UK Government consultation to remove US LLC double taxation

Rachel Reeves visited Washington DC in April last year, for the spring meetings of the IMF and talks with the US treasury secretary on a speculative US-UK trade deal. She pledged to “stand up for Britain’s national interest” and has committed to encouraging internationally mobile individuals to make their home in the UK.

The government have subsequently announced a consultation on the problem of double taxation which can arise where UK resident individuals have interests in US limited liability companies (LLCs). As the UK Government itself recognises, ‘US LLC’s are one of the most popular business vehicles in the US, used for trading and holding assets.’

This consultation is an attempt to seek views from stakeholders to consider changes to the current UK tax code, to essentially try and simplify the UK tax position connected to these businesses, but importantly, provide relief against the current double taxation position.

What’s the current issue?

For US tax purposes, an LLC is treated as “transparent” by default- the LLC’s profits as they arise, are taxed in its members’ hands, whether or not those profits have actually been distributed. It is possible to elect for the LLC to be treated as “opaque” for US tax purposes so that members are only taxed in the US when profits are distributed, but this is not common practice.

The double tax issue stems from HMRC currently viewing US LLC’s as a body corporate for UK tax purposes. Therefore, income only arises to the individual when the LLC actually makes a distribution, and it is generally treated as a dividend for UK purposes, rather than a direct share of the LLC’s underlying profit.

The US and the UK are therefore essentially taxing different amounts – the US taxes the underlying LLC profit, and the UK taxes a dividend. This mismatch in timing and characterisation of the income means that the US/UK Double Tax Treaty does not offer a credit between the US and UK taxes that has been suffered. The double taxation can be punitive, with the consultation suggesting an effective tax rate potentially as high as 75%.

Anson v HMRC [2015] uncertainty

In Anson, a UK resident taxpayer took their case all the way to the UK Supreme Court. The court decided in favour of the taxpayer that under Delaware law and the specific terms of the LLC operating agreement, the profits of the Delaware LLC arose directly to the member at the point the profits were credited to their capital account, not on distribution. Therefore, because the US and UK were taxing the same amounts, double tax relief was available.

Normally, a Supreme Court decision on a tax matter will establish a broad principle for future guidance. However, in this instance, HMRC have issued guidance that the Anson case was limited to its specific facts because the decision was based on a narrow interpretation of what was meant by “the same income”.

In December 2023, the guidance published states that despite the Anson decision, “HMRC continue to believe that the profits of an LLC will generally belong to the LLC in the first instance and that members will generally not be treated as ‘receiving or entitled to the profits’ of an LLC.” In HMRC’s view, the taxable event for UK purposes is the distribution from the LLC, which is characterised as a dividend.

Will the new proposals resolve this ?

To resolve the double taxation issue, the government is proposing to introduce legislation to allow UK resident individuals to treat their holdings on a transparent basis for Income Tax and Capital Gains Tax. This would only apply to individuals, and UK resident corporate members of US LLCs would not receive the same treatment.

US LLCs would be deemed transparent for UK purposes automatically if they are taxed on a transparent basis in the US, and the LLC is itself neither a UK tax resident entity or trading through a UK permanent establishment.

Individual members of an LLC would be deemed to be carrying on any trade or business of the LLC in partnership, or as a sole trade if they are they are the only member of the LLC. They would also be deemed to have a proportion of beneficial ownership of the LLC’s assets corresponding to their proportional ownership of the LLC, so an appropriate percentage of any investment income can be attributed to the member. Any tax liability on trading profits or losses, investment income and capital gains would need to be computed in accordance with UK tax rules.

The objective of the reform is to tax individual members in the UK on the underlying profits, income and gains of the LLC in a way that matches the US tax treatment, allowing for a claim for a foreign tax credit and eliminating double taxation.

The exact details are yet to be determined and will presumably follow the consultation, but in theory, this will be a very welcome change for those who benefit from any US LLC entity.

Any pitfalls?

It is possible that a UK resident individual may have already arranged their tax affairs so that the current status quo suits their particular circumstances. It is not yet clear whether it will be possible to elect to maintain an opaque UK tax status for an LLC.

There is also limited detail available on how a transition from opaque to transparent treatment will apply. There is no indication on how previous tax years will be addressed. The practicalities of transition have not yet been outlined, such as the treatment of profits allocated but not yet distributed to members before the transition date.

How can AAB help?

The current rules can prove a barrier to members of LLCs who wish to relocate to the UK, as well as causing difficulty for those who are already UK residents. Should the government’s new proposals go ahead, this should hopefully provide a clear framework to reduce double taxation and the deterrent to moving to the UK.

If you are seeking clarification around the current legislation, or would like to discuss how the potential changes may affect you, please contact Lynn Gracie or any of your usual AAB contacts.