In our previous article “HMRC’s forward thinking on reverse hybrids”, we welcomed the Government’s consultation on double taxation faced by UK-resident individuals with interests in US Limited Liability Companies (LLCs) and other ‘reverse hybrids’. We expressed cautious optimism, stressing that any solution needed to be effective and workable. The Government has now responded, and there is some good news for affected taxpayers.
In the Budget the Government announced that it favours an elective credit mechanism to address this issue, as opposed to its initial proposal of treating such entities as transparent for UK tax purposes. The Government’s aim is to provide a fair outcome across individuals whilst remaining workable. To refine the approach, there will be a further consultation. However, it is expected that credits may start to be claimed from early 2028 and, importantly, the Government is considering the options relating to historic periods or ongoing claims.
A lack of transparency
The original proposal was to treat qualifying reverse hybrids as transparent for UK income tax and capital gains tax, broadly aligning with jurisdictions such as the US.
Following consultation, the Government decided not to pursue this transparent treatment, citing significant new technical architecture, poor integration with existing tax rules and disproportionate compliance burdens. Blanket transparency could also negatively affect those choosing to retain profits within an LLC or other reverse hybrid.
As our response highlighted, and HMRC agree, computing income and gains under UK tax principles would materially affect minority and indirect investors lacking the necessary records. Capital gains issues were considered particularly difficult.
Credit where it is due
The Government therefore favours an elective credit mechanism providing fair outcomes across investor types and business structures, using obtainable information.
Envisaged legislation would specify eligible entities, including US LLCs and US ‘S’ Corps, as opaque for individual members’ UK tax purposes, consistent with HMRC’s general position. Ordinary corporation tax rules would continue where applicable.
The credit mechanism would mitigate double taxation and excessive effective tax rates when distributions are made, rather than recognising income and gains as they arise within the entity.
Distributions would attract UK dividend income tax rates (currently up to 39.35 percent). Individuals could then elect to claim credit for eligible foreign taxes paid personally on underlying profits, income and gains, including federal, state and local taxes. The allowable credit would use the individual’s average foreign tax rate, rather than tracing individual payments.
As our earlier article illustrated, the existing mismatch can produce effective global tax rates exceeding 75 percent. The Government intends relief to reduce these to levels broadly comparable with investment through a UK limited company.
What next?
This is not the end of the reverse hybrid story but represents an important and welcome step towards resolving longstanding disproportionate double taxation.
Details remain unresolved, including timing and rate mismatches across multiple income and gains categories. A further technical consultation will precede legislation in a future Finance Bill.
Credit claims should be possible from early 2028 but, importantly, the Government is also considering practical options for historic periods and ongoing disputes.
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