U.S. LLCs for U.K. tax purposes.

• Author: Whittall, Robert E.
• 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 for LLC members who are not U.S. residents?

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These issues were discussed in the August 2011 issue of The Tax Adviser (1) in light of a 2010 decision by the United Kingdom's First Tier Tribunal (Tax) that a U.K. resident was entitled to a U.K. income tax credit for U.S. tax paid on distributions from a U.S. LLC of which he was a member. (2) As noted in that article, Her Majesty's Revenue and Customs (HMRC) planned to appeal the decision. In a win for HMRC, the decision has now been overturned in the Upper Tribunal Tax and Chancery Chamber. (3)

Swift Case Decision

The main issue of the case was whether double-taxation relief was available, i.e., was a U.K. taxpayer, George Anson, liable for U.K. tax based on his share of profits from the U.S. LLC or on the equivalent of a dividend?

Anson, a U.K. resident and ordinarily resident, invested in a Delaware LLC, HarbourVest Partners LLC. The LLC distributed all profits to the members quarterly, withheld appropriate U.S. taxes, and filed U.S. tax returns. Anson reported the income as partnership income on his U.K. personal tax return and claimed foreign tax credits for the U.S. taxes withheld.

HMRC disagreed with the taxpayer's position and sought to disallow the tax relief for the U.S. tax paid. HMRC's position was that, under English law, the LLC should be treated as "opaque" (i.e., a corporation) and Anson should not be entitled to double-taxation relief. In effect, when a U.S. LLC distributes cash to a U.K. member, it is deemed a dividend for U.K. tax purposes and taxed accordingly; HMRC deems U.S. tax withheld as a tax paid by the corporation and not creditable on the U.K. taxpayer's return. (4)

The First Tier Tribunal stated that it preferred to apply Article 23(2)(a) of the 1975 United Kingdom--United States income tax treaty, "United States tax payable ... shall be allowed as a credit against any United Kingdom tax computed by reference to the same profits or income by reference to which the United States tax is computed" (emphasis added), as opposed to looking at whether the LLC was transparent versus opaque.

In the First Tier Tribunal, the two parties' experts analyzed a six-question test from HMRC Tax Bulletin 39 (February 1999), which HMRC uses to help with foreign entity classification. They agreed on four of the questions but disagreed on the answers to two:

1. Does the entity issue share capital or something else that serves the same function as share capital?

2. Are the persons who have an interest in the entity entitled to share in its profits as they arise; or does the amount of profits to which they are entitled depend on a decision of the entity or its members, after the period in which the profits have arisen, to make a distribution of its profits? (5)

   With respect to the "share capital" issue, the tribunal found:

   Our findings of fact in the light of this evidence in relationship to the membership interest in [the LLC] is that it is not similar to share capital but something more similar to partnership capital of an English partnership, the transfer of which requires the consent of all the partners but the economic benefits can be transferred without consent and without the transferee becoming a partner (s. 31 of the Partnership Act 1890). This conclusion would imply that the LLC was more transparent than opaque.

   With respect to the "profits arising" issue, the First Tier Tribunal indicated that it preferred the taxpayer's argument that the LLC operating...