Tax

You would be forgiven for assuming that a “reverse hybrid” is some chimeric monstrosity from ancient mythology, lurking at the edge of the map to gobble up passing heroes. In the world of international taxation, the reality is less fanciful – the term refers instead to foreign entities which are transparent for tax purposes in their jurisdiction of establishment, but opaque for tax purposes where one of its members is resident. However, this particular beast has still proved dangerous for certain UK taxpayers. On 10 June 2026, HMRC published a consultation on proposed reforms to the taxation of UK-resident individual members of US limited liability companies (“LLCs”) and other reverse hybrid entities. It addresses an existing mismatch in entity classification that can leave a UK-resident individual stakeholder effectively taxed twice on the same amount, once in the jurisdiction of source as the profits arise to the entity, and again in the UK when those profits are later distributed to the individual, producing an effective tax rate that the Government accepts can reach up to 75%.

The consultation is a welcome recognition of a barrier that the Government concedes may be deterring “talented globally mobile individuals” from relocating to, or remaining in, the UK – and of the Government’s intention to chart a new, safer passage for affected taxpayers.

Storms at sea – the mismatch in UK and US taxation of LLCs

For US tax purposes an LLC is generally transparent unless a “check-the-box” election has been made to treat it as opaque; in the absence of such an election, the US tax authorities look through the LLC and tax its members on their share of the underlying profits as they arise to the LLC. By contrast, HMRC has long treated most US LLCs as opaque, taxing the LLC’s members only when the LLC makes a distribution out of those underlying profits, which is then normally chargeable to UK tax as a dividend.

This can create problems where the US imposes tax on the members of an LLC. For example, the US generally claims taxing rights over income effectively connected with a trade carried on in the US (so called “ECI”). Accordingly, without more, a UK-resident individual holding interests in an LLC which generates ECI could be taxed in both the US (when the profits arise to the LLC) and the UK (when the LLC makes a distribution to the individual), resulting in double tax unless relief is available. Under the UK/US double tax treaty, the UK is often required to provide such relief in respect of ECI – however, it is a precondition for such relief that both the US and UK tax charges are incurred on “the same profits, income or chargeable gains”. While the US taxes the UK-resident member of the LLC on their share of the underlying profits of the LLC, and the UK taxes that member on the distributions they receive from the LLC, the UK does not regard these as the same profits or income, and so relief under the treaty is often unavailable. Additionally, while the UK’s domestic tax rules provide unilateral relief where a treaty does not solve for double tax, this is similarly restricted. As such, the mismatch results in the UK-resident LLC member being taxed in full in both jurisdictions on an amount derived from the same economic activity, resulting in potentially cyclopean effective tax rates.

Scylla and Charybdis – Anson and HMRC’s approach

In 2015, the UK Supreme Court held, in the case of Anson v HMRC, that the First-tier Tribunal had not erred in its finding of fact that the Delaware LLC in question should be regarded as transparent for UK income tax purposes. On that basis, Mr Anson, a UK-resident individual member of the LLC, was found to be chargeable to UK income tax at the point profits were allocated to his capital account within the LLC rather than on a subsequent distribution of those profits. The upshot of this conclusion was that the tax due in both the US and the UK was on the same income – being the member’s distributive share of the income as it arose to the LLC; the common mismatch described above did not arise, and so Mr Anson was entitled to UK tax relief under the UK/US treaty on the income that had already been taxed in the US.

Although many taxpayers have since sought to apply the Anson principles to their own interests in LLCs, HMRC’s published view since September 2016 has been that the Anson decision is confined to its facts and that claims for double tax relief would be considered on a case-by-case basis. However, in December 2023 HMRC somewhat hardened its stance and updated its guidance, challenging the findings of fact in the Anson case and more forcefully re-asserting that an LLC’s profits generally belong to the LLC in the first instance, such that UK individual members would be liable to UK tax, not on the profits of the LLC, but on any subsequent distribution. The tension created by HMRC’s resistance to the broader application of the Supreme Court decision in the Anson case has left affected taxpayers in an unenviably uncertain position. Those individuals who accept HMRC’s position remain exposed to double tax, while those who seek to rely on Anson remain exposed to HMRC’s scrutiny and the risk of a costly challenge. This leaves affected taxpayers caught between two competing hazards. The Government has acknowledged that challenge, and the objective of the consultation is to provide certainty through a change in law.

Although US LLCs are the focus, the consultation applies to reverse hybrids generally. Entities resident in the UK, or trading in the UK through a permanent establishment, are excluded from the reform proposals.

To Ithaca – transparency as the preferred solution

The Government’s preferred option is to tax UK-resident individual members of certain foreign reverse hybrid entities on their share of the entity’s underlying income, profits and gains as they arise – effectively, prescribing in law that the entity is treated as transparent in the UK. Where this solution applies, it should eliminate the mismatch described above and bring an affected LLC member’s effective tax rate down to, broadly, the higher of the two countries’ rates. The Government proposes that this “matching transparent treatment” would apply automatically and prospectively for tax years following the implementation of the new legislation. The consultation clearly states that there is no intention to change the position for UK corporate members of reverse hybrids (although those entities will often benefit from the UK domestic exemption from corporation tax on dividend receipts, such that they are less exposed to the mismatch risk than UK-resident individual members).

Mechanically, the UK-resident individual members would be treated as partners, carrying on a trade in partnership (or as a sole trader for a single-member LLC) and holding the beneficial ownership of the proportion of the entity’s assets that corresponds to their membership interest. Their share of profits and losses, and their UK tax liabilities, would be computed following the usual income tax and capital gains tax principles that apply for partnerships.

The consultation suggests two alternatives to the “matching transparent treatment”, both of which would still tax amounts received by UK individual members as distributions. One would allow a deduction for foreign tax already paid, and the other would give a credit for foreign tax on the underlying profits.

An arrow through an axe head – the open questions

The consultation leaves a number of open questions about the framework for reform – in particular:

• the proposals apply prospectively, but the tax treatment for historic years is a key issue for clients already under enquiry, or who have otherwise filed on the Anson basis; and
• the consultation does not set out detailed proposals for moving from opaque to transparent treatment, or vice versa, although it does ask for stakeholders’ views on issues that may arise. For example, it remains unclear whether HMRC would expect such a transition to be a taxable event for the UK-resident individual members of a foreign hybrid. This is likely to be a key point as the proposal develops.

The consultation is an encouraging signal that the Government is aligned with taxpayers in wanting both to eliminate uncertainty over the UK tax treatment of reverse hybrids, and to provide a clearer solution to potentially high effective tax rates for their UK-resident individual members. The preferred solution could, if enacted, make the UK a more attractive home for certain internationally mobile individuals. However, this remains a consultation rather than a commitment, with much of the detail still to follow. HMRC are seeking views from stakeholders until the consultation closes on 31 July 2026, following which they have committed to publishing a response “in due course”.