The Swift case centres on whether the profits of an LLC when in the hands of UK resident members, are eligible for double tax relief on the US tax already paid.
An LLC is a company format that takes aspects of the corporation structure and of a partnership, without being strictly one or the other. It offers its owners protection from any personal liability from the business debts. An LLC is traditionally treated as a pass-through entity with regards to tax, something a corporation is not. Being a pass-through entity means it can pass through to its owners the company’s profits as well as losses. They will then reflect these on their personal tax returns, just like in a partnership or a sole proprietorship.
“From a tax perspective, it is crucial to know whether an entity is to be regarded as opaque or transparent,” said Tony Beare, head of the tax practice at Slaughter and May in London.
“The profits of an opaque entity, such as a company, are treated as its own and not those of its members for tax purposes. Generally therefore, the member is not subject to tax on those profits until they are distributed by the entity,” he added.
Conversely, the profits of a transparent entity such as a partnership are treated as the profits of its members automatically, so a member is subject to tax on the relevant profits regardless of whether or when they are distributed.
It can be difficult to know whether entities established outside the UK are transparent or opaque. HMRC has provided extensive guidance on what it takes into account when deciding this issue, and has provided its view on certain specified foreign entities.
American LLCs have for some time been regarded by HMRC as being opaque for tax purposes.
In Swift the taxpayer's share of the profits of the LLC were taxed in the US at a rate of about 45% on the basis that for US tax purposes it was a transparent entity. However in the UK Her Majesty’s Revenue and Customs (HMRC) argued that it was a corporate entity and thereby should pay tax. The US federal tax was withheld and paid to the Inland Revenue Service (IRS) by the LLC. In the taxpayer's UK income tax returns, the gross profits of the LLC were reported as partnership income and foreign tax relief was claimed for the underlying tax, the total of which including state taxes exceeded 40%.
The judges held that the profits arising in a Delaware LLC were taxable in the hands of its UK resident member as they arose, because the relevant Delaware legislation defines the LLC interest as including “a member’s share of the profits and losses” of the LLC and goes on to provide that the profits of an LLC are to be allocated among the members in the manner provided in the LLC agreement or, if not so provided, in the manner laid down by the statute. The judges therefore concluded that, while the assets representing the profits of the LLC belonged to the LLC until they were distributed to its members, the profits themselves belonged to the members as they arose.
The Tribunal was keen to emphasise that this decision related to the particular LLC in question and would not necessarily have more general application because Delaware law gave significant flexibility in determining the terms of each LLC.
HMRC stands firm on their right to tax in this instance.
“On the basis of the principles set out in Memec plc v CIR (71 TC 77), it has been HMRC’s general practice to tax a UK resident member of an LLC on the profits of the LLC only if and when those profits are distributed by the LLC to its members,” said a spokesperson for HMRC.
A consequence of this treatment is that any tax paid in the US on the profits of the LLC is available for relief against UK tax only as underlying tax and, as such, only to a UK company which controls, directly or indirectly, at least 10% of the voting power in the LLC.
“HMRC has not yet seen any examples of US LLCs for which it has considered this general practice to be inappropriate. But UK resident members have always been free to ask HMRC to review their particular circumstances if they believe that HMRC’s general practice is inappropriate to them,” said HMRC.
Another issue that the Tribunal considered was whether membership interests in the LLC constituted share capital. This is important from a UK tax perspective because an opaque entity without share capital cannot form part of a group and breaks a group relationship when it forms part of the chain of ownership within the group. HMRC practice in relation to US LLCs has been that, while it is not automatically the case, it is possible to draft the relevant LLC agreement so that it does give rise to “share capital”. In Swift, however, the judges held that the membership interests in the LLC were not “share capital”, but were more like the interests of partners in an English partnership.
“It has been HMRC’s practice to accept that a Delaware LLC can in certain circumstances be regarded as having “ordinary share capital” for the purposes of Section 832 ICTA 1988,” said HMRC. “The Tribunal found as fact that the members’ interests in the particular US LLC under consideration were “not similar to share capital but something more similar to partnership capital of an English partnership”. HMRC [therefore] intends to continue its general practice in this respect in relation to US LLC’s.”
HMRC has now appealed the decision.
“HMRC intends, for the time being, to continue with its current general practices in relation to US LLCs. If, however, any member of a US LLC feels that the UK treatment of a particular LLC should be reviewed in the light of the decision of the Tribunal, they should write to Stan Surgin, Business International, Yorke House, Castle Meadow Road, Nottingham, NG2 1BG setting out fully why they believe that to be the case,” said HMRC.
