When tax systems collide: Why the UK is rethinking LLCs

When Rachel Reeves announced that the government will consult on the UK tax treatment of US LLCs, it may not have grabbed headlines. But for those who hold investments via these vehicles, it’s a significant development. This is an issue we see time and again, particularly for individuals moving to the UK, and it can lead to double taxation, restricted relief and ultimately a higher tax bill.

At its core, the problem is simple. The UK and US often don’t agree on how an LLC should be treated for tax purposes. The US typically treats LLCs as transparent, like a partnership, taxing profits in the hands of members as they arise. In contrast, the UK often treats them as opaque, like a corporate entity, taxing shareholders only when income is distributed. That difference might sound technical, but in practice it can produce materially adverse outcomes.

What’s been announced and why it matters

The government has confirmed that it will consult on the UK tax treatment of LLCs. That reflects a growing recognition that the current rules don’t always work in practice. They can create mismatches in how and when income is taxed, make it harder to access foreign tax credits and risk putting the UK at a disadvantage when it comes to attracting internationally mobile individuals and capital.

This isn’t just a technical tidy up. It’s a response to a structural issue that’s been sitting in the background for years, and a clear signal that change may be coming.

The starting point: Anson and the UK approach

Any discussion of LLCs from a UK perspective starts with Anson v HMRC (2015). In that case, the court considered whether a US LLC should be treated as transparent for UK tax purposes. The key question was whether the member had a direct right to the profits as they arose, rather than simply a right to receive distributions.

On the facts, the court concluded that he did. That meant the profits were taxed as they arose, aligning the UK position with the US and allowing credit for US tax paid. The important takeaway is that the UK doesn’t just follow labels. It looks at the underlying legal reality.

In practice, that comes down to whether the member has a real and enforceable right to profits as they arise, whether those profits are automatically allocated and whether entitlement depends on a formal distribution process. Many structures don’t meet that threshold, which is why LLCs are still often treated as opaque in the UK.

Where the problems arise

The issue isn’t just that the UK and US take different views. It’s that those differences can mean the same profits are taxed twice, without full relief.

There are two key drivers.

The first is the nature of the income. In the US, because the LLC is transparent, members are taxed on the underlying returns as they arise, and those returns keep their character. Capital gains are taxed as capital gains, interest as interest and dividends as dividends. However, in the UK, if the structure is treated as opaque, any amounts distributed to shareholders are typically treated as dividend income, regardless of their underlying nature. 

The second is timing. The US taxes profits in the hands of members as they arise. The UK, where the structure is treated as opaque, taxes shareholders when the post-tax profits are distributed. That misalignment can make it very difficult to match the income and the tax, which in turn can restrict the availability of foreign tax credits.

Put those together and you’ve got a situation where double tax relief doesn’t always do what it’s supposed to do.

A practical example

Take a US individual now living in the UK who holds investments through a US LLC. The investments generate $1million of returns in a year, comprising a mixture of interest, dividends and capital gains. 

The table below illustrates the position where the US taxes the underlying returns as they arise, and the UK subsequently taxes the same economic profits on distribution, but no credit is available for the US tax paid.
 

Note: US state and local taxes may also apply, which would increase the overall US tax burden.

What this highlights is the effect of the mismatch. The US taxes each component of the return based on its underlying character in the year it arises. The UK then taxes the same economic profits at a later point, typically as dividend income. Where the characterisation and timing do not align, foreign tax credits may be restricted or unavailable, with the result that the same return is effectively taxed twice.

The outcome is a significantly higher effective tax rate.

What could change

Against that backdrop, it’s not surprising that the government is taking a closer look. While we don’t yet have the detail, the consultation suggests there could be moves towards better alignment. That could include clearer routes to treating LLCs as transparent or improvements to how double tax relief works in practice.

For many people, that would be a welcome shift.

How we can help

In the meantime, this is something we see regularly. Many of our clients have both US and UK connections and LLC structures are particularly common in private equity and venture capital.

The key is to get ahead of the issue. Reviewing both the current and potential future tax exposure allows taxpayers to consider alternative options. In almost all cases, it’s about structuring in a way that better aligns how and when income is taxed across both jurisdictions.

The UK’s new Foreign Income and Gains regime may also create opportunities for certain individuals who have recently arrived in the UK. Where the regime applies, it may be possible to undertaking restructuring without triggering an immediate UK tax charge, which can help manage some of the mismatches described above.

Takeaway

This is a classic example of what happens when two tax systems don’t line up. The outcomes can be unpredictable and, more importantly, expensive.

The UK’s review is a clear sign that change may be coming. Until then, understanding how these mismatches arise and addressing them early can make a material difference.