United States: Delaware LLCs - Entity Status For UK Tax Purposes: Further Update - Court Of Appeal Confirms Tax Opaque Status

Appeal by Taxpayer

The Court of Appeal decision of Lady Justice Arden in Revenue & Customs Commissioners v George Anson [2013] EWCA Civ 63 was published today (13 February 2013). The taxpayer, George Anson, appealed against the decision of the Upper Tribunal (UT) in Anson v Revenue & Customs Commissioners (FTC/39/2010), which held that, in reversing the earlier decision of the First Tier Tribunal (FTT) in Swift v Revenue & Customs Commissioners [2010] UKFTT 88 (TC), Mr. Anson's share of the profits in a Delaware LLC did not qualify for a UK tax credit under the US-UK double tax treaty because the relevant Delaware LLC was considered opaque, not transparent, for UK tax purposes. The principal reason for the UT's decision was that, under the terms of the governing LLC agreement, the profits were held not to belong to the LLC members, but to the LLC itself.

Decision of Court of Appeal

In dismissing the taxpayer's appeal, the Court of Appeal affirmed the UT's decision, holding that i) the relevant test for determining whether a person is taxed on the same profits in both jurisdictions is whether the source of the profits in each jurisdiction is the same; ii) where a taxpayer became entitled to the profits of an entity because of some contractual arrangement, he had to show that the contract was actually the source of the profit, rather than a mechanism to secure a right to profits derived from another source – in other words, he had to show a proprietary right to the profits; (iii) the UT was right to conclude that the FTT erred in law in holding that the LLC's profits belonged to the members; and (iv) the UT was also right to conclude on the facts of this case that the LLC's profits did not belong to its members.

The Court also refused to allow the taxpayer permission to rely on the UK/US Exchange of Notes of 24 July 2001 as evidence, since it did not add anything to support his case and it had not previously been raised by the UT.

Grounds for the Decision

In reaching its conclusion on the first two points, referring to the decisions in Memec plc v IRC (1998) 71 TC 77, the Court considered factors cited in that case which determined whether a member of an entity had a right to that entity's profits as they accrued, or whether that member had a contractual right to receive a share in those profits. The Court's main reasons were that, where an entity earns profits the source of which from a member's perspective is a contract as between him and other members, then it usually follows that the source of his income must be a different source of income from that of the entity itself.

On the third point, the Court indicated that the reason the FTT erred in law was because, in holding that a contractual entitlement to profits meant that the LLC's profits belonged to the members, the FTT misinterpreted the effect of the LLC agreement since they decided the question on English law rather than Delaware law principles. On the fourth point, the Court held that the LLC's profits did not in fact belong to its members because they were not entitled to the LLC's profits as they arose – the key reasons being that the profits arose from the LLC's trading as principal, and that certain deductions needed to be made from those profits (such as setting off any claims by the LLC against the member, or creating reserves to meet cash requirements) before allocating residual amounts to the members. The automatic allocation provisions of Article V of the LLC agreement did not entail a member's right to the LLC's profits as they arose, but rather an automatic right to a distribution of the LLC's profits.

Practical Consequences

The Court's decision has reconfirmed HMRC's published view of Delaware LLCs as tax opaque entities for UK tax purposes. Groups who have relied on this treatment for their own tax planning will welcome this decision. However, the terms of each LLC agreement will still need to be considered on case-by-case basis in deciding whether, as a matter of law, the LLC is opaque or transparent for UK tax purposes.

It is not yet known whether the taxpayer will appeal to the Supreme Court of England & Wales, but a further update will follow if and when this occurs.

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