Government consults on taxation of UK-resident members of reverse hybrids including US LLCs

HMRC published a consultation in June on reforming the taxation of UK-resident members of limited liability companies (LLCs) and other reverse hybrids, ahead of its 2026 tax update on measures to simplify, modernise and strengthen fairness in the tax system. 

The consultation addressed the proposed removal of double taxation for investments by UK-resident individuals in non-UK entities that are treated as tax transparent in their home jurisdiction but opaque in the UK. The government has stated that the reform is part of its agenda to develop the UK's position in competing for talented globally mobile individuals.

Policy proposal

The government is consulting on a proposal to introduce legislation to allow UK resident individuals that hold interests in specific non-UK entities to treat those interests as tax transparent in the UK such that there is no mismatch between the tax treatment in the UK and non-UK home jurisdiction. The consultation indicates that there will be no change for UK resident corporates. The consultation closed on 31 July; the government has stated no specific date for its response but publication will be in "due course".

Reform background 

Reverse hybrids are entities treated as tax transparent in their home jurisdiction, where members are taxed on an arising basis on income, profits and gains, but as opaque in another jurisdiction, where members are taxed on distributions. The most commonly seen example is a US LLC, which is treated for US federal tax purposes as either a partnership or a disregarded entity, so that its members are taxed on a flow-through basis unless a "check the box "election has been made.

Historically, HMRC has treated US LLCs as opaque bodies corporate for all UK tax purposes as set out in its International Manual's entity classification guidance. This is on the basis that HMRC's view has always been that LLCs have separate legal personality distinct from their members (despite the US viewing them as disregarded in some circumstances), conduct their own business and are responsible for the debts and assets of the business. HMRC's approach follows its view on the multi-factorial analysis derived from the Court of Appeal decision in Memec plc v IRC [1998] STC 754. For income tax and capital gains tax purposes, members are generally subject to UK tax on distributions made from the US LLC rather than profits, income and gains as they arise.

The Anson case

This position was challenged in the case of Anson v HMRC [2015], where the relevant Delaware LLC's operating agreement provided that the profits of the LLC belonged to its members as they arose and that those members became entitled to their share of those profits before any distribution. Relying heavily on the principles of the Vienna Convention on the Law of Treaties, the Supreme Court held that tax arose on the same profits of the relevant LLC. 

HMRC concluded that the Anson decision was specific to its facts and that it would not disturb taxpayers that had previously treated LLCs as opaque nor influence HMRC's determination of whether LLCs have ordinary share capital. In 2023, further guidance reaffirming this position was published in section INTM180050 of HMRC's International Manual.

The implication of the mismatch in tax treatment is that tax arises on two different bases in the two jurisdictions and double tax treaty relief is not available. This is because article 24(4)(a) of the UK-US double tax convention restricts credit given for US tax to UK tax "computed by reference to the same profits, income or chargeable gains by reference to which the US tax is computed". If the US has primary taxing rights, no UK tax credit will be available where the LLC is treated as opaque in the UK. The position is exacerbated when distributions are made to members of LLCs precisely to fund US tax liabilities which itself creates a UK tax liability.

Impact of proposals

The consultation recognises that the mismatch has created an unsatisfactory situation for UK-resident members of US LLCs that can in theory be subject to a penal combined effective tax rate in excess of 75%.

These individuals stand to benefit from any change of law in this area to match the tax treatment between relevant jurisdictions and eliminate the burden of double taxation on what may be economically the same return. The consultation proposes that legislation will be introduced to "allow" UK resident individuals to treat their holding on a transparent basis for the purposes of income tax and capital gains tax prospectively from the point of any change in law, suggesting that any change will be automatic rather than elective and that historic periods could still be disputed. 

For income tax purposes, individual members will be treated as carrying on the entity's trade in partnership, or as a sole trader where relevant). For capital gains tax, individual members will be treated as owning a fractional share of each asset following HMRC's Statement of Practice D12. Other potential options involve deducting foreign tax paid from the distribution before computing UK income tax, or allowing a credit in the UK for foreign tax on underlying profits.

The proposals offer the prospect of legislative certainty, at least in respect of future returns, in an area where taxpayers have been forced to make complex arguments to HMRC as to whether the principles of Anson should apply to specific factual circumstances, with no guarantee that HMRC will either apply the Supreme Court judgment or follow its own guidance.

Corporate members and other entities 

No impact is anticipated on other members of LLCs. The consultation envisages that no change of law will be made in respect of corporate members that will still continue to be treated as holding an interest in an opaque entity. 

This could pose conceptual difficulties for LLCs with a mixture of UK-resident individual and corporate members. Where the relevant reverse hybrid is trading by way of a UK permanent establishment or is otherwise UK resident, there will be no changes made. It is also unclear whether other entities, such as UK resident trusts, will be able to treat interests in US LLCs as tax transparent.

Next steps  

With the consultation closed on 31 July, the government response is now awaited. If the government decides to proceed with the proposals, it is likely that HMRC will subsequently publish a technical consultation on draft legislation. The timeline will depend on the outcome of the consultation process, the feedback received on the workability of the proposals, and future fiscal events.

Osborne Clarke comment

Overall, the consultation is a welcome development for UK-resident individuals holding interests in US LLCs and, we assume, other reverse hybrid entities. Uncertainties remain, however, in particular around the list of entities that will be subject to any legislative change outside US LLCs and how other members such as trusts will be taxed. Assuming that the government proceeds to legislate, this is likely to be good news for those individuals holding cross-border interests.