A recent decision of the UK’s First-Tier Tribunal creates uncertainty in relation to the commonly accepted UK tax treatment of interests in Delaware Limited Liability Companies (Mr Swift v Commissioners, TC00399). These have commonly been considered to be opaque entities for UK tax purposes, in contrast to their treatment for US tax purposes (subject to election) as transparent. They have also commonly been considered to be capable of having “ordinary share capital” for UK tax purposes provided certificates of LLC membership interests are issued. The decision creates uncertainty in relation to the existing UK practice.
Mr Swift, a UK resident member of a Delaware LLC, Sandpiper Partners LLC (“SPLLC”), suffered US taxes on profits of SPLLC’s business. The UK’s HM Revenue & Customs (“HMRC”) challenged Mr Swift’s claim for credit for the US tax against his UK taxes.
HMRC argued that UK tax was chargeable on the distribution he received from SPLLC, and that this was not a double tax charge, as the US tax system had not taxed the distribution, but had taxed the profit of SPLLC itself. (This is in accordance with its published practice; for example, see the 2003 Tax Bulletin Special Edition on the UK/US double tax treaty.)
The First-Tier Tribunal found for Mr Swift, ruling that for UK tax purposes the tax charge on Mr Swift arose on the profits of SPLLC as they were earned, rather than on the distribution of those profits to him. SPLLC was transparent, not opaque as HMRC had argued, so the US tax was creditable.
Grounds for the decision
The UK tax status of non-UK entities is determined by assessing the legal characteristics of the relevant entity and comparing them to the characteristics of UK companies and partnerships, following the approach taken by the UK Court of Appeal in Memec plc v CIR (70 TC 77).
The decision stresses that it is specific to the LLC under consideration, and may not be of general application. However, the principal basis for the decision appears to be a finding that profits of SPLLC belonged to the members as they arose, and this finding was based to a substantial extent on s.18-503 of the Delaware LLC Act. The Tribunal was influenced by an understanding that the legislation required allocation of profit among the members, albeit that such allocation could be as provided in the LLC agreement. The requirement of allocation was considered to be indicative of partnership status.
Another key element of the decision appears to be the finding that the LLC did not have a feature which served the same function as “share capital” serves in an English company. This finding appears to have been influenced principally by findings in relation to the transferability of membership interests, a matter which appears to be subject to greater flexibility according to the specific terms of the agreement between the members, and therefore perhaps more clearly specific to SPLLC.
The decision creates doubt about the status of Delaware LLCs (and potentially LLCs of other States) for UK tax purposes. The potential implications extend to:
- The UK taxation of a member of an LLC on profits of, and distributions by, an LLC.
- The ability of an LLC and its subsidiaries to be a member of a group for UK tax purposes.
- The ability of a UK resident member of an LLC to obtain credit for US taxes suffered on LLC profits against UK taxes (as seen in the decision itself). The availability of such credit had previously been largely understood to be limited to corporate members holding at least a 10% interest.
The decision, being a decision of the First-Tier Tribunal, is not a binding precedent, and is potentially subject to appeal. However, where a UK resident taxpayer has an interest in an LLC, or an LLC is part of a group with UK resident members, careful consideration should be given to the potential consequences of this decision, and to the extent to which existing and historic HMRC guidance and practice can be relied upon.