Print article
Article:
Good news for our internationally mobile clients, as the UK Government is moving forward with its plans to address the double taxation faced by UK-resident individuals with interests in “reverse hybrids”.
A reverse hybrid for cross-border tax purposes is an entity which is treated as transparent in the country where it is established, but as non-transparent or opaque elsewhere (the reverse of a “hybrid” entity, which is treated as non-transparent in the country where it is established, but as transparent for foreign tax purposes).
US LLCs, Jersey LLCs and French SCIs are all reverse hybrids for these purposes.
The current issue
At present, UK resident individuals with interests in US LLCs and other reverse hybrid entities can face unexpectedly high effective tax rates where the UK and another jurisdiction classify the same entity differently.
For example, a US LLC is typically treated as transparent for US tax purposes, meaning that an individual member is taxed in the US on their share of the LLC’s underlying income or gains as they arise, whether or not these amounts have been distributed.
For UK purposes, the same US LLC is often treated as opaque, meaning the UK will only tax the individual when a distribution is received.
This results in timing and character mismatches with the US. The two countries tax different amounts at a different time and on a different legal basis, meaning that no relief is available under the US-UK income tax treaty, resulting in double taxation and high effective tax rates.
For US nationals, green card holders and British expats this means that LLCs need reviewing and often restructuring before they move to the UK.
A new credit-based relief mechanism
Following consultation, the UK Government has announced its intention to introduce a new domestic foreign tax credit mechanism to alleviate this tax mismatch.
Under the current proposal, individual members of eligible reverse hybrid entities would be able to elect for “eligible foreign tax” paid by them on the entity’s profits, to be credited against the UK income tax due (at the appliable dividend rate) when those profits are distributed. Eligible foreign taxes are expected to include federal, state and local taxes, which for US structures is potentially a very valuable credit.
The government notes that this proposal will not change an entity’s potential exposure to UK corporation tax under the usual rules – a common issue where the central management and control of an LLC is found to be taking place in the UK, resulting in a UK resident structure.
There will be a further consultation to confirm the finer details of the relief mechanism, with legislation to appear in a future Finance Bill. It is suggested that claims for the new credit will only be possible from early 2028. While the delay may be disappointing for existing UK resident US persons, there’s some good news in that the Government is also considering “practical options” relating to historic periods and ongoing claims.
While we welcome the government’s positive intentions, the devil remains in the detail. At this stage there is no clarity how these proposals will affect LLCs held within trust structures or other corporate structures. It is also not clear whether the government intends to include capital gains within the credit mechanism.
If you or your client has an interest in or a structure involving a US LLC, Jersey LLC or a French SCI, please do get in touch for advice on how this change in approach is likely to affect your tax and estate planning.