In a judgement given on 1 July 2015, the UK Supreme Court finally settled Mr Anson’s long running campaign to be allowed a credit against his UK tax for US taxes he paid on his profit share in a Delaware LLC. It was the unanimous decision of the five Supreme Court judges that Mr Anson should be allowed that credit.
Mr Anson gains full marks for persistence. Back in 2010, at the start of this judicial saga, he won his case in the First Tier Tribunal (FTT). However, that was followed by losing the next two rounds as appeals went successively to The Upper Tribunal (UT) and then The Court of Appeal (CoA).
Clearly, this is a good personal result for Mr Anson. Other individuals with an identical fact pattern will doubtless be grateful for the precedent established by his persistence. However, a wider audience will also be examining whether this Supreme Court decision has implications for their own tax affairs. Among the questions now being asked are:
- Does this decision only have a narrow application to members of Delaware LLCs, or will it impact on LLCs established under the legislation of other States?
- Are shareholders in US S Corporations impacted?
- Did the Court’s deliberations throw any new light on the question of entity classification for UK tax purposes?
- What public reaction is there likely to be from HMRC?
A Delaware LLC has its own legal personality. It is established under the terms of the Delaware LLC Act, and a specific LLC Agreement. The latter is governed by Delaware law and represents an agreement between the members of the LLC. The LLC itself is not a party to that Agreement.
For US Federal income tax purposes, the default treatment of a LLC is as if it was a partnership. Tax is paid by each member on that person’s pro-rata share of the LLC’s profits. It is possible to elect for the LLC to be taxed as a corporation, but this was not the case with the LLC which was the subject of Mr Anson’s proceedings.
HMRC believed that no credit should be given for the US tax paid by Mr Anson on his share of LLC profits because, in their view, that income belonged to the LLC and not to him. In effect this said that, for UK purposes, the LLC should be viewed as a body corporate and therefore the ‘owner’ of all its trading profits. Under that view, when Mr Anson paid US tax on his share of LLC profits, he was in effect paying tax on behalf of the LLC rather than himself. It is a fundamental tenet that you do not receive credit against your own liability for someone else’s foreign tax that you may have paid.
A basic premise in the system of UK Tribunals/Courts is that body which originally hears a case, in this instance the FTT, has two functions. These are to establish the facts and then make judgements on points of law relevant to those facts. Appeals to a higher body can only be made on points of law. The UT, CoA and Supreme Court may reverse the decision taken at a lower level only if that decision was incorrect on a point of law. What none of them is allowed to do is challenge anything the FTT found to be a question of fact.
A significant part of the Supreme Court’s judgement is devoted to pointing out this basic premise, and its relevance to the earlier decisions against Mr Anson in both the UT and the CoA. Both of those bodies mistook a finding of fact by the FTT to be a judgement on a point of law. Re-adjudicating that supposed ‘point of law’ was fundamental to the decisions then reached by both bodies against Mr Anson. So the Supreme Court took the facts established at the FTT and asked whether the FTT had correctly applied the law to those facts. It found that the FTT had performed that task correctly and Mr Anson is able to credit the US tax attributable to his share of the LLC’s profits.
Applying the US/UK Tax Treaty To The Facts As Determined By The FTT
In the case of a UK Resident person, Article 23(2)(a) of the US/UK Tax Treaty obliges the UK to give a credit for US Federal Income Tax provided that the income taxed in the UK is the same as that taxed in the US.
The HMRC argument throughout had been that since the business of the LLC was carried on by the LLC itself, then the profits generated by that business belonged to the LLC. Under that view, Mr Anson received a distribution from the LLC’s profits. To qualify for a credit, Mr Anson needed an entitlement to profits as they arose, rather than a later transfer of profits which had already vested in the LLC.
Unfortunately for HMRC, the FTT had established as a matter of fact that the members of this particular LLC did have an entitlement to profits as they arose. That is clear from reading the FTT’s decision, in particular the distinction made between profits arising to the members and assets held by the LLC prior to it then paying over members’ profit entitlements. However, that particular line in the sand was not recognised again until the matter came before the Supreme Court. At the UT and CoA, argument was based on the premise that the FTT had found on a point of English law as opposed having made a finding of fact in a matter of foreign law.
In establishing this particular matter of fact, the FTT received expert evidence on Delaware State Law. That testimony covered both the Delaware LLC Act and the meaning of particular parts of the LLC Agreement involved. In the case of this LLC, it was a combination of sections 18-101(8) and 18-503 of the Delaware LLC Act; together with the wording of articles IV & V of the LLC Agreement which caused all profits to belong to the members as and when any profits arose. So “article IV allocated the profit to members as it arose and article V required payment to be made.”
Article IV of the LLC Agreement dealt with the members’ capital accounts. The key provision in article IV which led the FTT to establish the factual situation under Delaware Law provided that:
“…all gross income and gains… realized during the period in question…shall…be credited, and all losses, deductions and expenses…during the period in question…shall…be debited, to the respective capital accounts of the members’ pro-rata.”
Article V set out provisions relating to distributions and provided that:
“Subject to the provisions of this article V, to the extent cash is available, distributions of all of the excess of income and gains over losses, deductions and expenses allocated in accordance with section 4.2 with respect to any calendar year will be made by the company at such time within seventy-five (75) days following the end of such calendar year and in such amounts as the managing members may determine in their sole discretion. The managing members may from time to time in their discretion make additional distributions in accordance with the provisions of this article V.”
Included in the facts summarised by the Supreme Court was a summary of how the LLC applied articles IV & V in practice. During each calendar year, all the LLC’s income and gains were credited quarterly to members’ capital accounts in accordance with section 4.2. All losses, deductions and expenses were similarly debited. Thus, in accordance with section 4.2 net profits were distributed to members on a quarterly basis, in arrears, in accordance with section 5.1, on the basis of the ratios set out in the LLC agreement.
Broad Or Narrow Implications?
Mr Anson was resident but not domiciled in the UK for the tax years in question. Some reports of the Supreme Court’s decision have been headlined as if this matter was an issue only of interest to non-UK domiciled individuals. That would be an incorrect conclusion. The Supreme Court’s decision is of relevance to any person resident in the UK who is a member of a US LLC.
Despite that wide relevance, the Supreme Court’s decision only sets a firm precedent for members of those Delaware LLCs with similar profit allocation clauses in the LLC Agreement to those in the LLC of which Mr Anson was a member.
- Although the provisions contained in sections 18-101(8) and 18-503 of the Delaware LLC Act are important in establishing that profits are allocated to LLC members as those profits arise, the finding of fact in the FTT was based on a combination of the effect in Delaware law of those statutory measures in combination with provisions in the LLC Agreement. In determining whether the Anson case sets a precedent applicable to them, members of Delaware LLCs will need to examine whether their own LLP Agreement compliments or dilutes the statutory provisions concerning profit entitlement.
- The finding of fact at the FTT was only concerned with determining the position of a member of a Delaware LLP under Delaware State Law. LLCs can be formed in a number of individual States in the US. When a member of a non-Delaware LLC completes their next self-assessment tax return in the UK, it will be necessary to ask if the State Law in question operates in a broadly similar way to Delaware in giving a profit entitlement to the LLC’s members, as those profits arise. As in the FTT’s analysis, that question needs to be considered via the twin prongs of statute and operation under State law of the LLC Agreement.
Are Shareholders In US S Corporations Impacted?
The Supreme Court’s decision has no relevance to UK residents who are shareholders in US S Corporations.
The US taxes S Corporation shareholders in broadly the same way as it does LLC members such as Mr Anson. However, there is a fundamental difference between the two for purposes of the UK tax analysis. A US S Corporation is no more than an ordinary body corporate, incorporated under the law of a particular state, where the shareholders have made an election under the US Internal Revenue Code that corporate tax will not be paid on the entity’s profits. Instead, the shareholders will mimic being members of a partnership and each pay individual taxes on their pro-rata shares of the corporation’s profits. This election is effective for purposes of the US Federal Income Tax. However, State Law applicable in the place of incorporation does not provide shareholders with an automatic entitlement to profits of the business as those profits arise.
Entity Classification For UK Tax Purposes
Before this matter came to the Supreme Court, there was much learned discussion at the lower levels on the question of entity classification for UK tax purposes. That subject is covered by HMRC guidance augmenting the landmark CoA decision in Memec. There had been anticipation that the Supreme Court might provide some additional guidance on application of the principles established in Memec.
Classification rules determine whether a particular non-UK entity is transparent or opaque for UK purposes. Transparent entities are not taxable in themselves. Instead the income, as in a partnership, flows through to the individual members. In contrast an opaque entity is itself taxable, like a UK company, and no income automatically flows through to the participants. HMRC guidance was that each US LLC should be looked at on its own merits, but with the rider that all the examples which HMRC had ever seen were opaque.
In the event, the Supreme Court had relatively little to say on this subject, because the finding of fact by the FTT rendered a detailed analysis superfluous. Nevertheless, there were some useful observations:
- If instead of Mr Anson, the taxpayer had been Anson plc (a UK resident company) owning more than 10% of the voting power of the LLC, a different question might arise under the US/UK Tax Treaty. Should the LLC have US subsidiaries which pay dividends to the LLC, Article 23(2)(b) of the US/UK Treaty offers the possibility of relief from UK Corporation Tax in respect of underlying tax paid by those US subsidiaries. However, that relief would only be available to the hypothetical Anson plc if the LLC was judged to be transparent under the Memec principles.
- So in the case of a LLC, entity classification (transparent v opaque) is only relevant in relation to whether receipts (e.g. dividends) from third parties are to be regarded for UK tax purposes as paid direct from those third parties to members.
Will HMRC Guidance Change?
In the main the answer is probably NO.
Clearly there will need to be some public recognition by HMRC of the fact pattern which the Supreme Court has now said results in the availability of credit for US taxes under the US/UK Tax Treaty. However, as indicated above, the decision in Anson has only narrow direct applicability to other taxpayers. It is doubtful that HMRC have either the available manpower or the inclination to embark on any meaningful post-Anson revision of their guidance. Expect the party line to remain that each US LLC must be analysed on the basis of its own facts and circumstances, but with the addition that a LLC with all the characteristics of Mr Anson’s LLC does get the same Treaty result which the Supreme Court afforded to Mr Anson. Even in the absence of any suggestion on the HMRC website to do so, any such analysis should involve advice taken from an appropriate expert in the relevant State Law.
- The Supreme Court has issued its own Press Release on the Anson case. It can be found here.
- The full report, which runs to thirty eight pages is here.
To discuss this matter in more details, or if you have any questions, please contact your Frank Hirth adviser.