proposals effectively put Anson on a legislative footing. The consultation offers no solution to address these uncertainties. This will be an issue of central importance, particularly for taxpayers with active HMRC enquiries.
Transitional rules: clarity will be needed as to transitional rules for situations where an LLC moves from opaque to transparent treatment (due to the proposed deeming rule) or vice versa, for example the treatment of unrealised gains accrued during the ‘opaque period’ (where taxpayers have adopted the approach in HMRC’s guidance), the base cost of assets for CGT purposes going forward, and profits allocated (but not yet distributed) to members before the transition date.
Whilst there are a number of important points that will need to be addressed, a carefully considered and properly designed legislative solution has the potential to resolve the problem definitively for the future.
2e57498c-0da6-4646-a5fb-7a7570a14975.tmb-editorspic.jpg?sfvrsn=3909c9d0_1)
