INTM180050 - Foreign entity classification for UK tax purposes: HMRC view of Delaware LLCs in light of Anson

Background

Tax Bulletin 29 (June 1997) and Tax Bulletin, Special Edition 6 (April 2003) explained the Inland Revenue’s view that the UK taxes a UK member of a US Limited Liability Company (LLC) by reference to distributions of profits made by the LLC and not by reference to the income of the LLC as it arises, and that relief for US tax on the profits of the LLC was not available for individual UK members. This view is now at DT19853, whilst INTM180030 confirms we have viewed US LLCs as opaque since June 1997.

Following Anson v HMRC [2015] UKSC 44, HMRC issued Revenue and Customs Brief (2015) which explained that HMRC concluded that the decision was specific to the facts found in the case. Where LLCs had been treated as companies within group structures and as carrying on a trade or business themselves, HMRC would continue to treat them as such. HMRC also proposed to continue its existing approach to determining whether an LLC should be regarded as issuing share capital and that claims for double taxation relief (DTR) made by individuals would be considered on a case by case basis.

This guidance is to provide further clarification of HMRC’s view of LLCs following Anson with regards to who the profits belong to and the availability of DTR.

Anson

In Anson v HMRC [2015] UKSC 44, Mr Anson was a UK resident (but non-UK domiciled) member of a Delaware LLC which carried on a trade. The LLC was classified as a partnership for US tax purposes so that Mr Anson was liable to federal and state taxes in the US on his share of the LLC’s profits. The issue was whether Mr Anson was entitled to DTR in the UK under the UK/US Double Taxation Convention (DTC) and the UK’s unilateral relief provisions.

This issue rested on whether he was liable to UK tax on the same profits or income which suffered US tax. It was agreed that Mr Anson was liable to UK tax under Case V of Schedule D “in respect of income arising from possessions out of the United Kingdom” and, that as a non-UK domiciled individual, he was only taxable on the amount remitted to the UK. However, the parties differed as to whether Mr Anson’s liability to UK tax arose when the profits were earned by the LLC or only if and when the profits were distributed.

The Supreme Court held that if Mr Anson was entitled to the share of profits allocated to him, rather than receiving a transfer of profits previously vested (in some sense) in the LLC, it followed that his “income arising” in the US was his share of profits. Based on the First Tier Tribunal’s (FTT) findings of fact, the Supreme Court held that Mr Anson was entitled to DTR as he was liable to UK and US taxes on his share of the profits.

FTT finding of fact

In Anson, the experts were agreed and the FTT found as a fact that the business was carried on by the LLC itself and not by its members. The experts did not agree, however, on whether the members had an interest in the profits as they arose.

Against the background that the rights of the members were found to arise from the Delaware LLC Act (Del), in combination with the LLC agreement and that the LLC was understood not to be party to the LLC agreement, the FTT found as a fact that “[t]he profits do not belong to the LLC in the first instance and then become the property of members…” and that the members “…have an interest in the profits of [the LLC] as they arise”.

In reaching this finding, the FTT regarded it as important that Del s18-101(8) (now re-written to s18-101(10)) defined a LLC Interest as “a member’s share of the profits and losses of a [LLC] and a member’s right to receive distributions of the [LLC’s] assets” and that Del s18-503 provided a default rule for the allocation of profits and losses among the members, and noted the US tax returns showed that the whole of the book profits were allocated to the members’ capital accounts. The FTT considered that the terms of the LLC agreement in view of s18-503 meant that profits allocated to the members’ capital accounts evidenced a liability to the members.

The Supreme Court held that the FTT’s finding that the profits did not belong to the LLC in the first instance and that the members had an interest in the profits as they arose was a finding of fact on foreign law. As such, it is not binding in subsequent cases.

HMRC’s view on Delaware LLC law

Based on HMRC’s understanding of Delaware LLC law (as at 06 December 2023), and contrary to the conclusion reached by the FTT in HMRC v Anson (sub nom Swift) [2010] UKFTT 88 (TC), 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 (see INTM180040). HMRC consider the following provisions of the Delaware LLC Act in particular support this conclusion:

a)       The LLC will usually carry on the business (Del s18-106(a)), and incur the expenses and receive the income, which gives rise to the profits. It is the LLC which earns the profits rather than the members.

b)      LLCs are separate legal entities distinct from its members (Del s18-201(b)). They are therefore capable of receiving and being entitled to profits.

c)       The LLC will usually own the assets which are used in carrying on the business. The members have no interest in specific property of the LLC (Del s18-701).

d)      The LLC will usually be responsible for the debts, obligations and liabilities of the LLC (Del s18-303). Any losses suffered are, like profits, those of the LLC.

e)      Members only achieve the status of a creditor to the LLC with regards to their economic interest in the LLC when they become entitled to a distribution (Del s18-606).

f)        A member is only entitled to receive an interim distribution to the extent provided by the LLC agreement (Del s18-601). Furthermore, the LLC would not be permitted to make a distribution to the extent that the LLC is insolvent or would make the LLC insolvent (Del s18-607).

g)       Creditors of members have no right to the property of the LLC. It is only where a court makes a charging order against a member’s “LLC Interest” that a creditor will have a right to receive any distribution which the member would otherwise have been entitled in respect of such “LLC Interest” (Del s18-703).

h)      On a winding up of the LLC, assets have to be distributed to the creditors of the LLC ahead of members (Del s18-804)

i)        The LLC is bound by the LLC agreement and is therefore party to it (Del s18-101(9) and Seaport Village Ltd v Seaport Village Operating Company LLC CA No 8841-VCL (Del Ct Ch 24 September 2014)). In HMRC’s view, the LLC agreement along with the Delaware LLC Act provide the mechanism for the transfer of profits from the LLC to the members.

 

HMRC does not believe Del s18-101(10) or Del s18-503 are significantly relevant (as also indicated by the fact that neither appear in the in the Revised Uniform LLC Act (RULLCA) or the LLC Acts of many US states).

HMRC understands that the purpose of Del s18-101(10) is to distinguish a member’s transferrable economic interest in an LLC and other non-economic interests (such as the right to vote and inspect the records) which are transferrable only with consent - see Del s18-702 and s18-301 to s18-305. The RULLCA achieves the same result by including a definition of “transferrable interest”, which refers solely to a member’s right to a distribution, and confirming that a transfer of such an interest does not entitle the member to participate in the management of or have access to the records of the LLC (RULLCA s102(24) and s502(a)(3)). The fact that a member’s economic interest in an LLC is transferrable may compensate for the fact that they cannot withdraw assets unilaterally.

The Official Comment to RULLCA s404 “Sharing of and Right to Distributions before Dissolution” suggests the reason why it does not contain a provision equivalent to s18-503 is because “[c]apital accounts are maintained for one purpose, to determine how distributions will be made to members…If the statute has a simple default rule for how distributions are to be made to the members, providing an additional set of default profit and loss allocation provisions and capital account rules will be, at best, duplicative and, at worse, inconsistent with the distribution rules.”.

HMRC also understands that the default rule in Del s18-503 (allocation of profits and losses), and indeed in Del s18-504 (allocation of distributions), is unlikely ever to apply in practice because if there is no agreement as to how the members will share in the capital and distributions of the LLC, it is unlikely that there would be the necessary agreement to be members in the first place. Furthermore, Del s18-503 itself states that the profits and losses are “of” the LLC which then have to be allocated amongst the members.

Contrary to the FTT’s view, HMRC understands that an allocation of profits to a member’s capital account does not evidence a liability to the member. Capital accounts are an equity concept and therefore appear in the equity, rather than the liability, section of the LLC’s balance sheet. HMRC understands that a positive balance on a member’s capital account does not provide a member with a right to a distribution. A member will only be entitled to a distribution to the extent provided by the LLC agreement and LLC Act, as above. Member creditors cannot seek recovery out of LLC assets merely by virtue of profits being allocated to a capital account. A member’s capital account therefore represents the member’s share of the net worth of the LLC and is fundamentally no different to a shareholder’s net worth share of a corporation.

HMRC also understands that if an LLC were to elect to be treated as a corporation for US tax purposes, such capital accounts would not be expected to feature. It is usually only as a consequence of an LLC being treated as a partnership for US tax purposes that they are maintained. How the LLC elects to be treated for US tax purposes however does not fundamentally change the rights of the members to the profits of the LLC.

Whilst the FTT were correct to note that profits and assets are different concepts, there must be a correlation between the two (see INTM180040).

A member of a Delaware LLC will not therefore usually receive or be entitled to the profits of the LLC for the purposes of s8 ITTOIA because the LLC would normally carry on the business on its own behalf and earns the profits which belong to the LLC in the first instance. The fact that LLCs display ‘strong entity shielding’ such that its assets are protected from the members and creditors of members supports the conclusion that members are not entitled to the profits for the purposes of s8 ITTOIA (see INTM180020 and INTM180040). Whether the LLC is treated as a partnership (or is disregarded) or company for US tax purposes makes no difference to this analysis.

HMRC understand that the LLC law of other US states is substantially the same as that of Delaware and, as such, do not believe members of other US LLCs will generally receive or be entitled to profits either.

Tax consequences

For the reasons stated above, HMRC generally regard members of Delaware LLCs as not being in receipt of or entitled to the profits of the LLC and individual members will therefore only be liable to UK tax on any dividends or other distributions from the LLC (see SAIM5020 and SAIM5210 for guidance on the charge to tax on dividends and other distributions from UK and non-UK resident companies, and CTM15100 for general guidance on distributions). They will therefore be taxed at the dividend rate and entitled to dividend allowance (see SAIM1080). If the LLC is treated as a partnership or is disregarded for US tax purposes such that the member suffers US tax on their share of the profits, they will not be entitled to DTR (as the same profits, income or gains would not be taxed in both countries – see INTM161040). Nor will any deduction be available under TIOPA10/S112 in respect of such US tax. However, if the LLC is treated as a company for US tax purposes, individual members will be entitled to credit in respect of US tax charged on any distributions from the LLC (subject to the amount the US could tax in accordance with Article 10 of the UK/US DTC and all other conditions being met) or a deduction under TIOPA10/S112 (see INTM161050).

Likewise, HMRC do not believe corporate members would generally be regarded as being liable to UK tax on the profits of a Delaware LLC (the profits are “of” the LLC, not the corporate member – see CTA09/S2).

A UK resident corporate member may be entitled to distribution exemption if the relevant conditions have been met (INTM650000). However, if the UK corporate member is a small company and the US LLC is treated as a partnership or is disregarded for US tax purposes, that may mean that such exemption will not be available as the US LLC would not be a resident of the US for the purpose of CTA09/S931B.

If distribution exemption is not available, a UK resident corporate member may be entitled to DTR in respect of any US tax withheld on the distributions (subject to the amount the US could tax in accordance with Article 10 of the UK/US DTC and all other conditions being met) and any US tax suffered on the profits (underlying tax) where the conditions of Article 24(4)(b) have been met (see DT19853).

Further information

If an individual member has claimed double taxation relief in respect of US tax on the profits, income or gains of a LLC, or any customer has otherwise self-assessed on the basis that the profits belong to the members rather than the LLC, HMRC will consider opening an enquiry or making a discovery assessment in accordance with its normal risk-based approach.

(This content has been withheld because of exemptions in the Freedom of Information Act 2000)

If any customer requires confirmation of HMRC’s view of whether a particular US LLC will be treated as transparent or opaque for the purposes of determining what profits, income or gains a member will be liable to UK tax on, they should contact the Base Protection Team following the guidance at INTM180060.