HMRC’s forward thinking on reverse hybrids

For US tax purposes, a US LLC is generally transparent, meaning its income, gains, losses and deductions are attributed directly to its members and taxed in their hands on a ‘flow-through’ basis. Although there is an option for certain US tax elections to be made to alter this default treatment, US LLCs are more often than not treated as passthroughs and therefore fiscally transparent for US tax purposes. Subsequent distributions from the LLC to the member are, broadly, considered previously taxed income and not subject to further US tax upon receipt by the individual.

By contrast, the UK has historically treated US LLCs as corporate entities which are fiscally opaque. Consequently, on the premise there is no UK permanent establishment and/or exposure to Transfer of Assets Abroad (TOAA) anti avoidance legislation, the amounts generated within the LLC are not ordinarily subject to UK tax as they arise in the LLC. Instead, members are subject to UK tax when profits are actually distributed to them. These amounts are typically treated as dividends as opposed to a share of the LLC’s underlying income, gains, etc.

The above difference in treatment between the US and UK can create mismatches in both the timing of when income is being recognised for US/UK tax purposes as well as the nature/character of ‘what’ is actually being subjected to tax.

This article will focus predominantly on US LLCs but many of the issues are relevant to other reverse hybrid entities (e.g. US ‘S’ Corporations).

Who is affected?

The aforementioned cross-border contradiction has historically had tangible consequences, especially for US-connected individuals and their families. This spans a broad range, including US citizens/Green Card holders resident in the UK, UK resident members of US headquartered professional partnerships (law firms, asset management firms, etc), other UK tax residents keen to invest in US businesses or funds, amongst others.

Indeed, the pertinence of these consequences are such that the current rules can, and do, serve as a deterrent for those US families considering a relocation to the UK, such families choosing to remain in the UK longer term, as well as impacting investment and commercial decision making for UK residents.

Following the abolition of the remittance basis for non-domiciled individuals and the limited period of application for the Foreign Income & Gains (FIG) regime for those that qualify, the exposure to UK income and capital gains tax on non-UK sources has increased and therefore a greater number of UK taxpayers will have to contend with these issues.

Whilst those that qualify for the UK’s FIG regime may be afforded temporary relief, this does still impact them given the obligation to report worldwide income and gains, even if they are then excluded from actual UK tax. Of course, the appropriate UK tax exposure must be considered as the individual’s FIG protection comes to an end.

The problem in practice

The timing and character mismatches referenced earlier may be best reflected through an illustration:

• A US LLC, treated as a partnership for US tax purposes, earns $1,000 of business profits from its US activities in year one and allocates 10percent/$100 of that profit to a UK-resident member who cannot claim the FIG regime. 
• The LLC agreement contains a ‘tax distribution’ clause to ensure sufficient funds are distributed to the member in year one to enable them to satisfy their US Federal tax liability (i.e. 37 percent). The balance of the profits is then distributed in year three.
• Due to the passthrough nature of the LLC in the US, the member pays US Federal tax of up to 37percent ($37) on their allocated share in year one. They have sufficient cash from the tax distribution to cover the liability.
• As HMRC treat the LLC as opaque, the UK resident member would only be subject to UK income tax when a distribution is made. Therefore, in year one when the tax distribution of $37 is made, UK income tax would be applied on the ‘foreign dividend’ at up to 39.35 percent ($14.56). In year three when the balance of the profit, $63, is distributed the member pays UK tax of $24.79 (39.35 percent) on the 'foreign dividend’.
• Double taxation is usually relieved through use of foreign tax credits. But as, for US tax purposes, the LLC is generating US business profits, the IRS will not allow the UK taxes being suffered to offset the US tax on these amounts. As HMRC view the amounts received as a foreign dividend there is, in HMRC’s view, no availability to use the US taxes being suffered to offset the UK taxes.
• Therefore, in this scenario, in year one the member bears $37 of US tax + $14.56 of UK tax, with a residual UK tax of $24.79 payable to HMRC re the amount distributed in year three. The total tax cost over the period would therefore be $76.35, or 76.35 percent, on $100 of LLC profit. This amount could be greater in cases where the US LLC profits are derived from a taxing state in the US.

The ‘Anson’ case

There was some hope in 2015 that HMRC would afford individual taxpayers relief from such excessive global tax exposure following the success of a UK taxpayer, George Anson, in a commonly cited Supreme Court case – the ‘Anson’ case (Anson v HMRC [2015] UK SC 44). 

In this closely-followed case, the taxpayer successfully argued that he was entitled to his allocated share of the Delaware LLC's profits as those profits arose, rather than being derived only upon subsequent distribution by the US LLC. Accordingly, Mr Anson was deemed to have been taxed on the same profits in the UK as had been taxed in the US, and double tax relief was therefore available. 

Crudely adapting this position to the illustrative example above, this would result in the $100 of US business profits being allocable to the member for both US and UK tax purposes at the same time (i.e. in year one). The US/UK tax treaty provides primary taxing rights of such income to the US first with a credit available against UK taxes. The net result would be $37 (37 percent) payable to the IRS with a residual $8 (8 percent) payable to HMRC after applying a 37 percent credit against the UK income tax rate on business income of 45 percent. A total effective global tax rate of only 45 percent compared to the 76 percent referenced above.

The outcome of the Anson case therefore provided hope that the double tax issue could be mitigated. Unfortunately, this hope was short-lived. The day after the success of Mr Anson, HMRC publicly restated their view that LLCs are opaque for UK tax purposes.

HMRC Consultation

In April 2026, whilst on a visit to Washington, the then Chancellor Rachel Reeves made an unexpected statement of the intention to review the UK tax rules that can lead to such double taxation. A few weeks later, on 10 June 2026, HMRC published a consultation document inviting interested parties to provide their commentary on the taxation of UK-resident individuals of LLCs and other reverse hybrids. The consultation focused on individuals affected by entity classification mismatches and the resulting double taxation, rather than the wider corporate anti-hybrid rules, and invited responses from affected taxpayers, businesses, advisers and representative bodies by 31 July 2026.

Given our experience with these issues and their pertinence for UK private clients, we submitted a full response to the 24 questions HMRC posed. The sharing of our experience and proposals, along with others, will hopefully improve HMRC’s understanding of this issue and help them to construct a workable solution.

KPMG Insights

Our response emphasised to HMRC the reality of the issue individuals face and the punitive tax impact this mismatch can have, particularly on the US citizen and Green Card holder community in the UK and those with a desire to invest cross border. It is a reality that the effective rate of tax that may be suffered by a taxpayer could exceed 75 percent.

Such exposure can potentially distort commercial and personal decision-making, discourage relocation to, or continued residence in, the UK, deter cross-border investment and cause profits to be retained offshore rather than being extracted and spent or invested in the UK.

Providing a mechanism to align the UK and US tax treatment would likely help to mitigate the aforementioned double taxation and ensure a more appropriate level of global tax is suffered. It also has the potential to support the Government and HMRC’s policy objectives by helping to make the UK a more attractive place to live, work and invest, whilst improving and simplifying the tax system and promoting further growth and competitiveness.

Some of the commentary included in our response includes:

UK Tax Transparency

HMRC’s headline proposal to handle the hybrid headache is treating eligible reverse hybrids as transparent/passthrough entities for the purposes of UK income and capital gains taxes. Consequently, the member would be taxed on the underlying profits rather than upon distribution.

We are supportive of this method to more closely align the UK tax treatment with the jurisdiction the entity has been established in, such that the taxing points and character are better matched.

To the extent there is a relevant double taxation treaty in effect, aligning the income/gains on a passthrough basis should enable individuals to mitigate double taxation using credits and enable each jurisdiction to collect the appropriate amount of taxation.

In our view, this may be best implemented by election at the entity or preferably at the individual level, rather than being mandatory, as whilst most taxpayers may prefer the alignment to mitigate double taxation some may have actively chosen such an entity for exactly this reason as the opaque treatment in the UK provides an ability to mitigate UK tax exposure until distributions are made or until a taxpayer is non-resident.

To Deduct or to Credit – that is the question

Without pursuing the passthrough proposal, an alternative option to at least mitigate the excessive global taxes would be to allow a deduction for foreign taxes suffered by the taxpayer.

This would result in the UK taxing distributions net of the foreign tax suffered, however, it would not eliminate double taxation and still likely result in a high overall effective rate of tax, albeit lower than at present (circa 61 percent rather than 76 percent). It may also require complex calculations to compute the UK taxable dividend amount, especially where profits are not distributed in full on an annual basis.

In our view, a credit system would be more effective and is more likely to achieve the objectives of HMRC.

It’s not simple!

This is a complex area, and it will be important for HMRC to get it right.

The current issue of double tax is clear, and taxpayers can, generally, apply the rules. It will be important that any changes to address this do not result in increased complexity for the taxpayer in understanding their exposure; computing their taxable income/credits; generate greater uncertainty for taxpayers or create inconsistencies in their application. As such, implementation of a clear and administratively workable solution is critical.

HMRC’s consultation document suggests the income and gains in such entities may need to be recomputed under UK tax principles which will, in many cases, increase administration and costs. For example, differences between US matching rules and UK share-pooling rules alone could require complex annual capital gains calculations and ongoing tracking.

There is also a risk of greater inconsistency, and reduced certainty, if individual taxpayers compute taxable amounts differently. For some, such as investors in US funds structured as LLCs, they will likely not have access to the necessary information to undertake this work or the expertise to do so themselves.

We would suggest the methodology may need simplification or rely on the home country tax reporting (e.g. Form K-1 in the US), potentially within thresholds or parameters based on factors such as ownership level (and therefore anticipated influence in obtaining the required data), revenue levels or asset value.

The transition from the legacy treatment that may have been applied by UK taxpayers to a new regime will also need careful consideration.

From complexity to clarity

Whilst the consultation provides reason for (cautious) optimism, it is essential that reform is workable in practice if it is to achieve its stated objective of providing clarity and certainty on the UK tax treatment for affected individuals. Doing so without expanding the compliance burden of the taxpayer disproportionately will be required.

Reform may remove barriers for individuals who might otherwise have been deterred from relocating to and/or doing business in the UK and help retain those who may have considered leaving before the end of their eligibility for the FIG regime. In that sense, it could make a meaningful contribution to UK growth and competitiveness.

What next?

We hope to have an update on the Government’s response to the consultation as part of the Autumn Budget due to be delivered on 28 October 2026.

For further information please contact:

• James Murray
• Iain Younger