UK: The US LL.C Scam

Last Updated: 13 November 2001
Article by Cyrille Emery Esq

Most of us are used to browse the internet for the best advisers in the offshore industry and for the latest developments in tax planning in well regarded jurisdictions. I would advise most of you to perform those regular checks as the fight against tax evasion and money laundering is toughening in the wake of the attack of September 11th. This is a requirement if you have been caught up in what I could only term the Limited Liability Company Scam. Some may wonder what it may be about so let me explain in simple words the complexitiy of the US Tax administration.

A Limited Liability Company, for short LL.C, is an hybrid type of company that was offered initially in few States but is now spread across all America. Many US agents offer to incorporate such typ of company in a very short period of time (approximately 2 days up to a week) at very low price. The most sought after were the Delaware LL.Cs, Nevada‘s, Wyoming‘s..etc.

The advantage of such structure is that at State‘s level you may not pay any taxes and that you could avoid double taxation by opting for the "see through" regime under the "check the box " rule. Under this regime, the profit of the LL.C is not taxed at corporate level but in the hands of each member of the LL.C according to their contribution into the company. It was not long before such feature attracted some offshore tax planners that offered to incorporate LLCs on behalf of international clients.

The proposition they expanded was that if the members were living abroad, meaning being non resident alien under the IRS definition, and the LL.C not trading within the USA then no taxes were due at Federal level as well. Mind you they never exposed the theory that clearly and they just mentioned that there was ambiguous rules that would allow such plan to succeed. In any case it is up to clients to take appropriate legal and tax advice... One can see for whom such limitation is operating...The scheme is now so much widespread that it has acquired some sort of legitimacy even there in Europe. I must admit I had been nearly fooled in until my critical mind takes over...

Therefore I think it is time to protect unsuspecting clients from such scam. The proposition above is purely ignoring international tax treaties and international taxation issues as well as ignoring completely IRS tax rules with regards to the taxation of Non Resident Alien. I have been told that nevertheless no taxation would be possibly enforced as long as the profits of the LL.C are not repatriated in the USA and that members are non resident alien.. Such tactic of deceit falls short of the Qualified Intermediary Status that most countries have agreed upon with the US administration. The Qualified Intermediary Status,inter alia, forces any bank that have accounts that are owned by US interests to withhold tax at the NRA withholding rate of 30%(I would suggest to read the following IRS litterature to get acquainted with the QI status IRS Announcement 2000-48 and Rev. Proc 2000-12) The penalty for not doing so is somehow harsh as the bank may loose its banking licence; It would be an interesting test to see if banks are putting clients‘ interest or theirs first. On the other hands the client may loose the benefit of any treaty against double taxation (DTT) its country may have signed with the USA. It must be reminded here that withholding tax under tax treaty may be lower than the NRA withholding.

Under D.T.T rules may differ from general definition provided by the IRS and therefore clients wishing to acquire an LL.C for tax planning purpose should first refer to the treaty, if any, in force between the USA and their country of residence. By incorporating a company in the USA, you may fall within the definition of having a "centre of principal interest" or a "place of business" thus a US tax liable body. In your country of residence, you may have what is considered, under DTT, as US source income ,of course, you have declared such income in your home country! If you have not you are in big troubles, not only you loose the advantage of the treaty but also face the possibility of an exchange of information between the USA and your country of residence...Compound this with the fact that you have not filed within the United States and you will feel the nasty coldness of the tax inspectors both sides. To know your exact position with regards US taxation, one should read IRS publication 901 (revised April 2001) "Tax Treaties".

The rules to follow for incorporating in the USA are relatively straightforward. First you have to obtain a Tax Identification Number that replaces the Social Security Number used by US resident/national. With this number you can go and incorporate your company safely but the alledged tax advantage disappears. Then you will have to file in US income tax returns both at LL.C and members level. The LL.C is responsible for the withholding of tax and shall maintain forms W-8BEN Certificate of Foreign Status of Beneficial Owners. This will assist you in claiming for DTT better rate when filing form 1042-S. On the light of the above I would strongly suggest that any person that have bought an LL.C on the asumption that there is no tax liabilities in the US to clean up its act, preferably with the assistance of a good tax attorney or to cease trading with such vehicle.

This letter is intended as general information and does not constitute legal advice to rely upon. Circumstances may vary from each case and one should seek specific legal advice to its own case.

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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