It is not uncommon for buyers to offer a combination of cash and equity as part of their sale consideration.  Equity is sometimes offered to individuals who will remain in the business post-acquisition, to align their interests with those of the buyer.  But it might also be offered in lieu of cash, to assist with the buyer’s cash flow and financing.   

While this structure can offer various benefits, it also presents unique tax challenges for UK sellers where the equity is offered by a US buyer.  The issues principally arise when the UK resident ends up with a ‘pass through’ interest in a US entity, such as interests in a US Limited Liability Company (LLC).  US buyers need to be mindful that the tax implications for UK residents of holding LLC interests can be complex and requires careful planning at an early stage of the transaction.

The issues arising from LLC units can best be illustrated by looking first at what a UK seller would expect on a ‘normal’ UK acquisition which is partly paid with UK buyer equity.

What UK sellers will typically expect in UK M&A deals from a UK tax perspective

Tax rate

UK tax residents will normally expect to pay UK capital gains tax (CGT) on any gain they make when they sell their shares.  Under current UK law, if a UK seller satisfies certain conditions then they will qualify for a relief known as “business asset disposal relief” (BADR) and pay CGT at a rate of 14% on any gain on their shares (up to a lifetime limit of £1million).  This rate is due to increase to 18% from 6 April 2026.  If a UK seller does not qualify for BADR, they will generally expect to pay CGT at a rate of 24% on any gain they have made on the shares they are selling.

Where UK sellers rollover into an equity stake in a UK buyer

UK sellers who roll a portion of their sale proceeds into acquiring equity in a UK buyer (or UK buyer group) will normally expect to get ‘rollover’ tax treatment, which essentially defers tax on that share-for-share element.  Assuming rollover treatment is achieved, a CGT charge will only be triggered for the UK sellers when they go on to sell their rollover equity in the buyer structure in the future.  CGT would then be payable by the UK seller on the difference between the value of the rollover equity when it is sold and the value paid by them for their original shares (which were then acquired by the buyer).

The downside of rollover treatment applying is that BADR may not be available to UK sellers when they eventually sell their rollover equity in the future (depending on the situation at the time).  As such, UK sellers may prefer to trigger an upfront tax charge on the value of the shares bought by the UK buyer instead of waiting to pay CGT when they sell their rollover equity in the future.  The type of equity offered to UK sellers on a UK rollover and the way a rollover is structured tends to be discussed early on in a transaction between the parties.

Crucially, UK sellers owning shares in a typical UK buyer group would only expect to be taxed in the UK on distributions they actually receive while holding that equity.  UK sellers would not expect to be taxed on the profits of the buyer group as those profits arise.

What tax challenges are there for UK sellers receiving rollover equity in an LLC?

Characterisation mismatch

The key issue for US buyers to be aware of is that there can be a mismatch in how an LLC is characterised for tax purposes by the US and the UK. 

For US tax purposes, an LLC is often treated as ‘tax transparent’ (also sometimes referred to as a ‘pass through’ entity).  Where LLCs are transparent for US tax purposes, holders of units in those LLCs are taxed (both at a US federal and at a state level) on the profits of the LLC as they arise, regardless of any actual cash distributions.  A similar principle will apply to direct and indirect subsidiaries of the group if there is an unbroken chain of tax transparent entities.

However in the UK LLCs are typically treated as ‘tax opaque’ (meaning that the LLC is recognised a separate entity rather than as a ‘pass-through’).  UK resident holders of LLC units will therefore be taxed on dividends they receive from the LLC.  This mismatch in classification can lead to tax issues for UK sellers both in terms of holding LLC units and when they eventually sell those LLC units.

Holding LLC units

Due to the mismatch in how the tax authorities in the US and the UK characterise these payments, a UK individual will get taxed in the UK on distributions and is unlikely to receive a tax credit in the UK for US tax they have already paid on their share of the profits of the LLC.  As such, a UK individual will be bearing both US and UK tax on their profit share in an LLC.  Being subject to double taxation in this respect will be a major disincentive for UK sellers in terms of agreeing to acquire LLC units in a US buyer’s group as part of an acquisition package.

From an administrative perspective, UK holders of LLC units may also need to file both US and UK tax returns.  US tax returns for the income they are deemed to have received and UK tax returns for dividends they receive from the LLC.  The administrative complexity for UK individuals of navigating the intricacies of US tax laws will also be a further disincentive.

Future sale of US business

Sale structures in the US can take a number of forms, and in particular the flexibility of the US system means LLCs sometimes sell their assets rather than structuring the sale as a sale of the parent LLC itself.  This can work well for US tax residents, but can lead again to double taxation for a UK resident; the US charges tax on the sale of assets by the LLC whereas the UK would tax functionally the same value when the LLC is wound up and distributes that value to equity holders.

Even a sale of LLC units isn’t guaranteed to avoid double taxation (depending on the LLC structure).

This can lead to an effective tax rate for UK individuals on a future sale of more than 50%, which is a far cry from the potential 10% or 24% they would have achieved on an eventual exit in a UK rollover structure.

How can US buyers make rollover equity packages more appealing to UK sellers?

There are a few ways that US buyers can make rollover equity packages more appealing to UK sellers:

• UK sellers could receive shares in a tax opaque US corporation (a so-called ‘C corp’) as opposed to units in an LLC to try and simplify the UK seller’s tax reporting obligations and to align the tax treatment of the UK seller’s US equity in both the US and the UK. For existing C corp buyers this requires no action, but other entity types could (where there’s sufficient commercial incentive) investigate converting into a C corp

• A corporate blocker could be placed above the LLC.This could be in the form of either a new holding company for the LLC or a personal investment company through which the UK sellers are shareholders.The key point is that the ‘blocker’ must be tax opaque.

By inserting a corporate blocker above the LLC, the LLC’s income and gains will be taxed at the level of that corporate blocker (as opposed to at the level of the UK sellers) with the UK sellers being taxed to the extent the corporate blocker makes distributions to them.  This option would help mitigate the risk of the UK sellers facing double taxation both on the ongoing profits of the LLC and also on an eventual sale of the LLC.

A US buyer should take specialist advice in both the UK and the US before implementing any structuring of this kind.

Acquiring interests in an LLC as part of a corporate transaction can offer significant benefits but also presents unique tax challenges for UK sellers. By understanding these issues and considering appropriate alternatives, it is often possible to mitigate the potential tax downsides for UK sellers and achieve a more favourable outcome for all parties involved.

Lewis Silkin regularly works with US financial and corporate buyers on M&A deals across a wide range of sectors on UK domestic and cross-border transactions. We’d be delighted to discuss any questions you may have regarding UK deal practice at an early stage in any discussions you may be having in relation to possible UK acquisitions.  We would also be happy to put you in touch with US tax advisers we work with on cross-border transactions to the extent you have any US tax questions on possible UK acquisitions.   

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