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This appeal is concerned with the interpretation and application of a double taxation agreement between the United Kingdom and the United States of America. FAC |
The appellant, Mr Anson was at all material times resident but non-domiciled in the UK for UK tax purposes. FAC |
He was liable to UK income tax on his UK sourced income and on foreign income remitted to the UK. FAC |
He was non-resident in the US for US tax purposes, but was liable to US federal and state taxes on his US sourced income. FAC |
Mr Anson was at all material times a member of a Delaware limited liability company, which was classified as a partnership for US tax purposes. Ratio |
As a member of an entity classified as a partnership, Mr Anson was liable to US federal and state taxes on his share of the profits. Ratio |
Mr Anson remitted the balance to the UK, and was therefore liable to UK income tax on the amounts remitted, subject to any double taxation relief which might be available. Ratio |
The respondent Commissioners decided that Mr Anson was not entitled to any double taxation relief, on the basis, put shortly, that the income which had been taxed in the US was not his income but that of the limited liability company. Ratio |
The question is whether they were correct to do so. Ratio |
The facts FAC |
The relevant period comprises the seven UK tax years running from 6 April 1997 to 5 April 2004. FAC |
Throughout that period, Mr Anson was a member of HarbourVest Partners LLC (the LLC), a limited liability company formed under the law of Delaware and carrying on business in Boston, Massachusetts. FAC |
The LLC was originally formed in 1996, when its founder members, including Mr Anson, provided the necessary capital. FAC |
The amount paid was returned to the members in 1999 by way of distribution. FAC |
The business of the LLC consisted of the management of a number of venture capital funds. FAC |
It had no economic interest in the funds, or in the gains or losses from fund investments, but earned fees from its investment management activities. FAC |
Its accounts were made up in respect of calendar years, which were also US tax years. FAC |
The LLC was established under the Delaware LLC Act (the LLC Act), and under the terms of a limited liability company agreement (the LLC agreement) governed by Delaware law. FAC |
The most significant provisions of the LLC Act will be mentioned shortly. FAC |
The LLC agreement was an agreement between the members: the LLC itself was not party to it. FAC |
Article IV dealt with members capital accounts. FAC |
In particular, section 4.1 provided for the crediting to each members capital account of his capital contributions, and for the debiting to his account of all distributions made to him. FAC |
Section 4.2 required the members capital accounts to be adjusted, at least annually, in specified respects. FAC |
In particular, it provided (read short) that all gross income and gains realized during the period in question shall be credited, and all losses, deductions and expenses during the period in question shall be debited, to the respective capital accounts of the members pro rata, in accordance with ratios prescribed in th... |
Mr Ansons profit share was 11.5%, which was similar to his ownership interest. FAC |
Article V set out the provisions relating to distributions. FAC |
Section 5.1 provided: Subject to the provisions of this article V, to the extent cash is available, distributions of all of the excess of income and gains over losses, deductions and expenses allocated in accordance with section 4.2 with respect to any calendar year will be made by the company at such time within seven... |
The managing members may from time to time in their discretion make additional distributions in accordance with the provisions of this article V. Mr Anson was not a managing member during the relevant period. FAC |
Among the other provisions of the LLC agreement, it is necessary to note article XI, which dealt with dissolution, and made provision in that eventuality for the sale of the assets, the allocation of losses or gains to members in accordance with section 4.2, and distributions to the members. FAC |
Under article 12.2, members were entitled on request to access to the books and records and to information about the business. FAC |
During each calendar year, all the LLCs income and gains were credited, and all losses, deductions and expenses were debited, to its members capital accounts on a quarterly basis, in accordance with section 4.2. FAC |
The excesses of the income and gains over the losses, deductions and expenses that is to say, the profits - were distributed to the members on a quarterly basis in arrears, in accordance with section 5.1, on the basis of the ratios set out in the LLC agreement. FAC |
The following matters of Delaware law were agreed by the expert witnesses who gave evidence before the First-tier Tribunal (Judges John F Avery-Jones CBE and Ian Menzies-Conacher FCA) (the FTT) and were found as facts: i) The LLC was a legal entity which was brought into existence by executing a certificate of formatio... |
ii) The business of the LLC was carried on by the LLC itself, rather than by its members, in the sense that the LLC as an entity with separate legal existence was engaged in business. FAC |
The members were however active in the business, each member being required by the LLC agreement to devote at least 90% of his full business time to the advancement of the LLCs business and interests. FAC |
iii) The assets used for carrying on the business of the LLC belonged beneficially to the LLC and not to the members. FAC |
iv) The LLC was liable for the debts incurred as a result of carrying on its business. FAC |
The members had no liability for the liabilities of the LLC. FAC |
The FTT made the following additional findings in relation to the nature of a members interest in a Delaware LLC, and in the LLC in particular: i) A Delaware limited liability company interest is defined by section 18-101(8) of the LLC Act as a member's share of the profits and losses of a limited liability company and... |
ii) That interest is in principle assignable, except as provided in the LLC agreement. FAC |
The assignee has no right to participate in the management of the business except as provided in the agreement and with the approval of all the other members. FAC |
An assignee does not become a member but becomes entitled to the same economic interest as the assignor. FAC |
iii) In the present case, the LLC agreement provided that a member's interest could not be transferred except for sales by a former member (a) under provisions giving the LLC a right of first refusal before any such sale, (b) to a person engaged in the full time business of the LLC, with the written consent of the mana... |
iv) Section 18-503 of the LLC Act provides that the profits and losses of a limited liability company shall be allocated among the members, and among classes or groups of members, in the manner provided in a limited liability company agreement. FAC |
v) A limited liability company interest is personal property. FAC |
A member has no interest in specific limited liability company property (section 18- 701 of the LLC Act). FAC |
vi) Subject to the LLC agreement, the members manage the LLC and vote in proportion to their interest in profits. FAC |
vii) The LLC agreement provided that the operation and policy of the LLC was vested in the managing members, who had power to contract on its behalf, but certain matters, such as mergers and incurring liabilities of more than $500,000 in a year, required the consent of the members. FAC |
viii) The interest of a member in the LLC was not similar to share capital, but was more similar to partnership capital in an English partnership. FAC |
The parties expert witnesses were asked to address a number of questions which had been listed in an Inland Revenue tax bulletin 39 issued in February 1999 (and subsequently repeated in later bulletins), following the decision of the Court of Appeal in Memec plc v Inland Revenue Comrs [1998] STC 754, as factors which w... |
One of those questions was the following: Are the persons who have an interest in the entity entitled to share in its profits as they arise; or does the amount of profits to which they are entitled depend on a decision of the entity or its members, after the period in which the profits have arisen, to make a distributi... |
Mr Ansons expert, Mr Abrams, treated the question as asking whether there was an automatic entitlement to share in profits, or whether any such entitlement depended, as in the case of a dividend, upon a decision taken after the end of the relevant period. FAC |
He focused particularly upon section 4.2 of the LLC agreement, since it addressed how profits were allocated among members, and upon section 5.1, since it governed distributions. FAC |
Applying the approach to contractual interpretation which, according to his evidence, applied under Delaware law, he concluded that section 5.1 created a mandatory requirement (subject to the other provisions of article V, and to cash being available) to distribute the excess of income and gains over losses, deductions... |
That was consistent with the earlier crediting of the income and gains to the members capital accounts, and the debiting of losses, deductions and expenses, under section 4.2. FAC |
The members were therefore entitled to participate in a share of the LLCs annual profits as they arose. FAC |
The witness was clearly not referring to a proprietary entitlement. FAC |
The Commissioners expert, Mr Talley, treated the question as asking whether the members had a proprietary interest in the profits as they arose. FAC |
He noted that, in terms of section 18-701 of the LLC Act, the members had no interest in specific property of the LLC. FAC |
It followed that they had no beneficial interest in the LLCs assets. FAC |
In that proprietary sense, they were therefore not entitled to a share in the profits prior to a distribution. FAC |
In a joint statement to the tribunal, each expert responded to the view expressed by the other in relation to this question. FAC |
Mr Abrams pointed out that assets and profits were distinct concepts in general and under the LLC Act. FAC |
Section 18- 101(8) defined a members interest in an LLC as including a members share of the profits and losses. FAC |
The members entitlement to share in the profits was not affected by section 18-701, which concerned a different issue, namely the ownership of specific property of the LLC. FAC |
Mr Talley, on the other hand, disagreed with Mr Abramss construction of section 5.1 of the LLC agreement: in his opinion, distributions were made at the discretion of the managing members. FAC |
In his oral evidence, Mr Abrams said that the law of Delaware drew the same distinctions between a loss and a liability, and between a profit and an asset, as had been explained in Reed v Young [1986] 1 WLR 649, 654; [1986] STC 285, 289. FAC |
In cross-examination, he observed that the questions put to him, which linked entitlement to profits to ownership of the LLCs income receipts as they were received, commingled two different concepts. FAC |
When the LLC earned fees, the dollars went into the companys bank account. FAC |
Those assets were the property of the company, just as the companys debts were the liability of the company. FAC |
Whether the dollars translated into profits was a different issue. FAC |
Profits and losses were an accounting concept. FAC |
The LLC Act recognised the distinction between profits and assets in section 18-101. FAC |
The LLC agreement imposed an obligation to distribute the profits at the end of each year. FAC |
Mr Talley, in his oral evidence, accepted that profits and assets were distinct concepts in the law of Delaware, and that profits were an accounting measure. FAC |
He maintained that profits nevertheless had to be reflected in the assets on the balance sheet, and in that sense formed part of the assets. FAC |
He stated, however, that his primary reason for considering that the members had no entitlement to share in profits prior to a decision to make a distribution was his interpretation of section 5.1 of the LLC agreement as rendering distributions discretionary. FAC |
In its discussion of this issue, the FTT stated that it accepted the contention, advanced on behalf of Mr Anson and supported by Mr Abrams, that in summary article IV allocated the profit to the members as it arose and article V required payment to be made. RLC |
It referred first to sections 18-101(8) and 18-503 of the LLC Act. RLC |
As explained earlier, section 18-101(8) defines limited liability company interest as a members share of the profits and losses of a limited liability company and a members right to receive distributions of the limited liability companys assets, while section 18-503 provides that the profits and losses of a limited lia... |
The FTT also noted that the whole of the profits were allocated to the members capital accounts. RLC |
It continued: This means that the profits do not belong to the LLC in the first instance and then become the property of the members because there is no mechanism for any such change of ownership, analogous to the declaration of a dividend. RLC |
It is true, as Mr Talley has said, that the assets representing those profits do belong to the LLC until the distribution is actually made but we do not consider that this means that the profits do not belong to the members; presumably the same is true for a Scots partnership. RLC |
Conceptually, profits and assets are different, as is demonstrated by the reference to both in the definition of limited liability company interest [in section 18-101(8) of the LLC Act]. RLC |
There is a corresponding liability to the members evidenced by the allocation to their capital accounts. RLC |
Accordingly, our finding of fact in the light of the terms of the LLC operating agreement and the views of the experts is that the members of [the LLC] have an interest in the profits of [the LLC] as they arise. RLC |
(para 10) RLC |
Having reached its conclusion on the basis of the legislation and article IV of the LLC agreement, the FTT did not regard the dispute as to whether distributions under section 5.1 were mandatory or discretionary as relevant. FAC |
It nevertheless considered the matter, and concluded that distributions were mandatory. FAC |
In relation to US tax treatment, as the profits generated by the LLC were connected with the conduct of a US trade or business, they were subject to US federal and Massachusetts state taxes, under the US Internal Revenue Code (the Code) and the General Laws of Massachusetts respectively, regardless of the residence or ... |
Under the US entity classification rules set out in the US Treasury Regulations, the LLC was classified as a partnership for US tax purposes (it might have elected to be classified as a corporation, but made no such election). FAC |
The Code states that in such circumstances the partners are liable to tax, rather than the partnership: in other words, the LLCs members, rather than the LLC itself. FAC |
As a result, each member, including Mr Anson, was personally liable for US federal and Massachusetts state tax on his share of the profits, as his income, whether or not that sum was actually distributed to him. FAC |
As required by the Code, the LLC filed an annual federal partnership income tax return, reporting the profits of the partnership. FAC |
Mr Anson was also required to file an annual federal income tax return, in which his share of the LLCs profits was reported as his income. FAC |
The federal income tax due by Mr Anson in respect of his share of the profits was withheld by the LLC at the rate of 39.6% applicable to withholding tax on foreign partners share of effectively connected income. FAC |
That withholding tax was remitted to the federal tax authorities, as required by the Code and authorised by the LLC agreement. FAC |
The LLC was required to file an annual return for partnership withholding tax for each member, and also to complete the foreign partners information statement of withholding tax, which foreign partners needed to furnish with their US federal income tax return in order to claim a withholding tax credit for the tax paid.... |
The distributions made to Mr Anson were accordingly reduced by the amount of the tax withheld and remitted on his behalf. FAC |
Mr Anson was then credited with the amount of tax withheld, when the amount of federal tax due by him on his share of income was assessed. FAC |
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