ENTITY CLASSIFICATION

Kimberly Blanchard TLHE SIGNIFICEANCE OF GAL

Many countries employ the term nerships, whether general or lim - “legal personality” to differentiate ited partnerships, might be con - an entity treated as a separate sidered to possess the attribute corporate taxpayer from a tax- of legal personality, and if so transparent partnership. In these might be treat ed as corporations countries it is sometimes said that for tax purposes in the client’s a corporation has legal person - country of residence. This hybrid ality, whereas a partnership does result can raise a variety of tax not. The author first encountered problems, including the loss of the term legal personality in the treaty benefits otherwise avail - course of advising foreign clients able, 1 the potential for timing and who were considering invest - character mismatches, and the ments in U.S. partnerships. The potential loss of credibility or concern raised by their non-U.S. exemption at home for U.S. taxes tax advisors was that U.S. part - paid by the nonresident partner.

4 BUSINESS ENTITIES March/April 2016 FOR U.S. TAX PURPOSES

WHILE THE CONCEPT OF LEGAL PERSONALITY REMAINS AN IMPORTANT FACTOR IN MANY OTHER COUNTRIES, THE UNITED STATES HAS ABANDONED ANY CONCEIT THAT IT MATTERS TO ENTITY CLASSIFICATION FOR TAX PURPOSES.

BUSINESS ENTITIES 5 Background term at all. The resulting tension In researching the issue, it soon became between tax systems can give rise to clear that virtually every type of U.S. hybrid entities, frustrating interna - entity that exists today, including a tional efforts to eliminate hybridity in simple general partnership, probably order to minimize classification con - has what many other countries would flicts and the resulting possibility of view as legal personality. Not only is either double taxation or “homeless the construct of legal personality irrel - income.” evant to U.S. tax classification rules; BEPS Project. This is a timely top - the construct barely survives as a mat - ic–the OECD recently completed a ter of U.S. commercial law. Already by monumental project, referred to as the the year 1928, papers presented at a Base Erosion and Profit Shifting legal symposium in Chicago on the (BEPS) project, to eliminate homeless subject of business entities illustrated income by tackling 15 areas where tax that the concept was beginning to lose rules might be harmonized or its meaning. 2 Over time, the conceit changed. 6 One of these 15 projects that in order to be a partnership for involved hybrid entities, and others U.S. commercial law purposes, an enti - implicate the subject of hybridity. ty must lack legal personality, was There is no question that one of the abandoned as a quaint artifact of an major drivers of the BEPS project was earlier age. the perception among many countries In one sense, U.S. tax law recognizes that the U.S. “check-the-box” entity that corporations, but not partnerships, classification rules 7 constitute one of have something we might call “legal the principal evildoers in fomenting personality.” A state law corporation homeless income. But natural hybrid - will always be taxed as a corporation; ity, which existed before and after the it cannot elect to be treated as a part - check-the-box regulations, is far more nership or other form of entity (putting common than many countries aside special tax regimes such as RICs, acknowledge. It arises in part from the REITs, and S corporations). Moline insistence by many countries that only Properties 3 stands for the proposition their own entity tax classification cri - that the mere act of incorporating a teria represent the “correct” approach. corporation creates a separate legal The hybridity that results when in legal classification. Legal personal - person that will generally be respect - one country classifies an entity as a ity, or something like it, is one criteri - ed as separate from its owners for all corporation and another country on that many countries use to classify tax purposes, absent sham or “piercing classifies the same entity as a part - entities. Because U.S. tax rules do not the corporate veil.” A domestic corpo - nership would be rarely encountered give effect to the existence or non-exis - ration is a taxpayer and a resident of if all countries adopted the approach tence of legal personality, this can result the United States for all tax and treaty set out in an earlier OECD report on in hybridity without any taxpayer plan - purposes, whereas a partnership is nei - treaties and partnerships. 8 That ning at all. The legal personality crite - ther. 4 But these are the legal results report recommended that the source rion is particularly pernicious in those that follow from incorporating a cor - country give effect to the taxation of countries that view it as a “superfactor” poration; they do not follow from any the partners in their home country, sufficient without more to require clas - conceit that only a corporation pos - ignoring the treatment of the entity sification as an opaque corporation. sesses what one might call legal per - in the source country and in the This article will undertake to sonality. country where the entity is formed. describe the concept of legal person - In a recent compendium on the sub - Unfortunately, the 1999 OECD report ality and examine the possible reasons ject of entity classification under was lim ited to treaty interpretation why it is often used as a tool for enti - treaties, published by the Internation - and therefore does not apply general - ty classification. It will also review al Fiscal Association (IFA), 5 about half ly. Moreover, many countries have some practical problems that arise of the 40 responding countries men - reserved on the report’s recommen - when countries take different views on tioned legal personality as an impor - dation and will not follow it. the significance of legal personality. tant factor in classifying entities for This article is not about entity clas - tax purposes. The other half, including sification generally, but only about how the United States, did not mention the the concept of legal personality is used I. What is “Legal Personality”? A. In General. A discussion of the KIMBERLY BLANCHARD is a tax partner in New York office of Weil, Gotshal & Manges LLP. Her practice encom - topic of legal personality ought to passes a variety of largely international transactions involving corporate acquisitions and mergers, internal restruc - turings, business formations, and joint ventures. An earlier version of this article was presented at the New York begin by defining what that term University School of Law Spring 2015 Colloquium on Tax Policy and Public Finance and at the Tax Review Club. means. Unfortunately, there appears to

6 BUSINESS ENTITIES March/April 2016 ENTITY CLASSIFICATION authoritative treatises 11 for the propo - person could be sued. This made sense sition that to have legal personality when most businesses were sole pro - means “to be capable of having legal prietorships or informal partnerships rights and duties within a certain legal of a few persons known well to one system, such as to enter into contracts, another. In those cases, the individuals sue, and be sued. Legal personality is were liable for the debts of and claims a prerequisite to legal capacity, the abil - against their business. For various rea - ity of any legal person to amend (enter sons that won’t be explored here, into, transfer, etc.) rights and obliga - around the time of the Industrial Rev - tions.” Under the common law, legal olution people stated to form corpo - personality consisted of five legal rations that afforded limited liability rights: for their owners. As long as only indi - 1. The right to own property (includ - viduals could be sued, there was no ing money). legal remedy if the corporation broke 2. The right to make and sign con - the law or harmed another person. 14 tracts. The owners were protected and the 3. The right to sue and be sued (i.e., to corporation, not being human, could - enforce contracts). n’t be sued. In order to solve this prob - 4. The right to hire employees. lem, the concept of legal personality 5. The right to make by-laws for self- was extended to corporations. governance. B. The Significance of Limited Lia - One might distinguish between bility to Legal Personality. While this “legal personality” in the abstract and brief history illustrates the link “separate legal personality” in the sense between limited liability of an entity’s of an entity having a legal personality owners and the development of legal separate and distinct from that of its personality, today many countries rec - owners. That is, it seems possible that ognize that an entity that does not con - an entity such as a partnership could fer limited liability upon its owners, have legal personality and yet not pos - or at least not to all its owners, can sess a legal personality separate from have separate legal personality. For its partners. However, most countries these countries, limited liability is not that give effect to legal personality do the equivalent of legal personality. Oth - be no universal agreement on what it not adopt that view. In those countries, er countries appear to equate limited means. Apparently the difficulty of there is no meaningful distinction liability with legal personality. defining it has been with us a long between an entity that has legal per - It might be supposed that an entity time; in 1928 Smith wrote that philoso - sonality and one that has legal per - that affords limited liability to all of its phers “have sought for the ‘internal sonality separate from its owners. members would generally possess legal nature’ of legal personality, for an Individual human beings have legal personality, and so it appears under abstract essence of some sort which personality in the sense that they can the laws of most countries that employ legal personality requires. . . . A more own property and be sued. 12 But it is the concept of legal personality. Most difficult task than to define the concept the concept of legal personality as would agree that a U.S. limited liabili - is to explain this persistent tendency to applied to entities–often called juridi - ty company (an LLC), like a U.S. cor - make it mysterious.” 9The author’s cal personality–that allows one or more poration, falls into this category, such understanding is that many countries natural persons to come together in that a country giving effect to legal per - that use the concept of legal personal - the form of a single entity for legal sonality would always classify an LLC ity do not generally bother to define it. purposes. The English refer to this as as a corporation. And as we shall see, The most common formulation of a “body corporate,” a term that is often this has in fact largely been proven out. legal personality is that an entity pos - confused with the term “corporation.” However, U.S. limited partnerships, sessing it owns property in its own Legal personality allows an entity to limited liability partnerships (LLPs), name and can sue or be sued in its be considered under law separately and limited liability limited partner - own name. West’s definition of legal from its individual members. ships (LLLPs) present more nuanced personality is the capacity of an enti - How did the concept of legal per - issues. A limited partnership provides ty to have a name of its own, to sue sonality arise? The best explanation of limited liability for limited partners, and be sued, and to have the right to the need for the concept of legal per - reserving personal liability for the gen - purchase, sell, lease, and mortgage its sonality this author has found is set eral partner. The early justification for property in its own name. Property forth in a short book entitled The Com - limited partners’ limited liability grew cannot be taken away from an entity pany: A Short History of a Revolutionary out of the division of managerial having legal personality without due Idea. 13 The argument goes essentially as duties. Limited partners did not par - process of law. 10 Wikipedia cites to follows. In ancient times, only a natural ticipate in management, and thus did

ENTITY CLASSIFICATION March/April 2016 BUSINESS ENTITIES 7 not bear personal liability for man - ity shield that is equivalent to the shield agement’s follies. This threshold test enjoyed by corporate shareholders, LLC abides today in the Revised Uniform members, and partners in an LLP.” 20 Limited Partnership Act (RULPA), Similarly, an LLLP, which is to a lim - which shields a limited partner from ited partnership what an LLP is to a gen - liability only to the extent such partner eral partnership, provides limited liability refrains from actively participating in for general partners and limited part - management or holding herself out as ners alike, not only for one another’s a general partner. 15 The more modern wrong doings but also for debts arising Uniform Limited Partnership Act in the ordinary course of the business. 21 (ULPA), in contrast, extends limited The LLP and the LLLP represent the log - liability to limited partners whether or ical extension of the ULPA’s extension not they participate in management. 16 of limited liability to partners who par - An LLP is a creature of general part - ticipate in management. nership law with LLP statutes having A non-U.S. observer focusing on evolved over time. The LLP was orig - limited liability as a factor in entity clas - inally conceived as a vehicle for pro - sification might well ask why this pro - fessional firms to achieve some level liferation of entities was needed. What of protection for innocent partners in do owners achieve by using a Delaware the face of malpractice by other part - LLP rather than an LLC? The answer ners. Notably, New York and California may be as simple as the fact that some still limit the availability of an LLP states have laws more suited to a par - election to professional entities. These ticular purpose than others, and have first generation LLPs dispensed only taken the lead in adopting new statutes, with vicarious liability for innocent only to find that other states eventual - partners from certain acts committed ly catch up. U.S. tax law, having seen by their partners. 17 A number of states the writing on the wall, has abandoned retain this “partial shield” for vicarious any conceit that limited liability matters liability today. 18 to entity classification for tax purpos - With the second generation statutes, es, given the reality that almost any type set in motion by Minnesota in 1994, of U.S. entity can today afford almost came “full-shield” limited liability pro - complete protection from liability. tecting partners of an LLP not only C. How Can We Tell Whether Legal merely tautological, it must mean that from other partners’ bad acts, but also Personality Exists? Whether an entity the capacity to acquire rights and to from debts arising in the ordinary can own property in its own name, or assume liabilities must be accorded by course of business. 19 There are statu - can be party to a lawsuit, should in the - a positive provision of law. However, it tory exceptions to the general provi - ory be ascertainable by reference to local appears that no Canadian statute con - sion of limited liability for limited law. An interpretive bulletin issued by the tains such positive provisions. Rather, partnerships and general partnerships, Canada Revenue Agency states that an it is simply understood to be the case i.e. for purporting to operate as a part - entity possesses legal personality or per - that a partnership formed under Cana - ner post-dissolution, but the official sonhood when it has an “existence sep - dian commercial law lacks legal per - comments to ULPA make clear that it arate and distinct from the personality sonality—in fact that it is not an “entity” is intended to buttress the limited lia - and existence of the person who creat - at all. 23 Various provisions of Canadian bility accorded to partners, stating ed it and that possesses its own capac - law distinguish between entities pos - “Both general and limited partners ity to acquire rights and to assume sessing legal personality or “person - benefit from a full, status-based liabil - liabilities.” 22 If this definition is not hood,” and those that do not. 24

1 See Reg. 1.894-1(d)(1). Under this regulation, if 3 319 US 436, 30 AFTR 1291 (1943). In Saba Enemy Trading Act. Although the lower court a nonresident person is a partner of a partner - Partnership, TCM 2003-31, the Tax Court went stuck with the fiction of legal personality and ship that earns an item of U.S. source income so far as to state that a partnership must be held the corporation to be English, on appeal such as a dividend, and his home country regarded as a separate entity in the same way it was held to be subject to the Act, because treats the partnership as non-fiscally transpar - that the Moline Properties case treated a state it could not appoint an agent without the act ent (e.g. because it considers the partnership law corporation as a separate entity. of Germans, and thus could not sue anyone to have legal personality), the U.S. will not 4 In Smith’s paper on the subject of legal per - as a practical matter. In this case we can see grant treaty benefits to the nonresident part - sonality, he mentions a fascinating English a premonition of what would later become ner. The theory of the rule is that the nonresi - case, Continental Tyre & Rubber v. Daimler, U.S. tax treaty policy in the form of its limita - dent partner is not paying tax at home on the [1915] 1 K.B. 893, [1916] 2 A.C. 307, tried dur - tion on benefits article–one can agree that a income as it arises, and therefore that no dou - ing the First World War. The plaintiff was an corporation is separate from its owners, sub - ble taxation exists. English corporation conducting business ject to tax at the corporate level and resident 2 Smith, “Legal Personality,” 37 Yale L.J. 283 solely in England, but all of its directors and wherever it is resident, but that does not (1928) (hereafter, Smith). This was one of sev - shareholders were residents of Germany. The require us to grant benefits to it if doing so eral papers submitted to the symposium, and question was whether the corporation was would offend some policy relevant to its ulti - refers to the others. English or German within the meaning of the mate ownership.

8 BUSINESS ENTITIES March/April 2016 ENTITY CLASSIFICATION a partnership at all, but a body cor - The next section of this article porate . . . ” 26 and that “it is clear from reviews some basic precepts of U.S. tax the [enabling legislation] that an LLP entity classification rules relevant to is a body corporate.” 27 So, notwith - the application of legal personality standing the fact that the word “part - principles in the United States. nership” appears in the name of the entity, it is not a partnership “at all,” apparently because the legislature II. Legal Personality decided that this was so. and U.S. Tax Classification In these and other countries, there - A. The Three-Step Approach. Both fore, it appears that the definition of before and after the promulgation of legal personality is, in fact, tautologi - the check-the-box regulations, 29 U.S. cal. The statement that an entity has tax law entity classification rules have legal personality is a conclusion based been unique both in ignoring com - not on its intrinsic characteristics, but mercial law 30 and in applying to domes - based on what the legislator deems tic and not just foreign entities. The desirable as a matter of policy. As apt - U.S. tax rules employ a three-step ly stated by Smith in his 1928 article: process to classify arrangements for tax Whenever society, in the adminis - purposes. First, it must be determined tration of justice, sees fit to disre - whether or not the arrangement rises to gard the individual members of an the level of an entity, or is merely a organization for a particular pur - contract or co-ownership arrangement. pose, and for that purpose to look If it is an entity, it must next be deter - upon the organization as a unit, the mined whether it is a “business enti - organization to that extent or for that purpose becomes a legal per - ty” or a trust. Finally, if the entity is a son. This is true even where the business entity, it will be characterized group is organized as a partnership as an opaque corporation or as a tax- or other unincorporated associa - transparent entity (a partnership or, tion. 28 under the current scheme, a disre - garded entity) under the regulations. The preceding observation explains The former entity classification reg - why many countries that purport to ulations replaced by the check-the-box In the same way, Dutch statutes do give legal effect to legal personality do regime in 1997 had their genesis in case not refer to the facts of legal person - not have statutes that make clear law. In Hecht v. Malley ,31 decided in 1924, ality, but merely state which entities whether a particular form of entity the Supreme Court determined that a have legal personality and which do can or cannot own property in its own business trust was subject to an excise not. 25 And under English law, it is name. And in fact, many countries tax because it engaged in carrying on a unclear whether limited liability fol - insist that certain types of entities, business enterprise, an activity that was lows from having legal personality or such as partnerships, lack legal per - fundamental to the concept of an asso - whether the presence of limited lia - sonality even though these entities can in ciation. The Hecht case laid the foun - bility dictates that one is in the pres - fact own property in their own name and dation for treating all business entities ence of an entity possessing legal otherwise possess all of the powers nor - as corporations or as partnerships. personality. A recent article discussing mally associated with separate legal per - Eleven years later, in Morrissey ,32 the English entity classification states that sonality. Thus, statements made about Supreme Court delineated the traits of an English law LLP, which confers lim - legal personality seem based more on a corporate entity for federal tax pur - ited liability on all its members, “is not tradition that on law. poses in considering whether a state

5 IFA Cahiers 2014 - Volume 99B: Qualification of 10 West’s Encyclopedia of American Law, 2d ed . of dual personality became accepted. See Smith, taxable entities and treaty protection. (Thomson Gale, 2008). The definition is of “corpo - note 2, supra , at pp. 289-291 (Smith also points out some anachronisms prevailing in 1928, such 6 OECD, Action Plan on Base Erosion and Profit rate” personality. as the fact that a partnership could not sue Shifting (2013), available at http://www.oecd-ili - 11 E.g., Smith, note 2, supra ; Dewey, “The Historic another partnership if they had a common mem - brary.org/docserver/download/2313331e.pdf?e Background of Corporate Legal Personality,” 35 ber – derived from the view that a partner could xpires=1445371581&id=id&accname=guest&c Yale Law Journal 655 (1926); Machen, “Corporate not sue a partnership in which he is a partner.) hecksum=C84F838E300C58C9FB619F39E390 Personality,” 24 Harvard Law Review 253 (1910). 13 9D53. 12 Individuals can in fact have multiple “legal per - Micklethwait and Wooldridge, (Modern Library Chronicles 2005). 7 Reg. 301.7701. sonalities.” A person acting as trustee has a dif - 14 In Salomon v A Salomon & Co Ltd [1897] AC 22, 8 ferent legal personality than when she contracts Organization for Economic Cooperation and on behalf of herself. The longstanding refusal of a unanimous ruling upheld the doctrine of corpo - Development, The Application of the OECD the IRS to acknowledge that an individual can be rate personality, as set out in the English Model Tax Convention to Partnerships: Issues both a partner of a partnership and an employee Companies Act 1862, such that creditors of an in International Taxation 6 (1999). of the same partnership is an anachronism trace - insolvent company could not sue the company’s 9 Smith, note 2, supra , at p. 284. able to ancient common law, before the concept shareholders to collect the company’s debts.

ENTITY CLASSIFICATION March/April 2016 BUSINESS ENTITIES 9 law trust created to develop a for-prof - teria rather than by special criteria it golf course was an association tax - sanctioned by the tax law, the regula - able as a corporation. In holding that the tions and the courts.” 34 trust should be classified as a corpora - Unhappy with the result in Kintner , tion under the federal tax law, the Mor - the IRS initially responded by issuing rissey court pointed to five traits that it Revenue Ruling 56-23, 35 which reject - associated with corporateness: (1) the ed any precedential effect emanating ability of the organization to hold title from the decision. The Revenue Ruling to property; (2) the continuation of the was rescinded the following year and organization regardless of the death of replaced by new entity classification an owner; (3) “centralized manage - regulations issued in 1960. Referred to ment”; (4) free transferability of own - as the “ Kintner regulations,” the newly- ership interests in the organization; and minted entity classification regulations (5) limitation of personal liability of listed six characteristics of an entity the organization’s members. taxable as a corporation for federal In applying Morrissey ’s multi-factor income tax purposes: “(i) associates, test, it was clear that an entity did not (ii) an objective to carry on a business have to display all the corporate char - and divide the gains therefrom, (iii) acteristics to be classified as a corpo - continuity of life, (iv) centralization of ration. In Kintner ,33 the IRS ran into management, (v) liability for corporate some difficulty with the multi-factor debts limited to corporate property, and test. Kintner turned on whether an asso - (vi) free transferability of interests.” ciation of doctors organized as a part - In applying the six factors, the regu - nership for state law purposes should be lations first sought to determine whether treated as a corporation for federal tax the organization being tested was a busi - purposes. The doctors had specifical - ness entity or a trust. The absence of ly structured the entity in order to use either of the first two factors would gen - certain pension benefits that were avail - erally cause the organization at issue to able only to organizations classified as be classified as a trust rather than as an corporations for federal tax purposes. association or business entity. 36 If an Citing the multi-factor test used in Mor - entity was a business entity, the regula - rissey , the court held that the entity at tions proceeded to determine if the enti - issue should be classified for tax pur - ty was a partnership or a corporation. The first corporations had to raise cap - poses as a corporation because it pos - Characteristics common to all business ital from numerous investors, not all sessed three of the five corporate traits: entities were disregarded. Thus, in deter - of whom could be managers of the 1. The organization held title to property. mining whether an entity should be clas - business; hence centralized manage - 2. The organization continued regard - sified as a partnership or as a ment. Investors deprived of manage - less of the death of an owner. corporation, the first two factors—pres - ment rights would naturally desire 3. The organization provided for cen - ence of associates and a business objec - protection from personality liability tralized management. tive—were ignored. An entity that had beyond their investment; hence limit - Further, the court specifically reject - at least three of the remaining four cor - ed liability. It would be very inconve - ed any reference to state entity classi - porate characteristics was classified as a nient if the corporation were to dissolve fication, reasoning that such a reference corporation. simply because one of the investors “would introduce an anarchic element Many of the Kintner factors derive were to fall off a ladder and die; hence in federal taxation if we determined from common law understandings of continuity of life. And to raise capital the nature of associations by State cri - what is entailed by “legal personality.” in large amounts, it would have been

15 RULPA § 303(a). explained in terms of liability protection from ship” by distinguishing the concept of person - 16 ULPA (2001) § 303. voluntary creditors vs. liability protection from hood from an organization treated as a partner - involuntary/tort creditors. See Naylor, note 17, ship); Uniform Law Conference of Canada, 17 See e.g., Naylor, “Is the Limited Liability supra , at 162. Uniform Income Trust Act (2008) (“Except to Partnership Now the Entity of Choice for 20 Delaware Law Firms?,” 24 Del. J. Corp. L. 145, ULPA (2001), ix. the extent otherwise provided in any other 156 (1999). 21 The LLLP form is prohibited in New York and enactment, a trust or a mutual fund is not a California, although California allows a foreign body corporate or other legal person.”) s. 4. 18 See Donn, “Is the Liability of Limited Liability LLLP to register and do business in state. See also Fredette v. R, 3 C.T.C. 2468 (Tax Court Entities Really Limited?,” Limited Liability Entities (ALI-ABA, 2013), page 501. 22 Interpretive Bulletin IT-343R (Sept. 26, 1977). of Canada 2001) (“It must be borne in mind that a partnership is not considered as having 19 Delaware is a full-shield state, protecting part - 23 See Johnson & Lille, “The Taxation of separate legal personality either in common ners from “any debt, obligation or other liability Partnerships in Canada,” Bull. for Int’l Taxation law or in civil law.”). of or chargeable to the partnership . . . whether (Aug./Sept. 2009), CTF, pp. 381-394 (hereafter, arising in contract, tort or otherwise” other Johnson & Lille). 25 For a paper by a Dutch tax lawyer complemen - than any liability arising from a partner’s own 24 See e.g. R.S.C., 1985, c. 1 (5th Supp.), s. 95 tary to this article, see Molenaars, “The Tax negligence. Sometimes this bifurcation is (defining the term “specified person or partner - Significance of Legal Personality: A Dutch

10 BUSINESS ENTITIES March/April 2016 ENTITY CLASSIFICATION property in its own name, this factor er, continuity of life had long since was no longer determinative. been reduced to a formalism, as most The four factors distinguishing a state laws allow the remaining part - partnership from a corporation are, as ners to reconstitute the partnership this discussion will show, quite similar and continue its existence as though if not identical to the factors that other nothing had happened. No U.S. law countries use to classify foreign enti - firm, even before LLP statutes were ties. Limited liability is nearly univer - introduced, took seriously the notion sally taken as an indication of corporate that the death or retirement of a part - status. In looking for the presence of ner had any effect on its existence. 37 limited liability, the regulations adopt - The last Kintner factor, centralization ed an all or nothing approach pursuant of management, does not seem as close - to which limited liability is present only ly linked to legal personality, although as if “under local law there is no member already noted, it is usually assumed that who is personally liable for the debts or an entity possessing separate legal per - claims against the organization.” By sonality would be centrally managed. 1980, the rise of the limited liability This factor was fairly easy to manipulate. company prompted the IRS to propose To this day, tax advisors intent on draft - amending the regulations so as to make ing a partnership or LLC agreement in limited liability a sufficient condition a fashion to convince a non-U.S. person or “superfactor” for classifying an asso - that it is “corporate like” will engraft ciation as a corporation. The proposed upon the agreement a board, even if regulations were withdrawn two years they otherwise would not bother. later in the face of widespread criticism. It will be noted that only one of the Free transferability of interests in four Kintner factors, limited liability, can the entity is another factor very com - be derived from any positive rule of non- monly seen in many countries. It is tax commercial law. Free transferabili - related to the existence of fungibility ty, continuity of life and centralization of of interests. The Kintner regulations management were each contractual pro - found free transferability to exist only visions and thus susceptible to drafting. when an owner could transfer all legal This was one reason that the Kintner reg - rights as an owner, not just economic ulations were replaced by the check-the- necessary to allow investors to transfer rights, to a third party. Thus, for exam - box regulations. Although many their shares to others; hence free trans - ple, an interest in a partnership would observers, within and outside the Unit - ferability. not be considered to be freely trans - ed States, mistakenly view the check- However, it will be noted that one of ferable if the assignor could not cause the-box regulations as unprecedented, the Morrissey factors did not make the the partnership to admit the assignee apart from their recognition of disre - cut of the regulations: the ability of as a partner. garded entities, they were not. They rep - the entity to hold property. Morrissey Almost all countries that employ resented merely the extension of the was decided in 1935, when U.S. law the fiction of legal personality take long-settled principle that U.S. entity still was wrestling with what effect, if seriously the notion that the death or classification for tax purposes is unre - any, to accord traditional legal per - retirement of a partner results in an lated to commercial law labels. sonality concepts. In the end, the automatic dissolution of a partnership. B. Deemed Partnerships. Recall that courts and the IRS appear to have rec - The Kintner regulations’ continuity of the first step in U.S. entity classification ognized that since any type of entity, life factor is thus highly correlated with analysis is to determine whether an enti - including a partnership, could own a finding of legal personality. Howev - ty exists or not. Under U.S. tax rules, it is relatively common to find an entity for tax purposes where none exists as a mat - View,” Tax Review No. 316 (12/15/2014) (unpub - 31 265 U.S. 144, 4 AFTR 3976 (1924). lished). 32 296 U.S. 344, 16 AFTR 1274 (1935). ter of non-tax law. If a given country 26 14 IFA Cahiers 2014 - Volume 99B: 33 216 F2d 418, 46 AFTR 995 (CA-9, 1954). believes that a partnership lacks legal Qualification of taxable entities and treaty pro - 34 tection: United Kingdom reporters Baldwin and Id . at 1001. This is an important observation. personality, one might suppose that that Kiranoglu, at 836. Because the income tax is a creature of federal law, it was early recognized that giving effect to country would have a robust concept of 27 Id. at 839. the labels adopted by the 50 states whose deemed partnerships. That is, if to be a 28 Smith, note 2, supra , at page 289. laws governed entity formation would be partnership it is necessary to lack legal 29 impracticable. Reg. 301.7701. personality, then any arrangement clear - 30 Reg. 301.7701-1(a)(1). In one very important 35 1956-1 CB 598. respect, U.S. commercial law reigns supreme: 36 For some helpful background on the trust clas - ly lacking legal personality, such as co- an entity formed as a state law corporation will sification issue, see Gross, “Is It a Partnership ownership of property, might seem to be be classified as a corporation. The following or a Trust? Are We Done With This Issue?,” Tax discussion deals only with entities not taking Forum Paper No. 660 (12/1/2014) (unpub - a candidate for a partnership. Yet few the form of a state law corporation. lished). countries outside the U.S. employ the

ENTITY CLASSIFICATION March/April 2016 BUSINESS ENTITIES 11 concept of a deemed partnership. 38 This el of an active trade or business. The key partnership based on whether the would seem to be a conundrum. is that the owners are able to demon - arrangement conducts a business. More - U.S. tax jurisprudence distinguishing strate that their income from the venture over, many countries treat investing as deemed partnerships from mere con - can be calculated without resort to the not a business for this purpose. tractual arrangements or co-ownership operating rules of Subchapter K, the The Netherlands and England view a arrangements illustrates the presump - most important of which is Section 704, passive investment vehicle such as a tion in favor of finding an entity. It is which generally prevents the artificial mutual fund as not a legal person; 43 the very difficult for two or more co-owners shifting of income among partners. Sec - same is true in the case of a French fonds of property to argue that their relation - tion 761 thus further illustrates the strong commun de placement and an Irish ship doe not rise to the level of a part - presumption in favor of separate legal common contractual fund. England and nership. In 2002, the IRS published Rev. personality—although that term is nev - Canada generally distinguish a partner - Proc. 2002-22, 39 announcing that it had er used—in the application of the federal ship from an unincorporated associa - lifted its no-rule policy on the question income tax to joint undertakings. tion based on the notion that the latter whether an undivided fractional interest Few other countries deem entities to is not formed to conduct a business. in real property (and only real proper - exist solely for tax purposes. Thus, they A recent release from the United ty) is an “interest in a separate tax enti - have no need to perform the first step of Kingdom sets out in detail the tax treat - ty” for purposes of the like-kind U.S. entity classification, which is to ment of “authorized contractual exchange rules. The ruling set out in determine whether an entity exists. Not schemes,” what we might call investment some detail the conditions under which only do other countries not “invent” enti - funds. 44 The release is very interesting the IRS would consider such a ruling, it ties, they often treat arrangements because it shows that, in England, an being understood that most taxpayers formed in fact as entities as non-enti - entity that clearly possesses every facet requesting such a ruling would desire a ties. At least in part, this seems to be of what one would define as legal per - ruling that there is in fact no separate explained by a finding that these entities sonality is nevertheless treated as lack - tax entity. Even where the conditions are lack legal personality. However, it remains ing legal personality due solely to the met, there is no safe harbor; the IRS will mysterious why a partnership is respect - labels placed on it. Moreover, the release merely consider the question. ed as an entity lacking legal personality, states that these arrangements do not In order to avoid deemed partner - whereas some other arrangement, such rise even to the level of a partnership— ship status, it must be shown that the as an investment fund, is not respected they are merely co-investment arrange - co-owners of property do not engage in as an entity. ments, and thus not entities at all. a business, even through an agent. 40 The mystery may be explainable by There are two types of authorized Even joint decision making—what one reference to whether a particular investment schemes: a “co-ownership might call “corporate governance”—is arrangement is used to conduct a busi - fund” and a “limited partnership.” The sufficient to find that a co-ownership ness. As noted earlier, U.S. entity classi - release starts out with a statement that an arrangement is a partnership for tax fication rules consider whether an entity authorized contractual scheme of either purposes. 41 As the Revenue Procedure is carrying on a trade or business to be type is a tenancy in common that “has no stated, “where the economic benefits to relevant to whether the entity should be legal personality.” It then proceeds to con - the individual participants are not classified as a trust or a business entity; tradict that claim on nearly every page. derivative of their co-ownership, but the conduct of a trade or business is First, an authorized contractual rather come from their joint relationship inconsistent with trust classification. scheme has “units,” a construct that toward a common goal, the co-owner - However, outside the United States, seems inconsistent with what we might ship arrangement will be characterized many countries seem to distinguish regard as a tenancy in common. Sec - as a partnership (or other business enti - between a mere co-ownership agree - ond, in the case of a coownership fund ty) for federal tax purposes.” 42 ment, not amounting to an entity, and a (but not a limited partnership), a sale U.S. tax law employs the concept of a deemed partnership to accord sub - 37 The U.S. tax rules pertinent to continuity of life 40 See, e.g., Rev. Rul. 75-374, 1975-2 CB 261. are schizophrenic. On the one hand, Reg. 1.736- 41 See, e.g., Bergford, 12 F. 3d 166, 73 AFTR2d 94- stance to certain types of contractual 1(a)(1)(ii) provides that after the death or retire - 498 (CA-9, 1993). relationships that incorporate sharing ment of a partner, the retired partner or his suc - 42 Rev. Proc. 2002-22 at § 2. cessor in interest is treated as a partner until his of risk of loss and possibility of upside. 43 IFA Cahiers 2014 - Volume 99B: Qualification of interest is completely paid out, a rule totally at The need to invent entities out of whole taxable entities and treaty protection: The odds with lacking continuity of interest, and inci - Netherlands reporters de Graaf and Gooijer, at cloth may arise from assignment of dentally of no local relevance to the non-U.S. part - 560. The Dutch form of mutual fund, fonds voor income principles, another concept that ners of a global partnership. On the other hand, gemene rekening or FGR, is a creature of the Section 708(b)(1)(B) deems a partnership to be tax law rather than corporate law, much like U.S. most countries lack. U.S. law does not terminated for tax purposes if more than 50% of RICs and REITs. recognize attempts to separate income the partnership interests are sold or exchanged 44 http://www.hmrc.gov.uk/drafts/acs-manual.pdf. over any 12-month period, a vestige of continuity 45 Canada also recognizes that a partner has a from the person who economically earns principles often criticized as being antiquated. separate tax basis in her partnership interest, 38 the income. Certain entities classified A contractual joint venture may be treated as a even though Canada insists that a partnership as partnerships may elect out of Sub - partnership in Canada, generally where it is not is not an entity but only a “relationship” limited to the accomplishment of a specific between its partners. Johnson & Lille, note 23, chapter K pursuant to Section 761. In purpose within a specific timeframe. Johnson supra , at ¶ ¶ 3.4, 3.5. gener al, the election out is limited to & Lille, note 23, supra , at ¶ 2.3. 46 Inoue & Katahira, Foreign Entity Classification in arrangements that do not rise to the lev - 39 2002-1 CB 733. Japan, Tax Notes Int’l 335 (10/26/2015).

12 BUSINESS ENTITIES March/April 2016 ENTITY CLASSIFICATION U.S. or the other country) and that they agree to split the income from the rental activity such that A is entitled to receive 100% of the cash flow until A has earned a certain threshold amount, whereupon B will become entitled to receive 100% of the cash flow until B has caught up with A, fol - lowing which A and B will split cash equal - ly. U.S. tax rules would certainly treat this arrangement as a partnership. But the oth - er country might not deem this to be a partnership, perhaps because the arrange - ment is not organized under any law or because that country does not regard the mere ownership of a rental building to rise to the level of a business justifying a finding of an entity. Thus, instead of a partnership-corporation hybridity, we have a partnership-nonentity hybridity. The next section of this discussion will examine how countries classify enti - ties and the degree to which they apply the concept of legal personality in doing so.

III. Entity Classification Outside the United States Countries fall along a continuum in whether and how they take legal per - sonality into account in entity classifi - cation. A few countries apply a per se rule that equates “personhood” or legal of an asset by the fund does not result In many if not most non-U.S. juris - personality with tax opacity, and reserves in the realization of any gain to the dictions, the taxation of partnerships is transparent treatment for entities that owner; the owner is taxed on her gain very close to a pure aggregate approach, lack legal personality. Japan is one exam - only when she sells “units.” 45 This is with results that are not very different ple of such a country. A recent article inconsistent with any claim that the from those that would be obtained discusses a Japanese Supreme Court assets of the fund are owned by its ben - under U.S. tax rules if the arrangement decision that classified a Delaware lim - eficial owners rather than the fund were treated as the mere co-ownership ited partnership as a corporation for itself, which one would think is funda - of property. The concept of legal per - Japan ese tax purposes. 46 The authors mental to the lack of legal personality. sonality as used outside the U.S. might explained that the court employed a two- Third, a co-ownership fund can be a be seen as a proxy for distinguishing step test. It first asked whether the foreign party to a merger. It is unclear to this between what the U.S. entity classifica - entity was clearly the same as a Japanese author how an entity that cannot own tion rules would call a “business entity” corporation, and concluded that a property can be a party to a merger. and what the U.S. rules would call no Delaware limited partnership is not clear - The release states that an authorized entity at all. Put differently, it may be ly the same. It then asked whether the investment scheme is a simple contract, helpful to think of a partnership in a foreign entity is an entity “to which rights but not a “partnership contract,” which country employing the legal fiction of and obligations are attributable.” That is, apparently would connote legal per - legal personality as nothing more than the second step asks whether the entity sonality. This is true even for a scheme a co-ownership arrangement that carries has legal personality. that takes the form of a limited part - on a business, leaving all true entities Others countries count legal per - nership. Why the written document evi - to be classified as corporations. sonality as one factor in classifying dencing the existence of a limited The implications of this theory might entities, but not the sole factor. (Cana - partnership is not a “partnership con - be profound in terms of how hybridity da’s approach was relaxed from the tract” is a riddle. It is evident from read - between taxing systems can arise. Sup - first, per se, approach to a factors test ing the release that to a person in the pose that individuals A and B, one resident after the episode involving U.S. gen - United Kingdom, “has no legal person - in the United States and the other resi - eral partnerships described below in ality” really just means “is treated as tax dent in a second country, jointly own a Part V. A of this article.) Still other transparent because we said so.” rental building (which might be in the countries, including but not limited to

ENTITY CLASSIFICATION March/April 2016 BUSINESS ENTITIES 13 the United States, simply ignore the does domestically. Alternatively, it may concept of legal personality. simply be that the legal personality fac - One important difference between tor is redundant of the Kintner factors. the U.S. tax approach to entity classi - Germany takes into consideration fication and the approach used in oth - all four Kintner factors plus four more, er countries is that other countries reserving the right to consider other generally undertake the task only to factors as it deems necessary. The four classify foreign entities. 47 Many coun - additional factors are: tries approach the task of classifying 1. Allocation of profits. foreign entities by comparing enumer - 2. Provision of capital. ated characteristics of foreign entities 3. Profit distribution. with those of domestic entities and 4. Formal requirements for organization. attempting to determine whether a for - Note the absence of any reference to eign entity is “more like” a domestic legal personality in the German list. This entity treated as an opaque corpora - may be because Germany, like the Unit - tion or “more like” a domestic part - ed States, has a long tradition of using nership treated as transparent. partnerships to conduct business oper - Countries that employ factors tests use ations. these as a guide in making compara - The Dutch tax authority publishes a bility determinations. list showing the presumptive tax classi - The assumption underlying the fication of selected foreign entities. The comparability approach is that it is pos - Dutch base this list on a four-factor test, sible to make analogies between a but the list is not considered final or domestic entity and a foreign one. So, definitive. Under Dutch rules, an entity for example, if a German lawyer is try - is generally considered non-transpar - ing to decide whether a particular U.S. ent if it possesses at least three out of limited liability company is more like four indicative factors, which are: an opaque German corporation or 1. Whether the entity can hold legal more like a transparent German part - title to the assets of the business (legal nership, she will examine the LLC law personality). in question and usually also examine 2. Limited liability. the particular provisions of the LLC 3. Free transferability. Operating Agreement in an effort to 4. Whether capital is divided into ferability. A CV in which the partners ascertain whether the U.S. LLC is “more shares. can freely transfer their interests will be like” one or the other. An obvious short - Like the old Kintner regulations, the classified as “open” and generally taxed coming of this approach is that it is Dutch four factors are on the face of as a separate entity, whereas the absence hardly useful when the entity encoun - things weighted equally. However, a fair - of free transferability will cause the CV tered bears no resemblance at all to any ly recent Dutch court case involving a to be treated as a tax-transparent “open” local entity, such as a common law trust U.S. LLC seems to have adopted a per se partnership. 49 from the point of view of a civil law rule. In that case, that country’s Supreme Taking these two observations country like Germany. A country that Court ruled that a U.S. LLC was non- together, one can conclude that the insists on trying to ascertain whether, transparent for Dutch tax purposes. 48 Dutch entity classification rules are say, a U.S. partnership has legal per - Among other things, the court found sonality based on its examination of that the business of the LLC was not 47 England seems to be unique in that it does not U.S. law (as The Netherlands explicit - conducted “for the risk and account of have clear rules applicable to either domestic or ly does, and Canada once did), is the members.” foreign entities. doomed to arrive at an imperfect Following this case, the Dutch tax 48 Supreme Court 2 June 2006, no 40919, BNB answer, given that U.S. law doesn’t authority adopted a special rule pur - 2006/288. 49 These rules are surveyed by Molenaars, note 25, accord significance to the concept. suant to which an entity will be treated supra . Four “factors” regimes are worth men - as opaque if (1) it owns its own assets, 50 IFA Cahiers 2014 - Volume 99B: Qualification of taxable entities and treaty protection: United tioning here. Canada employs the four (2) it confers limited liability on all of its Kingdom reporters Baldwin and Kiranoglu. Kintner factors plus legal personality. As members, and (3) the business was not 51 Memec Plc v. IRC [1988] STC 754. has already been noted, however, Cana - carried on at the risk and account of 52 U.S. readers will recall the fussing in the 1980s da takes the view that a partnership lacks the members. The first of these factors when MLPs first began appearing in the public markets. There was a great deal of concern over legal personality even where it clearly restates the legal personality test. provisions such as Section 704(c) and Section 754, owns assets in its own name, and can When it comes to the tax treatment of which can render partnership interests not fungi - ble. Although this problem has never been solved, sue and be sued in its own name. It thus a locally-formed entity such as a CV, the the public markets appear to have adapted to it. appears that Canada may be applying Dutch rules turn almost exclusively on 53 UKSC 44 (July 1, 2015). stricter tests to foreign entities than it the presence or absence of free trans - 54 Revenue and Customs Brief 15 (Sept. 25, 2015).

14 BUSINESS ENTITIES March/April 2016 ENTITY CLASSIFICATION U.K. tax authority to issue guidance clearest formulation of that factor is that listing six factors to be taken into if a board or similar body has to declare account in determining whether an a dividend before an owner becomes entity is opaque or transparent for tax entitled to anything, one is in the pres - purposes. 51 These are: ence of a corporation. In contrast, the 1. Does the foreign entity have a legal owners of a partnership own the profits existence separate from that of the whether or not they decide to distribute persons who have an interest in it? them. Given that this is so, it makes sense 2. Does the entity issue share capital or to tax them on the profits whether or something else, which serves the not distributed, since they already belong same function as share capital? to the partners. 3. Is the business carried on by the However, there is a subtlety to the entity itself or jointly by the persons “as profits arise” test that can easily who have an interest in it that is sep - confuse taxpayers and tax administra - arate and distinct from the entity? tors from different countries. Under 4. Are the persons who have an inter - the traditional formulation of a part - est in the entity entitled to share in nership lacking legal personality, its its profits as they arise; or does the profits really did belong to the partners amount of profits to which they as they arose, because the partners had are entitled depend on a decision the right of partition. Since the part - of the entity or its members, after ners owned the assets, they of course the period in which the profits were entitled to the profits earned on have arisen, to make a distribution those assets. In essence, the partner - of its profits? ship, not being an entity separate from 5. Who is responsible for debts incurred its partners, did not come between as a result of the carrying on of the them and the fruits of their enterprise. business; the entity or the persons Although U.S. tax lawyers would who have an interest in it? readily agree that partners are taxable as 6. Do the assets used for carrying on profits arise, that is not the same thing the business belong beneficially to as saying that they are entitled to the the entity or to the persons who have cash profits as they arise. Most part - an interest in it? nership agreements provide for distrib - not as objective as they first appear. The first and last factors appear to utions to the partners only under certain For foreign entities such as U.S. LLCs, this author to implicate the concept of circumstances. Indeed, it would be near - there seems to be a hidden per se rule legal personality. The first factor is tau - ly impossible to run a business in part - that turns on limited liability. For tological by its own terms. The last is nership form if the cash profits actually Dutch entities such as CVs, there seems a proper inquiry into traditional con - belonged to the partners as they arose; to be a hidden per se rule that turns on cepts of when legal personality can be for one thing, it would be difficult for a free transferability. Perhaps the broad - said to exist. partnership to borrow. So it may well er conclusion is that The Netherlands It will have been noted that a factor be the case that U.S. partnerships are reserves the right to adopt tax classi - used by The Netherlands and England, not entities in which the owners are enti - fication rules that deviate from non-tax and by implication in Germany, is tled to profits as they arise. forms, just as the United States does. whether the entity has capital divided The significance of being taxable on The entity classification tests set out into shares. Other countries also employ profits as they arise is well illustrated by under English law appear at first to a this concept, and indeed it is encoun - a fairly recent English case. The case, U.S. observer to be vague, subjective, tered quite frequently. It may be thought Anson v. Commissioners for HMRC, 53 con - tautological and circular. A recent arti - that a hallmark of corporate status is cerned the U.K. tax classification of a cle 50 listed only three main questions that each share of a given class entitles U.S. LLC. It involved four decisions: pertinent to the analysis: the holder to exactly the same econom - first that of the First-tier Tribunal (the 1. What is the nature of the entity? ics and is fungible with every other share FTT), second on appeal by the gov - 2. What is the nature (income or cap - of that class. Having capital divided into ernment to the Upper Tribunal, third ital) of a value flow from an entity? shares ensures fungibility, which is gen - on appeal by the taxpayer to the Court 3. Has the entity affected a value flow, erally thought necessary to promote free of Appeal, and finally on appeal by the so that UK tax law sees the value flow transferability of interests. 52 government to the Supreme Court. Fol - out of the entity as different from the Another factor that seems important lowing the Supreme Court’s decision inflow? under German law, and is certainly in favor of the taxpayer, which essen - Fortunately we have a bit more to go important in the United Kingdom, is tially treated the LLC as tax-transpar - on. An English court case involving a whether the owners of the entity are ent, the government issued a response German “silent partnership” led the entitled to profits “as they arise.” The in which is announced that the holding

ENTITY CLASSIFICATION March/April 2016 BUSINESS ENTITIES 15 was limited to its facts and that the gov - than an English partnership. Ultimately land, Canada, and Australia, all com - ernment would not change its approach the Supreme Court upheld the FTT’s mon law countries, seem to accord great to U.S. LLCs, generally treating them as findings that under Delaware law the weight to legal personality. Moreover, corporations. 54 profits of the LLC belonged to its mem - Germany, a civil law country, seems Mr. Anson was a member of an LLC, bers as they arose. This could be viewed quite able to accord tax transparency to taxable as a partnership in the United as a rejection of the significance of legal partnerships that possess what most States, that was the management com - personality to the entity classification would regard as legal personality. These pany for a U.S.-based investment fund. issue. Alternatively, it could be viewed as observed facts refute any obvious link - He was not a U.S. resident, and was res - a mistaken reading of Delaware law. In the age between civil law countries and ident in the United Kingdom only on a latter case, the Supreme Court may have linkage to legal personality. nondomiciliary basis. He paid U.S. tax understood the emptiness of an exercise B. Form over Substance? There on his income earned as a partner and that would decide cross-border tax ques - may be a correlation between accord - sought credit for such tax against the tions by relying upon concepts such as ing meaning to legal personality and U.K. tax he paid when the profits were legal personality that have no signifi - having a tax system that accords more remitted to him. 55 The Upper Tribunal cance in the other country. 58 weight to legal formalities than to eco - had denied a foreign tax credit to Mr. Having surveyed the ways in which nomic substance. The whole concept of Anson based on a finding that the LLC entity classification rules incorporate legal personality appears to have was a “body corporate” that paid no tax - the concept of legal personality, this become a merely formal one that does es and hence was not a qualified resi - discussion will now turn to the ques - not really explain why countries clas - dent. The case turned largely on the tion of why many countries give effect sify entities as they do. Perhaps there “profits as they arise” factor. The Upper to legal personality in distinguishing is nothing more to it than emphasis Tribunal was unconvinced that the own - corporations from partnerships. on form and the type of papers filed. ers of an LLC became entitled to profits There are different kinds of formal - as they arose—notwithstanding the fact ism built into different tax systems. One that this is exactly what U.S. tax law pro - IV. Why is Legal Personality kind of formalism that seems very vides. The judge was not interested in Linked to Tax Transparency? closely linked to legal personality con - U.S. tax law, but in Delaware “corporate” As we have seen, some countries include cepts is where a country’s tax laws treat law. He interpreted the LLC operating the existence, or not, of legal personal - as the owner of assets the person who agreement as a contract, not the charter ity as a factor in determining whether holds pure legal title, rather than the of a legal entity. According to a summa - a foreign entity is tax transparent or person we would see as having “the ry of the holding, the taxpayer/owner not. Some countries appear to treat legal benefits and burdens of ownership.” “must show that the contract is actually personality as a “super factor” leading The Netherlands in particular appears the source of the profit, rather than a invariably to corporateness and non - to give great weight to how legal title to mechanism to secure a right to a profit transparency. In either case, the question property is held, and does not employ derived from another source. This in gen - is why they do so. the concept of benefits and burdens of eral will mean he has to show a propri - A. Civil Law vs. Common Law? One ownership—tax ownership—in the etary right to the profits as they arise.” 56 possible theory is that civil law countries way that the U.S. does. A Dutch CV, This is difficult language for a U.S. may be more likely than common law lacking legal personality, does not own English speaker to understand, but the countries to link legal personality to its own assets. Instead, legal title to its gist of it has already been hinted at above. opacity. It is fairly well understood that assets is held by its general partner. The court was looking to find in civil law countries place greater weight This is difficult for a U.S. tax lawyer Delaware law some provision that made on the state’s protection of creditors to understand. If the CV does not own the members the owners of the entity’s than do countries like the United States, its assets, how is it able to conduct its profits without more. Not surprisingly, where economic actors are expected to business? How is it able to borrow? How the court did not find it. Delaware state exercise their own due diligence and can it meet payroll? Given that the CV law, of course, does not specifically pro - judgment. The intuition here might be has a business to run, it is tempting for vide that the entity’s income belongs to that if a country is interested in pro - a U.S. observer to suppose that, in sub - its members “as it arises.” The most that tecting creditors from extending loans stance, the general partner holds legal Delaware law provides, as the Supreme to entities that themselves cannot own title to the CV’s assets in trust for the Court found, is a definition of the term property or be sued, it would deny legal real beneficial owners of the business, “limied liability company interest” that standing to entities lacking legal per - being all of the partners. refers to a member’s share of the profits sonality. In the United States, if a lender This suggests that there may be a and losses of the LLC. 57 It is U.S. feder - wished to extend credit to a partner - link between giving effect to pure legal al tax law that provides for this result. ship borrower, it is expected to protect (as opposed to beneficial) ownership The Supreme Court, like the FTT, rec - its interest by private contract, seeking and recognition of the concept of legal ognized that there is a spectrum of legal security in partnership assets or through personality. personality within which entities fall. guarantees by one or more partners. C. Treating a Partnership as a Pure And the courts conceded that an LLC However, any such correlation is Aggregate. Although difficult to prove, has more in the way of legal personality fairly easily refuted by noting that Eng - observation suggests that countries

16 BUSINESS ENTITIES March/April 2016 ENTITY CLASSIFICATION income to its owners is possible only by creating separate classes of shares. In a partnership, however, non pro rata allocations are possible and, at least in the United States, common, and as a tax matter it is actually impossible to have capital divided into shares. Although the drafter of a partner - ship or LLC agreement can dress up the partnership interests as “units,” U.S. tax law, at least, will give no effect to such drafting. A partner can have only one capital account for tax purposes, and all the partnership math is premised on one common basis in an indivisible partnership interest. A recent ruling from the Chinese tax authorities supports the second approach. 59 A Taiwan corporation owned an interest in a foreign investment part - nership (FIP) (set up in an unspecified country outside of China) through two wholly owned entities. One wholly owned entity was a Hong Kong compa - ny that was a 99% limited partner in the FIP. The other wholly owned entity was a Chinese company that held a 1% inter - est as general partner. The Hong Kong limited partner received a distribution from the FIP. It took the position that the distribution was a dividend from a company. But the Chinese tax authority that condition tax transparency on the ownership. This is not the way Sub - took the position that the distribution absence of legal personality tend to chapter K of the Code has evolved. was instead a distribution of business have tax rules that apply pure aggregate Subchapter K is a blend of “aggregate” profits from a tax-transparent entity and theory to partnerships. This does not and “entity” principles for taxing part - thus not a “dividend.” seem surprising. If a tax system takes ners, each of which co-exist with the The theory espoused by the Chinese seriously the notion that a partnership notion that a partnership has a legal tax authority in this case was the same lacks legal personality, it will view the personality separate from its partners. theory that U.S. law would apply to a relationship between the partners as As has been noted, several coun - foreign partner under Section 875. But very close to, if not identical to, co- tries look to whether the entity’s inter - to apply that theory, one must first con - ests take the form of “capital divided clude that the underlying entity, in this into shares,” and some seem to equate case the FIP, is a partnership. In deter - 55 Although the courts do not seem to mention it, it seems as if the real problem in this case this trait with legal personality. There mining that the FIP was tax transparent, was that Mr. Anson was subject to tax in the are two ways of thinking about the sig - the Chinese tax authority cited three United Kingdom only on a nondomiciliary nificance of this factor. One is to posit findings. First, it referred to the fact that basis, a concept that does not exist in the United States. Thus, although he was taxed that in most countries recognizing tax- in the case at hand, profit allocations in the United States on the LLC’s profits “as transparent partnerships, it will be were non pro rata, being based on the they arose,” he did not report income on that basis in the United Kingdom by virtue of the assumed that all allocations of income partnership agreement rather than on a nondom rules. must be straight up, as they would be straight up corporate model. 56 IFA Cahiers 2014 - Volume 99B: Qualification of in a co-ownership arrangement. Thus, If having capital divided into shares taxable entities and treaty protection: United Kingdom reporters Baldwin and Kiranoglu, at to have capital divided into shares per - is a hallmark of legal personality, then 850. mits non pro rata allocations by cre - one might conclude that U.S. partner - 57 Del. Limited Liability Company Act, Section 18- 101(8). ating separate classes of shares. ships uniformly lack legal personality, 58 For a good summary of the case, see Johnson, The other way of thinking about despite being the legal owners of their “The Anson Decision - Transparency and capital divided into shares is to start own assets. Partnerships and LLCs in Opacity,” Tax Notes Int’l 431 (11/2/2015). from the observation that when an the United States are characterized by 59 For a description, see “Foreign Company Subject to 25 Percent Enterprise Income Tax,” entity has capital divided into shares, differences in capital accounts; it is very Tax Notes Int’l 33 (10/6/2014). non pro rata allocations of the entity’s common for a partner to be awarded

ENTITY CLASSIFICATION March/April 2016 BUSINESS ENTITIES 17 an interest in profits only, to have a pref - There is almost certainly a connection erence on distributions or to have eco - between the way in which a particular nomic shares shift upon the meeting of country classifies entities for tax pur - prescribed milestones. This of course poses and they way in which it regulates cannot be replicated in a corporation. publicly traded or widely held compa - D. Legal Personality as a Proxy for nies. A U.K. LLP, for example, is required Public or Widely-Held Ownership. to maintain audited public accounts; this There is evidence suggesting that when is not true of a U.S. partnership. a country speaks in terms of legal per - Although a U.K. LLP can be treated as sonality being important to tax classi - tax transparent, it is said to possess legal fication, what the country may really personality. This seems to be a case of an mean is that it is too difficult to treat entity that the state reserves the right to publicly held or widely held entities as audit and regulate as a widely-held enti - tax transparent. The concept of legal ty, but that can be a pass-through if it personality may be employed to dis - meets certain conditions. tinguish those entities that are capable E. Conclusion. To some extent, the of having, or likely to have, many unre - theories set out above support the view lated owners unknown to one another that a corporation must have, or is char - from entities whose owners are known acterized by, legal personality. This is to one another and thus capable of act - consistent with the Kintner regulations, ing as something like mutual agents. which were derived from traditional Although being widely held or pub - ideas of what distinguished a corporation licly traded was not traditionally a fac - from a partnership, which ideas were tor in classifying entities for U.S. tax certainly related to the concept of legal purposes, it is well understood that personality. However, none of the theo - some of the traditional Kintner factors ries set out in this Part IV seems capa - tended in this direction. In particular, ble of explaining why so many countries free transferability and centralization continue to insist that a partnership must of management are characteristics of lack legal personality. And this seems to widely-held companies and less often be the central paradox—just because we seen in closely held businesses. While can all agree that an entity treated as a when these criteria are applied to for - these characteristics were eliminated corporation has legal personality, why eign entities, and the foreign country’s by the check-the-box regulations, the must it be that an entity treated as a part - rules incorporate no such distinctions, elimination was made easier by the nership must therefore lack legal per - one is sure to encounter hybridity. intervening enactment of Section 7704 sonality? Why can’t a partnership have In 2000, a Canadian government offi - of the Code, classifying certain publicly legal personality, but differ from a cor - cial discovered that a general partnership traded partnerships as corporations. poration in other ways? formed under Delaware’s newly-revised Today, the list of “per se” foreign enti - Countries have in fact made strides version of RUPA possessed legal per - ties treated as corporations includes in de-emphasizing legal personality, at sonality. In July of 2000, Canada mainly those entities thought to be least as applied to foreign entities. But announced that Delaware general part - capable of being publicly traded. as long as the conceit survives, tax - nerships would henceforth be treated The factor of free transferability payers and their advisors will struggle as corporations, with the result that— seems highly correlated to the finding, with the practical consequences. because partnerships do not pay taxes at in other countries, of legal personali - the entity level—treaty benefits would be ty. If I can transfer my ownership inter - denied to U.S. persons investing in est to a stranger, it is unlikely that my V. Practical Problems with Legal Canada through such partnerships. 60 interest represents an interest in a close Personality (Or the Lack Thereof) Predictably, uproar ensued. It was point - corporation among persons who know A. Qualification Conflicts. It is a per - ed out that all U.S. partnerships, regard - each other and have come together as fectly legitimate exercise of a taxing less of the state in which they were partners. Moreover, free transferabili - state’s powers to decide upon whatever formed and regardless of whether they ty is closely related to fungibility of entity classification rules, including a were general or limited partnerships, interests, a factor usually deemed crit - per se rule based on legal personality, possessed legal personality in the sense ical to a publicly traded corporations. seem best to its own purposes, so long “discovered” by Canada in 2000. And The intuition behind free transfer - as those rules are applied internally. A that this had been true long before the ability is that where it exists, the enti - given country may decide that the exis - 1980 tax treaty between the U.S. and ty is sufficiently remote from it owners tence or non-existence of legal person - Canada was signed. that it is right to tax it as an entity sep - ality is important in distinguishing Following this incident, Canada relent - arate from its owners; hence, “legal per - entities that are opaque from those that ed. In November of 2000, it was sonality.” are transparent for tax purposes. But announced that henceforth Canada would

18 BUSINESS ENTITIES March/April 2016 ENTITY CLASSIFICATION wasn’t needed. In TD Securities (USA) LLC ship terminates when a partner retires, v. Her Majesty the Queen , 2010 TCC 186 the court treated the start-up expendi - (4/8/2010), the court held that a U.S. LLC tures incurred by the prior partnership as must be considered to be a resident of sunk costs that could not be recovered by the U.S. for purposes of the treaty. In so anyone—as expenses of a “failed” enter - deciding, the court respected the LLC as prise. There is no indication that the court a separate legal entity having a legal per - considered the possibility that the expen - sonality distinct from its members. It thus ditures incurred by the prior partner - tested residence for treaty purposes at the ship might be taken into account by the entity level. However, it sensibly over - reconstituted or “successor” partnership, came the objection of Canada that the very probably because the notion of pre - LLC was not taxable at the entity level, and decessor or successor partnerships would therefore could not qualify as a resident not occur to anyone who believed that a under the treaty, by holding that the LLC partnership must lack legal personality. “must be considered to be liable to tax in Here, as it does generally, U.S. tax the US by virtue of all of its income being law looks to economics and substance, fully and comprehensively taxed under not to legal fictions. Doing so not only the US Code albeit at the member level.” 62 gets the right result, it can protect the In essence, then the court determined IRS against whipsaw by taxpayers. For that having separate legal personality was example, in Madison Gas & Electric irrelevant to the tax classification of an Co. ,64 the taxpayer argued that it should LLC, albeit only for the limited purpos - be entitled to deduct certain costs asso - es of the U.S.-Canada treaty. In this sense, ciated with a joint venture, on the the Canadian case is similar to the Anson ground that had it incurred those costs case in England. in its own trade or business, they would As noted earlier, most countries that have been deductible as ordinary and apply comparability tests to determine necessary business expenses associat - the entity classification of non-local enti - ed with the expansion of its existing ties are not so rigid as to insist that legal business. The Tax Court and Seventh personality is the sole determinative fac - Circuit disagreed, finding that the ven - not apply the legal personality criterion to tor. Nevertheless, the application of any ture was a deemed partnership. Since partnerships formed under U.S. uniform type of comparability test risks creating a partnership is an entity separate from partnership laws. 61 It took ten years for a hybridity absent taxpayer planning. its partners with its own distinct busi - new protocol to the treaty to be approved, B. Treaty Benefits. A common ques - ness, the costs incurred by the taxpayer extending the same courtesy to U.S. lim - tion is whether an “entity” lacking legal as a partner of the deemed partner - ited liability companies (but only to the personality in its home country may ship were treated as costs of the part - extent owned by U.S. residents). Ironi - claim benefits under a tax treaty, such as nership in establishing a new business, cally, after the new protocol was adopted, protection from taxation absent a per - and were required to be capitalized. the Tax Court of Canada decided, at least manent establishment. One might sup - Thus, in this type of case, income on the facts before it, that the protocol pose that such an entity could never be may be allocated differently for U.S. a resident of its own country. However, and non-U.S. tax purposes, resulting

60 The Canadian revenue authority issued a tech - this seems not to be the rule in practice. in mismatches of the type that gov - nical interpretation (TI) referring to the earlier TI Many U.S. tax treaties specifically provide ernment are trying to minimize. cited at note 22, supra . See “Revenue of D. U.S. Estate Tax Issues. DRUPA,” 8 Canadian Tax Highlights 57 (August for benefits to accrue to entities, such as Although 29, 2000). a French fonds commun de placement, U.S. federal income tax principles gen - 61 See “Revenue’s New DRUPA Position,” 8 that very clearly lack legal personality erally ignore the concept of legal per - Canadian Tax Highlights 89, 12/27/2000. See also Johnson & Lille, note 23, supra , at ¶ 2.2. at home. Yet absent a specific rule in the sonality, U.S estate tax rules might give 62 2010 TCC at 247. treaty, this question will often be unclear. the concept some effect. A nonresident 63 BFH, decision of 12/26/2014, I R 56/12, BStBl.II C. Misallocation of Income. In a alien decedent is subject to U.S. estate 2014, at 703. This citation and the text are taken from Kramer, “German Tax Treatment of Expenses recent German case, seven doctors orga - tax only on property located within the for a Foreign PE That Fails, Tax Notes Int’l 709 nized a practice in Abu Dhabi as a part - U.S. The situs of corporate stock is the (11/24/2014). That author was focused on a differ - ent issue and did not notice the irony of his title— nership. Before the venture was place of incorporation of the issuer. With the permanent establishment did not in fact fail; established, one of the partners retired. respect to partnerships, however, it is all that occurred was that one partner retired. Under traditional partnership principles unclear—and has been so for many 64 633 F. 2d 512, 46 AFTR2d 80-5955 (CA-7, 1980), aff’g 72 TC 521 (1979). prevailing in Germany, the partner’s years—whether a nonresident’s estate 65 For further background on the great uncertainty in retirement dissolved the partnership. 63 includes the partnership interest itself or this area, see Cassell, Karlin, McCaffrey, and Nevertheless, a new partnership was looks through the partnership to its Streng, “U.S. Estate Planning for Nonresident Aliens Who Own Partnership Interests,” 99 Tax formed to continue the business. Fol - assets, and if the former, how to deter - Notes 1683 (6/16/2003). lowing the legal fiction that a partner - mine the situs of a partnership interest. 65

ENTITY CLASSIFICATION March/April 2016 BUSINESS ENTITIES 19 The position of the IRS appears to be differences in the source and taxing personality is likely to treat anything the that it is the partnership interest, and not rules of different countries can lead to partnership does as being done by the the partnership’s assets, that is subject to double taxation or double nontaxation. partner. While this is an approach that being included in the estate. 66 The IRS E. Payments by Partnerships. If an U.S. tax law generally follows even where also appears to believe that the situs of the entity such as a partnership cannot own a partnership possesses what everyone partnership interest is the place where its own assets, it seems to follow that the would agree is separate legal personali - the partnership conducts its business. source of any payment by such an “enti - ty, 72 the approach might be taken much There is no indication of what rule to ty” must be determined as if the pay - further. For example, under Canadian follow if the business of the partnership ment were made by the partners. A pure law, if a partnership lacking legal per - is conducted in more than one country, aggregate theory would similarly treat sonality borrows, that borrowing may as for example would be common in law a payment by a partnership as a pay - be imputed to the partners for non-tax firms and other service partnerships. 67 ment by its partners. This approach can purposes. 73 Since under certain Cana - It is likely that the situs of a partner - lead to somewhat odd source rules. dian statutes it is illegal for certain types ship interest would not be determined In Canada, for example, where part - of entities to borrow, this can pose real the way the situs of stock is determined, nerships are said to lack legal personality, practical issues. The problem, I am told, by the place of formation of the issuer. a payment made in form by a partnership would not exist where it is clear that a The reason for the different treatment is sourced by the residence of its partners. partnership has separate legal person - is not so much that a partnership lacks Where source derives from the residence ality, as it then would be considered to legal personality, but rather that a part - of the payor, such as interest, this approach be borrowing in its own name. nership, because it is not subject to tax means that if some partners are Canadi - G. How Does U.S. Law Apply? It is at the entity level, is relatively indifferent an resident and other are not, a payment sometimes asked whether an entity can to its place of incorporation. In theory all by the partnership has mixed source. 70 be a “business entity” eligible to check partnerships could be established in the Similar rules apply in Belgium, another the box under U.S. entity classification Cayman Islands, effectively negating any country that conditions tax transparency rules if the foreign country under estate tax based on place of formation. on the lack of legal personality. whose laws it is created does not rec - However, the “residence” of a partnership In contrast, in the U.S., where a pay - ognize it as an “entity” and insists that is generally where its business is carried ment by a partnership is generally it is a mere contractual arrangement on, at least for certain income tax pur - respected as a payment by a separate without legal personality. The answer poses, 68 so a place of residence rule is entity, the payment in this case would is that U.S. principles should apply, similar to what appears to be the current be sourced by the residence of the part - and that the entity is an entity and can position of the IRS. nership. It must be noted, however, that make an election. It should be clear To the extent one takes the view that U.S. source rules in this instance are that what constitutes a “business enti - a partnership has legal personality, and somewhat confused, owing to the fact ty” for purposes of U.S. classification that this is somehow meaningful, it might that the “residence” of a partnership is rules is a matter of U.S. law only. follow that a partnership interest of a often irrelevant. That is, while a part - The IRS has issued several private nonresident should never be subject to nership may be an entity, it is still tax rulings stating that foreign entities such estate tax at all. The theory would be transparent such that its residence as a fonds commun de placement, not that the interest in the partnership is should by rights be irrelevant. 71 treated locally as entities at all, are busi - intangible property similar to stock, but F. Attribution of Activity. A country ness entities that can check the box to be that unlike stock of a corporation, it has that insists that a partnership lacks legal classified as corporations or as partner - no situs other than the domicile of the decedent. The opposite approach would 66 Rev. Rul. 55-701, 1955-2 CB 836. Because this rul - 183. Note also that the anti-hybrid provisions of be to disregard the existence of the part - ing was interpreting a treaty, it is unclear whether Article IV(7) of the U.S.-Canada tax treaty apply nership entirely and tax a nonresident as it represents the view of the IRS more generally. only when a payment by a hybrid is treated “the 67 Perhaps fortunately for partners of global firms, same as” a payment by a non-hybrid. It is reput - if he or she owned a proportionate share an interest in a services partnership rarely has ed to have been a surprise to the Canadian com - of all partnership assets. The obvious any ascertainable value, and what value it might petent authority when it discovered that, under have would almost always be zero at death. U.S. tax rules, a payment of interest by a partner - ship is “the same as” the payment of interest by difficulty with this approach is that it 68 Section 861(a)(1)(B). a corporation, such that the anti-hybrid rule did would be very difficult to apply and to 69 The author and many others have criticized Rev. not apply in the case of a hybrid treated as a audit in the case of widely-held part - Rul. 91-32, 1991-1 CB 107, on this and other partnership in the United States. nerships with assets all over the world. 69 grounds. See, e.g., Blanchard, “Rev. Rul. 91-32 71 For some tax fun and games with the “resi - May Be Granted Authority – 20-Plus Years Late,” dence” of a partnership, see NYSBA Tax Section There exists law suggesting that 41 Tax Mgmt Int’l J. 237 (May 2012). Report 1124, “Differences in Tax Treatment of whether the situs determination is made 70 IFA Cahiers 2014 - Volume 99B: Qualification of Domestic and Foreign Partnerships” (2006). taxable entities and treaty protection: Canada 72 See, e.g., Sections 875 and 512(c). with respect to the partnership interest reporters Bunn and Johnston, at 182. 73 Wildenburg Holdings Ltd. v. Ontario, 98 DTC Notwithstanding that Canada applies this pure or with respect to the underlying assets 6462 (Ontario Court of Justice), upheld 2001 aggregate approach to payments by partner - of the partnership may turn on whether DTC 5145 (Ontario Court of Appeal). ships, Canada will not accord treaty benefits to 74 the partnership has legal personality, foreign corporations that receive Canadian Regs. 1471-5(e)(1)(ii), -5(e)(3). at least in the sense that the partner - source dividends through a partnership, insisting 75 As noted above, the Dutch classification chart that the shares of the Canadian corporation are treats similar entities formed in different states dif - ship can continue even after the death “owned” by the partnership and not, as the ferently. Other countries do the same, whether of a partner. This is another area where treaty requires, by the foreign corporation. Id . at formally or informally.

20 BUSINESS ENTITIES March/April 2016 ENTITY CLASSIFICATION for U.S. tax purposes. This makes the CV a “controlled foreign corporation” (CFC). The CV will have at least two partners, usually one general partner and one limited partner, both of which will be 100% owned by the U.S. multi - national. In most cases, the two part - ners will be disregarded entities. A pledge of any assets of a CFC to support debt of its U.S. parent triggers a deemed dividend under Section 956, although the U.S. parent may pledge up to 66% of the stock of a CFC without triggering that rule. Therefore, it is com - mon for the U.S. parent to pledge 65% of the interests in each of the general and limited partner entities owning the CV. From a U.S. tax perspective, this is the equivalent of the U.S. parent pledg - ing 65% of the stock of the CV, a CFC. The U.S. parent might become con - cerned when Dutch counsel announces that the general partner entity “owns” all the assets of the CV. If that fiction were respected for Section 956 pur - poses, the pledge of 65% of the stock of that entity would be a pledge of assets, rather than a pledge of stock. It would give rise to a Section 956 inclu - sion to the full extent of the earnings and profits of the CFC. Again, it seems relatively clear that ships. In effect, these are deemed part - tion,” defined as an entity that “holds, as in applying Section 956, the U.S. would nerships. (A recent deemed partnership a substantial portion of its business . . not respect foreign legal fictions that ruling, PLR 201305006, entailed the dif - ., financial assets for the benefit of one are inconsistent with U.S. legal fictions. ficult question of whether a deemed or more other persons.” 74 If an invest - partnership is domestic or foreign.) ment fund is set up in a country like The principal conundrum faced by Guernsey, where the general partner is VI. Self-Help U.S. tax advisors confronted with enti - treated as the legal owner of the fund’s Given that U.S. partnerships invari - ties that the foreign country believes assets, the question arises whether the ably possess what other countries lack legal personality is that the foreign general partner is an FFI by reason of believe to be legal personality, it is country does not regard the entity as holding financial assets for the benefit worth asking whether legal personal - actually owning its own assets. Instead, of the limited partners (or the part - ity is something that can be expunged the general partner or trustee or some nership itself). from a U.S. partnership, or from any similar actor is treated as the legal own - These types of questions should be entity formed in a country that has er of those assets. Because U.S. tax rules resolved by adopting the U.S. view of similar rules, simply by drafting its applicable to most types of entities, an arrangement, not the local view. In governing documents. Other countries including all partnerships, are written the case of a Guernsey partnership, for seem to believe that there are relevant on the assumption that the partnership example, one would conclude that the differences among various state laws and not the partners is the tax owner of partnership itself is clearly an FFI. That governing the formation of limited partnership assets, some odd questions conclusion depends upon an assump - partnerships, limited liability compa - can arise. Two of these are described tion that the partnership actually owns nies, LLPs and LLLPs. 75 Many coun - below. its own assets, which is true if and only tries take into account the relevant 1. FATCA. FATCA requires the iden - if U.S. principles are applied to this organizational documents of a U.S. tification of “foreign financial institu - simple case. entity to determine how to classify it tions” (FFIs) as well as “non-financial 2. Section 956. Suppose a U.S. for local tax purposes. foreign entities.” The terms “institution” multinational sets up a CV in The Tax lawyers in the U.S. are often or “entity” are not generally defined. Netherlands and makes a check-the- asked to draft partnership agreements One type of FFI is a “custodial institu - box election to treat it as a corporation or LLC operating (Coninued on page 48)

ENTITY CLASSIFICATION March/April 2016 BUSINESS ENTITIES 21 Entity Classification Conclusion Stepping back from this extended dis - cussion of legal personality and factors in classifying entities, some observa - tions seem clear. It is very noticeable that the Kintner factors applied by U.S. tax rules prior to the adoption of the check-the-box regulations were nearly identical to the factors that other coun - tries employed to determine whether an entity should be treated as tax trans - parent or as tax opaque. It is also obvi - ous that those factors relate to traditional notions of legal personality. In some countries, an entity lacking enough of the Kinter -type factors, such as a partnership, is said to lack “legal personality.” But it is unclear why the reverse should be true: just because an entity has legal personality does not mean it must be classified as an opaque corporation. Rather, the existence of the Kintner factors indicates nothing more than the fact that the entity is an entity. Its tax classification is another matter. Why should the presence or absence of this elusive concept called “legal per - sonality” have anything to do with tax or with entity classification? Way back in 1928, Bryant Smith took on the arti - ficiality of the legal personality fiction. At that time, there was at least a linger - ing notion that a partnership did not have legal personality. Assuming for the (Coninued from page 21) agreements in Partnership as entity sake of argument that this might be true a way that will support the conclusion as a general matter, Smith wrote: that the partnership or LLC has, or (a) A partnership is a separate legal entity which is an entity distinct It is not the part of legal personality lacks, legal personality from the point from its partners unless otherwise pro - to dictate conclusions. To insist that of view of another country. For exam - vided in a statement of partnership exis - because it has been decided that a ple, in order to make an LLC look more tence or a statement of qualification and corporation is a legal person for clearly like a U.S. body corporate, the in a partnership agreement. 76 some purposes it must therefore be lawyer might be asked to draft an oper - a legal person for all purposes, or to insist that because it has been decid - ating agreement to provide for certifi - This provision of Delaware law was ed that a partnership is not a legal cated units and the ability to have a enacted in 1999. The evident intent of person for some purposes it cannot board declare dividends—concepts that the “unless otherwise provided” lan - therefore be so for any purposes, is are essentially meaningless from a U.S. guage was to allow the partners to pro - to make of both corporate person - commercial or tax law point of view. vide in their agreement that the ality and partnership impersonality a master rather than a servant, and to It is more difficult to remove legal partnership was not an entity distinct decide legal questions on irrelevant personality from a U.S. entity through from its partners. Some Delaware considerations without inquiry into drafting. Recognizing this fact, lawyers recall that Delaware did this to their merits. Issues do not properly Delaware, the leader amongst U.S. states accommodate concerns of non-U.S. turn upon a name. in adapting its commercial laws to inter - investors needing an entity lacking legal national business, has gone so far as to personality. Whether this “presto change- Legal personality was originally enact a provision whereby a general o” provision is effective is unclear. Nev - invented as a means to an end. It should partnership may effectively elect to ertheless, tax advisors from several be limited to that role. It was not invent - eschew legal personality. The law states: countries have relied upon it to get com - ed to be of use for tax classification fortable that the U.S. partnerships they purposes, and should not be used for 76 6 Del. C. § 15-201 (2014) (emphasis added). invest in lack legal personality. such purposes. G

48 BUSINESS ENTITIES March/April 2016 ENTITY CLASSIFICATION