U.S. LLCs with Separate Legal Identity Eligible for Treaty Benefits: Key crux of General Motors case

In an era of increasing global economic interdependence, cross-border transactions and tax compliance have become focal points for businesses operating internationally. One such intricate issue arises in the context of tax treaties between nations. A pertinent example is the case of a Limited Liability Company (LLC) incorporated in the United States, which recently claimed eligibility for treaty benefits under the India-U.S. Double Taxation Avoidance Agreement (DTAA). The LLC, while deriving income in India through fees, applied a preferential tax rate of 15%, as outlined under the DTAA. Crucially, this claim was rooted in the assertion that the LLC qualified as a ‘person’ under Article 4 of the treaty, due to its tax liability in the U.S. under American income tax laws.

This article delves into the crux of the case (General Motors Company USA v. ACIT, Circle International Taxation 1(3)(1)) in which the order was passed in the month of September 2024, exploring the criteria that enable an entity to invoke treaty benefits, and the broader implications for international taxation and corporate structuring. By examining the interplay between U.S. domestic tax laws and the provisions of the Indo-U.S. DTAA, we gain valuable insights into how businesses navigate complex tax landscapes while striving to optimize their global tax positions.

Facts

The case involves an appeal filed by General Motors Company USA (Assessee), a LLC incorporated in the USA, against the orders of the Assessing Officer (AO) and the Dispute Resolution Panel (DRP) for the assessment years 2014-15 and 2015-16. The key issue in the case is whether the Assessee, being a LLC, is eligible for the benefits of the India-USA DTAA. Procedural History: The Assessee, General Motors Company USA, claimed to be a resident of the USA and offered to tax its income from fees at the rate of 15% as per the India-USA DTAA. However, the AO held that LLCs are fiscally transparent entities under US tax law, and their income is not subject to tax in their own hands in the USA. Relying on Article 4 of the DTAA, the AO concluded that such corporations do not qualify as ‘residents’ of the USA and are not eligible for treaty benefits.

The AO proceeded to tax the Assessee’s income at the rate of 25% under the Income-tax Act, 1961. The Assessee filed objections before the DRP, which upheld the AO’s decision. Aggrieved, the Assessee filed the present appeals before the Income Tax Appellate Tribunal (ITAT). Factual Background: The Assessee, General Motors Company USA, is a LLC incorporated in the USA. The Assessee claimed to be a resident of the USA and offered to tax its income from fees at the rate of 15% as per the India-USA DTAA. The AO examined the Assessee’s return and found that the receipts were from two Indian entities, General Motors India Pvt. Ltd. and Chevrolet Sales India Pvt. Ltd., for “Fees for Technical Services/Fees for Included Services.”

The AO noted that the rate of tax on FTS/FIS under Section 115A of the Income-tax Act, 1961 was 25%, while the treaty rate under Article 12 of the DTAA was 15%. Consequently, the AO reopened the case and proposed to tax the Assessee’s income at 25% instead of 15%, as claimed by the Assessee. The Assessee provided detailed submissions to the AO, arguing that it qualifies as a ‘person’ and is ‘liable to tax’ in the USA under the DTAA.

The issues addressed in the judgment are as follows:

• Whether the Assessee, a LLC incorporated in the USA, qualifies as a ‘resident’ of the USA under Article 4 of the India-USA Double Taxation Avoidance Agreement (DTAA) and is therefore eligible for treaty benefits.
• Whether the Assessee, being an LLC, is considered ‘liable to tax’ in the USA under the ‘laws of that State’ as required under Article 4 of the DTAA, even though its income is not directly taxed in its own hands but is attributed to and taxed in the hands of its owner(s).
• Whether the fact that LLCs are treated as ‘fiscally transparent entities’ under US tax law, meaning their income is not subject to tax in their own hands, disqualifies them from being considered ‘residents’ eligible for treaty benefits under the DTAA.
• Whether the special provision in Article 4(1)(b) of the DTAA, which recognizes partnerships, trusts and estates as ‘residents’ to the extent their income is subject to tax in the hands of the partners, beneficiaries or members, can be extended to LLCs that are treated as transparent entities for US tax purposes.

The appellant(s) made the following arguments:

• The Assessee is a LLC incorporated in the USA and claimed to be a resident of the USA. The Assessee offered to tax its income by way of receipts on account of Fees at the rate of 15%, applying the rate given in the India-USA DTAA.
• Under US federal income tax law, an LLC with a single owner is disregarded as separate from its owner unless the LLC elects to be treated as a corporation for US federal income tax purposes. The ability of the LLC to elect its tax classification under US federal income tax law also supports the legal situation or aspect of the LLC being liable to tax. Further, where an LLC is disregarded as separate from its tax owner for US federal income tax purposes, the tax owner of the LLC pays tax on the tax owner’s share of the taxable income attributed from the LLC. This further supports the legal situation of an LLC being liable to tax, i.e., the LLC is essentially ‘liable to tax’ but the income is attributed to its tax owner and such tax is imposed and paid by its respective tax owner.
• The Tax Residency Certificate (TRC) received from the United States Internal Revenue Service in accordance with the requirement of the law as applicable to the Assessee, being an LLC, which is organized as a body corporate as it fulfills all the requirements of a body corporate in the form of legal recognition of a separate existence of the entity from its Member and a perpetual existence distinct from its Members. Thus, the Assessee being a resident under Article 4 of the Indo-US DTAA by virtue of incorporation and its recognition as a separate existence from its Members qualifies as a ‘person’.
• The Assessee is liable to tax in the resident State (USA) by virtue of US Income-tax Law as an LLC is given an option to either be taxed as a corporation or be taxed as a disregarded entity or partnership (depending on the number of members) wherein the income of the LLC is clubbed in the hands of its owner who merely discharges the tax that is assessable in the case of the LLC.
• The intent of the Indo-US DTAA has to be given precedence wherein the concept of fiscally transparent entity is the recognized way of recognizing the phrase ‘liable to tax.’ The fact that paragraph 1(b) of Article 4 of the Indo-US DTAA recognizes a partnership as a resident of the US for the purpose of the Indo-US DTAA to the extent that the income derived by such partnership is subject to tax in the US as the income either in the hands of the partnership or in the hands of its partners or beneficiaries.
• The provision in paragraph 1(b) of Article 4 of the Indo-US DTAA imposes a limitation on the eligibility of a partnership to avail the benefits of the India-US tax treaty, i.e., it seeks to exclude from the eligibility of provisions of the India-US tax treaty such income of the partnership which is not ‘subject to tax’ in the US (either in the hands of the partnership or partners). This suggests that ordinarily, without the restriction, a fiscally transparent entity would be eligible to be treated as a resident eligible for tax treaty benefits.

The respondent(s) made the following arguments:

• The AO noted that the Assessee’ s own filings before the income tax authorities make it abundantly clear that the Assessee is a LLC incorporated in the state of Delaware in the USA. The AO held that LLCs are fiscally transparent entities according to the US tax law, i.e., their income is not subject to tax in their own hands in the USA and such corporations, therefore, do not qualify as residents of the USA in terms of Article 4 of the India-USA DTAA.
• The AO relied on Article 1 of the India-US DTAA, which states that the treaty is applicable to “residents of one or both of the Contracting States”. Article 4 of the DTAA defines the term “resident of a Contracting State” and makes it clear that for the purposes of this Convention, the term “resident of a Contracting State” means any person who, under the laws of that State, is liable to tax therein by reason of their domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature. The AO, accordingly, concluded that only persons or entities that are liable to tax in their country under the laws of that country are considered residents for the purposes of the DTAA. Since the Assessee, being an LLC, is not liable to tax in the USA, it does not qualify as a resident.
• The AO also observed that LLCs do not come under the special clause for partnerships and trusts laid down in paragraph 1(b) of Article 4 of the DTAA. Accordingly, the AO proceeded to bring the Assessee’s returned income to tax at the rate of 25%, thereby denying the treaty benefit.
• The DRP found no infirmity in the action of the AO and upheld the AO’s findings. The DRP noted that the OECD has specifically stated in the official commentary to the OECD Model Convention on Article 4, in paragraph 8.4, that where a particular country disregards a partnership for tax purposes and treats it as fiscally transparent, taxing the partners on their share of the partnership income, the partnership itself is not ‘liable to tax’, and may not, therefore, be considered to be a resident of that country. The DRP held that this recent work of the OECD, which goes to the root of the matter, was neither pointed out nor considered in any of the decisions relied upon by the Assessee.
• The DRP was of the considered opinion that the Assessee cannot be considered a resident of the USA in view of the recent work of the OECD in this regard, reflecting the international law on the point. The DRP, accordingly, upheld the action of the AO and dismissed the Assessee’s objections.

ITAT’s analysis

The key issues under the consideration:

1. Whether the Assessee, a LLC incorporated in the USA, qualifies as a ‘resident’ of the USA under Article 4 of the India-USA DTAA and is therefore eligible for treaty benefits.

2. Whether the Assessee, being a fiscally transparent entity in the USA, is ‘liable to tax’ in the USA and therefore qualifies as a ‘person’ under Article 4 of the India-USA DTAA. The ITAT analyzed these issues as follows:

3. Assessee’s status as a ‘resident’ under the India-USA DTAA:

• The ITAT noted that under US federal income tax law, an LLC with a single owner is disregarded as separate from its owner unless the LLC elects to be treated as a corporation for US federal income tax purposes.
• The ITAT observed that the ability of the LLC to elect its tax classification under US federal income tax law supports the legal situation or aspect of the LLC being liable to tax.
• The ITAT examined the TRC obtained by the Assessee from the United States Internal Revenue Service. The TRC stated that the Assessee LLC is a branch, division, or business unit of a U.S. corporation that is a resident of the United States of America for purposes of U.S. taxation.
• Based on this, the ITAT concluded that the assessee being a resident under Article 4 of the Indo-US DTAA by virtue of incorporation and its recognition as a separate existence from its members qualifies as a ‘person’.

1. Whether the assessee is ‘liable to tax’ in the USA:

• The ITAT noted that under US federal income tax law, an LLC with a single owner is either treated as a disregarded entity or as a partnership (depending on the number of members), wherein the income of the LLC is clubbed in the hands of its owner who discharges the tax assessable on the LLC.
• It observed that this further supports the legal situation of the LLC being ‘liable to tax’, as the income is attributed to its tax owner and such tax is imposed and paid by the respective tax owner.
• The ITAT held that the phrase ‘liable to tax’ has to be interpreted in the way that the Assessee is liable to tax under the authority of the US Income-tax law.
• Further, relied on the concept of fiscally transparent entities recognized in the India-USA DTAA and the fact that paragraph 1(b) of Article 4 of the DTAA recognizes partnerships as residents of the USA to the extent their income is subject to tax in the USA. In conclusion, the ITAT held that the tax authorities erred in not extending the treaty benefit to the Assessee. The ITAT allowed the Assessee’s appeal, finding that the Assessee, being an LLC organized as a body corporate and recognized as a separate entity from its members, qualifies as a ‘person’ resident in the USA and is ‘liable to tax’ in the USA under the India-USA DTAA.

The key points from the ITAT Order are:

1. The Assessee, an LLC incorporated in the USA, claimed to be a resident of the USA and offered to tax its income at the rate of 15% under the India-USA DTAA.

2. The Assessing Officer held that LLCs are fiscally transparent entities under US tax law and therefore do not qualify as residents of the USA under Article 4 of the India-USA DTAA. The Assessing Officer proceeded to tax the Assessee’s income at 25% under the Act, denying the treaty benefit.

3. The ITAT held that under US federal income tax law, an LLC with a single owner is disregarded as separate from its owner unless the LLC elects to be treated as a corporation. The ability of the LLC to elect its tax classification supports the legal situation of the LLC being liable to tax.

4. The ITAT further held that the TRC received by the Assessee from the US Internal Revenue Service recognizes the Assessee, being an LLC, as a body corporate that fulfills the requirements of a separate legal entity. Therefore, the Assessee qualifies as a ‘person’ and a resident under Article 4 of the India-USA DTAA.

5. The ITAT concluded that the tax authorities erred in not extending the treaty benefit to the Assessee and allowed the Assessee’s appeal.

References

1. Union of India v. Azadi Bachao Andolan, ([2003] 132 Taxman 373/263 ITR 706 (SC)) – Cited to support the interpretation that liability to taxation is a legal situation, and not the fiscal fact of actual payment of tax.

2. Linklaters LLP v. ITO, ([2010] 40 SOT 51/[2011] 9 ITR(T) 217) – Cited to support the position that as long as the entire income of a partnership firm is taxed in the residence country, treaty benefits cannot be declined.

3. General Electric Pension Trust, In re., ([2006] 150 Taxman 545/280 ITR 425 (AAR)) – Cited to support the position that an exclusion provision can only exclude something if it was included at the outset.