Supreme Court ruling means investors should review Delaware LLC structures, says expert

The ruling means that Delaware LLCs can be classed as tax transparent and not tax opaque for the purposes of double tax relief in relation to income profits, said Heather Self a tax expert at Pinsent Masons, the law firm behind Out-Law.com.

If Delaware LLCs are classed as tax transparent, it will have tax implications for other investors within the UK tax net, she said. This is because LLC investors could have to account for UK tax on their share of the profits of the Delaware LLCs immediately as they arise, she said.

Self said that the prevailing practice of HM Revenue and Customs (HMRC) has been to treat Delaware LLCs as tax opaque. This means that UK tax only becomes payable when the LLC profits are distributed by way of dividend and corporate recipients are usually exempt from paying tax on dividends, she said.

Self was commenting after the Supreme Court ruled (39-page / 382KB PDF) that a man who was subject to both US and UK tax was not liable for income tax payments in the UK on income derived from his share of profits made by HarbourVest Partners, an LLC in Delaware in the US of which he was a member.

A Mr Anson was resident but non-domiciled in the UK which meant he was liable to pay UK income tax on his UK source income and on foreign income transferred or 'remitted' to the UK. He was non-resident in the US for US tax purposes, but was liable to pay US federal and state taxes on his US source income. HarbourVest Partners was classified as a partnership for US tax purposes and Anson was liable to pay US federal and state taxes on his share of the profits.

Anson paid tax on his share of profits made by HarbourVest Partners in the US and then transferred the remaining money to the UK. HMRC claimed that Anson was liable for income tax on the money he transferred to the UK. However, Anson argued that he was eligible for double taxation relief. HMRC said that Anson was not entitled to any double tax relief because the income which had been taxed in the US was not his income but that of the LLC.

A double tax treaty between the US and UK seeks to ensure that people are not taxed twice on "the same profits or income" by US and UK tax authorities.

The First Tier Tax Tribunal (FTT) previously ruled that Anson was entitled to relief under the UK/US double tax treaty. However the Upper Tribunal and the Court of Appeal both found that double tax relief was not available.

Anson appealed to the Supreme Court arguing that he was subject to UK tax on his share of the LLC's profits, and this was the same as the income taxed in the US so double tax relief should be available.

The Supreme Court said that Anson was entitled to double taxation relief because the income on which he had paid tax in the US could be classed as the same as the income on which he was liable to pay tax in the UK.

The FTT had considered the way that HarbourVest Partners was structured. After hearing evidence about the application of Delaware law, the FTT had decided that the members of the LLC automatically became entitled to their share of the profits generated by the business carried on by the LLC as they arose: prior to, and independently of, any subsequent distribution. The Supreme Court said that the evidence entitled the FTT to make that finding and there was no basis on which to overturn it.

The Supreme Court said that on the basis of the FTT's finding of fact, Anson was entitled to the share of the profits allocated to him, rather than receiving a transfer of profits previously vested in the LLC, and so it followed that his income arising in the US was his share of the profits. That was therefore the income liable to tax under UK law, to the extent that it was remitted to the UK and the income which was taxed in the US was Anson’s share of the profits of the LLC. The Court said that Anson’s liability to UK tax was therefore computed by reference to the same income as was taxed in the US and he therefore qualified for double tax relief.

Heather Self of Pinsent Masons said: "This was a surprise decision and is contrary to HMRC's established practice. We will therefore need to wait to see how HMRC responds".