From the US LLC trap to Pillar Two’s participation exemption collision, the gaps between UK tax law and its OECD counterparts are wider — and more dangerous — than most practitioners realise.

By Dr Clifford Frank  LLM(Tax) PhD HDipICA ATT

Senior Partner, LEXeFISCAL LLP  |  16  March 2026  |  Estimated reading time: 14 minutes

When the Same Transaction Means Two Different Things

In more than forty years of advising clients on cross-border tax matters, I have never encountered a period in which the risks arising from tax mismatches between the United Kingdom and its OECD partners have been so acute, so varied, and — frankly — so underestimated. A mismatch occurs whenever the same entity, financial instrument, transaction, or income stream is characterised or treated differently by two different jurisdictions. The consequences range from the merely inconvenient — an unexpected withholding tax, an additional filing obligation — to the catastrophic: double taxation of the same profit, denial of a relief that a client has relied upon for years, or a deduction that HMRC disallows with interest and penalties running from the day it was claimed.

The problem is not new, but the landscape has changed dramatically. The UK implemented the OECD’s Base Erosion and Profit Shifting (BEPS) project recommendations through the hybrid and other mismatches regime in Part 6A of TIOPA 2010, introduced by the Finance Act 2016 and effective from 1 January 2017. Pillar Two’s Global Minimum Tax came into force for the UK from 31 December 2023 under Finance Act 2023. The November 2025 update to the OECD Model Tax Convention rewrote the permanent establishment commentary on remote workers. The UK-Luxembourg double tax treaty was renegotiated with effect from 1 January 2024. And following Brexit, UK companies lost access to the EU Interest and Royalties Directive — a change whose full ramifications are still being worked through in corporate treasury departments across the country.

To help advisers and clients navigate this shifting terrain, we at LEXeFISCAL have compiled a comprehensive reference table mapping thirty-one distinct tax mismatches between the UK and key OECD partner jurisdictions. In this article, I want to draw attention to what I consider the most commercially significant of those mismatches, explain the underlying legal mechanics, and offer some practical thoughts on how to manage the risks they create.

Part I: Entity Classification — The Hybrid Entity Problem

The US LLC: A Trap That Keeps Claiming Victims

Nothing in my experience illustrates the entity classification mismatch more vividly than the American Limited Liability Company. In the twelve months to March 2025, more Americans applied for British citizenship or indefinite leave to remain than in any previous period on record. Many of them arrive with LLCs — often Delaware LLCs — either as trading vehicles or as holding structures for investment portfolios. They assume, not unreasonably, that because the LLC is transparent for US federal tax purposes under the check-the-box regime (IRC §7701), it will be treated the same way in the UK. It will not.

HMRC’s position — maintained since 1997 and reinforced by updated International Manual guidance at INTM180050 in December 2023 — is that a Delaware LLC is opaque for UK tax purposes: it is treated as a separate taxable person, akin to a company. The practical consequence is devastating. The US taxes the member on their share of LLC profits as they arise. The UK taxes the member only on distributions they receive. But because the UK views the LLC as opaque, it does not accept the US tax as paid on the same profits — and so double tax relief is denied. The member pays US tax on arising profits, UK tax on distributions, and has no credit mechanism to neutralise the duplication.

The Supreme Court decision in Anson v HMRC [2015] UKSC 44 offered a brief moment of hope: the Court held that on the specific facts of that case, a Delaware LLC was transparent for UK purposes and the member was entitled to credit against UK tax for US taxes paid on LLC profits. HMRC’s response was immediate and, in my view, deliberately discouraging: Revenue and Customs Brief 15 (2015) declared that Anson was confined to its facts, that HMRC would continue treating LLCs as opaque in the generality of cases, and that it reserved the right to open enquiries against taxpayers who had claimed credit in reliance on the decision. The further guidance in December 2023 doubled down on this position.

The abolition of the remittance basis from April 2025 has removed what was, for many recently arrived Americans, the only practical mitigation: deferring UK tax by not remitting offshore income. That option is now closed. Anyone arriving in the UK with an active LLC structure needs immediate, specialist advice — and should act before profits arise in the UK tax year, not after.

The Reverse Hybrid: UK Investment Funds and EU Investors

The entity classification problem runs in both directions. A UK limited partnership or LLP is transparent for UK tax purposes — UK partners are taxed on their share of profits as they arise at the entity level. But under the EU Anti-Tax Avoidance Directive 2 (ATAD 2), effective 1 January 2022, where an EU-resident investor holds an interest in an entity that is transparent in the UK but is treated as opaque by the investor’s home state, the entity becomes a ‘reverse hybrid’ — and the EU state is entitled to impose entity-level tax on the income attributable to that investor.

The UK responded with Chapter 8 of Part 6A of the Taxation (International and Other Provisions) Act 2010 (TIOPA 2010), introduced by Finance Act 2021, which addresses reverse hybrid mismatches from the UK end. But this is an area where the interaction between the UK rules, the ATAD 2 implementation of each EU member state, and the position of qualifying institutional investors (pension funds, life assurance companies, sovereign wealth funds) creates genuine complexity. Fund managers with EU-domiciled investors in UK limited partnerships should not assume that structures which worked before 2022 continue to operate cleanly.

Part II: Hybrid Financial Instruments — When Debt is Not Debt

The hybrid financial instrument mismatch is captured in Chapter 3 of Part 6A TIOPA 2010 (sections 259CA to 259CB). It arises where the same instrument is treated as debt in one jurisdiction — generating a deductible interest payment — but as equity in another, so that the corresponding receipt is an exempt dividend. The mechanics are straightforward: deduction in one state (D), non-inclusion in the other (NI). The outcome — sometimes styled a D/NI mismatch — is exactly what the BEPS Action 2 Final Report was designed to neutralise.

Profit-participating loans are the classic example. A UK subsidiary borrows from a German or Dutch parent on terms that tie the return to the subsidiary’s profits. Under UK GAAP or IFRS, the instrument has the legal form of a loan — the return is deductible interest for UK corporation tax purposes. But Germany and the Netherlands may treat the return as a non-deductible distribution on equity, with the corresponding receipt exempt under the parent-subsidiary regime. The result, absent any counteraction: the UK subsidiary deducts the payment; the German or Dutch recipient does not include it. The primary response under Chapter 3 is to deny the UK deduction. That sounds simple, but identifying whether Chapter 3 applies requires analysis of the tax treatment of the payment in every jurisdiction through which the payment flows — not just the UK and the immediate counterparty.

Repo and securities lending arrangements present a variant that is particularly prevalent in financial services. Chapter 4 of Part 6A TIOPA 2010 addresses ‘hybrid transfer arrangements’ — situations where one jurisdiction treats a securities repo or stock lending as a secured loan (with deductible interest) whilst the other treats it as a full disposal and repurchase, characterising equivalent dividend payments as exempt income. The breadth of Chapter 4 means that REPO desks in UK banks must routinely run hybrid transfer assessments on transactions with counterparties in jurisdictions that have different classification rules — including the United States.

Part III: Permanent Establishment — The Remote Working Revolution and Its Tax Consequences

The OECD approved significant updates to the Commentary on Article 5 of the Model Tax Convention on 18 November 2025. Those updates address a question that has exercised advisers and multinationals since the pandemic: when does an employee working from home in another country create a permanent establishment for their employer?

The 2025 update introduces a two-part framework. The first element is a 50% working time threshold: where an employee works from a home office in another country for less than 50% of their total working time, the home will not generally be considered a ‘fixed place of business’ of the employer. The second element is a qualitative ‘commercial reason’ test: even where the 50% threshold is crossed, a PE will not arise unless the employee’s presence in that country serves a genuine commercial purpose for the enterprise — something more than personal preference or employee retention.

In my view, the 2025 OECD update is welcome and long overdue. But it creates its own mismatch risk. The update revises the Commentary, not the text of Article 5 itself. Many UK bilateral treaties have not been amended via the Multilateral Instrument to incorporate the post-2025 Commentary position. HMRC has not yet updated its own guidance in the Business Income Manual to reflect the November 2025 Commentary. Until both of those things happen, there is a risk that HMRC applies a different standard to the question of UK PE creation from the one that the foreign enterprise’s home state applies — generating either double taxation (both states assert a PE and attribute profit) or irreconcilable uncertainty for an employer that is trying to manage the working arrangements of a genuinely mobile workforce.

The practical message for multinational employers is clear: implement robust cross-border working time tracking; review your global mobility policy against the 2025 Commentary before allowing employees to work remotely from another jurisdiction; and take advice before a PE is created — not after HMRC has written to assert one.

A separate but related PE mismatch arises from the BEPS Action 7 revision to the agency PE definition. Under the Multilateral Instrument (Article 12), a person who habitually plays the leading role in concluding contracts on behalf of a foreign enterprise creates a PE even if they do not physically sign those contracts. But not all UK bilateral treaties incorporate the MLI Article 12 position — some treaty partners have reserved on that provision — and a mismatch therefore persists between the PE threshold applied by the UK and that applied by the other state.

Part IV: The Post-Brexit Withholding Tax Problem

Before 31 December 2020, UK companies paying interest or royalties to EU group companies within the scope of the EU Interest and Royalties Directive (2003/49/EC) paid those amounts free of withholding tax. The mechanism was simple and administratively straightforward. Brexit ended all of that. The UK is no longer a member of the European Union, and as HMRC has confirmed in its International Manual at INTM412000, the IRD is no longer applicable to payments made by or to UK companies.

The consequence is that UK companies must now apply domestic withholding tax rates — 20% on annual interest under Income Tax Act 2007 section 874 and 20% on qualifying royalties under section 906 — and then rely on the applicable bilateral double tax treaty to reduce those rates. Many UK treaties with EU member states provide 0% withholding on interest and a reduced rate on royalties. But some do not. The UK-Portugal treaty provides for 10% withholding on royalties; the UK-Greece treaty provides 0% on royalties but the administrative process for obtaining relief at source is cumbersome; and several EU states have domestic rules that determine whether a treaty claimant satisfies the beneficial ownership and substantive requirements for treaty protection.

There is also a timing mismatch that receives less attention than it deserves. Even where a treaty provides 0% withholding, the UK payer must either apply for a direction to pay gross (using HMRC’s DTTP5 procedure) or deduct at source and file for repayment. Neither route is instantaneous. For treasury teams managing significant intercompany interest flows, the cash-flow consequences of even a temporary over-withholding can be material.

Part V: CFC Rules and Transfer Pricing — The GILTI Collision

The interaction between the UK’s Controlled Foreign Company (CFC) rules under Part 9A of TIOPA 2010 and the United States’ Global Intangible Low-Taxed Income (GILTI) charge under IRC section 951A is one of the most technically demanding — and practically costly — mismatches in the UK-OECD landscape. Both regimes are attempting to do the same thing: prevent profits from being sheltered in low-tax subsidiaries. But they go about it in structurally different ways, and the differences create genuine double taxation.

The UK CFC regime uses a gateway-based structure: it identifies categories of CFC income — non-trading finance profits, trading finance profits, solo consolidation profits, captive insurance income — and subjects them to a CFC charge at UK corporation tax rates where the subsidiary is insufficiently taxed. The US GILTI regime operates differently: it applies a blended effective tax rate test across all of a US shareholder’s CFCs, rather than on a jurisdiction-by-jurisdiction basis, and provides an 80% foreign tax credit mechanism. The divergence between the two approaches means that a UK company with US ultimate shareholders may find its profits subject to a UK CFC charge in the UK and to GILTI in the United States, with neither jurisdiction’s credit mechanism fully accommodating the other’s charge. The US blended rate calculation may show an effective rate above the GILTI rate even where a particular entity is within the UK CFC gateway — meaning the GILTI credit does not relieve the UK CFC charge, and the UK CFC charge is not creditable in the US.

Transfer pricing presents a related problem that is often underestimated. The UK applies the OECD arm’s length principle under Part 4 of TIOPA 2010, consistent with the OECD Transfer Pricing Guidelines 2022. The United States applies its own arm’s length standard under IRC section 482, which for intangible property includes the ‘commensurate-with-income’ standard — a requirement that goes beyond the OECD approach and allows the IRS to make periodic adjustments over the life of an intangible transfer. Where the IRS makes a transfer pricing adjustment increasing the US subsidiary’s income, the UK parent is entitled to seek correlative relief under the Mutual Agreement Procedure (OECD MTC Article 25) or under the terms of the UK-US treaty. But MAP is not fast: it routinely takes three to five years. During that period, both jurisdictions are taxing the same profit.

Part VI: Pillar Two — The New Frontier of Mismatches

The OECD’s Pillar Two Global Minimum Tax — implemented in the UK by Finance Act 2023 and effective for accounting periods beginning on or after 31 December 2023 — introduces an entirely new category of mismatch: one between existing domestic tax systems and the GloBE (Global Anti-Base Erosion) rules that operate alongside them.

The most immediately practical example involves the participation exemption. The Netherlands, Germany, France and Luxembourg all provide corporate income tax exemptions for dividends received from subsidiaries — a cornerstone of continental European tax law that has existed for decades. Pillar Two does not automatically treat such exempt dividends as ‘excluded dividends’ for the purpose of calculating the effective tax rate of the receiving entity. Instead, the GloBE rules require a minimum holding period of one year and a minimum ownership interest of 10% for the dividend to qualify as an excluded dividend. Where a portfolio holding — below 10% or held for less than a year — generates a dividend that is exempt under domestic law but not excluded under Pillar Two, the receiving entity’s effective tax rate falls below the 15% minimum rate, and a top-up tax liability arises.

The interaction with the United States is the most systemically important Pillar Two mismatch. The US has not enacted Pillar Two-equivalent legislation. It applies GILTI as its own minimum tax on CFC income, but GILTI does not meet the OECD’s standard for a ‘qualified income inclusion rule.’ The OECD’s Inclusive Framework has provided a transitional Country-by-Country Reporting safe harbour — a temporary measure that delays the full impact — but that safe harbour will not last indefinitely. UK-parented multinational groups with US operations should not assume the transitional safe harbour will protect them beyond the periods currently designated. Modelling Pillar Two effective tax rates territory by territory, including the US, is no longer optional for any group within scope — it is a basic compliance requirement.

Dr Frank’s Commentary: The Systematic Failure at the Heart of International Tax

Having spent four decades at the intersection of UK domestic tax law and the increasingly complex web of OECD standards, treaties, and anti-avoidance regimes that surround it, I find myself returning to a single observation: the international tax system was designed to prevent double taxation, but in the current environment it is producing double taxation — and double non-taxation — with uncomfortable regularity.

The BEPS project was intended to close the gaps. And it has closed some of them. The hybrid mismatch rules in Part 6A of TIOPA 2010 are technically sophisticated and, where they apply, effective. But they are applied on a self-assessment basis, without safe harbours for SMEs, and in a legislative environment that is deliberately broader in scope than the OECD’s own recommendations — as HMRC’s International Manual openly acknowledges at INTM550010. The result is that ordinary commercial transactions — straightforward intragroup financing, standard REPO arrangements, ordinary intercompany royalty payments — can fall within the rules unless carefully structured, whilst the taxpayer bears the burden of demonstrating that they do not.

What troubles me more, however, is the mismatch that arises not from aggressive planning but from the simple reality that thirty-eight OECD member states have thirty-eight separate domestic tax systems, each of which characterises entities, instruments, income, and residency in its own way. A US citizen who moves to the UK with a Delaware LLC is not engaging in tax avoidance — they are simply using a vehicle that is legally unremarkable in their home country, and discovering that it creates a structural double taxation problem in ours. A multinational employer who allows its German employees to work from home in the UK is not abusing the treaty network — they are responding to the realities of post-pandemic working life, and finding that the PE rules have not kept pace.

My advice to practitioners is this: treat the mismatch reference table we have compiled not as a checklist of avoidance schemes to be avoided, but as a map of the structural risks that any genuinely international client may face. Before any cross-border transaction is completed, before any new entity is established, before any employee moves country, the relevant mismatches should be identified and their consequences modelled. The cost of doing so is modest. The cost of discovering a mismatch after the transaction has completed — with penalties, interest, and potentially a Tribunal hearing in prospect — is not.

Practical Implications: What Advisers and Their Clients Should Do Now

Review All Existing Cross-Border Structures

Any client with a US LLC holding UK assets or UK activities, a UK partnership with EU investors, an Irish Section 110 SPV with UK-source income, or any form of intercompany financing involving jurisdictions on HMRC’s known hybrid entity list should treat those structures as requiring immediate review. The hybrid mismatch rules at Part 6A TIOPA 2010 operate on a self-assessment basis: the taxpayer must identify the mismatch and make the counteraction — HMRC does not send a notification before the filing deadline passes.

Establish a Pillar Two Monitoring Framework

Any multinational group with consolidated revenue of €750 million or more is within scope of the UK’s Pillar Two rules. That group must, for each qualifying entity in each territory, model the effective tax rate under the GloBE rules — which is not the same as the domestic effective rate. Participation exemptions may inflate qualifying income without a corresponding tax charge; deferred tax positions may distort the ETR calculation; and the transition between the QDMTT safe harbour period and full IIR exposure is not far away.

Use the Mutual Agreement Procedure

Where a transfer pricing adjustment or a treaty characterisation dispute generates double taxation, the Mutual Agreement Procedure under the applicable treaty (generally OECD Model Tax Convention Article 25) is the correct mechanism for relief. MAP is slow — three to five years is typical, and complex cases can take longer — but it is often the only mechanism that produces a binding result in both jurisdictions simultaneously. The EU’s mandatory binding arbitration regime and the OECD’s MAP statistics publication have brought welcome pressure on competent authorities to resolve cases more promptly. UK taxpayers should not be deterred by MAP’s pace: it remains the gold standard for eliminating double taxation from treaty disputes.

The Remote-Work Audit

Every employer with cross-border employees — and in 2026, that is a very large number of employers — should conduct a working time audit of their mobile workforce. The November 2025 OECD Commentary provides a helpful 50% safe harbour, but it is a Commentary provision, not treaty text, and it will take time for bilateral treaty practice and domestic legislation to align with it. Until that alignment occurs, any employee spending a substantial proportion of their time working from home in a jurisdiction other than their employer’s residence state creates a PE risk that must be assessed treaty by treaty.

Conclusion: Complexity Is the New Normal

The era in which a UK company with a handful of overseas subsidiaries could rely on a treaty-based framework to eliminate double taxation, and a competent adviser to flag any unusual hybrid or withholding tax issue, is over. The introduction of Pillar Two, the post-Brexit dismantling of EU tax directives, the 2025 OECD Model update, and HMRC’s increasingly aggressive approach to hybrid mismatches mean that cross-border tax risk is no longer confined to large multinationals with elaborate structures. It reaches into straightforward intragroup financing, into the working arrangements of remote employees, into the holding vehicles of private individuals who have simply moved country.

The thirty-one mismatches catalogued in the LEXeFISCAL UK–OECD Tax Mismatch Reference Table represent, in my view, the most significant structural cross-border tax risks facing UK-connected businesses and individuals in 2026. Understanding them — and understanding which ones apply to a specific client’s circumstances — is the starting point for sound international tax advice.

At LEXeFISCAL, we advise on all aspects of UK and international tax, with particular expertise in cross-border structuring, HMRC disputes, and the planning needs of ultra-high-net-worth individuals. If you would like to discuss any of the issues raised in this article, or to obtain a copy of our UK–OECD Tax Mismatch Reference Table, we would be pleased to hear from you.

Vincit Veritas.