LLCs and UK tax - a trap for the unwary

Viewed from the UK, the US limited liability company (or LLC) is a slightly strange beast. Although it is called a company, it is not necessarily a company as English lawyers would understand it. The governing legislation is flexible, and affords the members of an LLC considerable flexibility to set up governance arrangements as they wish, much like a partnership, while still benefiting from limited liability. It's possible for an individual to set up a single-member LLC if they wish. 

In addition, the so-called ‘check-the-box’ US tax regulations afford considerable flexibility for US taxpayers - the default position is that LLCs are ‘pass-through’ entities, meaning that their income is taxable in the hands of their members, but they can elect to be treated as separate taxable persons.

As they combine the corporate benefit of limited liability with partnership-style tax treatment, LLCs - commonly established in Delaware - have long been the entity of choice in the US for a variety of business purposes. Entrepreneurs may choose to operate their businesses through LLCs; wealthy individuals may use them to hold investment portfolios; private equity executives may hold carried interests through them.  

These hybrid characteristics cause problems, however, when an LLC comes into contact with the UK tax system. The difficulty stems from the fact that an LLC is generally regarded by HMRC (the UK tax authority) as an opaque entity - that is, as a taxable person in its own right. This poses particular difficulties for individual members of LLCs who become resident in the UK. The US will tax them directly on their share of the profits of the LLC, while the UK will tax them on distributions they receive from the LLC without allowing a credit for the US tax paid on the LLC's profits. 

This can easily result in an effective tax rate of more than 60% on an LLC's profits. In addition, where the LLC is being managed and controlled by UK-resident individuals, HMRC may regard it as a UK-resident company that is chargeable to corporation tax, with attendant compliance obligations. 

There is nothing new about HMRC's approach, which dates back to 1997. Large corporate taxpayers are generally aware of HMRC practice and have planned accordingly. But it is far from intuitive, particularly to US individual taxpayers who are accustomed to LLCs being treated as pass-through entities in the US. If they have moved to the UK before becoming aware of this issue, they may have a significant problem, and recent developments mean that two potential means of mitigating it have become less easy to use.

Firstly, it has always been possible for a taxpayer to argue that an LLC should, in fact, be treated as transparent for UK tax purposes. Indeed, in the only reported case on this question (in 2015), the Supreme Court found for the taxpayer, and allowed him to claim a credit for the US tax suffered on the LLC's income against his UK income tax liability. HMRC took the view that this case was confined to its facts and that its default position would not change, but that it would consider arguments to the contrary. 

Shortly before Christmas 2023, this guidance was replaced by more detailed guidance referencing specific provisions of Delaware law. While HMRC does not state that it believes that the Anson case was incorrectly decided, it clearly takes the view that it is hardly ever applicable - and it explicitly states that where a taxpayer has claimed a credit for US tax, it will consider opening an enquiry or making a discovery assessment. A taxpayer can, of course, still argue that an LLC is transparent - but it should not expect HMRC to be receptive. 

Another course of action for recent arrivals to the UK may be to claim the remittance basis of taxation. This is available to individuals who are not domiciled in the UK, which will normally be the case for individuals becoming resident in the UK for the first time. Under the remittance basis, foreign-source income will not be taxable in the UK unless it is remitted to the UK, and is available for up to 15 years. However, in its 2024 Budget, the government announced its intention to abolish the remittance basis of taxation. The replacement exemption for foreign-source income and gains for new arrivals to the UK would last for only four years. 

Restructuring an LLC interest after an individual has become UK-resident risks triggering other adverse UK tax consequences, so any planning to mitigate double taxation is best done before an individual becomes UK-resident. US individuals considering moving to the UK should take advice accordingly. 

It is also worth noting that LLCs can also cause tax complications for UK-based corporate groups - although that is a story for another day.