ENTITY ORGANIZED UNDER GREAT BRITAIN'S CORPORATION STATUTE WILL BE TREATED AS A PARTNERSHIP FOR FEDERAL TAX PURPOSES.

Rev. Rul. 88-8

ISSUE

Whether an entity organized under foreign law is classified for federal tax purposes on the basis of the characteristics set forth in section 301.7701-2 of the Procedure and Administration Regulations.

FACTS

In 1986, twenty-five United States citizens organized M in Great Britain as an unlimited company by registering M under the Companies Act 1985 (ACT), Vol. 8, Halsbury's Statutes of England and Wales, (4th Ed., 1985). M will not be conducting insurance business (and thus is not an insurance company within the meaning of section 7701(a)(3) of the Internal Revenue Code).

Chapter I, Section 1(2) of the Act provides that a company may be:

(a) a company having the liability of its members limited by the [Memorandum of Association] to the amount, if any, unpaid on the shares respectively held by them ("a company limited by shares");

(b) a company having the liability of its members limited by the [Memorandum of Association] to such amount as the members may respectively thereby undertake to contribute to the assets of the company in the event of its being wound up ("a company limited by guarantee"); or

(c) a company not having any limit on the liability of its members ("an unlimited company").

A company is registered under the Act by delivering to the Registrar of Companies for England (Registrar) the company's Memorandum of Association (Memorandum) and Articles of Association (Articles). After registration, the Registrar provides a certificate which indicates that the company is incorporated. Thus, the Act represents Great Britain's "corporation" statute. The effect of registering a company is that, from the date of incorporation stated in the Certificate of Incorporation, the subscribers of the Memorandum, together with such other persons as may from time to time become members of the company, shall be a body corporate by the name contained in the Memorandum, capable of exercising all the functions of an incorporated company, but with such liability on the part of the members to contribute to the assets of the company in the event of its being would up as provided by the Act.

The Memorandum sets forth the company's name, location, business objective, and share capital. The Memorandum also states the degree of liability assumed by the members of the company. The Memorandum of M provides that there will be no limit on the liability of its members.

The Articles contain regulations for the internal management of the company and for the conduct of its business. Under the Act, there are no restrictions on transfer except as imposed by the Articles of Association. The Articles provide that a member may not substitute a person who is not a member of M, unless the member obtains the consent of the other members.

LAW AND ANALYSIS

Section 7701(a)(3) of the Code provides that the term "corporation" includes associations, joint-stock companies, and insurance companies.

Section 301.7701-1(b) of the regulations states that the Code prescribes certain categories or classes into which various organizations fall for purposes of taxation. These categories or classes include associations (which are taxable as corporations), partnerships, and trusts. The tests or standards that are to be applied in determining the classification of an organization are set forth in sections 301.7701-2 through 301.7701-4.

Section 301.7701-2(a)(1) of the regulations sets forth the following basic characteristics of a corporation: (1) associates, (2) an objective to carry on business and divide the gains therefrom, (3) continuity of life, (4) centralization of management, (5) limited liability, and (6) free transferability of interests. Whether a particular organization is to be classified as an association must be determined by taking into account the presence or absence of each of these corporate characteristics.

Section 301.7701-2(a)(2) of the regulations further provides that characteristics common to partnerships and corporations are not material in attempting to distinguish between an association and a partnership. Since associates and an objective to carry on business and divide the gains therefrom are generally common to corporations and partnerships, the determination of whether an organization that has such characteristics is to be treated for tax purposes as a partnership or as an association depends on whether there exists centralization of management, continuity of life, free transferability of interests, and limited liability. Section 301.7701-2(a)(3) provides that an unincorporated organization shall not be classified as an association unless such organization has more corporate characteristics than noncorporate characteristics.

Rev. Rul. 73-254, 1973-1 C.B. 613, holds that the classification of a foreign unincorporated business organization for federal tax purposes will be determined under section 7701 of the Code and the regulations thereunder. However, it is the local law of the foreign jurisdiction that must be applied in determining the legal relationships of the members of the organization among themselves and with the public at large, as well as the interests of the members of the organization in its assets.

An entity organized under foreign law cannot be classified for federal tax purposes on the basis of the label attached to the entity by the statute under which it is established, without an inquiry into the legal relationships of the members of the entity as established under applicable local law. Accordingly, the applicable foreign statute and the entity's organization agreements must be examined to determine whether the entity is classified as a corporation for federal tax purposes. In order to ensure uniformity and certainty regarding the classification of an entity organized under foreign law for federal tax purposes, the standards set forth in section 301.7701-2 of the regulations must be applied. All foreign entities are considered to be "unincorporated organizations" for purposes of section 301.7701-2(a)(3) of the regulations. Consequently, no foreign organization or entity is classified as an association unless such organization or entity has more corporate than noncorporate characteristics.

In the present situation, M has associates and an objective to carry on business and divide the gains therefrom and, therefore, is properly classified as either an association or a partnership. M will be classified as a partnership for federal tax purposes unless the organization has a preponderance of the remaining corporate characteristics of continuity of life, centralization of management, limited liability, and free transferability of interests.

Section 301.7701-2(d)(1) of the regulations provides that an organization has the corporate characteristic of limited liability if under local law there is no member who is personally liable for the debts of or claims against the organization. Personal liability means that a creditor of an organization may seek personal satisfaction from a member of the organization to the extent that the assets of such organization are insufficient to satisfy the creditor's claim.

As permitted under the Act, the Memorandum provides that the member's liability to contribute to the payment of M's debts and liability is unlimited. Consequently, M lacks the corporate characteristics of limited liability.

Under section 301.7701-2(e)(1) of the regulations, an organization has the corporate characteristic of free transferability of interests if each of the members or those members owning substantially all of the interests in the organization have the power, without the consent of other members, to substitute for themselves in the same organization a person who is not a member of the organization. In order for this power of substitution to exist in the corporate sense, the member must be able, without the consent of the other members, to confer upon the substitute all the attributes of the member's interest in the organization. The characteristic of free transferability does not exist if each member can, without the consent of the other members, assign only the right to share in the profits but cannot assign the rights to participate in the management of the organization.

Under the Articles, no member may transfer any interest in M without the unanimous prior written consent of the other members. Consequently, M lacks the corporate characteristic of free transferability on interests.

HOLDING

An entity organized under foreign law is classified for federal tax purposes on the basis of the characteristics set forth in section 301.7701-2 of the regulations.

M has associates and an objective to carry on business and divide the gains therefrom but lacks the corporate characteristics of limited liability and free transferability of interests. Therefore, M is classified as a partnership for federal tax purposes.

DRAFTING INFORMATION

The principal author of this revenue ruling is Dianna Miosi of the Individual Tax Division. For further information regarding this revenue ruling contact Ms. Miosi on (202) 566-4543 (not a toll-free call).