The First-tier Tribunal’s recent decision in Swift v. HMRC has cast some doubt on whether US (and in particular Delaware) limited liability companies (“LLCs”) are to be classified as opaque or transparent for UK tax purposes. The case will be of interest not only to UK investors in Delaware LLCs, but also to international organisations which rely on LLCs having share capital in establishing a UK tax group.
Whether an entity is regarded as fiscally “opaque” or “transparent” will determine how its members are taxed on their interests in the entity. The members of opaque entities (e.g., UK companies) are broadly only charged to tax on the entity’s profits if and to the extent those profits are distributed to them. On the other hand, the profits of a transparent entity (e.g., a partnership) are treated as arising for tax purposes directly to the entity’s members, regardless of whether or when members receive profit distributions.
The tax treatment of an entity or its members (or even the entity’s affiliates) can also turn on whether membership interests in the entity constitute “share capital”.
There is no clear test for determining whether a non-UK entity is opaque or transparent for UK tax purposes or whether it issues shares (or something similar). There is, however, case law and HMRC guidance on the factors considered relevant to classifying an overseas entity for UK tax purposes and, whilst acknowledging that each case depends on its own facts and circumstances, HMRC has published its views on a range of entities: US LLCs have generally been regarded for many years as opaque and capable of issuing shares.
Swift v. HMRC
The primary question facing the tribunal in the Swift case was whether a UK resident individual was entitled to double tax relief for US tax paid on the profits of a Delaware LLC, of which he was a member. HMRC argued, in line with its practice, that the LLC was an opaque entity and the UK taxpayer was not entitled to a share of the LLC’s profits as they arose, but had instead received the equivalent of a dividend. In deciding that double tax relief was available to the taxpayer, the tribunal’s conclusions included the following:
1. Entitlement to profits
The LLC had legal personality separate from that of its members and the assets of the LLC were beneficially owned by the LLC itself and not the members. However, the tribunal decided that the profits of the LLC's business belonged as they arose not to the LLC but to its members. In relation to profits, therefore, the LLC was fiscally transparent, not opaque.
2. Nature of members’ interests
The tribunal also considered that the members’ interests in the LLC were less like share capital in a company and more like a partnership capital in an English partnership, placing weight on the restrictions on transfer of interests imposed by the LLC’s operating agreement.
The tribunal’s decision on this point is not necessarily inconsistent with HMRC’s current practice of accepting that a Delaware LLC is capable of issuing shares, depending on the terms of its constitutional documents.
Does the decision have a wider impact?
The tribunal in Swift stressed that its decision was based on the circumstances of the particular LLC in question and was not necessarily of general application. However, its finding on the entitlement of the LLC's members to profits as they arose seems to be based on (or was at least heavily influenced by) certain provisions of the Delaware LLC Act which apply to all Delaware LLCs.
The availability of various tax reliefs and exemptions for transactions or arrangements within a group of companies is dependent upon the group’s members having share capital. The presence of a US LLC without shares may therefore break a UK tax group, which can have significant consequences. Care should therefore be taken, where relevant, to ensure that a LLC issues shares.
It is understood that HMRC is appealing the decision. In the meantime, arrangements which rely upon Delaware LLCs being opaque for UK tax purposes, or having shares for UK tax grouping (or other) purposes, should be reviewed.