With effect from 6 April 2025, the UK's historic 'non-dom' regime has been replaced by the 'new' UK tax regime. The 'new' regime represents a seismic change for those formerly 'non-dom' UK resident individuals who were previously able to take advantage of the 'remittance basis' to limit their UK tax liability to UK income and gains and non-UK income and gains actually remitted to the UK. From 6 April 2025, all UK resident individuals (who do not fall within the beneficial four-year foreign income and gains (FIG) regime) will be subject to UK tax on an arising basis on their worldwide income and gains.
From 6 April 2025, UK residents who have interests in US LLCs may have to report and pay tax on their LLC income in the UK for the first time. This presents a new issue for many UK resident taxpayers in working out exactly how their LLC income will be treated for UK tax purposes.
Classification of LLCs for UK tax purposes
As a starting point, it is important to consider how an LLC would be classified for UK tax purposes.
As with most tax systems, the UK tax system draws a distinction between partnerships and companies. Partnerships are transparent for UK tax purposes, and their profits are taxable in the hands of their partners in accordance with the profit-sharing arrangements agreed between the partners. Companies are taxable persons and pay corporation tax on their profits, with their members being taxed on any distributions they receive from the company, or on a disposal of their interest in the company.
Where a UK resident person holds an interest in an entity formed under foreign law, it is therefore necessary to establish whether that entity is more akin to a partnership (transparent) or to a company (opaque) in order to establish whether the UK resident is taxable on the profits of the entity as they arise (whether or not they are distributed), or merely on distributions they receive from the entity.
From a UK tax perspective, there is not a uniform classification of foreign LLCs and there is no mechanism equivalent to the 'check the box' election in the US which allows a taxpayer to elect to treat an entity as either a corporation or a pass-through entity. Any US tax election has no effect for UK tax purposes, and the US tax classification of an entity is not relevant in determining its classification for UK tax purposes.
Instead, the following factors have been considered by English courts as key in determining the classification of a foreign entity for UK tax purposes:
- whether the entity has a legal existence separate from that of its members (ie whether it has separate legal personality)
- whether the entity issues share capital or something that serves the same function
- whether the business is carried on by the entity itself, or jointly by its members (who have an interest separate and distinct from the entity)
- whether the members of the entity are entitled to share in its profits as they arise, or whether their interest in the profits is dependent on a decision by the entity or its members to make a distribution after the end of the relevant period
- whether the entity or its members are responsible for the debts of the business
- whether the assets of the business belong beneficially to the entity or its members.
HMRC's approach and recent case law
HMRC has published a list of different types of foreign entity setting out whether it classifies them as transparent or opaque based on the factors outlined in case law. LLCs are listed as being opaque .
However, the HMRC list should be treated with caution in relation to LLCs as it is not law – it is merely HMRC's view of how the law applies to specific types of entity. Further, LLC statutes in various US states allow for considerable flexibility as to how an LLC is constituted and operated.
From a tax perspective, the key challenge here arises due to the mismatch between the US and the UK treatment of LLC income. In the US, many LLCs are taxed as 'transparent' or 'pass-through' entities, meaning the LLC's profits are taxed directly on the members as they arise (rather than on the LLC itself). By contrast, HMRC generally treats an LLC as 'opaque,' akin to a corporation.
When an LLC is opaque in the eyes of the UK, the UK will usually tax distributions when they are paid to the member, rather than taxing the profits of the LLC as they are earned. Conversely, from a US viewpoint, the member is taxed on the profits as they arise. Therefore, a situation can develop where the US taxes the LLC’s profits immediately, under its pass-through rules, but the UK then taxes distributions to the members when the profits are actually paid out.
Without special relief (eg credit for foreign tax paid on the profits or a 'look through' for UK tax purposes in a similar way to the US), an individual could end up paying US tax on the profits as they are generated and then UK tax on the same profits on distributions, with no automatic credit for the US tax already paid. This leads to potential double taxation resulting in potentially very high effective rates of tax on the profits generated by the LLC.
The only case to date on the classification of LLCs for UK tax purposes is Anson v HMRC [2015] UKSC 44. In the Anson case, the UK Supreme Court ruled that the member of the LLC in question was entitled to the profits of the LLC as they arose and should therefore be entitled to claim a credit against his UK tax for the US income tax paid on the LLC's profits (as both the US and UK tax was paid on the same profits). In essence, therefore, the LLC was viewed as transparent for UK tax purposes.
HMRC subsequently published Revenue and Customs Brief 15 (2015), in which it stated its view that the decision in Anson was confined to the facts of the case. As such, HMRC's default view remains that LLCs are opaque, although it is prepared to consider submissions to the contrary on a case-by-case basis. However, a taxpayer is likely to need strong evidence to convince HMRC that an LLC is, in fact, transparent.
Therefore, in order to determine how a particular LLC will be classified from a UK tax perspective, the relevant US legislative provisions and, more fundamentally, the terms of the specific LLC operating agreement will need to be analysed to come to a view as to whether the LLC in question is transparent or opaque.
How can we help?
Our Private Client team has experience in reviewing LLC operating agreements and advising as to their classification from a UK tax perspective. We have extensive experience in successfully challenging HMRC on its classification of LLCs. We also advise on the tax treatment of LLCs for UK tax purposes and the various planning opportunities available for UK resident individuals with LLC interests depending on LLC classification.
If you would like to hear more about how we can help, please do get in touch.
