Tax Talk: Doing business in the US through an LLC – UK tax pitfalls
UK companies and resident individuals conducting business in the US often do so through a US limited liability company (LLC). But there are uncertainties for UK taxpayers. Jonathon Collins and Tom Golding explain.
An LLC is a common business form in the US and does provide some benefits. But mismatches can arise between US and UK tax treatments. There can also be tax inefficiencies when UK residents hold an LLC as an investment.
What is an LLC?
An LLC is a type of business entity available in all US states. It is a hybrid: part statutory corporation and part partnership. The UK has various forms of partnerships and companies, as does the US, but there is no direct equivalent to an LLC in the UK. This makes it difficult to determine the UK tax treatment of LLCs, an uncertainty not resolved by the UK/US Double Taxation Agreement (DTA).
What are the LLC benefits from a US perspective?
An LLC can provide some benefits compared to a US statutory corporation (or Inc.), including:
- an LLC, by default, is a transparent entity for US tax purposes and its profits are taxed as if it is a partnership (so taxed on its owners) – this means business profits can be taxed just once as opposed to an Inc., whose profits are taxed at the corporation level and again when distributed to its owners
- a less formal management structure
- greater flexibility for LLC members to allocate profits and losses amongst themselves (other than per their capital contributed)
- enhanced protections from external creditors
So what’s the problem?
Under the UK/US DTA, UK residents are entitled to receive credit for US tax against any UK tax “computed by reference to the same profits, income or chargeable gains”. But HM Revenue & Customs (HMRC) usually regards an LLC as an opaque, not a transparent, entity and generally denies claims for US tax credit relief against the UK tax liabilities of LLC owners.
In 2015 the UK Supreme Court held that a UK resident, Mr Anson, could claim credit for US taxes he paid as a result of his membership of a Delaware LLC. HMRC maintained Mr Anson should pay US tax on his allocated LLC profit share, as well as UK tax on distributions from the LLC – without any credit for US tax. Although HMRC lost this case, it did not change its general approach and says the decision was “specific to the facts found in the case”.
Uncertainties for UK taxpayers
When a UK company owns a US LLC as part of a group, HMRC generally treats the US LLC as an opaque entity, with no tax credit relief available to the UK company. This is not usually a problem if distributions fall into one of the exempt categories.
Even when a UK resident individual owns an LLC, as in the Anson case, HMRC says claims for tax credit relief will be considered on a case by case basis. Individuals wanting to use an LLC and claim US tax credit relief should take legal advice with a view to mirroring the agreements in Mr Anson’s Delaware LLC. But they must be prepared for a challenge by HMRC.
Electing for corporate treatment
As we’ve said, an LLC is by default a transparent entity for US tax purposes. But under US law an LLC can elect to be taxed as a corporate (or opaque) entity. Although this option doesn’t mean HMRC will allow a claim for US tax credit relief, it could result in reduced US taxes. That means it could benefit UK resident members of existing LLCs.
UK anti-hybrid rules
For UK corporate entities, distributions from LLCs will often be exempt from UK tax. But there are other factors to consider.
An LLC that is transparent for US tax purposes but treated as opaque for UK tax purposes will fall within the definition of a hybrid entity for the purposes of the UK legislation relating to Hybrid and Other Mismatches. Payments made from an entity within the charge to UK corporation tax to an LLC may result in a counteraction, under these provisions, that denies any deduction for the purposes of corporation tax in the UK.
The UK government has said it intends to make changes to the rules so that certain payments involving US LLCs are not captured by the provisions. This may resolve the situation long-term, but until then there’s still uncertainty for UK corporate taxpayers.
Other UK tax considerations
HMRC acknowledges that LLCs don’t sit comfortably with the UK/US DTA and some of its interpretations and treatments are by concession. So care must be taken when applying the DTA. What’s more, while HMRC generally treats an LLC as opaque, it won’t necessarily treat an LLC as a corporate body having share capital for all UK tax purposes. UK group structures containing LLCs that rely on certain UK tax reliefs are particularly subject to risk and should be carefully reviewed.
In view of the uncertainty and mismatches that can arise between the US and UK tax treatments of LLCs, UK companies and resident individuals planning to conduct business in the US should take advice to make sure they’re clear about the tax consequences of investing via an LLC.
Alternatively, they may wish to consider other structures from a US and UK perspective. But where simplicity and certainty are desired, it may be best to avoid using an LLC altogether.