19 August 2011

Double taxation relief and tax transparent entities

The Upper Tribunal for Tax and Chancery matters in London delivered judgment in the case of HMRC v George Anson [2011] UKUT B21 (TCC) on 3 August 2011. This is an interesting case in that the court had to consider whether Mr Anson had effectively been taxed twice on the same profits of a limited liability company in Delaware in the United States. Mr Anson was a participant in a Delaware company known as HarbourVest Partners LLC. He was entitled to be paid sums of money that amounted to a share of the profits of that entity. He was taxed on those profits in the United States on the basis that the company was treated as a tax transparent entity and the profits fell to be taxed as income of the members. At the time in question he was not domiciled in the United Kingdom and was taxed on his remittances from the company. Her Majesty's Revenue sought to tax him on the footing that the remitted income was akin to a dividend. Her Majesty's Revenue's contention was that in English law the company fell to be treated as an opaque tax entity and so there was no entitlement to double tax relief.

The court referred to the English case of Memec v CIR [1998] STC 754 where the court had referred to opaque and transparent entities. The court needed to analyse the question whether Mr Anson was entitled to the profits in some sort of proprietary sense, or whether it was a contractual entitlement that was short of proprietary. Mr Justice Mann found that the company had its own corporate identity, it conducted the business and owned all of the business assets. The business liabilities were those of the entity, not those of the members. Mr Anson received whatever he was entitled to as a result of the various entries against his capital account. The court found there was nothing in this legal construct which would suggest anything like a proprietary entitlement in something that would otherwise be the assets of the company. On this line of reasoning the court held that the profits were not something which one can own as an asset because they are the profits of the company.

With regard to the issue of whether Mr Anson would be entitled to a tax credit for the taxes levied in the United States, the test under the English law was whether Mr Anson was entitled to the profits as they arose. The crux of the matter was whether the same profits were taxed in the United Kingdom and in the United States. Mr Anson's counsel seemed to accept that the question as to whether Mr Anson fell within the Double Tax Agreement depended on the status of the company - whether it was transparent or opaque and whether Mr Anson could be said to be entitled to the profits of the trading as they arose in some meaningful sense. The court, using the logic that had been used in the Memec matter said that one needed to use the English partnership as a starting point.

The court quoted from the judgment in Memec that an English partnership (including a limited partnership) is treated as transparent because the partners carrying on business in common have a beneficial interest in the partnership assets and profits. In Memec they then analysed the position of a partner in a Scottish partnership. They then moved on to analyse the position in a German GmbH. The public limited company in question had for the contribution of a capital sum and an undertaking to contribute to losses of the owner of a business up to the amount of the contribution, purchased a right to income of a fluctuating amount calculated as a share of the annual profits of the business. That would not make him a partner in the GmbH and would not of itself be determinative of the transparency of the GmbH. The court also quoted from the First Court in Memec where Robert Walker J had said that the issue was not whether the arrangement was called a partnership.

Transparency is normally associated with the situation where the ultimate recipient of the income in question has a beneficial interest in it from the start, and moreover the income is not transmuted at some intermediate stage by the need for trustees to exercise a discretion or by its being packaged so as to reach the ultimate recipient in the form of a fixed annuity.

The court concluded that the relevant interest in the profits for the purposes of the test is what makes the profits the same profits for the purposes of the double taxation test. But it is relevant to view the question as one of transparency because that illustrates the equivalence of the profits for the purposes of the double taxation test. What was taxed in the United States were in law, reality and substance the profits of the company, albeit attributed to the members for taxation purposes. Although the members were entitled to the monies which were the monetary equivalent of the profits of the company, what they received was not the same thing. It was a contractual entitlement to money similar to the public limited company's interest in the silent partnership in Memec. Mr Anson had no proprietary right to the underlying assets.

The company owns everything and it pays out to its members an aggregate sum of money which is the monetary equivalent of its profits - on this basis it did not retain any of its profits. The contractual obligation to credit and distribute the profits did not make them the members profits at least for English tax purposes. Accordingly, the court found that the position of the members was nothing like the position of an English partner. The interest of the members was not comparable to that of a Scottish partner because they did not have an interest in the assets of the company. He accordingly found that the company was not transparent, that the members did not have an interest in the profits in any meaningful sense, and that therefore the profits on which tax had been paid in the United States were the profits of the company.

What Mr Anson was being taxed on was something different - his distributions from or his entitlement under an agreement with the company. Accordingly this was a different source and the double taxation test was not fulfilled.

Alastair Morphet

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