Consultation outcome

UK resident individual members of LLCs and other reverse hybrids — Summary of responses

Updated 28 October 2026

Foreword

The government is committed to ensuring the UK remains a leading destination for global talent and investment.

The UK’s internationally competitive residence-based tax regime provides new arrivals with 100 per cent tax relief on their Foreign Income and Gains for their first 4 years of UK tax residence, encouraging them to bring funds to the UK to spend and invest.

We are expanding visa routes and support for exceptional entrepreneurs, investors and researchers choosing to locate in the UK. We have responded to concerns raised by internationally mobile individuals by introducing a cap on 10-year anniversary charges on certain trusts settled by former non-domiciled individuals.

In partnership with the Global Talent Taskforce, we have identified that double taxation of investors in common ‘reverse hybrid’ entities such as United States Limited Liability Companies (US LLCs) can be a barrier to growth, affecting decisions to move or remain in the UK.

We are grateful to have heard from a range of sectors and interested parties who have considered the policy options put forward to address this. This engagement has highlighted the benefit of resolving the anomaly as quickly as possible.

Having considered the consultation responses, this publication summarises the feedback received and sets out the next steps. The government will address this double taxation and provide investors with greater certainty by introducing a new domestic foreign tax credit mechanism. To support effective implementation, the government will launch a technical consultation on the policy detail shortly, before legislating in a future Finance Bill. It will be possible to make claims for the new credit immediately from early 2028.

1. Introduction

The government consulted over the summer on reform to taxation of UK-resident members of US LLCs and other reverse hybrids. This provided an opportunity for stakeholders to explain their experiences with this issue and give views on the policy propositions within the publication.

The government is grateful to those who took the time to contribute their views, experiences, and evidence in response to this consultation. In total, 64 written responses were received, primarily from professional and representative bodies, legal firms, tax agents, and individuals and businesses investing in reverse hybrids. HM Revenue and Customs (HMRC) also held a series of engagement meetings between June and July 2026 to discuss the consultation in more detail with interested stakeholders.

The following chapters provide a summary of the responses to the consultation, the government’s response, and next steps.

2. Responses

Stakeholder experiences with reverse hybrids

Question 1: Have you or your clients faced a high effective tax rate (ETR) on income from reverse hybrids? If so, please provide details about the circumstances, including the ETR, the type of entity and income it related to, and what kind of member you or your clients were.

There were 50 responses to this question.

The responses overwhelmingly agreed that very high ETRs currently arise for individual members of reverse hybrids, as a direct result of a mismatch in UK and overseas tax treatment.

US LLCs were the most cited vehicle, with respondents providing a wide range of examples of majority and minority holdings in LLCs with active businesses and passive investments. LLCs were described as a ‘default’ entity for US-based investment, being chosen for commercial, legal and privacy reasons.

Common structures cited included LLCs being used as:

• trading entities with a US and non-US business, or both
• holding companies for real estate and other assets
• investment fund entry points for institutional and family investors
• carried interest vehicles
• employee incentive vehicles
• personal service companies

Other entity types frequently cited as following the same reverse hybrid pattern included US corporations taxed transparently (‘S-Corps’), Jersey LLCs, and French Sociétés civiles immobilières (SCIs).

Several respondents noted that exposure to reverse hybridity can occur via direct investment in a relevant vehicle, or indirectly via participation in a more complex tiered structure.

Reported ETRs were commonly in the 55 to 75% range, with several respondents citing rates above 80% and certain examples exceeding 90% after accounting for US state and local taxes.

Question 2: Have you ever taken steps to mitigate a high ETR related to a reverse hybrid? If so, please provide details. If you were not able to take steps to mitigate a high ETR, please explain what the barriers were.

There were 44 responses to this question.

Respondents reported a range of potential mitigation strategies currently available, including but not limited to:

• leaving the UK or limiting days in the UK
• deferring or avoiding distributions
• modifying the entity’s constitutional documents
• restructuring the entity to a non-hybrid vehicle via conversion, reorganisation, or US ‘check-the-box’ election
• reliance on Anson when making UK filings
• reliance on the Foreign Income and Gains (FIG) regime
• altering ownership to exclude UK resident members
• use of corporate blockers or holding companies
• use of alternative remuneration structures like cash bonuses

Several respondents mentioned the LLC issue has become more acute in recent years.

The above mitigations were broadly viewed as imperfect defensive mechanisms, being in practice limited, commercially undesirable, distortive, costly, risky, or simply unavailable, particularly for minority investors or individuals with established structures. Several responses noted the possibility of mitigations causing collateral damage to other investors in the same entity or having adverse interactions with parts of the US Internal Revenue Code.

Some respondents characterised available mitigations as at best a temporary reduction to cashflow pressures, as opposed to a genuine resolution to the underlying problem.

Question 3: Have you or your clients ever sought Double Taxation Relief from a foreign jurisdiction with respect to UK tax paid on income from a reverse hybrid entity? If you were granted relief, on what basis was this given? If you were not granted relief, why not?

There were 35 responses to this question, with almost all respondents stating that relief from a foreign jurisdiction was unavailable, or extremely difficult to obtain. The problem was widely characterised as structural.

Several respondents described attempts to seek relief in the US for UK tax paid on distributions from an LLC, which failed due to the Internal Revenue Service (IRS) finding that the UK charge was not on the same basis as the US charge. These responses underlined the fact that the US has primary taxing rights over income from a US business under Article 7 of the UK-US Double Taxation Convention (DTC).

Some respondents gave experiences of relief being obtained where an LLC was characterised as transparent on an Anson analysis, but these cases were marginal, fact-specific, and restricted to US citizens.

A few respondents emphasised that even where a foreign tax credit is theoretically available, in practice the credit value may be limited or nil due to timing, character and sourcing mismatches, an inability to re-source certain income, or a lack of foreign-source income to utilise the credit against.

Question 4: Has the UK tax treatment of income from reverse hybrids affected your or your clients’ personal decisions about where to live and work? If so, please give details.

Question 5: Has the UK tax treatment of income from reverse hybrids affected your or your clients’ commercial decisions such as where to locate offices and staff, do business and make investments? If so, please give details.

There were 46 responses to question 4 and 38 responses to question 5. Responses were clear that the current UK tax treatment is a significant factor in investors’ personal and commercial decisions, albeit not the only factor.

Around a third of firms and individuals responding described how high ETRs have driven decisions not to relocate to the UK, to decline UK assignments, to limit time spent in the UK, or to make active plans to leave. A few respondents included detailed case studies explaining their own or their clients’ circumstances and reasoning.

Other responses focussed on the effect on UK business, describing negative impact on how businesses establish or expand UK operations; attract, retain and reward UK staff; and locate substantive functions here. Several respondents gave examples of businesses having decided to relocate operations to other European countries, rather than opening an office or warehouse in the UK and hiring employees here.

Some respondents — particularly those from a private capital background — discussed difficulties with recruitment of UK managers and executives due to having reduced or no flexibility with equity, profit-share and incentive arrangements. Multiple advisers mentioned conducting reviews to help clients move management and decision-making functions from the UK to more favourable jurisdictions.

Restricted and foregone growth opportunities were also identified as an impact, with one respondent perceiving a ‘chilling effect’ on investment. Multiple respondents noted that the issue has deterred them or their clients from making otherwise commercially desirable investments in targets like US-based start-ups, media and film projects, technological and scientific research, private equity, asset management, and real estate structures. Even where investments have gone ahead, respondents described added friction and being exposed to materially greater risks than their foreign counterparts.

Scope and conditions

Question 7: Do you see any issues with defining the scope in the way stated above? Can you identify any potential boundary issues with any specific entity types?

Question 8: Do you think that these conditions are reasonable? Do you see any potential issues with these conditions? Should further conditions be imposed to limit the holdings to which this treatment would apply?

There were 52 responses to Question 7 and 47 responses to Question 8.

Most respondents agreed with the proposed scope and conditions in principle, finding it sensible and appropriate to focus on an entity’s foreign tax treatment and taxation status of the member, rather than relying entirely on the entity’s legal label. There was overwhelming support for not limiting any new treatment to holdings of a specific size or nature.

Multiple respondents stressed that taxpayers should be able to determine whether they are within the remit of any new regime without needing the time and expense of commissioning a specialist entity classification analysis every year. Another point of emphasis was that any legislation should be principled and jurisdiction-neutral, even if US LLCs are a primary policy concern.

To this end, several respondents raised the concern that ‘transparent’, ‘opaque’, ‘reverse hybrid’ and even ‘entity’ are not self-evident concepts, such that determining whether an entity and its members are eligible for any new form of treatment could in itself be difficult and — contrary to policy aims — give rise to uncertainty.

These respondents in the main emphasised that UK classification depends on a close analysis on foreign law, governing documents and the specific factual arrangements, and that particularly in the case of LLCs, the outcome of this analysis can be a matter of dispute between the member and HMRC.

A few respondents then mentioned further cases that cause problems for seemingly simple labels. A substantial concern was the possibility that foreign classification may be elective, may change, or may operate differently at federal and sub-national level — making defining ‘transparent for foreign tax purposes’ more difficult. Other concerns included ‘translucent’ entities (transparent for income but not gains, or vice versa); entities which allow for different members or classes of member to receive different treatment; and arrangements (such as contractual funds) which may not clearly constitute an ‘entity’.

To resolve uncertainty about entity eligibility, several respondents recommended a positive list of eligible entities - possibly accompanied by a negative list — maintained in HMRC guidance, regulations or secondary legislation and updated as foreign laws evolve. An alternative suggestion was a principles-based statutory test, supplemented with examples in guidance, on the grounds that a fixed list could become outdated or fail to reflect entity-specific fact patterns. One respondent suggested relying on the existing definition of a hybrid entity in s259BE of the Taxation (International and Other Provisions) Act 2010.

Some respondents called for clarity on what it means for an entity to be ‘resident in any other jurisdiction’, asking whether such a test would refer to formal residence, registration or domicile and how frequently residence would be tested.

Some further added that residence can itself be fact-intensive, uncertain and potentially costly to establish. One response pointed specifically to residence determination difficulties under existing mutual agreement procedures, while another noted that unadvised individuals may be particularly disadvantaged in this area.

A related concern was that testing transparency only in the jurisdiction of establishment could exclude economically equivalent cases. One respondent gave the example of a Cayman entity treated as a partnership for US federal tax purposes. Several respondents therefore favoured looking to the jurisdiction in which the member’s relevant tax liability actually arises, not solely the entity’s place of residence or establishment.

A key subset of respondents disagreed with the proposed scope and conditions specifically because they would exclude single-member entities and those entities with some form of UK presence (be it UK owner-management or a UK permanent establishment).

These respondents argued that the exclusions could leave single-member and small owner-managed entities stuck in precisely the double taxation mismatch that the proposal is intended to alleviate — as these individuals would be likely to create UK residence or a UK permanent establishment (PE) simply through ordinary commercial activity.

These respondents considered that as drafted, the regime would assist passive investors while failing to assist working founders, entrepreneurs and family offices. Some believed that the exclusion could encourage owners to move management offshore, restructure the business, or otherwise make tax-motivated structuring decisions contrary to commercial objectives.

Several respondents questioned whether the existence of any UK PE need necessarily disqualify all of the entity’s profits. A commonly suggested alternative was to preserve UK taxation of profits attributable to the UK PE while allowing transparent treatment for overseas income, gains or profits not attributable to that PE.

However, some respondents noted that identifying whether an entity has a UK PE in the first place (and if so, the profits properly attributable to that PE) could be difficult or impossible for a minority investor without full access to information.

Others asked more broadly why any residence or PE exclusions should be necessary where the individual members would be fully liable to UK tax on the entity’s profits. It was suggested by a couple of respondents that targeted anti-avoidance rules for artificial or tax-motivated arrangements could address the risk of UK tax leakage while still preserving access to relief for all categories of investor.

Another key subset of respondents identified uncertainties around the eligibility of entities within more complex and tiered structures. Examples mentioned included:

• interests held indirectly through another entity or chain of entities
• structures containing both transparent and opaque entities
• interests held through a trust
• interests held by a UK pension fund wishing to avoid exposure to trading income
• any entity that is itself a member of a UK LLP
• any UK limited company or UK LLP electively treated as a partnership or disregarded entity for US tax purposes

It was repeatedly noted that uncertainties surrounding more complex structures such as these become more acute where the UK investor cannot readily discover classification changes lower down the chain. A recurring recommendation was that HMRC publish guidance to accompany any new legislation providing examples of how any new rules will apply to a range of structures and fact patterns, and how much knowledge any investor is expected to have of other entities in the structure they have invested in.

Several respondents also called for clarity on entities with mixed ownership, to ensure that corporate members of any relevant entity would not be exposed to unintended consequences.

Question 9: Do you see any advantages or disadvantages to transparent treatment applying automatically, rather than by irrevocable election?

There were 54 responses to this question.

Approximately one-third of respondents favoured the automatic approach set out in the consultation; two-thirds preferred an elective approach at the member level.

Those in favour of automatic application considered that it would be more principled, remove the risk of taxpayer error or omission and provide consistency both for members of the same entity and across taxpayers in similar factual positions, reducing risk of ‘cherry-picking’. This option was seen as overall providing more certainty and administrative simplicity than an election, which could be subject to questioning over its validity or become compromised if a taxpayer’s circumstances change — for instance, if the entity’s overseas tax status were to change, or the member were to cease to be UK resident.

Several of those in favour of automatic treatment however recognised that transparency might not be preferred by all investors in reverse hybrids and so proposed providing an opt-out mechanism, possibly with a time-limit attached to prevent abuse. Others suggested that automatic treatment could be applied only prospectively to new holdings, with an elective ‘grandfathering’ mechanism or other form of elective transitional relief provided for existing holdings.

Those in favour of a fully elective approach saw this option as providing substantially better taxpayer control and flexibility. A repeated emphasis was that taxpayers’ circumstances differ significantly and may change over time. It was pointed out that since the target population of investors is globally mobile, any new regime should have the ability to accommodate for movement of individuals and entities between jurisdictions and changes to international tax systems.

It was stressed by these respondents that transparency does not necessarily benefit every individual. Respondents identified a range of circumstances in which opaque treatment may be preferable, including but not limited to:

• interests in businesses retaining profits for reinvestment rather than distributing
• interests in growth companies
• interests in incentive vehicles
• interests in entities generating significant depreciation deductions in the US (or other deductions not relievable in the UK)
• holdings in structures generating mainly capital gains
• investors who are temporary UK residents
• investors within fund structures
• investors affected by specific regimes such as FIG

The recurring concern about minority investors was also present within these responses. These respondents were clear that new compliance burdens should not be imposed automatically where investors do not have access to the full information necessary to comply with the rules (absent any simplifications or concessions).

Another frequently cited factor in favour of election was the capacity for automatic treatment (as presented) to create dry tax charges, which respondents felt that taxpayers should have some means to avoid. Other unexpected consequences of automatic transparency were feared where existing arrangements have been built around opaque UK treatment; again, respondents felt that taxpayers should have some means to avoid disturbing these structures.

Opinions were split on whether any election should be irrevocable (subject to foreign classification remaining static) or revocable. Where respondents supported irrevocability, their core concern tended to be preventing frequent switching and tax planning. Other factors in favour of irrevocability included improved certainty, reduced administrative complexity, and familiarity to taxpayers with experience of the system in the US, where entity-level elections are irrevocable within a period of 60 months. A few respondents explicitly proposed mirroring the US election window or imposing a similarly binding period.

Where respondents preferred revocable elections, the main argument put forward was flexibility. Respondents noted that taxpayer circumstances and holdings can change, business models can evolve, and foreign tax systems can be updated. These respondents felt that an irrevocable election could plausibly trap a taxpayer in an unsuitable outcome. Respondents however recognised the risk of frequent changes; suggested safeguards included restrictions on retrospective changes, a default rule as a backstop, and targeted anti-abuse rules where avoidance or other harmful action is suspected.

Transparent treatment

General view

Question 16: Do you believe that the approach set out above would solve the issue of high effective tax rates for individual members of reverse hybrids? Please explain why/why not.

Question 17: Do you see any issues with this approach, including any unintended outcomes for individual or non-individual taxpayers? If so, what are these?

There were 47 responses to question 16 and 38 responses to question 17.

The majority of respondents felt that the transparency approach set out in the consultation could solve the issue. Respondents described the proposal as addressing the cause, rather than merely mitigating the symptoms, of the mismatch, and considered that it would materially unlock or improve foreign tax credit relief. Its anticipated positive effects were seen as an important contribution to the competitiveness of the UK for internationally mobile individuals and particularly those undertaking work or investment in both the UK and the US.

Respondents also explicitly appreciated the proposal’s clear statutory answer to the uncertainty in the years since the Anson decision. These respondents welcomed the proposal’s ability to give a workable answer for taxpayers, advisers and HMRC, as well as remove what they regard as an anomalous outcome under the current rules.

Respondents however cautioned that the success of the proposal would be conditional on a substantial amount of technical work to resolve issues including but not limited to the intended scope, transitional adjustments, matching rules, interactions with other tax rules and reliefs, historic periods, existing disputes, the possibility for elective application, computational methods, and proportionate evidential requirements. Several respondents called for a further round of consultation, early publication of draft legislation, and detailed HMRC guidance with worked examples to support the implementation of any new rules.

A key minority of respondents went further in their caution to a more sceptical overall assessment.

These respondents were concerned that the proposal as drafted would simply not work for UK-resident working founders, sole members and small group/family member-operators, who would fall foul of residence and permanent establishment exclusions.

A critical overarching concern was that the proposal may be so difficult as to be fundamentally unworkable where an individual is a minority or passive member without copies of or even the contractual right to inspect the entity’s records and detailed accounts. The member may therefore have only foreign tax reporting to rely upon and be unable to identify the adjustments necessary to convert the foreign result into a UK tax computation.

A particular criticism of these respondents was the impact on the recognition and computation of capital gains, with this seen as having the potential to create more problems than it resolves. These responses highlighted the need for detailed rules (beyond Statement of Practice D12) on disposals, changes in membership, liquidations, redemptions and sales of interests, but again noted that these may not be sufficient in the case of a minority investor who lacks sufficient information to carry out even an estimated UK capital gains computation.

Further, it was noted that the proposed transparency regime could still see the character of certain income misaligned between jurisdictions, and that even where character is aligned, the tax periods in which items are recognised may not be — such that relief could be delayed, restricted or unavailable.

The preference of these respondents was for a credit relief mechanism as the default, potentially combined with an elective transparency route for taxpayers unable to obtain relief through the credit mechanism.

Multiple responses were also specifically negative in their assessment of a prospective-only proposal. The argument expressed here was not that transparency would not work, but that the approach as a whole would fail to solve a key problem for affected taxpayers: historic liabilities, open enquiries and litigation risk.

Income

Question 10: Do you see any issues with deeming the trade or business of eligible foreign entities to be carried on in partnership (or as a sole trade), and profits/losses being computed in accordance with UK Income Tax rules? If so, what are they?

Question 11: Do you see any issues with attributing investment income to members in line with their proportional membership interest, and tax liability being computed in accordance with UK Income Tax rules? If so, what are they?

There were 45 responses to question 10 and 35 responses to question 11.

A substantial group of respondents considered a deemed partnership approach to be logical and reasonable in principle. They argued that the UK already has a well-established body of rules for taxing partners and sole traders, and that it is sensible to apply those rules (which are also applied to foreign partnerships) rather than attempt to create an entirely new computational framework.

Several respondents however identified a conceptual concern where the new approach would apply only to certain UK resident individuals, while other members of the same entity remained outside the regime. One respondent questioned whether a partnership can coherently exist between only some members, when a genuine partnership normally requires all participants to be in partnership with one another.

Related difficulties were seen to arise where an entity has both individual and corporate members, such that the entity would remain opaque for corporates but be treated as transparent for qualifying individuals, posing a risk of distortion. The possibility for different individual members to receive different tax treatment (whether by election or because only some members are within the UK tax system) was also identified by some respondents as a risk. One suggested mitigation was to make transparency applicable by election at entity level and apply it consistently to all members.

Several respondents expanded on the earlier-raised concern as to how the deemed partnership would interact with corporate residence and permanent establishment rules, especially for single-member and small owner-managed entities. Respondents noted that the same profits could fall within both a corporation tax charge associated with a UK resident company or PE, and an Income Tax charge on an individual member; this would require clear rules to prevent double counting.

Multiple respondents stated that any legislation would need to explicitly specify that the deemed partnership exists only for Income Tax and Capital Gains Tax (CGT) computation and attribution, to prevent an unrestricted partnership fiction from producing unintended consequences elsewhere in the tax code.

Respondents listed a range of existing UK provisions whose application to a deemed partnership would require technical clarification, including but not limited to:

• mixed-member partnership rules
• salaried member rules
• connected person tests
• national Insurance liabilities
• capital allowances rules
• offshore funds rules
• loss relief
• commencement and cessation rules
• basis period rules and reforms
• Making Tax Digital obligations

One respondent suggested that a way to reduce the technical complexity could be to implement a modified form of transparent treatment that would in practice often align with partnership treatment, without legally mandating full partnership treatment.

Respondents broadly felt that proportional attribution of trading profits and investment income would be a reasonable default for simple cases, but a repeated conclusion was that it may not reflect the commercial allocation of income in more complex structures.

The principal concern was that legal ownership percentages can differ materially from members’ actual economic entitlements. A related point was that a ‘proportional interest’ might be difficult to establish where capital ownership, voting rights, rights on liquidation and current rights to profits each produce a different outcome.

Several respondents identified additional challenges where the individual holds their investment through one or more intermediate entities. In a tiered structure, the member might be expected to trace income through several levels, each of which might use different sharing ratios, allocation rules or reporting periods.

Several respondents specifically noted the possibility for entities to have features including:

• flexible or floating profit-sharing ratios
• preferred or priority returns
• class-based, special or asset-specific allocations
• different classes of membership interest with differing rights
• interests that vary during the reporting period
• distribution waterfalls
• catch-up provisions
• carried interest and performance allocation arrangements
• tax distributions

To accommodate these patterns, respondents tended to favour an approach wherein attribution would follow the member’s genuine economic entitlement, rather than automatically applying a fixed ownership percentage.

The prevalent suggestions were for any new legislation to use proportional ownership only as a default or fallback; to permit attribution according to the legal and economic rights in the governing agreement where these differ; to accept allocations shown in the entity’s foreign tax computations or member statements where these reasonably reflect economic entitlement; and to allow HMRC to challenge arrangements that are demonstrably artificial.

A few respondents referred to the partnership approach in section 850 of the Income Tax (Trading and Other Income) Act 2005 as a possible model. Others noted that US reporting already attempts to reflect economic entitlement through allocations reported to members.

Several respondents considered however that even where the foreign allocation method is clear, there might still be difficulties in translating this into a UK tax computation. Foreign reports may not align with UK rules on allowable expenses and deductions, matching, tax years and reporting periods, currency conversion, and calculation of tax basis. Respondents warned that this could require taxpayers to incur higher fees for compliance and monitoring, submit provisional figures, later amend returns, and manage the attendant risk of enquiries, inaccuracies or penalties.

Several respondents also made the point that income items may be reported or characterised differently between jurisdictions. These differences could make the proportional share of a UK-computed figure substantially harder to determine than the allocation in the foreign return.

Gains

Question 12: Do you see any issues with applying Statement of Practice D12 to individual members, and capital gains/losses being computed in accordance with UK Capital Gains Tax rules? If so, what are they?

Question 13: Do you see any issues specifically with respect to establishing each member’s fractional interest in the assets of the entity? If so, how could these problems be overcome?

There were 38 responses to question 12 and 32 responses to question 13.

While respondents were broadly in agreement that Statement of Practice D12 provides a logical and familiar starting framework, it was not seen as a complete or reliably workable solution for LLCs and other foreign entities. While some considered that D12 could work subject to reverse hybrid-specific modifications, a key minority considered it wholly unsuitable for foreign entities with sophisticated economic arrangements outside of standard UK partnership patterns.

These respondents diagnosed the central problem as being that D12 assumes that a member’s fractional interest in each underlying asset can be straightforwardly identified and tracked. Respondents described the reality wherein LLC and similar interests often represent changing, conditional or class-specific economic rights rather than a fixed undivided share of every asset; as identified in the responses to questions 10 and 11, a headline ownership percentage may not (and indeed frequently will not) correspond to the member’s actual economic entitlement for a variety of reasons.

Some respondents suggested that — similarly to suggestions made in respect of income — fractional interests should follow genuine economic entitlement under the operating agreement, rather than nominal ownership. Where the agreement does not assign specific assets, these respondents suggested determining entitlement by reference to a hypothetical realisation and liquidation of the entity. Alternative suggestions included reliance on foreign tax reporting, capital accounts, or another reasonable and consistently applied method.

Respondents further highlighted that D12 can lead to dry tax charges, either where a change in the ownership of an entity is treated as involving a deemed disposal and acquisition of fractional interests, or where a revaluation of the entity’s assets is allocated to members’ capital accounts.

Suggested mitigations included using year-average fractions where changes are immaterial, testing interests only at defined CGT events, rolling over or otherwise deferring gains until the underlying asset or membership interest is actually realised, or again allowing any reasonable and consistently applied method of calculation.

Other technical issues identified included establishing members’ base costs, allocating the consideration paid for an entity interest among underlying assets, adjusting for assets not recognised in the entity’s accounts, the interaction between foreign concepts of inside and outside basis, foreign currency calculations, tracing within tiered structures, multi-class interests, and the treatment of disposals of the member’s entity interest itself.

A few respondents saw these issues as being so significant and complex as to warrant maintaining opacity for CGT or allowing separate elections for Income Tax and CGT purposes. If transparency were to be pursued, these respondents favoured placing the relevant capital gains principles for reverse hybrids on a clear statutory footing (as opposed to the non-statutory framework in D12) and providing detailed accompanying guidance with worked examples.

Other rules, reliefs and exemptions

Question 14: Do you see any other issues with the transparent treatment outlined above in respect of the application of any other UK tax rules (or reliefs/exemptions)? If so, which UK tax rules (or reliefs/exemptions) are these? What are the issues that arise? How might these be mitigated?

There were 45 responses to this question.

Respondents identified a very wide range of interactions, spanning Income Tax, CGT, Corporation Tax, other business and employment taxes, Inheritance Tax (IHT), anti-avoidance rules, administrative obligations and transitional issues. A recurring mitigation request from respondents was for an explicit interaction schedule setting out which existing rules apply, which are modified or disapplied, and the limited purposes for which the entity is treated as transparent or as a partnership.

In relation to Income Tax, respondents requested clarity on topics including categorisation of income, existing foreign tax credit relief, losses and loss restrictions, partnership anti-avoidance rules, interest deductions, personal allowances, pension contributions and Gift Aid. Recent changes to the taxation of carried interest were flagged as a relevant consideration, as were proposed modernisations to the distributions framework recently subject to a separate government consultation.

Several respondents highlighted interactions with the foreign income and gains regime, former remittance basis positions, mixed funds, pre-commencement earnings and existing offshore attribution and anti-avoidance rules, including the Transfer of Assets Abroad and settlements provisions. Respondents emphasised that any new rules should avoid double taxation or double attribution where income or gains were already captured within another charging provision.

A number of respondents queried Capital Gains Tax reliefs, including Business Asset Disposal Relief, incorporation relief, roll-over relief, hold-over relief and share reliefs.

Some respondents also sought clarity on employment-related consequences. These included employment-related securities and disguised remuneration rules, the treatment of founder and management interests, restricted securities, options, growth shares, sweet equity, vesting arrangements, salaried members, PAYE and National Insurance contributions. Some respondents expressed the view that profit allocations should not become employment income merely because of the statutory fiction and recommended that existing employment tax rules should continue to apply on their own terms.

For business and international tax, respondents identified possible issues with transfer pricing, connected person rules, hybrid mismatch counteractions, Controlled Foreign Company rules, Diverted Profits Tax, Pillar 2 and withholding taxes. They requested safeguards against the same profits being taxed both at entity and member level and confirmation that transparent treatment would not, in and of itself, create a UK permanent establishment. Respondents also requested clear treatment of entities with mixed individual and corporate ownership and of multi-tier structures.

Several respondents identified possible interactions with IHT, including asset situs and Business Property Relief, and were of the view that the proposed transparency should not extend to IHT so as to alter the nature or situs of the member’s interest.

Other respondents further sought confirmation that any reform would not affect the identity of the taxable person for VAT, the importer of record for customs purposes, the application of stamp taxes, or any other rules that depend on the entity being able to be seen as a company or body corporate.

Finally, respondents emphasised the importance of clear administrative rules on Self Assessment notification and filing, white-space disclosures, Making Tax Digital, record keeping and the steps to follow where foreign information is not available by the UK filing deadline. Some respondents requested explicit assurance from HMRC that entering the prospective regime would not, by itself, be treated as an admission that an earlier filing position was incorrect.

Transitions

Question 15: Do you see any issues that might arise upon these transitions, in respect of tax rules (or reliefs/exemptions) applicable to a holding that begins or ceases to be treated on a transparent basis? What are the issues that arise? How might these be mitigated?

There were 48 responses to this question.

The majority of respondents regarded transition as one of the most important and highest risk parts of the proposed reforms. The overriding concern was that a change in UK tax treatment should not itself create a dry tax charge where there has been no disposal, distribution or other economic realisation. In general respondents considered that transition into and out of transparent treatment could work, but only with comprehensive relieving, basis, income-streaming and continuity rules.

With regards to the transition from holding an interest in the entity to holding a share of the entity’s underlying assets, respondents were generally in favour of an express no-disposal rule or an appropriate no-gain/no-loss, rollover, hold-over or deferral mechanism to be applied on entry and exit from the regime. Respondents were similarly in favour of express specification within legislation as to the member’s opening basis in the underlying assets and their original entity interest, although there was no single view on the preferred basis.

Some favoured rebasing assets to market value at the transition date, so that gains which accrued before transparent treatment commenced would not fall within the new regime. Others preferred the preservation or allocation of historic base cost to maintain continuity and avoid an unwarranted uplift. A few respondents suggested optional rebasing or deferral until the date of an actual disposal.

One respondent described IRS changes in 2020 which brought in a new requirement for partnerships (including LLCs taxed as partnerships) to report capital accounts on a mandatory US tax basis, where previously it had been acceptable to use Generally Accepted Accounting Principles, book or other methods. The respondent gave worked examples of permitted easement methods recommended to entities that had never previously recorded or tracked this information.

Many respondents also identified the treatment of accumulated undistributed profits as a central issue. They were concerned that treating all pre-transition profits as arising when the entity entered the regime would create a substantial one-off charge without a corresponding distribution. Several respondents favoured identifying and ring-fencing profits from the opaque period so that they would remain taxable, where appropriate, when distributed. Conversely, if transparent treatment were to end (for example due to a change in foreign tax status), respondents considered that profits already attributed to and taxed on members should not be taxed again when subsequently distributed. Several respondents recommended separate statutory pools and clear ordering or streaming rules for profits arising during opaque and transparent periods.

Other complexities identified included the treatment of accrued but unrealised (or deferred) gains and losses, foreign tax credits, trading and capital losses, capital allowance pools, stock, historic reliefs and qualifying ownership periods. Several respondents requested continuity rules to ensure that tax attributes were neither lost nor duplicated and that a classification change did not itself generate balancing charges, artificial losses or recapture of existing reliefs.

Many respondents also requested clarity on the date of commencement and any impact on historic periods, particularly for taxpayers who have previously adopted an Anson-based transparent position or who may currently be subject to an enquiry. Suggestions on this point included grandfathering, retrospective elections for taxpayers who had consistently reported on a transparent basis, a settlement framework for existing enquiries and a transitional or grace period for bringing positions up to date.

Minority and indirect investors

An overarching and very significant concern shared by a substantial group of respondents to questions 10 to 15 was the compliance burden associated with this method of computation for minority investors and those investing indirectly via a tiered or complex structure.

Respondents were consistent in their assessment that a full UK re-computation could be costly, burdensome or impracticable to the point of impossibility for members who receive only a Schedule K-1 (or equivalent foreign tax reporting) and have no contractual ability to access to the relevant entity’s underlying records. Such records would be crucial to identify the necessary adjustments to convert the foreign result into an acceptable UK tax computation.

Several respondents considered that to be workable, the proposal could effectively require an entity or its members to maintain a separate UK-standard set of accounts and computations, which was seen as an unrealistic expectation for foreign entities with no existing obligation or incentive to produce this type of reporting (or whose existence is unclear to investors in a tiered or complex structure).

Respondents highlighted the importance of there nevertheless being a way to make adjustments; otherwise, differences between UK and foreign rules on depreciation, capital allowances, financing costs, other allowable expenses, income recognition, fiscal periods and profit allocations could produce significant distortions to the UK tax base and leave residual mismatches. Real estate businesses were identified as a particularly difficult case because of the substantial differences in the treatment of depreciation and financing costs in overseas jurisdictions, particularly the US.

Specifically for capital gains, the concern was that minority or indirect investors would not have access to the asset registers, valuations, base-cost records and ownership information required to apply D12 at even a basic level. Transitions were described as especially complex and as requiring extensive asset-level valuations and base-cost allocations, which would again be difficult to obtain for minority members or those invested in multi-tier structures. Respondents stressed that it could be very difficult if not impossible for these investors to identify members’ fractional interests, determine whether changes in sharing ratios had given rise to deemed disposals, ascertain whether the entity had actually disposed of any of its assets, and calculate the corresponding gains or losses.

Proposals for mitigation made by respondents included:

• accepting US Schedule K-1 (or equivalent) reporting and member statements as the starting point
• allowing the foreign accounting period or calendar year to be used (with an adjustment mechanism where use of the foreign period produces a material advantage or disadvantage)
• treating foreign reporting categories as their closest UK equivalents
• allowing reasonable adjustments to foreign reporting figures
• prescribing a short list of the most material UK adjustments
• introducing a simplified method for minority or indirect investors
• providing a de minimis threshold or concession for small holdings
• accommodating white-space disclosure
• providing an advance clearance service for difficult cases
• establishing safe harbours
• publishing guidance or a suggested annual reporting format for foreign entities supplying information to UK resident members

Prospective and retrospective application

Although the prospective application of the proposals was not the subject of a specific question within the consultation, many respondents provided views on this matter and raised the treatment of historic periods as an important issue.

Multiple respondents characterised retrospective application not merely as a desirable addition, but as essential to the reform achieving its objectives in practice.

They considered that prospective reform alone would not resolve the significant problems with existing liabilities, disputes and enquiries, particularly for taxpayers who have previously adopted an Anson-based transparent filing position for LLC income. Some said that historic treatment was of greater immediate importance to these taxpayers than the position for future years, and that the reform’s intended benefits would be materially reduced without a practical route for resolving earlier periods.

Suggested approaches included a retrospective election, grandfathering or safe-harbour treatment for reasonable and consistently applied filing positions, targeted relief for historic double taxation, and a pragmatic settlement mechanism for open enquiries. Some respondents proposed restricting any retrospective treatment to taxpayers who have consistently adopted and disclosed transparent treatment, to protect good-faith positions while preventing opportunistic claims.

Respondents requested early clarity on HMRC’s intended approach to earlier years and, if the reform is to be prospective only, assurance that entering the new regime would not itself be treated as evidence that an earlier filing position was incorrect.

Alternative approaches

Question 19: What are your views on the deduction for foreign tax and credit relief options outlined above? Do these approaches have advantages or disadvantages in comparison to UK matching of transparent treatment? Please give details.

Question 20: Do you see any issues with either of these approaches, including any unintended outcomes for individual or non-individual taxpayers? If so, what are these?

There were 47 responses to question 19 and 26 responses to question 20.

Most responses demonstrated a general hierarchy of preference: most respondents were in support of the lead transparency option, but credit relief was regarded as a strong alternative, and relief by deduction was consistently the least favoured option.

Several respondents suggested a combined model under which automatic transparency would apply where it was workable, credit relief would be available as a backstop where transparency could not reasonably be applied, and deduction relief would provide a final fallback. Other respondents proposed elective transparency, but with credit relief applying as a default if no election is made.

There was however a material minority view that a well-designed standalone credit regime may be simpler, less disruptive and more practical overall, particularly for minority and indirect investors or complex structures. This group of respondents made the case that credit would in this way be maximally aligned with the objectives of the policy — that is, lowering ETRs and giving greater certainty for all investors in these entities.

The majority of respondents viewed deduction relief as ‘better than nothing’, but broadly ineffective. These respondents argued that deduction does not significantly reduce ETRs, leaves the fundamental mismatch unchanged, leaves residual UK tax even where foreign tax has been paid, and can be complex to apply where the entity has multiple sources of income and gains.

Credit relief was viewed much more favourably in principle because it could substantially reduce or eliminate double taxation while preserving the entity’s existing classification for other UK tax purposes. Some respondents explained that credit could avoid a substantial number of the technical complexities associated with transparent treatment, including the extensive cut-across to other tax regimes, interaction with residence and permanent establishment rules, calculation of profit and investment income shares, application of Statement of Practice D12, establishment of fractional interests in underlying assets, base-cost adjustments, and the treatment of mixed-member entities.

Credit relief was also considered particularly helpful for minority investors who lack the information needed to compute their share of profits and gains under UK rules. Respondents anticipated that the evidential requirement would be much reduced in comparison to transparency and would be broadly workable even with simple foreign tax reporting.

A number of respondents nevertheless identified potential design issues with a bespoke credit regime. A recurring comment was that it would be imperative for the government to consult further on the detail of any proposed credit mechanism, as the present consultation did not go into detail on how such a mechanism would work.

A general note made by multiple respondents was that if a credit relief regime simply takes the UK’s opaque treatment of these entities as an unspoken given, it could fail to deal with current uncertainty over their classification, in particular for members of LLCs caught between the Supreme Court’s view in Anson and HMRC’s position in its guidance. A few respondents suggested it would therefore provide more clarity if it were to be provided explicitly in legislation that these entities are to be treated as opaque going forward.

With regards to the functioning of the foreign tax credit mechanism itself, respondents noted that the relevant foreign tax would typically arise when the entity earns the underlying profits, while the UK tax would still arise only when those profits are distributed, potentially in a much later period. Respondents said that any new rules would therefore need to match foreign taxes to distributions across accounting periods and deal with distributions funded over several years or made from a mixture of trading profits, interest, dividends, rents and capital gains. Multi-tier structures and taxes imposed in more than one foreign jurisdiction would add further complexity to any issues with timing, source and nature of returns.

Several respondents also sought clarity on which foreign taxes would qualify, including federal, state, local and third-country taxes, and how relief would operate where the foreign and UK computational bases or characterisations differed. The coordination provisions at Article 24(6) in the UK-US DTC were flagged as a potential barrier to the effective operation of credit for US citizens.

Respondents noted that existing Double Taxation Relief requirements concerning the ‘same income’ and the ‘same taxpayer’ would need to be disapplied within a new bespoke regime; they generally favoured modified matching rules, together with provisions for carrying credits forward, amending claims when the foreign liability is finalised, and preventing credits from being used against unrelated income.

Several respondents further noted that credit relief would need careful design work in order to cope with the range of capital gains issues relating to reverse hybrids, including tax on disposals of an entity interest, foreign tax on underlying gains, and international differences between income and capital treatment. Some recommended that credits should be made explicitly capable of applying against CGT as well as Income Tax.

A few respondents considered that if a bespoke credit were to become available for underlying tax paid by UK resident individual members of a foreign transparent entity, then equivalent relief should also be made available to a UK resident individual shareholder in an ordinary foreign opaque company.

A few respondents also raised the possibility that credit relief could reduce UK receipts more than transparency or otherwise cause the UK to give a disproportionate share of Double Taxation Relief relative to the foreign jurisdiction. They reasoned however that the precise effect would depend on the credit limit and whether relief would correspond to the foreign tax, the UK tax, or some other measure.

Question 22: Are there any other options or ideas for reforming the taxation of individual members of reverse hybrids that you believe the government should consider? This could include forms of treatment or relief not mentioned above.

There were 32 responses to this question.

The most recurring proposal was for a broader reconsideration of the UK’s current common law entity classification system. Some encouraged a move towards an elective classification regime, similar to the US ‘check-the-box’ system, while others preferred a ‘similarity’ approach that would follow the entity’s classification in its home jurisdiction. Respondents considered that changes to introduce more predictability into entity classification could provide greater certainty and reduce the time, effort and expense required by common law analysis. One respondent suggested that it could be beneficial to give more weight to the views of foreign tax authorities and courts when carrying out common law analysis.

Some respondents proposed addressing the current ETR issue through targeted renegotiation of the UK’s double taxation agreements, although they recognised that this would require bilateral agreement. These and other respondents emphasised that any approach pursued should preserve compatibility with existing agreements such as the UK-US Double Taxation Convention and ensure that interpretative differences in character or timing would not prevent effective foreign tax credit relief.

A few respondents suggested broadening the scope of reform to non-individual taxpayers, including corporates, LLPs, trusts and foundations. Particular corporate issues raised included current uncertainty over the availability of the Substantial Shareholding Exemption and dividend exemption for reverse hybrid entities within group structures. In a similar vein, a few respondents asked whether comparable relief to that proposed for individuals should be available where a UK or foreign company had elected to be treated as transparent in another jurisdiction.

Other specific suggestions included clarity on treatment for non-commercial LLCs holding privately owned family property; special consideration for personal service companies; broader reform for trusts, foundations and family offices; and simplified treatment for appropriately regulated foreign funds. Respondents also identified wider UK-US mismatches involving mutual and money-market funds, grantor trusts, short sales, pensions and Individual Savings Accounts.

A number of practical simplifications were frequently recommended as easements for hybrid investors, regardless of the government’s decision on any policy proposal. These included explicitly permitting the use of the entity’s foreign tax year or another coterminous reporting period, providing enhanced guidance on adapting foreign tax reporting information for UK filings, and establishing a dedicated clearance or advance certainty mechanism beyond HMRC’s existing non-statutory clearance route.

More broadly, some respondents asked about the government’s strategy regarding the tax treatment of internationally mobile individuals and cross-border investments following the introduction of the FIG regime.

International comparisons

Question 6: Do other jurisdictions offer more favourable treatment for your or your clients’ income from reverse hybrids? If so, which jurisdictions are these? What makes the treatment more favourable than the UK?

Question 21: Do you have experience of the rules applied by other jurisdictions with respect to income from reverse hybrids? What jurisdictions are these, and what are the rules? What advantages and challenges have you encountered when applying these rules?

There were 30 responses to question 6 and 20 responses to question 21.

Several respondents outlined a general perception of the UK as unusually uncertain and more punitive in its approach to hybridity than other jurisdictions.

Several respondents described their experience in applying the US foreign tax credit and ‘check-the-box’ rules, viewing these rules as broadly clear and flexible, with the ability to reduce mismatches and uncertainty. Limitations identified included complexity in calculating credits, elections being entity-level rather than investor-level, and navigation of anti-arbitrage rules.

A few respondents commented on their awareness of the Australian rules for foreign hybrids (Division 830 of the Income Tax Assessment Act 1997), under which an individual’s interests may be held on a transparent basis if certain conditions are met. These respondents however noted that eligibility criteria can be complex and may exclude entities formed in common jurisdictions for private equity and hedge fund structures.

A few respondents identified the French and Canadian treaty interpretation approaches to hybridity as producing more favourable outcomes for individuals seeking credit. A few respondents commented on provisions within Israeli law for members of LLCs to report LLC income on an ongoing basis and receive relief for foreign tax paid, calculated in accordance with Israeli computational principles only where a certain tax or ownership threshold is exceeded.

A few respondents mentioned jurisdictions with a fundamentally different approach to entity classification in general, citing the Netherlands, Germany, Luxembourg, Denmark, Sweden and Ireland as key comparators. Respondents stated that jurisdictions which take a ‘mirroring’ or ‘similarity’ approach to entity classification may offer more scope to treat a reverse hybrid as transparent, such that an individual investor could more easily obtain credit for foreign tax.

A few respondents mentioned jurisdictions which they considered to have more holistically favourable regimes for globally mobile individuals, beyond issues with reverse hybrids.

Impacts

Question 18: Do you have any comments on the potential impacts of these changes on tax receipts or taxpayer behaviour? How might individuals and businesses respond to these changes? For instance, would these changes increase UK tax receipts overall? Conversely, are there specific tax planning techniques which these changes would incentivise or otherwise fail to capture?

There were 37 responses to this question, which were substantially optimistic in their assessment of overall impacts on receipts and behaviour.

The principal direct Exchequer cost identified by respondents was that foreign tax credit would become available against UK liabilities for which relief is currently restricted. On a static calculation, this would reduce UK Income Tax collected. Respondents specifically recognised that receipts could decrease in relation to categories such as foreign trading or rental income, where taxing rights would fall to the foreign jurisdiction.

However, a dominant theme of responses was anticipated positive dynamic effects, stemming from greater willingness of individuals to move to or remain in the UK, establish or expand UK operations, locate staff in the UK and accept UK assignments. Respondents considered that these decisions would naturally lead to an improvement in UK reputation and an increase in longer-term personal, business, employment and consumption tax receipts, the quantum of this increase being albeit difficult to quantify with any degree of certainty.

Several responses highlighted that the relevant population extends beyond high-net-worth individuals, noting that LLCs are used by people at a wide range of income levels when looking to do business or invest in the US. Respondents suggested that sectors to particularly benefit might include technology, scientific research, media production, asset management, real estate, financial services, and private capital.

Several respondents moreover described an anticipated restoration of commercial considerations to business and investment decisions, and a reduction in incentives to leave entity profits undistributed, with positive effects. Under the current treatment, some taxpayers with the control to do so defer distributions as a means of mitigation – but after reforms, distributed funds may be spent or invested in the UK, generating wider economic activity and potentially associated tax receipts. The UK would also be positioned to collect tax on amounts currently left undistributed indefinitely.

Some respondents expected clearer statutory treatment to produce more consistent reporting, a reduction in disputes, and therefore a more settled taxpayer population. However, others observed that compliance work could in fact increase under transparent treatment, due to the need for more detailed UK-standard computations. That additional compliance was nevertheless described as preferable to a tax outcome that is commercially prohibitive.

Some respondents identified risks of tax planning, particularly if taxpayers could elect into or out of the regime from year to year. Suggested safeguards included minimum or irrevocable election periods, main purpose tests, restrictions on short-term holdings, basis continuity rules and provisions addressing artificial allocations, loss acceleration and mixed-member structures. Other respondents considered that existing anti-avoidance rules would already address many of these risks.

Question 23: In relation to any of the proposals above, apart from change to UK liabilities, what would be the other impacts on you or your clients? For example, would there be impacts on time spent managing tax compliance, fees, cashflow, certainty, foreign tax expenses?

There were 39 responses to this question.

Respondents consistently stated that they welcomed changes to make the UK tax treatment more certain and thus allow decisions to be taken on a more commercial basis. At the same time, responses cautioned that any such benefits would be conditional on legislation and guidance being clear on the technical details of scope, transitional adjustments, and computations.

The general expectation was that changes would ultimately reduce the need for specialist UK and overseas tax advice, which would in turn to result in lower costs, after an initial increase due to re-evaluation of existing arrangements. Respondents similarly anticipated a reduced need in the long term for complex restructuring, protective analysis and prolonged engagement with HMRC.

Compliance and reporting burdens were however a particular concern with the transparency treatment set out in the consultation. Respondents were concerned about difficulty in obtaining detailed entity-level information to prepare UK computations, which may be exacerbated by limitations in foreign tax reporting. This was considered especially problematic or even insurmountable for minority or indirect investors.

Some respondents restated possible accommodations for these types of investor, such as model information requirements, elections, safe harbours, permission to rely upon existing foreign reporting information, and proportionate simplifications.

Cashflow and foreign tax expenses were broadly expected to benefit from improved predictability, especially where UK and overseas tax timings are aligned. However, several respondents expressed concerns that where UK tax may be charged on undistributed profit under a transparency model, cashflow could be negatively impacted by timing differences between the UK and overseas tax years and filing dates. Foreign currency conversions were also mentioned as a relevant consideration on cashflow.

Question 24: How might any of the proposed changes to the tax treatment of income from reverse hybrids impact your or your clients’ view of the UK as a place to live, work, do business and make investments?

There were 47 responses to this question.

Nearly all respondents stated that the proposed changes would have a significant positive impact on the UK’s attractiveness as a place to live, work, build a business and grow an investment portfolio.

The proposed changes were variously characterised as:

• removing a material disincentive to UK residence
• signalling that the UK is willing to adapt to the practical realities of cross-border entrepreneurship and investment
• facilitating long-term planning
• encouraging UK business expansion and innovation
• allowing UK staff equal participation in equity and profit-sharing arrangements

A few respondents took a more balanced view, stating that this issue alone would not be sufficient to motivate decisions and instead highlighted a broad scope of factors such as (but not limited to) the new FIG regime, the scope of UK IHT, recent changes to the taxation of carried interest, and proposed modernisations to the distributions framework.

Several respondents called for early clarity on the timing for implementation of any policy changes, to enable cashflow and reporting implications to be carefully managed.

4. Government response

The government welcomes the depth and breadth in which respondents expressed their views on these proposed reforms to the treatment of individual investors in reverse hybrid entities. The government is committed to ensuring that the UK continues to be a place where individuals choose to live, work, and invest. As part of this, the government welcomes opportunities to consider how the UK’s tax system can be modernised and reformed to support growth and competitiveness.

The intentions of any reforms in this area are to reduce unintended and high effective tax rates (sometimes exceeding 75%) for affected investors and provide them with long-term certainty over their UK tax position, while minimising disruption elsewhere in the tax framework. With these intentions in mind, the government has analysed the responses provided and has made the following decisions on the proposals set out in the consultation.

The government considers that the right approach is to pursue a credit-based relief mechanism. Following a review of the evidence and continued policy development, the government came to the view that the transparency proposal would require a significant amount of new technical architecture, which would be complex to navigate and integrate poorly with the wider tax system.

The government considers that its desire for long-term certainty in this policy area would be best met by a credit mechanism that gives a fair outcome for all types of investor across a full range of business structures, functions effectively using information available to investors, avoids excessive complexity and disruption, and reduces opportunities for avoidance.

The government agrees with those respondents who considered that transparency would exclude some of the people most affected by the problem. Exclusions for single-member entities and entities with UK residence, owner-management or a UK permanent establishment would deny relief to many working founders, entrepreneurs and family businesses; however, the government considers that such exclusions would be a necessary safeguard to the existing UK tax base if transparency were to be implemented.

The government also shares the concerns of those respondents who noted that transparency would be unworkable in practice for a significant part of the intended population, especially minority and indirect investors, unless it were to be supported by extensive simplifications, exceptions and bespoke legislation. The government understands that Capital Gains Tax issues in particular could be so complex as to be intractable, highlighting a fundamental tension between practical compliance and the fair application of standard UK tax principles to all UK taxpayers.

By contrast, the government considers that credit relief would address high ETR outcomes while avoiding many of the difficult structural consequences of transparency. It is more accessible to all categories of investor and allows the scope of relief to be precisely targeted to instances of double taxation where these arise.

The government recognises that credit relief is not without its own technical challenges. However, it sees these challenges as smaller in scale than those associated with transparency, and resolvable through further technical consultation.

The government acknowledges that automatic treatment was not respondents’ preferred design for any solution; approximately two-thirds of respondents preferred an elective member-level approach.

The government is therefore minded towards providing a new form of elective domestic credit relief for individual investors in reverse hybrids. The relief would reduce the investor’s ETR to a reasonable level, often broadly comparable to that of an investor in a business conducted through a UK limited company by allowing credit for taxes suffered by the individual in foreign jurisdictions.

The government envisions that under this approach, legislation would be introduced to specify eligible entities and provide that these are treated as opaque for the UK tax purposes of an individual member, such that the individual is liable to UK Income Tax on distributions received from the entity.  The entities specified statutorily would include US LLCs, US S-Corps, Jersey LLCs, and French SCIs. The entity would remain potentially chargeable to Corporation Tax according to the usual rules.

Distributions to individual members would be charged at dividend rates of Income Tax. Individual members would then however be entitled to elect to receive credit for eligible foreign taxes paid by them personally on the entity’s profits, income and gains. The credit would be calculated on the basis of the average rate of foreign tax payable by the investor, in accordance with mechanical rules as opposed to by tracing. Federal, state, and local-level taxes would be eligible for credit.

The government will consult on the detail of these rules, to ensure appropriate consideration is given to questions including but not limited to:

• how to calculate the effective foreign tax rate where an entity has a range of sources of income and gains
• how to account for timing mismatches between the foreign tax charge arising and distributions becoming chargeable in the UK
• how to give an equitable outcome with respect to the differential between dividend and other rates of Income Tax, including devolved rates

Claims for the new form of credit will be possible from early 2028. The government understands the significance of prior periods and ongoing disputes for affected stakeholders and is considering practical options available to address these.

The government will be careful to consider the impact of other recent or proposed changes relevant to the affected population, including the consultation on the modernisation of the distributions framework.

5. Next steps

The government would like to thank all stakeholders for their engagement with the consultation.

The government is committed to working closely with stakeholders to ensure their views are taken into account as policy reforms are designed and delivered. This engagement will assist in the drafting of detailed rules and any accompanying HMRC guidance, as well as designing the systems and processes to support their practical implementation.

The government will publish a further technical consultation shortly on the proposed credit relief mechanism, before legislating in a future Finance Bill.

HMRC and HMT will also continue to work with stakeholders to understand the issues raised by this consultation in detail. Stakeholders who would like to be included in any roundtable meetings or other engagement sessions should write to entityclassificationmailbox@hmrc.gov.uk to register their interest.

Annex: List of stakeholders consulted

The government is grateful to the 15 individuals and the following organisations who responded to this consultation:

Akin Gump LLP

Alternative Investment Management Association (AIMA)

Alvarez & Marsal Tax LLP

Baker & McKenzie LLP

BDO LLP

Blick Rothenberg Ltd

Buzzacott LLP

Charles Russell Speechlys LLP

Debevoise & Plimpton LLP

Deloitte LLP

DLA Piper UK LLP

Eldrin Legal LLP

Ernst & Young UK LLP

Forsters LLP

FTI Consulting LLP

Ground Control Business Management

Institute of Chartered Accountants in England and Wales (ICAEW)

Johnston Carmichael LLP

Kirkland & Ellis International LLP

KPMG LLP

The Law Society

Linklaters LLP

Macfarlanes LLP

Managed Funds Association (MFA)

Mercer & Hole LLP

Middlesex University Tax and Accounting Clinic

Mishcon de Reya LLP

Moore Kingston Smith LLP

PJD Tax Consultants Ltd

PricewaterhouseCoopers LLP

Railpen Ltd

Rosetta Tax Ltd

RSM UK Tax and Accounting Ltd

Saffery LLP

Sidley Austin LLP

Simmons & Simmons LLP

Skadden, Arps, Slate, Meagher & Flom (UK) LLP

Slaughter and May

Society of Tax and Estate Practitioners (STEP)

SRLV LLP

TaxFlare

Travers Smith LLP

UK Private Capital

US Tax Consulting Europe

Wedlake Bell LLP

Weil, Gotshal & Manges (London) LLP

White & Case LLP

William Blair

Withers LLP