UK tax treatment of US LLCs: consultation

HMRC has published a consultation document proposing reform of the UK tax treatment of UK individual members of US LLCs and other reverse hybrid entities. UK members of such entities do not, in principle, qualify for double tax relief against the UK tax chargeable on distributions of profits even where the same economic profits have already suffered taxation in the jurisdiction where the reverse hybrid entity is established. This can give rise to very high effective rates of tax on such UK members, creating a disincentive for location in the UK of what the government recognises is a pool of “talented globally mobile individuals”.

The consultation raises a series of questions both on the current impact of the high effective tax rates on UK individual members of reverse hybrid entities and also on potential solutions to the problem identified. In particular, the consultation puts forward a proposed solution which would see UK individual members of such entities treated as members of a transparent entity such that they would qualify for double tax relief by reference to the foreign tax liability suffered on relevant profits.

HMRC’s engagement with this long-standing issue is very welcome and affected individuals should certainly consider engaging in the consultation process. Simmons & Simmons will be responding in due course and would be delighted to discuss any specific issues that you may have in relation to this area and include them in our feedback.

The problem

The consultation document explains that UK individuals who are members of a reverse hybrid can suffer very high levels of UK tax. A reverse hybrid is an entity which is treated as transparent in its jurisdiction of establishment, but treated as opaque in the UK when applying the UK entity classification rules. Whilst this is not limited to US LLCs, clearly the focus of the consultation is on such entities as a particularly common example of a reverse hybrid. US LLCs are typically treated as transparent in the US (unless they opt to “check the box to be taxed as a corporation”) but as opaque in the UK (see HMRC guidance at INTM180050). The result is that UK members are typically taxed in the US on the business profits of the US LLC as they arise on the basis that the relevant share of the profits has essentially been earned directly by the member. However, where the US LLC is regarded as opaque in the UK, the member is not treated as in receipt of those profits directly. Instead, the member will be taxed on any distribution of those profits from the US LLC to the UK individual.

The result is that individual members of an LLC who are tax resident in the UK can face a high effective tax rate, potentially as high as 75%: they will be chargeable directly on profits, income and gains as these arise in the US, and taxable again in the UK on any distributions of the LLC’s pre-tax profits. Where an individual is taxed in relation to business profits, income and gains in one state, but in relation to distributions in the other state, this does not meet the ‘same profits, income or chargeable gains’ requirement for relief to be available against UK tax under Article 24(4)(a). These tax charges being on a different basis prevents the provisions of the UK/USA Double Taxation Convention (DTC) from providing double taxation relief. This issue has always existed as a consequence of HMRC’s treatment of US LLCs, but has been brought to the fore as a more significant concern following the abolition of the UK’s non-domicile tax regime, as previously, distributions of the LLC’s profits to a remittance basis user would only have been taxable on remittance.

HMRC also recognises that the UK position is not without uncertainty. In particular, although HMRC’s position is that US LLC’s will normally be opaque for UK tax purposes, that position is not supported by the Supreme Court decision in Anson v HMRC [2015] UKSC 44. Applying the findings of Anson more widely to any taxpayer with an interest in a US LLC (without specific analysis of the LLC in question) would itself create uncertainty for individual and corporate taxpayers who rely on HMRC’s existing position. Difficulty thereby arises for some individual taxpayers, who in seeking to apply the principles of the Supreme Court decision to their own interest in an LLC, risk entering into dispute with HMRC over the extent to which their own circumstances are comparable to those of Anson.

The government recognises the issue of high effective tax rates for UK resident individual members of reverse hybrids and suggests that is committed to finding a solution which is effective and robust in providing a fair outcome with long-term certainty. The consultation seeks to explore the impact of the current position and put forward solutions for individuals. It asks a range of questions about how well these solutions might address the issue, possible problems with the proposed solutions, implications for different types of investors, and details of technical implementation such as timeframes and practical scope.

The proposed solution

The consultation document seeks input into a proposed solution to this current situation in the form of the introduction of legislation to allow UK resident individual members in specific eligible reverse hybrids to treat their holding on a transparent basis for the purposes of income tax and capital gains tax.

No equivalent legislation would be introduced for UK resident corporates. The consultation does not explain why, beyond “avoiding unnecessary disruption”. It may be that given the broad dividend exemptions available to UK corporation taxpayers, the mismatch in tax treatment is considered to be less of an issue.

The objective would be to charge individual members to UK tax on the underlying profits, income and gains of the foreign entity in a way that matches the tax treatment in the relevant foreign jurisdiction. Individuals would not be chargeable to income tax on distributions from the entity. This would then allow individuals more certainty over their UK tax and the extent to which Double Taxation Relief would be available. The effective tax rate on these individuals’ income would reduce to the higher of the domestic effective tax rates applicable to the individual in each state.

For example, a UK resident individual entitled to trading profits from a US LLC would pay US taxes (at perhaps 37%) on these profits. UK income tax would then also be chargeable on trading profits (up to an effective rate of 45%). The UK would be able to give Double Taxation Relief for US taxes paid on the same profits, giving an overall effective rate of 45%.

The specific foreign entities within scope would be those which are taxed on a transparent basis in their jurisdiction of establishment, but which are treated as opaque for UK tax purposes. It would not apply to entities which are resident in the UK (or considered resident by any other foreign jurisdiction), or trading in the UK via a permanent establishment.

UK resident individual members of a foreign entity meeting the eligibility conditions would automatically receive matching transparent treatment for UK tax purposes. If the foreign entity began to be taxed on an opaque basis in its home jurisdiction, it would cease to be an eligible entity and transparent UK treatment would cease to apply to UK individual members. It should be noted that whilst the consultation talks of “allowing” such treatment, the current intention is that it would actually be mandatory, although one of the specific questions raised in the consultation is whether there are particular advantages or disadvantages of automatic treatment as opposed to by irrevocable election.

Transparent UK treatment would only apply prospectively for tax years following the date of introduction of new legislation.

Alternative solutions

Although the consultation puts forward a solution based on treating reverse hybrid entities as tax transparent for UK tax purposes, the consultation makes it clear that HMRC are also interested in views on alternative forms of relief that could be provided for in legislation. As examples, the consultation also mentions:

• Deduction for foreign tax: for example, that where a UK resident individual member of an eligible foreign entity is chargeable to UK income tax on distributions from the entity, the UK tax could be calculated on the distributions net of foreign tax already paid by the individual on the distributed profits.
• Credit for foreign tax: a further potential solution could be to provide a form of credit for foreign tax on underlying profits against an individual’s UK income tax on distributions, to reduce the overall effective tax rate applicable to that individual’s income from an eligible entity.

Comments

The publication of the consultation and recognition of the double taxation issue for UK members of US LLCs and similar entities is very welcome. The proposed solution will require careful consideration to ensure that it deals with the problem effectively without creating further issues. In particular, many businesses will already have set up arrangements to deal with the problem of high effective tax rates and will need to ensure that the proposed solution does not adversely impact those existing arrangements. Whilst the measure is framed in terms of “allowing” individual members to treat the foreign entity as transparent, elsewhere the consultation suggests that the transparent treatment will be automatic, which may prove contentious, again particularly for existing structures where the UK treatment is well understood. In addition, it will be necessary to ensure that the solution deals effectively with multiple tiers of LLCs.

The consultation is clearly at an early stage, both seeking further information and suggesting a possible solution for feedback. Accordingly, there is no current suggested timetable for the implementation of any eventual solution.

The consultation is open for comments until 31 July 2026 and responses should be sent to entityclassificationmailbox@hmrc.gov.uk.