Swift v. HMRC TC00399  UK FTT 88
The First Tier Tribunal's finding in the Swift case that a Delaware limited liability company was not an opaque vehicle for UK tax purposes has caused a stir in the international tax structuring arena. However, whilst this decision appears to go against HMRC's stated general view that Delaware LLCs are not transparent vehicles and so are treated as companies rather than look-through vehicles for UK tax purposes, the tribunal reached its decision in this case on its particular findings of fact relating to the agreement governing the LLC in question.
It is important to note that the decision does not cover all LLCs and it results from the tribunal's finding that under the agreement governing this LLC the members of the LLC were entitled to the LLC's profits as they arose. This decision highlights, however, that taxpayers cannot automatically follow HMRC's published general practice and assume that a Delaware LLC will be treated as a company for UK tax purposes. Instead, the taxpayer must look at the particular rights of members of the LLC in question and cannot assume that all Delaware LLCs (or other non UK entities) will be treated in the same way for UK tax purposes. The individual facts of each case must be considered.
Briefly, the facts of the Swift case were that the appellant taxpayer was a UK resident and ordinary resident but non-domiciled individual who was a member of Sandpiper Partners LLC (SPLLC), a Delaware LLC. SPLLC operated under a limited liability company agreement dated 28 January 1997 (the LLCA). This agreement set out the prescribed ownership interests of each member and the method for determining the distribution of profits. All SPLLC's profits were distributed to its members quarterly in arrears in the proportions set out in the LLCA. Profit allocations were credited to the capital accounts of the members and distributions were charged against these.
SPLLC's profits were subject to US federal and state taxes. SPLLC was classified as a partnership for US tax purposes and so the members were liable to tax, rather than SPLLC. The appellant taxpayer was
therefore subject to US tax on his share of SPLLC's profits, regardless of whether the profits were distributed or retained. The appellant received distributions in the UK which were net of US federal and state taxes.
The main issue in the appeal was that the appellant claimed he was entitled to tax relief for the US tax paid on his distributions from SPLLC. HM Revenue & Customs (HMRC) claimed that SPLLC was opaque and so the appellant was treated as receiving a dividend from a company (SPLLC) for UK tax purposes and, therefore, this was not the same income as that on which the appellant had borne US tax. Accordingly, argued HMRC, the appellant was not entitled to any foreign tax credit. To illustrate this difference, the tribunal cited the example of, say, the appellant's share of profits being 100, of which roughly 45 would be paid in US taxes, the balance of 55 being distributed to him, on which 22 of UK tax was payable (40% of 55). If, however, the appellant had received, as he claimed, 100 of gross income on which 45 had been paid in US tax, no UK tax remained to be paid after double tax and unilateral relief had been given.
Categorising Foreign Entities
HMRC has published a set of questions to determine the categorisation of foreign entities as transparent or opaque. These questions are:
- Does the foreign entity have a legal existence separate from that of the persons who have an interest in it?
- Does the entity issue share capital or something else which serves the same function as share capital?
- Is the business carried on by the entity itself or jointly by the persons who have an interest in it?
- Are the persons who have an interest in the entity entitled to share in its profits as they arise; or does the amount of profits to which they are entitled depend on a decision of the entity or its members, after the period in which the profits have arisen, to make a distribution of its profits?
- Who is responsible for debts incurred as a result of the carrying on of the business: the entity or the persons who have an interest in it?
- Do the assets used for carrying on the business belong beneficially to the entity or the person who has an interest in it?
These six questions were put to experts and their answers were considered by the tribunal. The experts were agreed on the answers to questions: (1) – yes it did; (3) the business was carried on by SPLLC itself; (5) SPLLC was liable for the debts incurred as a result of carrying on the business; and (6) the assets used for carrying on the business belong specifically to SPLLC and not its members.
The experts did not agree, however, on the answers to questions (2) and (4). The tribunal accepted the answers on which the experts were agreed and found in answer to question (2) that in light of the evidence presented to it the membership interest in SPLLC was not so much share capital but more similar to partnership capital of an English partnership; and in answer to question (4) that the profits did not belong to SPLLC in the first instance and then subsequently to its members (analogous to a dividend) but that they always belonged to the members. The tribunal drew a distinction between profits and assets representing those profits. The tribunal accepted that the assets representing the profits belonged to SPLLC until the distribution was actually made, but they considered that the profits always belonged to the members, likening this to a Scottish partnership.
The tribunal found as a matter of fact in the light of the terms of the LLCA that the appellant was entitled to a credit under the US/UK double tax treaty because the appellant was liable for tax in the UK on his share of the profits of SPLLC, which were the same profits that were taxed in the US and so fell within the provisions of the treaty for the purposes of the US federal tax borne and within the UK domestic provisions for unilateral relief so far as relief for state tax was concerned.
HMRC have stated that it intends to appeal the decision but in the meantime it will continue with its current general practice. However, it is open to taxpayers to seek a review of the treatment of a particular LLC in the light of this decision.
The appeal will be watched with interest.