Press Room

12 Apr 2022

The Anson problem is not just for individuals

National Technical Director, Andrew Parkes, takes a look at the Anson case through a corporate lens.

We were reminded recently that the difference in treatment of US Limited Liability Companies (LLCs) by the UK and the US can have an impact for companies as well as individuals. With companies the difference can be starker and, given the general operation of the UK/US double taxation agreement (DTA), hard to justify.

As a reminder, US LLCs are generally treated as partnerships or disregarded entities for US tax, whilst they are treated as companies by the UK. This difference in treatment can lead to actual double taxation in situations where a little tweak could lead to single taxation either via exemption or double taxation relief (DTR).

The obvious question to ask then is why not make that tweak? In many cases the UK member of the LLC facing double taxation has only a minority interest and the majority (usually US based) are quite happy with the LLC as intended.

Mr Anson was able to persuade the First Tier that DTR was available with respect to the US income of his LLC, but that may not be available to everyone. We know some agents believe that the Anson decision is carte blanche to claim DTR for LLC income, but I am much less sanguine. If/when Anson 2 rolls around, my money is on HMRC to level the score.

Back to companies. Our client had a UK company that was investing in a number of US LLCs that were carrying on trades in the US. Under the UK/US DTA, the US is able to tax the UK company as if it was carrying on the underlying trades due to the operation of Article 1(8) of the DTA. This allows the US to tax UK residents where the US sees the UK person as receiving the relevant income, even if the UK sees someone else, which here it does.

The UK sees the “top” LLC and, as that LLC is not UK resident and has no UK source income, the UK does not see anything to tax. Therefore, the UK company has nothing in the UK to set the US tax it has paid against. So far, so Anson.

Now, we are looking at companies, and the UK has the Distribution Exemption (DEx). With Mr Anson, HMRC’s view was that the distributions he received from the LLC were taxable as dividends upon him. Here, for UK purposes, the US LLC has paid a dividend to the UK company. As a portfolio investor (holding less than 10%), if the UK company was not small (so at least 50 employees with either turnover and/or balance sheet total of more than €10mn) then the DEx would almost certainly exempt the distribution from UK tax.

This is fair treatment – the US business profits have been taxed once in the hands of the UK company. There will be a second level of taxation when that dividend is passed to the shareholders of the UK company, but that would be the same if the UK company ran a UK business.

However, the situation is horribly different for a small company using the small company DEx. The first criterion of this DEx is that the taxpayer has to be resident in a qualifying territory (and the US is a qualifying territory) – but is the LLC resident in the US?

To be resident it has to be “liable to tax there by reason of its domicile, residence or place of management…

The important wording is “liable to tax”. This phrase is not defined by UK legislation, but we understand that HMRC interprets “liable to tax” for the DEx as they would for DTAs (i.e. the company is capable of being taxed in the relevant country, not that it actually pays tax there).

For example, a charity is liable to tax in the UK although it generally pays no tax. This is because a charity is first and foremost a company and it is only exempt from tax if it and its income meet certain criteria. The charity is said to be liable to tax.

In contrast, a UK partnership is not liable to tax as it is not capable of being taxed here – the partners are instead.

This is not to be confused with the expression “subject to tax” which requires the relevant person or income to be charged to tax even if no actual tax is paid, say, due to losses carried forward. A discussion of liable and subject to tax is at the heart of Paul Weiser v HMRC ([2012] UKFTT 501 (TC)) that rested on whether his UK pension was subject to tax. Spoiler alert – it wasn’t.

US LLCs are inherently transparent for US tax, unless they have “checked the box”. Where they have more than one member (like here) they are partnerships and the US view of partnerships is the same as the UK (in this instance). The LLC is not itself liable to tax in the US and, therefore, the Small Company DEx is not available for distributions paid by a LLC.

This brings in a horrible cliff edge. As mentioned above, Article 1(8) of the UK/US allows the US to tax the US source income of the UK company, so everyone is happy that the underlying income is being taxed by the correct country. Nothing is being avoided. Further, the UK is happy for the DEx for non small companies to apply in this situation. Now, consider you are a company with 51 employees but two resign leaving you with 49; if those employees are not replaced, you risk becoming taxable on distributions from US LLCs due to no action on your part and for no obvious policy rationale. (Admittedly you have to have 49 employees for two years, but the principle is the same.)

Now, the US taxes the business income of the LLC upon the UK company, the UK taxes the distributions from the US LLC but gives no relief for the US tax paid on the profits – the UK company cannot even claim the benefits of underlying tax relief in respect of the tax on the profits as the shareholding has to be a minimum of 10% for this to kick in. We have actual double taxation, as with Mr Anson, if he had not won his case. Then, when the UK company pays dividends to its shareholders, there is a third instance of taxation.

This is something that is easily fixed by a tweak to the small company DEx. Extend the first criterion so that the payer is either resident in a qualifying territory or the profits out of which the distribution are paid have been liable to taxation in a qualifying territory. This brings the treatment in line with Article 1(8) of the UK/US DTA and equivalent provisions in other DTAs. Without it, corporate portfolio investors in US LLCs are unfairly penalised compared to their larger brethren.

If you have any questions regarding the UK treatment of LLCs, the UK/US DTA or the Distribution Exemption, please contact Andrew Parkes.

Andrew Parkes

Andrew is a highly experienced international tax specialist who worked at a senior level in HMRC’s international teams for over 10 years. He has a wealth of experience and technical knowledge.

Email: Andrew Parkes