Framework Agreements: the customer contract model for technology service providers
In July 2015, the U.K. Supreme Court in Anson v Commissioners for HM Revenue & Customs  UKSC 44 held that a UK resident’s share of the profits in a Delaware limited liability company (“LLC”) qualifies for a UK tax credit under the 2001 Income and Capital Gains Tax Convention between the UK and US (“the Convention”) because the profits that were to be taxed in the UK were the same as those taxed in the US.
The Supreme Court's judgment reversed a February 2013 decision of the Court of Appeal (“CA”), which had unanimously upheld the August 2011 findings of the Upper Tribunal (Tax and Chancery Chamber) (“UT”) that under the terms of the LLC agreement, the profits belonged to the LLC itself and not to its members and therefore a UK tax credit was not available under the Convention because the UK and the US were not taxing the same income.
In response to the Supreme Court decision, HMRC published Brief 15 (2015) which stated that the finding was fact specific. Accordingly, HMRC will consider individuals claiming double tax relief and relying on the Anson decision on a case by case basis.
Mr Anson was resident but not domiciled in the UK and was claiming the remittance basis of taxation. This meant that he paid UK tax on his UK source income and capital gains and on any foreign income and gains that he remitted to the UK. He was not resident in the US, but was required to pay US tax on his US source income.
Mr Anson was a member of a Delaware LLC called HarbourVest Partners LLC (“HarbourVest”). In the US, taxpayers can arrange for an LLC to be treated as transparent for US tax purposes (similar to a partnership in the UK). The LLC has no tax liability itself, but the members pay tax on their share of the profit generated by the LLC. The source of the income in the US is therefore the trading profits of the LLC. In the UK, HMRC has treated LLCs as opaque for UK tax purposes, so the profits of the LLC belong to the LLC itself. Under the UK treatment of LLCs, when an LLC member receives income from the LLC, the source of the income is considered to be the distribution of profits from the LLC (rather than the trading profits themselves).
Mr Anson paid tax in the US at the rate of 45% on his share of the profits from HarbourVest. He remitted these funds to the UK and sought to claim relief from double taxation under the Convention. To obtain relief from double taxation under the Convention, it generally needs to be shown that the income in question would be taxed twice and is from the same source for the purpose of US and UK tax (Article 24(4) of the Convention). HMRC were of the view that in the UK the source of the income was a distribution of the profits of HarbourVest, while in the US the source of income was a share of the trading profits of HarbourVest. On the basis that this did not satisfy Article 24 (4) of the Convention, HMRC refused to grant Mr Anson relief from double taxation, meaning that the income remitted would be taxed again at a rate of 40% in the UK.
First tier tribunal decision (FTT)
The FTT found in favour of Mr Anson, holding that he was entitled to relief under the Convention on the basis that the profits of HarbourVest belonged to Mr Anson as they arose and therefore Mr Anson was taxed on the same income in both countries.
The UT reversed the decision of the FTT and held that double tax relief was not available under the Convention. Mr Anson did not have an interest in the profits of the LLC and the profits on which tax had been paid in the US were the profits of the LLC. Mr Anson was taxed on something different - his distributions from (or entitlement under) the LLC agreement. The Judge held that these were two different sources.
The CA decision
The CA upheld the UT's decision. It held that the relevant test was whether the source of Mr Anson’s income was the profits of HarbourVest or merely a distribution of its profits. To obtain relief under the Convention, Mr Anson would have to show that he had a proprietary right to the profits if HarbourVest was to be treated as transparent from an English law perspective. The CA considered that it would be difficult or unusual for an entity with a separate legal personality to be tax transparent for English law purposes.
The Supreme Court
The Supreme Court found that double taxation relief under the Convention should have been granted to Mr Anson. In its judgment, the Supreme Court criticised the CA’s focus on whether Mr Anson had a proprietary right to the profits of the HarbourVest as they arose, rather than the critical issue of whether the income taxed in the U.S. was the same as the income taxed in the U.K. It was stated that the income Mr Anson received in the US was his share of the profits and that income was liable to taxation under UK law to the extent that it was remitted to the UK. Mr Anson’s liability for taxation in the UK was therefore found to be calculated by reference to the same income as was taxed in the US.
HMRC Brief 15 (2015)
HMRC has stated that the Supreme Court decision is specific to the facts of the case. The reasons for this include the importance given by the court to the particular terms of the agreement made between the members of the LLC and the legislative framework in which the LLC operated, i.e. the Delaware Limited Liability Act.
HMRC states that ‘where US LLCs have been treated as companies within a group structure HMRC will continue to treat the US LLCs as companies, and where a US LLC has itself been treated as carrying on a trade or business, HMRC will continue to treat the US LLC as carrying on a trade or business’.
HMRC also proposes to continue its existing approach to determining whether a US LLC should be regarded as issuing share capital. HMRC’s existing approach is set out in the guidance on the Meaning of Ordinary Share Capital. This highlights section 18-702c of the Delaware Limited Liability Act which states that “a member's interest in a limited liability company may be evidenced by a certificate of limited liability company interest issued by the limited liability company”. HMRC suggests that if a Delaware LLC issues "shares" in this way and the other factors relating to the company suggest that it has share capital then it will accept that these “shares” may be regarded as "ordinary share capital".
Following HMRC’s statement, it is clear that they do not regard Anson as a case of general application.
However, HMRC’s approach appears to be a pragmatic one. It will generally continue to treat US LLC’s as opaque for tax purposes, which should be welcomed by those UK companies that are members of LLCs (partly because this means that the UK company will only be liable to UK corporation tax on profits of the LLC that are distributed, and not undistributed profits). Yet, HMRC has not closed the door on arguments that the LLC is transparent for tax purposes. This should be welcomed by individuals whose facts and circumstances are similar to Anson and who wish to claim double tax relief, albeit such relief will not follow automatically and taxpayers will need to be prepared to argue their case.
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