Should you do business in the US through an LLC?
UK companies and residents often express interest in doing business in the US through a US LLC. Their interest is often triggered by well intentioned advice offered by legal and tax advisors with little understanding of the complexities of cross-border business ownership or of the issues that arise out of the UK-US Tax Treaty. While a US LLC offers some benefits that are not available to a statutory corporation (i.e., an “Inc.”), the ownership of a US LLC by a UK company or resident may result in adverse tax consequences. Thus, in choosing the LLC as a business form, caution is critical and obtaining the advice of competent counsel is recommended.
In the UK business environment, six options – other than sole trader – are available through which business can be conducted: the general partnership, the limited partnership, the limited liability partnership, the private limited company, the public limited company, and the private unlimited company. All but two of these business entity types are available under the laws of the US states. In addition, the laws of the US states have additional business forms that are not available in the UK, one of which is the limited liability company (or “LLC”).
An LLC is a hybrid form, part statutory corporation and part partnership, available in all fifty US states and the District of Columbia. There are four distinctive features of an LLC.
- The availability of pass-through (or transparent) tax treatment. A statutory corporation organized under the laws of a US state is subject to federal and (usually) state corporate tax on its net income. As with the UK private limited company, dividends are then distributed to shareholders out of after-tax profits, resulting in a double-tax on the profits. Under the default rules, in contrast, an LLC is a transparent entity for tax purposes. The profits of an LLC pass-through to its owners and are taxed as though the LLC were a partnership, rather than a separate corporate entity. Consequently, under the right circumstances, LLCs can enjoy favourable tax benefits that arise from the fact that business profits are subjected only to one level of tax.
- Less formal management structure. Although the required formalities vary based on the state of incorporation, generally statutory corporations require the shareholders to periodically (typically, annually) elect one or more directors, who in turn elect one or more corporate officers to govern the corporation. In practice, these formalities are not onerous, since, typically: (1) only one director is required; (2) the same person can serve in multiple officer roles; and (3) shareholders and directors can typically waive the requirement of an actual meeting and act instead by written resolution. Nevertheless, it is accepted that LLCs generally operate more informally, since they do not have the two tier structure reflected in a board of directors separate from a slate of officers. Instead, “managers” – the functional equivalent of the directors of the UK private limited company – govern the LLC directly.
- Flexibility in profit and loss sharing. In a statutory corporation, the corporation’s profits are distributed, via dividends, pro rata according to the allocation of the corporation’s shares. Although statutory corporations can have different classes of shares each with differing dividend preferences, practical limitations still exist on the corporation’s ability to distribute its profits disproportionate to ownership. The members of an LLC, in contrast, can (within certain limits) agree to allocate profits and losses disproportionate to the members’ interests in the company and even disproportionate to the members’ capital contributions.
- Increased protection from outside creditors. All corporations – including LLCs – generally prevent the creditors of the corporate entity (so called “inside creditors”) from attempting to collect directly from the corporation’s owners. When an owner personally owes money to a creditor (so called “outside creditors”), what recourse does the creditor have to recover against the owner’s interest in the company? Generally, with a statutory corporation, the creditor can levy upon the shareholder’s shares in the corporation and thereby enjoy all of the rights of shareholding, including voting rights. With an LLC, in contrast, outside creditors generally are limited to a “charging order” against the interest. A charging order entitles the creditor to receive any distributions that the member would have otherwise received. However, outside creditors generally cannot levy upon the LLC interest itself, nor can they exercise any management or control over the LLC.
Notwithstanding these benefits, UK residents or companies should be careful when choosing to form a US LLC. Under Article 24(4)(a) of the UK-US Tax Treaty, UK residents are entitled to receive a tax credit for taxes paid on income sourced to the United States, provided that the tax is “computed by reference to the same profits, income, or chargeable gains.” Historically, HMRC has taken the position that a US LLC is an opaque entity, not a transparent entity. As a result, while under US law an LLC’s members are liable for the tax on the LLC’s income, from HMRC’s perspective the tax is computed by reference to the entity’s income, not the owners’ income. Accordingly, from HMRC’s historic perspective, any tax paid by the LLC member to the United States is not a tax computed “by reference to the same profits, income, or chargeable gains” as would be computed for the LLC itself. The result is a disjunction that deprives the UK owners of the right to claim foreign tax credit on account of taxes paid to the United States.
HMRC’s historic position was called into question in the 2015 UK Supreme Court case of Anson v. HMRC,  UKSC 44. In Anson, the UK Supreme Court allowed Mr. Anson, a UK resident, to claim a foreign tax credit for taxes paid by him to the United States and arising out of his membership in a Delaware LLC. HMRC contended that the income in question arose only if, and when, the LLC distributed its profits to Mr. Anson and thus, logically, that the LLC’s profits or income were not “the same” as Mr. Anson’s profits or income. Mr. Anson contended that the income in question arose regardless of whether that income was ever distributed to Mr. Anson. In finding for Mr. Anson, the Court’s conclusion hinged upon the lower court’s finding that, under the specific terms of the Delaware LLC Act and the LLC agreement among the members, Mr. Anson was “entitled to the share of the profits allocated to him, rather than receiving a transfer of profits previously vested (in some sense) in the LLC.” Consequently, on these facts, the tax that Mr. Anson paid to the United States was “computed by reference to the same profits, income, or chargeable gains” as the tax that HMRC sought to collect.
In the wake of Anson, HMRC announced its response to the Supreme Court’s decision. According to HMRC, Lord Reed, in delivering the Court’s judgment, “made clear that he relied on the facts” found by the First-Tier Tribunal (“FTT”), specifically:
The FTT made findings that the profits of the LLC did not belong to the LLC in the first instance but the members became automatically entitled to their share of the profits as the profits arose and before any distribution. The FTT also found that the interest of a member in the LLC was not similar to share capital.
HMRC concluded that the ratio decidendi in the Anson rested upon the specific facts as found by the FTT.
HMRC has after careful consideration concluded that the decision is specific to the facts found in the case. This means that where US LLCs have been treated as companies within a group structure HMRC will continue to treat the US LLCs as companies, and where a US LLC has itself been treated as carrying on a trade or business, HMRC will continue to treat the US LLC as carrying on a trade or business.
Here, HMRC seems to imply that where the US LLC is owned by a UK corporate entity (rather than an individual owner) as part of a group structure, HMRC will continue to treat the US LLC as an opaque entity, for which no foreign tax credit will be available to the member. Even where, as in Anson, the US LLC is owned by an individual, the availability of the foreign tax credit is in doubt as, according to HMRC, “[i]ndividuals claiming double tax relief and relying on the Anson v HMRC decision will be considered on a case by case basis.”
In short, notwithstanding the Anson decision, considerable uncertainty exists as to whether, or under what circumstances, HMRC will allow foreign tax credits for taxes paid to the United States arising out of LLC profits. Where the US LLC is owned by a UK corporate entity, it is very likely that HMRC will continue to take the position that the US LLC is an opaque entity for which no foreign tax credit will be allowed. At a minimum, in deciding to create a US LLC owned by a UK resident individual, careful attention must be paid to the applicable LLC Act and to the specific provisions of the agreement governing the relationship between the LLC members.
It should be noted that an LLC is a creature of state law. By default, it is taxed as a pass-through (or “transparent”) entity. However, under US tax law, an LLC can elect to be taxed as a separate corporate (or “opaque” entity). By making this election, an LLC can enjoy many of the benefits described above – e.g., a less formal management structure, greater flexibility in profit and loss sharing, and increased protection from outside creditors – without the risk that HMRC will refuse foreign tax credits arising out of the LLC’s profits. Absent such an election, the safer course of action is to do business in the US through a statutory corporation or some other entity form.