UK taxation of US LLCs – HMRC responds to Supreme Court decision in Anson
HM Revenue and Customs (HMRC) has confirmed – in Brief 15 (2015) - that its current practice of treating (for UK tax purposes) limited liability companies (LLCs) formed under Delaware law as companies, rather than as transparent entities, will remain largely unchanged as a result of the recent Supreme Court decision in Anson v. HMRC ( UKSC 44).
Although the Supreme Court’s decision was helpful to Mr Anson (preventing his income from being subject to double taxation), it caused concern for numerous businesses who rely on ‘company’ characterisation of US LLCs for various purposes, including accessing the UK’s participation exemptions for dividends and capital gains.
As such, HMRC’s decision to treat the Supreme Court’s decision as limited to the “specific to the facts found in the case” is likely to be welcomed widely. It however has made it clear that there is no “one size fits all” characterisation.
UK treatment of entities formed under foreign laws
Unlike the US, the UK does not have a ‘check the box’ regime for selecting how foreign entities are characterised for UK tax purposes. Nor is there a single statutory test which addresses this issue, or many court decisions on the point.
As a result, taxpayers rely heavily on the published guidance from HMRC as to the characterisation of particular entities which it has considered in the past. This includes a list of ‘opaque’ entities (generally taxed as companies) and of ‘transparent’ entities (taxed as branches or partnerships), as well as a list of the factors which HMRC takes into account in determining which category any given entity falls into. These factors can be summarised as:
is it a separate legal entity, distinct from the persons who are its members?
does it issue ‘share capital’, or something which performs a similar function?
does it, rather than its members, carry on the business?
are its members entitled to share in its profits as they arise, or does their entitlement depend on a decision to distribute profits which is made by the entity (or its members) after the period in which the profits have arisen?
is it liable for the debts incurred by carrying on the business, or are they liabilities of its members?
does it own the assets used for carrying on the business, or do they belong beneficially to its members?
These factors are largely based on a Court of Appeal decision (Memec plc v CIR (70 TC 77)) in which entity classification (in that case, a German silent partnership – stille Gesellschaft) played a particularly significant role, but are only of limited assistance because none of these factors is determinative.
US LLCs, particularly those formed in Delaware
Not only do Delaware LLCs appear on the HMRC list of ‘opaque’ entities, but a separate piece of HMRC guidance also contains a helpful explanation of why two particular entities - the German GmbH and the Delaware LLC – are usually viewed as companies which issue ‘ordinary share capital’ (HMRC Brief 87 (2009)). Brief 15 (2015) confirms that it will continue to operate this practice, which is of particular significance for the UK’s capital gains participation exemption (the “substantial shareholding exemption”).
Although the HMRC guidance focuses on Delaware LLCs, that guidance is regarded as also applying to LLCs formed in many other States of the US. These views were not particularly controversial, as they reflected the general view among practitioners and were widely seen as welcome clarifications on a subject which Parliament has not addressed specifically.
Mr Anson, and the UK courts
Mr Anson’s facts were particularly unfortunate. He had to pay US tax (on a look-through basis) on his share of the profits of a Delaware LLC of which he was a member. As his holding was not sufficiently large to qualify for relief, in the UK, for underlying tax, he was left facing a 67% rate of tax on that income; ie, the aggregate of US and UK tax on that income, rather than just the higher of the two taxes. HMRC’s view that the income on which he paid US tax – his share of the LLC’s profits – was not the “same income” as that on which he paid UK tax (distributions from the LLC), and so he was not entitled to credit the US tax which he paid against his UK income tax.
The first level of UK tax court (the First Tier Tribunal, which included two experts in the field) allowed Mr Anson’s appeal against HMRC’s decision, finding that he was entitled to the LLC’s profits as they arose. As such, the US tax was paid on the ‘same income’ as the UK tax was due on, and accordingly, thereby entitling Mr Anson to relief against his UK tax liability for the US tax which he had paid on his share of the LLC’s profits.
This decision came as a surprise to many, as it contradicted the orthodoxy that LLCs – particularly Delaware LLCs – should be treated in the UK as companies. It was overturned on HMRC’s appeal to the Upper Tribunal, and Mr Anson’s subsequent appeal to have the Court of Appeal reinstate the FTT’s decision was rejected. This seemed to signal the return to the status quo ante, to the relief of many UK companies.
The Supreme Court
Mr Anson was allowed to appeal to the UK’s Supreme Court, and in July 2015 that Court allowed his appeal. As this decision is the final word on Mr Anson’s appeal, it has generated much debate about whether the Supreme Court has overturned HMRC’s existing practice as to the UK’s tax treatment of LLCs (and other non-UK entities); did it call into question the efficacy of US LLCs as ‘blockers’ in both outbound and inbound investment structures?
Although some of the comments in the Supreme Court’s decision about the tax treatment of the particular LLC which Mr Anson invested in might suggest this, the judgment was confined to a very narrow issue, namely whether Mr Anson was entitled to relief under article 23(2)(a) of the 1975 UK/US Double Taxation Convention (and the equivalent provision in the 2001 convention). It is notable that in reaching their conclusion that Mr Anson was entitled to that relief:
the Supreme Court emphasised that they were interpreting a treaty provision, and that different considerations apply to that than would apply to the interpretation of domestic tax law – interpreting treaty provisions may require a degree of ‘pragmatism’; and
the critical issue – whether Mr Anson was entitled to a share of the profits as they arose - is a question of fact, which higher courts, such as the Upper Tribunal and Court of Appeal - should not interfere with unless there was no evidence to support it, or the FTT had misdirected itself.
The two critical facts in Mr Anson’s case seem to have been: (a) at least annually, all income, gains, losses etc. of the LLC during the period had to be credited to the capital accounts of members pro rata, and (b) to extent cash was available, distributions had to be made within 75 days in such amounts as the management members determine; although this determination was in their sole discretion, the FTT decided that distribution was mandatory.
It is not surprising that HMRC have focussed on the importance of the FTT’s findings of fact to justify continuing its existing approach in relation to US LLCs. In a very short announcement, Brief 15 (2015) states that:
“The FTT made findings that the profits of the LLC did not belong to the LLC in the first instance but the members became automatically entitled to their share of the profits as the profits arose and before any distribution. The FTT also found that the interest of a member in the LLC was not similar to share capital.
HMRC has after careful consideration concluded that the decision is specific to the facts found in the case. This means that where US LLCs have been treated as companies within a group structure HMRC will continue to treat the US LLCs as companies, and where a US LLC has itself been treated as carrying on a trade or business, HMRC will continue to treat the US LLC as carrying on a trade or business.
HMRC also proposes to continue its existing approach to determining whether a US LLC should be regarded as issuing share capital. Individuals claiming double tax relief and relying on the Anson v HMRC decision will be considered on a case by case basis.”
Lessons to be learned from Anson and Brief 15 (2015)
It would be a mistake to view the Anson decision as having changed nothing, but there are some lessons to be learned about the UK’s approach to entity classification.
the terms ‘opaque’ and ‘transparent’ are merely convenient labels, and should be used with caution – in each case, the question is whether the entity in question meets the requirements of the particular statutory (or treaty) provision in question; for example, the fact that a non-UK entity is treated as a company for certain purposes does not mean that its members will be taxed as shareholders for another statutory purpose. This is a point which the HMRC’s guidance makes, but has not always attracted the attention it deserves;
in Mr Anson’s case, the question was whether he qualified for treaty relief, under a particular article of the treaty – this is a question of fact, and evidence of the effect of local law (which is treated as a question of fact, not law, by UK courts) will be vitally important, and not something which a higher court should overturn except in exceptional cases;
treaty provisions are not necessarily interpreted in the same way as domestic tax law;
the principles applied in Memec do not resolve all questions of entity classification, and they might not be relevant where (as in Anson) a different provision in the treaty is being considered; and
although Mr Anson’s case is confined to its facts, taxpayers wishing to achieve ‘opaque’ treatment of a US LLC, or any similar non-UK entity, would be advised to ensure that the terms of that entity (for example, the LLC agreement) differ from those of Mr Anson’s LLC – in particular, it may help for there to be an intervening act between the earning of profits and the distribution of those profits to members (for example, distributions might require the decision of a separate body, rather than following automatically from the earning of those profits).
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