Summary

The Supreme Court (SC) has held in Anson v HMRC Commissioners [2015] UKSC 44 that an individual taxpayer was entitled to double tax treaty relief in respect of his share of profits in a Delaware limited liability company (LLC).

Mr Anson was resident but not domiciled in the UK for UK tax purposes and was subject to UK tax on foreign sourced income on a remittance basis.

Mr Anson paid US taxes on his share of the LLC’s profits as they arose, and then remitted the balance to the UK. HMRC argued that Mr Anson was not entitled to UK tax credits under the US/UK double tax treaty for the US taxes paid on the basis that the US and UK taxes were not computed on the “same" income. That is, the income which had been taxed in the US was not Mr Anson’s income for UK tax purposes but that of the LLC.

The SC rejected the Commissioner’s argument. The SC agreed with the decision of the First-tier Tribunal (FTT), and not with those of the Upper Tribunal (UT) and the Court of Appeal (COA).

Further details

The LLC was established under the Delaware LLC Act and under the terms of an LLC agreement. The LLC had its own legal identity and, among other things, beneficially owned the business assets.

In accordance with the LLC agreement, all the LLC’s income and gains were credited, and all losses, deductions and expenses were debited, to its members’ capital accounts on a quarterly basis. The profits were then distributed to the members in arrears.

The LLC was classified as a partnership for US tax purposes, which meant that Mr Anson paid US taxes on his share of the LLC’s profits as they arose regardless of when they were distributed to him. When Mr Anson remitted his share of the profits (minus the US taxes) to the UK, HMRC sought to deny UK tax credits for the US taxes paid.

Under the UK/US double tax treaty applying at the relevant times, US taxes ‘shall be allowed as a credit against any UK tax computed by reference to the same profits or income by reference to which the US tax is computed.’
 
The question was whether the UK tax to which Mr Anson was liable was computed by reference to same profits by reference to which the US tax was computed.  

The FTT

In the FTT, HMRC argued that the LLC was "opaque" rather than "transparent" (applying the principles adopted in the case of Memec plc v Inland Revenue Cmrs [1998] STC 754).  On this basis, it followed that Mr Anson should be taxed in the UK on his share of the LLC's profits only when he received a distribution of the profits (and not by reference to the profits of the LLC as they arose, as in the case of the US).  

The FTT, however, preferred to concentrate on the words of the double tax treaty rather than ask whether the LLC was “opaque” or “transparent”.

While the assets were held beneficially by the LLC (unlike a UK partnership), the FTT distinguished between the concepts of 'assets' and 'profits'. As ‘profits’ were not the same as ‘assets’, it was irrelevant that the assets first vested in the LLC. After considering Delaware law and the LLC agreement, the FTT found that the profits did not first belong to the LLC and then to the members, but arose directly to the members. Therefore, the FTT concluded that Mr Anson should be subject to UK tax on his share of the LLC's profits as they arose.

As this was the same basis upon which the US taxes were computed, Mr Anson was entitled to double tax treaty relief.

The UT and COA

The UT and COA came to a different conclusion. The fact that the members of the LLC did not have a proprietary right in the underlying assets of the LLC appeared to be crucial. In the absence of such a right, the profits were said to be owned by the LLC (not the members). Put simply, the COA said that in order for a member to show that he was entitled to the profits from the moment that the profit arose, it will be necessary to show that he had a proprietary interest in the assets.

The present appeal

The SC held that the correct approach was:

  1. Identify the profits by reference to which the UK tax was computed
  2. Identify the profits by reference to which the US tax was computed (it was undisputed that this was Mr Anson’s share of the profits of the LLC as they arose)
  3. Using a degree of pragmatism, compare the profits in each case above and decide whether they are the same.   

In respect of point 1, the SC agreed with the FTT that there is a distinction between the concepts of 'assets' and 'profits', and found on the basis of Delaware law and the LLC agreement that the profits did not belong first to the LLC, but automatically vested in the members prior to, and independently of, any subsequent distribution. Consequently, Mr Anson’s UK tax liability should be computed by reference to his share of the LLC's profits as they arose.

Accordingly, the SC held that the US and UK taxes were calculated by reference to the “same” profits and therefore Mr Anson was entitled to double tax treaty relief.

Comment

HMRC’s published view is that US LLCs are not fiscally transparent for UK tax purposes. Therefore, a UK member of a US LLC should be taxed by reference to the distributions from the US LLC rather than by reference to a share of the LLC’s profits as they arise.  

The Anson case produces a contrary result to this published view.

UK members of US LLCs should not automatically assume that they are entitled to double tax treaty relief for relevant US taxes paid following this case. Rather, the constitutional documents of the LLC and underlying arrangements between its members will need to be reviewed carefully in light of this judgment. The analysis may not be straightforward.

Further, the issue may be wider than just US LLCs and could affect other structures which are see-through as a matter of the law of the place where they are set up.

It will be interesting to see if HMRC will revise its published guidance or issue additional guidance to clarify its views following this judgment.