US Business Structures Can Create UK Tax Mismatch for Investors

Following the UK government’s decision to abolish the non-domiciled, or non-dom, regime—and against a backdrop of heightened competition for internationally mobile capital—Chancellor Rachel Reeves has been keen to reaffirm the UK’s position as “open for business” for global high-net-worth individuals.

Part of that agenda involves reviewing areas of the UK tax system that can produce economic double taxation for UK residents with US-source income and structures. A more navigable regime for internationally mobile entrepreneurs, investors and executives is welcome; the challenge is to deliver a solution that is technically coherent, targeted and administrable.

For internationally mobile HNWIs, clarity and certainty are paramount: They need confidence that the rules are intelligible, stable and—crucially—produce outcomes that are broadly fair over the long term.

Government tax changes have made clear that the UK expects wealthy internationally mobile residents, including those previously within the non-dom regime, to pay more UK tax. For some, that has prompted a reassessment of whether the UK remains the right long-term base for them and their families.

Pitfalls for Taxpayers

Although the UK and the US have a double taxation treaty intended to mitigate the risk of tax being paid twice on the same income, classification and timing mismatches can still produce punitive outcomes. The treatment of earnings from US limited liability companies has long been problematic for some UK-resident taxpayers.

UK-resident taxpayers may become members of a US LLC for commercially sound, but typically US-focused, reasons. The issue can affect both non-US individuals investing into US businesses and US citizens/green card holders living in the UK (for whom the overall compliance and cash-flow profile is often more complex).

LLCs are generally treated as tax-transparent in the US (broadly, like partnerships), so members are taxed in the US on their share of the underlying profits as they arise. In the UK, however, an LLC is often treated as a company (that is, opaque)—the position is fact-specific, but this outcome is common. So the member is taxed when value is extracted, typically on distributions (often analyzed as dividend income).

This classification mismatch commonly denies foreign tax credit relief because, in broad terms, UK credit relief and treaty mechanisms generally require the foreign tax to relate to the same income and the same period as the UK tax charge. The outcome can be double US-UK taxation: US tax on profits as they arise in the LLC and then UK tax on distributions when made, with no credit for the US tax already paid.

This can produce very high effective tax rates overall (in some cases more than 60%), which sits uneasily with the double tax treaty’s underlying purpose.

Equally, in some cases the UK’s opaque treatment of an LLC can operate as a “blocker” or deferral feature, which may be desirable in certain structures. It’s therefore not surprising that views on changes may be mixed.

Addressing the tax treatment mismatch. Tax changes invariably create winners and losers. If the government wants the UK to appear more appealing to internationally mobile HNWIs, it is vital that responses to the consultation are reflected in a workable regime—one that addresses genuine double taxation without undermining legitimate, long-standing commercial structures.

One option would be targeted changes to the UK-US double taxation treaty (or its associated protocols) so that where UK tax is levied on LLC distributions that economically represent profits previously taxed in the US, appropriate credit relief can be given.

Practically, this could be achieved by deeming (for treaty-credit purposes) a distribution to carry underlying profits that have already borne US tax, and by treating the relevant US tax as paid in respect of the same income and period as the UK charge on the distribution (thereby aligning timing). This may be preferable to attempting to override settled UK case law on entity classification, which could create wider uncertainty and unintended consequences.

Wider Concerns

A considered review to address the unfairness arising from the mismatch is likely to be welcomed by both US and UK taxpayers. However, it remains less certain whether measures focused on this issue alone will be sufficient to persuade wealthy individuals to remain in—or relocate to—the UK.

If the policy objective is to encourage internationally mobile capital and talent, the government may need to go further than resolving the LLC mismatch.

For many in the former non-dom population, wider concerns include the breadth of UK taxation on worldwide income and gains, the interaction with transitional and anti-avoidance rules, and (in particular) the extension of exposure to UK inheritance tax on worldwide assets after a period of UK residence.

Measures outside the tax code, such as immigration policy and investment routes, also form part of the overall attractiveness of the UK as a long-term base.

Clarity, certainty and confidence, are vital. Addressing the UK-US LLC mismatch would be a meaningful improvement. But unless the wider package gives individuals and families sufficient certainty over their prospective UK tax exposure, including on income, gains and succession, many HNWIs will continue to view the UK as presenting an unacceptable level of fiscal risk.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

Lucy Woodward is a partner with Saffery, advising on all aspects of private client tax, with a focus on high-net-worth individuals and non-domiciled clients.

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