The problematic use of transparent U.S. LLCs by foreign taxpayers.

• Author: Stuardi, Pietro M.
• Position: Limited liability companies

The use of U.S. limited liability companies (LLCs) as holding vehicles or operational business entities has become increasingly popular among U.S. taxpayers. Along with a remarkably flexible charter, U.S. LLCs offer the opportunity to shield owners from unlimited liability while retaining flowthrough treatment for tax purposes. A U.S. LLC that has not made an election for corporate treatment--a "transparent" U.S. LLC--is effectively disregarded as an entity separate from its owner or, in the case of multiple owners, treated as a partnership for federal income tax purposes.

However, when it comes to cross-border structuring, transparent U.S. LLCs should be used with great caution. This item explores some common issues encountered by foreign taxpayers adopting transparent U.S. LLCs to invest or operate in the United States. Unless otherwise noted, any reference to an LLC is to a U.S. LLC that has not elected to be treated as a corporation for U.S. tax purposes.

Classification of an LLC for Foreign Tax Purposes

The crux of the issue is the potential mismatch in how an LLC is classified under U.S. tax law and the laws of a foreign jurisdiction. In many instances, the transparent treatment accorded under federal law is not relevant in determining how the LLC is classified for the tax purposes of another country. If the LLC is regarded as a nontransparent entity by the jurisdiction of its foreign owner, a mismatch will arise as to the identity and residency of the taxpayer who recognizes revenues and expenses, as well as the timing of income recognition.

A recent case before the U.K. Supreme Court is helpful in illustrating this scenario and its potential consequences, Anson v. Commissioners for Her Majesty's Revenue and Customs, [2015] UKSC 44. George Anson was a U.K. resident who ran his investment management business in the United States through a Delaware LLC. In the United States, he was taxed on his share of the LLC's profits regardless of actual distributions and was personally liable for federal and state income taxes. As the profits were distributed to the LLC's members, Anson was then taxed in the United Kingdom on the distributions. Problems arose when Anson attempted to claim a foreign tax credit in the United Kingdom for the U.S. taxes he paid, arguing that the profits subject to tax were the same, and under the United States-United Kingdom treaty, they could not be taxed twice (i.e., by the United States when earned and by the...