UK government consults on reform to taxation of UK resident members of LLCs and other reverse hybrids

Why should I read this?

HMRC have published a consultation regarding potential reform to the taxation of UK resident individuals who are members of reverse hybrid entities, such US Limited Liability Companies (LLCs).

The consultation identifies that high effective tax rates may arise for UK resident individuals who are members of reverse hybrids such as LLCs, and seeks to understand the effect of this issue on individuals and businesses and on how they structure their affairs.

The consultation requests views on proposals to mitigate the issue, primarily a proposal to treat entities (including LLCs) which are treated as tax transparent in their jurisdiction of establishment, as transparent for the purposes of the UK taxation of UK resident individuals. The consultation does not represent an intention to change the position for corporates.

The consultation does not indicate when the new regime will come into effect.

Affected stakeholders should consider the consultation proposals and respond by 31 July 2026.

What issue does the consultation seek to address?

Entities may be classified as either ‘transparent’ or ‘opaque’ for the tax purposes of a specific jurisdiction. If an entity is transparent, it is not itself subject to taxation on business profits, income or gains. These are instead chargeable on the members of the entity, even where undistributed. By contrast, if an entity is opaque, it is itself subject to tax on business profits, income and gains. Members will be taxed on dividends and other distributions that are made to them.

High effective tax rates can often arise for UK resident individual members of reverse hybrids (where an entity is transparent in its jurisdiction of establishment but opaque in the UK). This occurs because the member is charged to tax on a different basis in the UK and the foreign jurisdiction, which prevents the UK and the other jurisdiction from providing treaty or unilateral relief from double taxation.

For example, US LLCs will generally be taxed transparently in the US unless a ‘check-the-box’ entity classification election has been made with the Internal Revenue Service, whereby the LLC specifically elects to be taxed as an opaque corporation. By contrast, HMRC has historically taken the view that most US LLCs are opaque entities for UK tax purposes (although this position is not without uncertainty, in particular following the 2015 Supreme Court case of Anson, in which it was held that the Delaware LLC under consideration should be treated as transparent for UK tax purposes). US LLCs are therefore a common example of a reverse hybrid entity, taxed transparently in the US and opaquely in the UK.

The result of the different views on the opacity of LLCs is that individual members of an LLC who are tax resident in the UK can face both uncertainty as to the correct treatment and a high effective tax rate (the consultation refers to a rate potentially as high as 75%), because they are chargeable directly on profits, income and gains as these arise in the US, and taxable again in the UK on any distributions of the LLC’s pre-tax profits. These tax charges are made on a different basis (at least in HMRC’s view), preventing the provisions of the UK/USA Double Taxation Convention from providing double taxation relief.

The UK government have stated their commitment to removing this barrier to relocating into the UK and finding a solution which is effective and robust in providing a fair outcome with long-term certainty.

What are the consultation proposals?

After setting out questions which seek to understand the impact of the issue, the consultation seeks views on proposals for reform.

The consultation’s main proposal is the introduction of legislation to allow UK resident individual members in specific eligible reverse hybrids to treat their holding on a transparent basis for the purposes of UK income tax and capital gains tax. No equivalent legislation would be introduced for UK resident corporates.

This proposal would mean that:

• individual members are charged to UK tax on the underlying profits, income and gains of the foreign entity in a way that matches the tax treatment in the relevant foreign jurisdiction;

• individuals would not be chargeable to income tax on distributions from the entity;

• individuals would therefore have more certainty over their UK tax and the extent to which double taxation relief would be available; and

• the effective tax rate on the income of these individuals would reduce to the higher of the domestic effective tax rates applicable to the individual in each state.

The details of this proposal may be summarised as follows.

• Scope – The proposed scope would be those foreign entities which are taxed on a transparent basis in their jurisdiction of establishment, but which are treated as opaque for UK tax purposes. The proposed treatment would be limited to holdings in those entities which are not themselves resident in the UK (or considered resident by any other foreign jurisdiction), or trading in the UK via a permanent establishment. The treatment would not be limited to holdings of any specific size or to eligible entities with a specific number of members.

• Implementation – Transparent UK tax treatment would apply prospectively for tax years following the date of introduction of new legislation.

• Application – UK resident individual members of a foreign entity meeting the eligibility conditions would automatically receive matching transparent treatment for UK tax purposes. If the foreign entity began to be taxed on an opaque basis in its home jurisdiction, it would cease to be an eligible entity and transparent UK treatment would cease to apply to UK individual members.

• Taxation of profits – Individual members of an eligible foreign entity would be deemed to be carrying on any trade or business of the entity in partnership (or as a sole trader for single member entities). This would bring the member’s share of profits into charge, allow relief for their share of losses, and give access to allowances and reliefs. A member’s share of profits and losses would be computed using UK income tax rules.

• Taxation of investment income – Individual members would be deemed to have such proportion of the beneficial ownership of the entity’s assets as corresponds to their proportional membership interest in the entity. This would allow for the attribution of a proportion of investment income (interest, dividends, royalties) to the member. A member’s tax liability with respect to investment income would be computed using UK income tax rules.

• Disposal of assets – The attribution of asset ownership described above would allow for the calculation of capital gains in line with the partnership principles in HMRC’s Statement of Practice D12. Individual members would be treated as owning a fractional share of each of the entity’s assets and not as owning an interest in the entity itself.

Upon a disposal of an asset, members would be treated as disposing of their fractional share of the asset, with proceeds allocated to members in the ratio of their interests in the entity (or in accordance with specific different ownership ratios set out in the entity’s constitutional documents, for example, its operating agreement). A member’s capital gain or loss would be computed using UK capital gains tax rules.

The consultation also seeks views on the following proposals for alternative forms of relief.

• Deduction for foreign tax – For example, where a UK resident individual member of an eligible foreign entity is chargeable to UK income tax on distributions from the entity, the UK tax could be calculated on the distributions net of foreign tax already paid by the individual on the distributed profits.
• Credit for foreign tax – A form of credit could be provided for foreign tax on underlying profits against an individual’s UK income tax on distributions, to reduce the overall effective tax rate applicable to that individual’s income from an eligible entity.

Finally, the consultation seeks feedback regarding stakeholders’ experiences of equivalent rules applied by other jurisdictions, and asks general questions including whether the UK government should consider any other options or ideas for reforming the taxation of individual members of reverse hybrids.

What else do I need to know about the consultation proposals?

At present, the conflict between the 2015 Supreme Court judgment in Anson, which found a Delaware LLC to be transparent for UK tax purposes, and HMRC’s view that such LLCs are generally opaque for UK tax purposes, causes a significant amount of uncertainty for UK resident individuals. Filing their UK tax return in accordance with Anson puts taxpayers at risk of an HMRC enquiry, while filing on the basis of HMRC’s approach may result in significant double taxation.

HMRC’s recognition of the issues caused by the UK tax treatment of reverse hybrids including LLCs is a significant and positive development. The proposed new regime will hopefully provide clarity to affected UK resident individuals, reducing high effective tax rates in respect of membership of reverse hybrids, and removing a barrier to globally mobile individuals (including US citizens holding interests in LLCs) coming to the UK (or even an incentive for existing UK residents to leave the UK).

At present, the consultation leaves certain questions unanswered. For example, prior to the introduction of the new regime, taxpayers may have relied on HMRC’s guidance and treated an LLC as opaque for UK tax purposes. Equally, a taxpayer may have open HMRC enquiries in respect of tax returns in which they have sought to rely on Anson and treat an LLC as transparent for UK tax purposes. The consultation states that transparent UK tax treatment will be ‘prospective’, but it does not otherwise indicate how historic periods will be dealt with, or provide detailed proposals in relation to transitional rules when tax treatment switches from opaque to transparent. These issues will need to be carefully addressed as the proposals are developed.

It is helpful that the government is consulting with stakeholders at an early stage, which will hopefully mean that the eventual legislation is effective and aligned to the needs of affected taxpayers.

Stakeholders should respond to the consultation and carefully consider any resulting draft legislation.

For more information on this consultation

If you would like to discuss the implications of the proposed reform of the taxation of UK resident members of LLCs and other reverse hybrids, please do not hesitate to get in touch with any of the Eversheds Sutherland contacts listed below.