The UK Supreme Court (being the court of final appeal in the UK) has found that the profit share arising from a Delaware LLC to a UK individual is eligible for relief under the UK/U.S. double tax treaty.
The decision overturns an earlier finding by the Court of Appeal, in which relief under the UK/U.S. double tax treaty was found not to be available to the UK individual.
Summary of the case
The taxpayer set up a Delaware LLC which acted as an investment manager to various venture capital funds. The relevant LLC operating agreement provided for the taxpayer to receive a share of the profits of the LLC, on which, in principle, he was liable to both U.S. tax (at a rate of approximately 45 percent) and UK tax (at an effective rate of 22 percent). As the U.S. had primary taxing rights, the taxpayer sought to credit his U.S. tax liability against his UK tax liability.
Under the UK/U.S. double tax treaty, double tax relief is only available if the UK tax and the U.S. tax are computed by reference to the “same” profits. The issue in this case was whether the income on which the taxpayer paid tax in the U.S. was the same as the income on which he was liable to tax in the UK.
Prior to the Supreme Court’s decision, the UK Revenue treated income arising to a UK individual through a profit share in an LLC in much the same way as receipt of a dividend from a corporate entity. The funds were treated as passing from source to entity, and from entity to individual. Accordingly, the profits sought to be taxed in the UK would not be the “same” as those taxed in the U.S. and double tax relief would not be available under the UK/U.S. tax treaty.
The basis of the taxpayer’s case was that he was entitled to the profits of the Delaware LLC as they arose and consequently was due relief under the UK/U.S. double tax treaty.
The Supreme Court agreed with the taxpayer, reversing (as noted above) the decision of the Court of Appeal in favor of the UK Revenue. The “lottery” of litigation is illustrated in this case by the fact that two of the tribunals which heard the appeal found for the UK Revenue and two (one of which, most importantly, was the final arbiter) for the taxpayer.
Following the Supreme Court’s decision, the difference to the taxpayer is an effective rate of approximately 45 percent (the U.S. tax incurred, fully crediting any additional UK tax liability) as opposed to 67 percent (which would have been the combined rate of U.S. and UK tax).
The Supreme Court’s decision had been eagerly awaited and will likely be welcomed by certain UK taxpayers.
However, it will be necessary to wait to see how the UK Revenue formally responds to the decision, particularly in light of the UK Revenue’s long-standing practice to treat U.S. LLCs as being fiscally opaque from a UK tax perspective. For example, given the Supreme Court’s decision relates to one specific U.S. LLC, it is not yet clear whether the UK Revenue will apply the Supreme Court’s decision to all U.S. LLCs.
In the meantime, the decision will likely be of particular interest to those groups which already have - or are considering the introduction of - Delaware LLCs: (i) in which UK individuals or corporate entities hold an interest; and/or (ii) which operate as an effective “corporate blocker” from a UK tax perspective. Although relief under the UK/U.S. double tax treaty may now be available with respect to such arrangement, it will also be important to give consideration to whether any prospective changes to the UK tax treatment of U.S. LLCs may create new, or additional, UK tax liabilities and/or filing obligations for members of a U.S. LLC.