A recent decision of the UK's First Tier Tax Tribunal in Mr Swift v The Commissioners has raised doubts in relation to the UK tax treatment of US limited liability companies (LLCs) and members' interests in such entities. Similar issues were discussed and ruled on by the Tax Court of Canada in TD Securities (USA) LLC v The Queen last month. In each case the court had to decide whether the appellant was entitled to double tax treaty relief.

For both UK and Canadian tax purposes US LLCs have commonly been considered to be opaque, which contrasts with the US tax position under which (in the absence of an election to the contrary under the "check-the-box" regulations) such entities enjoy tax transparency. Why is the distinction important for tax purposes? The profits of an opaque entity, for example a company, are treated as its own and the company itself is taxed thereon. Members (i.e. shareholders) are then generally only taxed in relation to any profits actually distributed by way of dividend. On the other hand, the profits of a transparent entity, such as a partnership, are treated as profits of the members (i.e. partners) themselves who are taxed on those profits as entitlement to them arises, irrespective of whether such profits are actually distributed or retained. In addition, HM Revenue and Customs ("HMRC") and the Canadian Revenue Agency ("CRA") have traditionally regarded US LLCs as capable of having share capital which has its own implications for cross border tax planning.

In summary, it is questionable if the judgment in either case stands up to technical scrutiny, whilst clearly justice was done. However, in relation to the TD LLC case, the deadline for the Crown to file an appeal has passed so the ruling of the Tax Court will stand and taxpayers may wish to consider claiming refunds of overpaid Canadian taxes where treaty benefits were denied in circumstances similar to those of TD LLC. In contrast, it is hard to advise what action should be taken in reliance on the Swift decision as HMRC is appealing the Tribunal's decision and will be maintaining its existing view of the LLP as opaque pending the result of its appeal. In the meantime, however, in line with HMRC guidance published last week (accessible here), any member of a US LLC who feels that the UK treatment of a particular LLC should be reviewed in light of the Tribunal's decision is invited to write to Stan Surgin, Business International, Yorke House, Castle Meadow Road, Nottingham, NG2 1BG providing full details of the basis of their application.

One thing that is clear is that even closer scrutiny should be made by non-US resident taxpayers of structures whether in bound or outbound USA as some surprising results can accrue whichever way the final decision goes. If opaque, then UK residents will continue to suffer double tax on US source profits of the LLC. If transparent, then group structure will be broken and relief such as substantial shareholding put at risk.

It is also essential not merely to accept standard LLC documentation. Much can turn on the manner in which the statutes are worded in deciding whether the LLC is akin to a partnership or is opaque with an issued share capital.
Finally, taxpayers are well advised to consider other US entities where the treatment is perhaps clearer such as S Corps or Delaware partnerships.

Please use this link to access summaries of the two cases and our comment on their implications.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 02/06/2010.