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USA Update continued Employers apply for the program by filing Form 8952, Application for Voluntary Classification Settlement Program. This form must be filed at least 60 days before the taxpayer wants to begin treating the workers as employees. Observation: The IRS has indicated that an employer which wants to begin treating a class or classes of workers as employees for the fourth quarter of 2011 may do so, but should file the Form 8952 as soon as possible. Additional VCP Consequences and Limitations In addition to filing Form 8952, employers which participate must sign a closing agreement with the IRS extending the statute of limitations from three years to six years for the first three calendar years beginning after the agreement is signed. The agreement also requires the taxpayer to treat the same class of workers as employees in the future. It should be noted that this Program only applies to employment taxes and does not address the impact of the reclassification of workers on the employer’s retirement plans and welfare plans (medical, dental, life, etc.). At this time, there does not appear to be any special relief for retirement and other benefit plans, so employers need to review the impact of any filing under the Program on the benefit plans they offer. Specifically for retirement plans, corrective contributions on behalf of misclassified workers and retesting of the plan’s coverage (required by regulation) for the years that workers were misclassified may be required. Insured benefits also should be discussed with an insurance agent. Observation for foreign investors: For a foreign business which has classified US individuals conducting US activities (perhaps incorrectly) as independent contractors, reclassifying them as employees may create a substantial risk of the foreign business being engaged in a US trade or business or having a permanent establishment in the US for US income tax purposes, resulting in increased US taxation. For more information please contact: Brent Lipschultz EisnerAmper LLP T: +1 212 949 8700 E: brent.lipschultz@eisneramper.com W: www.eisneramper.com The problems of US LLCs for non-US investors United States Limited Liability Companies (LLCs) are treated as transparent for US tax purposes unless an election is made to treat them as corporations. They have generally become the preferred way for US individuals to operate business or make investments. Almost all countries (other than the US) treat LLCs as corporations. While the US has entered some tax treaties that deal with LLCs, many issues remain on the foreign tax treatment of LLCs and their members and there have been several recent cases in the United Kingdom and Canada when non-residents of the US invested in US LLCs. As a general rule it is not beneficial for non-US individuals to hold interest in US LLCs because, if the LLC is treated as a corporation in their jurisdiction, they cannot obtain a credit for US taxes incurred by the non-US members. In many jurisdictions corporations which own interest in US LLCs do not have a problem with LLCs but in some such as Canada, US LLCs present problems. However, as a general rule, Section 894 denies tax treaty benefits to certain types of income received by an LLC and distributed to a foreign corporation. George Anson v HMRC A recent UK tax case, George Anson v. HMRC, involves the tax treatment of income remitted to the UK from a member of a Delaware LLC. The issue was whether the UK member of the LLC should be taxed on partnership profits or dividends in the UK. An LLC formed in the US state of Delaware is taxed transparently in the US so that its profits are taxed as the income of its members. In the UK, these LLCs are treated as companies by HMRC. The Upper Tribunal’s decision to support the appeal by HMRC of the First-tier Tribunal's decision in this case is a victory for HMRC and restores the traditional understanding (which had arguably been called into question by the First-tier Tribunal's decision) that a Delaware LLC should be regarded as opaque for UK tax purposes. Although UK individual investors would generally prefer an 51 // PKF International Tax Alert All Regions Issue 8 November 2011
USA Update continued LLC to be transparent, the opposite is generally true of UK corporate investors who would be exempt from corporate tax on a distribution of profits by an LLC if it were considered opaque for UK purposes. However, if the LLC were considered transparent for UK purposes, the corporate investor would be taxed on its share of underlying profits with credit for any US tax paid. Double taxation relief (DTR) can be problematic so outright exemption would be better. Background George Anson, a UK non-domiciled individual, was a participant in a Delaware LLC and was subject to US federal and state tax on the profits of the LLC on the basis that the LLC had not elected to be treated as a corporation and was thus treated as transparent for US tax purposes. Mr Anson remitted his income from the LLC to the UK and HMRC sought to tax him on the basis that the remitted income was a dividend. No credit was given for tax paid in the US. Mr Anson successfully appealed to the First-tier Tribunal which found that the LLC was transparent for UK tax purposes and so directed that HMRC should allow a credit (under the US-UK double taxation agreement) for the US tax paid by Mr Anson on the basis that it was computed by reference to the same profits or income which HMRC sought to tax in the UK. The Decision The Upper Tribunal strongly doubted the reasoning of the First-tier Tribunal and found that Mr. Anson had no proprietary interest in the profits of the LLC. It pointed to section 18-701 of Delaware LLC Act, which states that members of the LLC have no interest in specific LLC property, and said that there was “nothing in the findings, or in the evidence” which could have justified the conclusions of the First-tier Tribunal. The Upper Tribunal regarded the absence of a proprietary interest as “fatal” to Mr Anson’s contention that the LLC was transparent for UK tax purposes. The Upper Tribunal explained that there cannot be any ownership of profits in the absence of a proprietary interest in the underlying assets, since the profits are “not something which one can own as an asset. The profits of an enterprise are an abstract notion arrived at after a calculation”. Instead, the Upper Tribunal found that Mr Anson merely had a contractual entitlement to receive amounts credited to his capital account. As such, those amounts when distributed to Mr Anson were clearly not the same amounts which had been subject to US tax and, accordingly, he lost on appeal. Comment HMRC has not yet commented on the decision which is consistent with its long-standing position that a Delaware LLC should generally be treated as being a corporation for UK tax purposes. The approach of the Upper Tribunal is also useful in confirming the traditional approach of applying the criteria laid down by the Court of Appeal in Memec plc v IRC [1998] STC 754 alongside an analysis of the local law and the drafting of the governing/constitutional documentation of the vehicle in question when considering the matter of entity classification. Bayfine v HMRC This is another interesting case on the interpretation of the UK/US treaty, which has potential ramifications for the tax treatment of US LLCs. Two UK subsidiaries of a US parent (BDE) entered into complex forward contract arrangements with a counterparty structured to be ‘self-cancelling’ - i.e. one UK subsidiary produced a loss and the other UK subsidiary an equal and opposite profit (BUK). The UK subsidiaries were each UK incorporated limited companies while BDE was US incorporated and resident and an ultimate subsidiary of Morgan Stanley. BUK and its sister company were ‘check the box’ entities for US tax purposes, meaning that the US treated them as transparent entities and taxed the profit produced by BUK as profits of BDE (as far as HMRC is concerned ‘checking the box’ has no impact on an entity’s UK tax treatment). On appeal from the Special Commissioners, the High Court had to determine whether DTR was applicable in the UK to the profits of BUK as a result of the tax paid by BDE in the US. HMRC had argued that, as BUK was a UK resident, the UK had primary taxing rights. The Special Commissioners had agreed and also decided that the profits subject to tax had a UK source on a ‘common sense’ approach. HMRC had also argued that, even if there was DTR on the profits, the extent of the relief should be limited as the taxpayers had not taken all reasonable steps to reduce the foreign tax burden. If there was no DTR, then the taxpayers argued that they 52 // PKF International Tax Alert All Regions Issue 8 November 2011
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