When is a U.S. LLC a partnership for U.S. and U.K. tax purposes?

• Author: Bakale, Anthony S.
• Position: Limited liability companies

U.S. limited liability companies (LLCs) have become the preferred business entity in many situations because their members get the best of both worlds: legal liability protection while being taxed in the United States as a partnership. But what are the global tax implications of using an LLC if it has nonresident LLC members--for example, an individual resident in the United Kingdom?

U.S. Tax Implications

Assuming the LLC is profitable, it must pay withholding tax at the highest individual tax rate (35% for 2011) on the U.K. partner's share of U.S.-sourced effectively connected income (Sec. 1446(b)). The U.K. individual then files Form 1040NR, U.S. Nonresident Alien Income Tax Return, reporting his or her share of the effectively connected income reported on Schedule K-l, and is taxed on his or her share of that income at the individual graduated tax rates.

U.K. Tax Implications

The June 1997 position of Her Majesty's Revenue and Customs (HMRC) as published in Inland Revenue Tax Bulletin 29, "UK/US Double Taxation Convention--US Limited Liability Companies (LLCs)," was that a U.S. LLC is treated as an opaque entity--i.e., a corporation. (Tax Bulletin 29 was superseded by HMRC DT 19853A, but HMRC's position remains unchanged.) The bulletin specifically provided as follows:

[F]or the purposes of United Kingdom tax we have taken the view in relation to those LLCs that we have so far considered that they should be regarded as taxable entities and not as fiscally transparent. Accordingly we tax a United Kingdom member of a LLC by reference to distributions of profits made by the LLC and not by reference to the income of the LLC as it arises. If tax is paid in the United States on the profits of the LLC, we regard that tax as underlying tax and credit relief is available for it if the member is a United Kingdom company which controls, directly or indirectly, at least 10 per cent of the voting power in the LLC. In effect, a U.K. resident individual taxpayer will be taxed in the United Kingdom when the LLC distributes cash; it will be deemed a dividend for U.K. tax purposes and taxed accordingly. However, HMRC's position is that the U.S. withholding taxes are deemed to be underlying taxes that will not be creditable on the U.K. individual taxpayer's tax return. The U.K. taxpayer is therefore subject to double taxation on profits from a U.S. LLC, which is not tax efficient.

HMRC Tax Bulletin 83

In HMRC Tax Bulletin 83, HMRC discusses whether certain foreign entities are transparent or opaque, stating:

When considering the classification of a foreign entity (i.e. whether it is either opaque or transparent) for UK tax purposes, due regard is given to the approach of the Court of Appeal in the case of Memec plc v CIR (70 TC 77) and the line of case law that precedes it. In particular, the following matters should be considered: (a)...