UK: UK Tax Treatment of US Hybrid Entities

Last Updated: 7 July 2010
Article by Catherine Ramsay


Two recent cases have considered the availability of double taxation relief in the UK in circumstances involving US hybrid entities. 

In Swift UK v HMRC1, the Tribunal considered whether a US LLC was an opaque or transparent entity for UK tax purposes and therefore whether a UK resident member of the LLC could obtain double tax relief for US tax paid on his share of the profits.  The Tribunal held, contradicting HMRC's established practice, that the LLC was transparent for UK tax purposes as it is more akin to a partnership than a company.  This will be a concern, for example, to UK taxpayers with direct or indirect interests in LLCs.

In Bayfine UK v HMRC2, a claim was successfully made to credit US taxes against a UK company's tax liability where such taxes arose on the same income in the company's US parent as a result of the UK company being treated as transparent for US tax purposes following a "check the box" election.  The case looked at the analysis of the US tax treaty and unilateral tax relief under UK law for a circumstance which had not been envisaged by the treaty or UK legislation.


HMRC general practice follows the principles in Memec plc v CIR3. Pursuant to this case, in determining whether an entity is transparent or opaque and HMRC will follow the guidelines set out in its manuals and previous Tax Bulletins.

In particular, the following matters should be considered under the relevant local commercial law:

  1. Does the foreign entity have a legal existence separate from that of the persons who have an interest in it?
  2. Does the entity issue share capital or something else, which serves the same function as share capital?
  3. Is the business carried on by the entity itself or jointly by the persons who have an interest in it that is separate and distinct from the entity?
  4. Are the persons who have an interest in the entity entitled to share in its profits as they arise; or does the amount of profits to which they are entitled depend on a decision of the entity or its members, after the period in which the profits have arisen, to make a distribution of its profits?
  5. Who is responsible for debts incurred as a result of the carrying on of the business: the entity or the persons who have an interest in it?
  6. Do the assets used for carrying on the business belong beneficially to the entity or to the persons who have an interest in it?

Particular attention is paid to factors c. and d.

HMRC have a list of foreign entities which they have considered to be transparent or opaque, which includes a US LLC as opaque – however they are at pains to point out that for any particular entity the classification will depend on the specific facts including the details of its constitutional documents.

Swift is a decision of the first tier tax tribunal concerning the UK tax treatment of an LLC. The facts were that a UK resident taxpayer was a member of a US Delaware LLC ("SPLCC"). SPLCC paid distributions (net of US tax already paid) to the taxpayer in the UK. The taxpayer reported such income as gross partnership income in his UK income tax returns and claimed relief under the US/UK double tax treaty (the "Treaty") on the basis he was liable to tax in the UK on the same share of profits of SPLCC that were taxed in the US and that SPLCC was a transparent entity in both the US and the UK.

For US tax purposes, SPLCC was classified as a partnership (a transparent entity) and therefore its members, rather than SPLCC itself, were liable to US tax on their share of the profits of SPLCC regardless of whether such profits were distributed to the members.

For UK tax purposes, SPLCC was treated as a corporate (and therefore opaque) entity and therefore a profit distribution to the UK taxpayer was the equivalent of a dividend.

HMRC therefore contended that the UK taxpayer was not entitled to relief for the US tax paid as SPLCC was classified as an opaque entity for UK tax purposes, so the US tax arose in SPLCC, whereas for UK tax purposes the tax liability was that of the member of the LLP.  Therefore the taxpayer did not have a US tax liability to credit against his UK tax liability.

As set out above, the key to deciding whether US and UK tax had been computed by reference to the same income was in considering whether the profits of SPLCC belonged either to the members as it arose (hence SPLCC was transparent in nature and Treaty relief would be available) or the income was more similar in nature to dividends (hence SPLCC was opaque and HMRC were correct to deny Treaty relief).

In deciding whether SPLCC was transparent or opaque, the Tribunal referred to HMRC Tax Bulletin 39 and the categorisation of foreign entities as transparent or opaque. It was agreed that SPLCC was a legal entity, that it carried on its own business, that the business beneficially belonged to SPLCC and not the members and that SPLCC was responsible for any debts incurred as a result of carrying on the business. In dispute were whether SPLCC had share capital or something else that served the same function and whether the members had an interest in the profits as they arose (as discussed above).

In respect of profit distributions, there was some debate as to whether distributions by the LLC were discretionary or mandatory because the LLC agreement was ambiguous in this respect.  The Tribunal looked at the Delaware LLC Act which states that profits and losses are allocated amongst the partners and determined that the members were therefore beneficially entitled to the profits as they arose even though they are not entitled to the assets representing those profits until distributed.   Conceptually this is difficult to understand and is likely to be the subject of further debate on appeal.

'Share capital' is not a term used in relation to the LLC. A Delaware LLC interest is defined as being "a member's share of the profits and losses of a limited liability company and a member's right to receive distributions of the limited liability company's assets". SPLCC's operating agreement broadly provided that a member's interest was not assignable other than with the consent of the other members or on death. Even then the assignee did not become a member and it was only entitled to the economic benefit of the interest.

It was held in this case that a membership interest in SPLCC was not similar to share capital and is not "issued". It more closely resembled that of a partnership interest, where transfer of partnership capital requires the consent of the other partners, as opposed to a UK company where shares are usually transferable and if there are restrictions, it is normally limited to director consent only.

The Tribunal therefore held that SPLCC was a transparent entity for UK tax purposes, being somewhere between a Scottish Limited Partnership and a UK Company but being closer in nature to a partnership.

Although not necessary (as the court decided that the LLC was opaque) the Court also determined that if the LLC were opaque, the taxpayer could not rely upon section 739 ICTA applying to treat the LLC's income as his own in order to obtain DTR.  Section 739 was not relevant as there was no tax avoidance motive.

The case is to be appealed and HMRC is maintaining its previous practice of treating LLCs as opaque for UK tax purposes.


Bayfine was an appeal in the High Court of a decision of the Special Commissioners concerning a US parent company which was taxed in the US on the profits of its wholly owned UK subsidiary. It provides an interpretation of the UK rules on unilateral relief and the UK/US double tax treaty in the context of UK tax resident companies that are disregarded for US tax purposes.

The facts of the case concerned the Morgan Stanley Group entering into financial transactions in 2000 whereby two of its UK subsidiaries (one of which was Bayfine UK Limited - "Bayfine") entered into transactions resulting in a loss in one of the UK companies and an equivalent gain in the other. The transactions had no commercial purpose, but the effect was to create two losses which could be set against other profits within the Group, a capital loss in the US and an income loss in the UK.

Bayfine recognised a profit on its particular transaction with its US parent and this formed part of the overall non-trading profit to which Bayfine was liable to UK corporation tax. The US parent was subject to US federal income tax on the profits of Bayfine under the US "Check the Box" Regulations which treated Bayfine as transparent for US tax purposes.

Bayfine appealed against the original decision that US tax only arose due to the fact that the "Check the Box" Regulations disregarded Bayfine for US Federal income tax purposes and that this was the only reason the US parent was taxed and not because the income was US source. 

Bayfine claimed Treaty relief against the tax due on its UK profits for the US federal income tax paid by its US parent. Hence Bayfine declared no further tax was payable in the UK.

The usual scenario in these cases is that tax is both paid and payable by the same entity in both jurisdictions.  The difference in this case was that "Check the Box" Regulations meant that two different entities were taxed on the same profits. The Treaty was silent on what to do in this circumstance and it conferred the right to both the UK and US to tax Bayfine's profits.

It was held (overturning the decision of the Commissioners) that:

  1. unilateral relief under section 790 Income and Corporation Taxes Act 1988 ("ICTA") would apply to the extent that treaty relief did not apply.  Specifically under section 790(4) ICTA unilateral relief applies to tax in a territory outside the UK on "income arising or any chargeable gain accruing in that territory".  The profits were clearly made in the US (the financial transaction had taken place on US soil, the parent company was US resident and it related to US situs assets) and that as such Bayfine paid US tax and would be entitled to credit this against the UK taxation on these profits under s790.  Whilst the profits were taxed on different entities, it was held to be irrelevant which entity actually pays the tax as it is the same profit being taxed in both jurisdictions.
  2. the treaty was silent on the situation where different entities were paying tax on the same profit.  In the end it was decided that provided the "tax is properly paid first in the US (which had in fact occurred) treaty relief would be available in the UK for the US tax.   The order in which the tax is paid and credited is the deciding factor on which jurisdiction can claim the tax credit in this circumstance.  Therefore, if UK tax had been properly paid first, it would have been creditable against the US tax.

The Court in this case reached a pragmatic solution as to which country should have the primary taxing right.  However, it does seem rather arbitrary to base this on time of payment.  Whilst this is potentially an unusual fact pattern, it would seem logical to deal with such situations in a more scientific way and specifically deal with double tax relief on the same profits arising in different entities in both local legislation and double tax treaties.


1.  [2010] SFTD 553

2.  [2010] EWHC 609 (Ch)

3. 70 TC 77

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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