On July 1st, 2015 the UK Supreme Court released its judgment in the case of Anson v. Commissioners for Her Majesty’s Revenue and Customs (Anson), in which the issue was how a taxpayer's interest in a Delaware limited liability company (LLC) should be treated under UK tax law. The Court’s decision has received a great deal of attention in the UK, as it contradicts, to a certain extent, Her Majesty’s Revenue and Customs (HMRC)’s historic position that an LLC should be treated as “opaque” for UK tax purposes.
The facts in the case may be summarised as follows. The taxpayer in the case (Anson) was a non-domiciled UK resident and member of an LLC which carried on the business of managing venture capital funds in the US. The LLC was treated as a partnership for US tax purposes and thus, a transparent entity for US tax purposes, meaning that the partners were liable to tax on its income, rather than the LLC itself. Anson received distributions from the LLC (net of non-resident withholding tax which was applied against his US tax owing in respect of the LLC’s income) and “remitted” them to the UK, causing them to be included in his income subject to UK tax. When Anson claimed double taxation relief under Article 23(2)(a) of the 1975 UK/US Double Taxation Convention (the Treaty) and its successor, Article 24(4)(a) of the 2001 UK/US Double Taxation Convention, the HMRC refused to provide a credit for the US taxes paid on the LLC’s income. These provisions stated that “United States tax payable under the laws of the United States […] on profits or income from sources within the United States (excluding in the case of a dividend, tax payable in respect of the profits out of which the dividend is paid) shall be allowed as a credit against United Kingdom tax computed by reference to the same profits or income by reference to which the United States Tax is computed.” According to the HMRC, Anson had paid taxes in the US on the income of the LLC, and in the UK on the distributions declared by the LLC. These were two separate sources of income and so the “profits or income” subject to tax in the two jurisdictions were consequently not “the same”. As noted by the UK Supreme Court in its reasons, the result was that Mr. Anson paid an effective tax rate of 67% on the income derived from the LLC.
Experts before the First Tier Tribunal (FTT) testified that the agreement governing the LLC (LLC Agreement) in issue and the Delaware Limited Liability Company Act (LLC Act) provided the members of the LLC with a right to its profits “as they arose” and not only upon the declaration of distributions. A “limited liability company interest” was defined under the LLC Act as “a member’s share of the profits and losses of a limited liability company and a member’s right to receive distributions of the limited liability company’s assets.” Section 4.1 of the LLC Agreement, for its part, provided that the members’ capital accounts must be credited by an amount equal to all gross income earned in a period, and section 5.1 stated that the “excess of income and gains over losses, deductions and expenses” must be distributed to the members on a quarterly basis. Accordingly, there was income from a single source (the underlying business income) and not two sources of income (i.e. income from business earned by the LLC and income from property earned by Anson).
HMRC appealed to the Upper Tier Tribunal (UTT). The UTT considered the appeal in light of Memec plc v. Inland Revenue Commissioners (Memec), in whichthe Court of Appeal had concluded that a member of a German “silent partnership” did not have a proprietary interest in the partnership’s property, and could therefore not be considered to have received dividends paid to the partnership for purposes of the UK-Germany Tax Treaty. The UTT held that, as in Memec, the assets were the LLC’s assets. Accordingly, the LLC was “opaque” and Anson’s income consisted of distributions declared on his membership interest in the LLC (i.e. income from property), rather than income from the business carried on by the LLC. Anson appealed this decision to the Court of Appeal, which upheld the UTT’s conclusions, based largely on the reasons adopted by the UTT.
Before the UK Supreme Court, Anson argued that the parenthetical in Article 23(2)(a) (reproduced above), which excluded relief for taxes paid by a corporation paying dividends to a UK-resident, suggested that the underlying tax paid by an entity making distributions could otherwise be covered by the provision. The Court disagreed. It analysed the history of the relevant treaty provisions, noting that the 1945 version of the Treaty had provided explicitly that the UK must grant a foreign tax credit for the tax paid by a US company when taxing its residents on dividends paid by such a company. The point of the parenthetical was merely to highlight that this would hitherto no longer be the case.
The Court then went on to consider the Crown’s argument (which had been accepted by the UTT and the Court of Appeal) that Memec prevented a finding that the distributions and income of the LLC were the same item of “profits or income” for the purposes of the Treaty. According to the Court, Memec concerned a different issue than Anson, namely, whether a dividend received by a partnership could be considered to have been received by its partners (the case dealt with a provision of the UK-Germany Tax Treaty requiring the UK to grant a foreign tax credit for German tax paid by a corporation where it paid dividends to a UK-resident corporation holding a significant interest in the payer – in other words, the question whether the taxpayer had received the dividend paid to the silent partnership). It made sense in this context to ask who had a property right in the dividend since the notion of “profits or income” used in Article 23(2)(a) was a more abstract one, and not dependent on who owned the cash in which such profits or income might be embodied.
Like the FTT, the Court was ultimately of the view that whether or not the profits and distributions of the LLC represented the same item of “profits or income” or two different sources, depended on whether Anson’s income arose when profits were earned by the LLC, or only when they were distributed by the LLC. The Court adopted the former view, basing itself largely on the findings of fact made by the FTT regarding the LLC Act and the provisions of the LLC Agreement providing that its profits must be distributed on a quarterly basis to its members. Accordingly, Anson’s appeal was allowed.
Following the decision in Anson, HMRC published its response on September 25, 2015 stating that “the decision is specific to the facts found in the case [which] means that where US LLCs have been treated as companies within a group structure HMRC will continue to treat US LLCs as companies, and where a US LLC has itself been treated as carrying on a trade or business, HMRC will continue to treat the US LLC as carrying on that trade or business”. HMRC therefore did not revise its general approach to the categorization of US LLCs for UK tax purposes. HMRC also added that double tax relief claims by UK individuals with income arising through a US LLC would be considered by HMRC on a “case-by-case” basis.
Anson is similar to TD Securities (USA) LLC v. R. in the sense that it challenges the traditional view that an LLC and its income must be treated as being distinct from that of its members. Nevertheless, it is not clear how big an impact the decision will have in Canada. The UK Supreme Court’s reasoning was not based on the view that an LLC is not a corporation or that LLCs should be treated as fiscally transparent entities for general UK tax purposes, but rather on the particular wording used in Article 23(2)(a) of the Treaty, the LLC Act and the LLC Agreement. Moreover, the legislative context surrounding the Canadian foreign tax credit regime is quite different from the one established by the Treaty. Subsection 126(2) of the Income Tax Act explicitly states that a credit for “business-income tax” may only be claimed by a taxpayer in respect of a business carried on by the taxpayer.That leaves only subsection 126(1), subsection 20(11) and subsection 20(12) in the case of an individual shareholder such as Anson. Interestingly, for the purposes of subsection 20(11), the CRA has historically taken the view that tax paid by the members of an LLC on its income may be considered to be “in respect of an amount that has been included in computing [their] income for the year” where the LLC distributes its income to the members and is included in income as a dividend (to some extent echoing the reasoning underpinning the UK Supreme Court’s decision in Anson). Because the term “non-business income tax” is essentially defined as any tax other than “business-income tax” or an amount of tax deductible under subsection 20(11) or deducted under subsection 20(20), the result is that only 15% of the income earned by the LLC may be considered to be “non-business income tax” of the taxpayer and eligible for a credit under subsection 126(1).
It will be interesting to see how the UK Courts and those of other countries apply and interpret Anson, and more particularly, whether they follow its lead in granting recognition for certain purposes of the flow-through nature of LLCs and other similar foreign entities.