Rev. rul. 93-4 (entity classification).

• Position: Foreign organizations

On September 9, 1993, Tax Executives Institute submitted the following comments to the Internal Revenue Service on Rev. Rul. 93-4, relating to entity classification. The submission, which took the form of a letter to Robert E. Culbertson, Associate Chief Counsel (International), and Paul F. Kugler, Assistant Chief Counsel (Passthroughs and Special Industries), was prepared under the aegis of the Institute's International Tax Committee. The chair of the committee is Lisa Norton of Ingersoll-Rand Company. Joseph S. Tann, Jr. and Neil Pinzer of Ameritech Information Technologies materially contributed to the development of the submission.

This letter addresses several issues raised by Rev. Rul. 93-4, 1993-3 I.R.B. 5 (Jan. 19, 1993), relating to the classification of foreign organizations for tax purposes. The ruling, which was issued on December 23, 1992, modifies Rev. Rul. 77-214, 19771 C.B. 408.

General Comments

TEI commends the Internal Revenue Service for issuing Rev. Rul 934. The ruling significantly clarifies the classification of an entity under German law for federal income tax purposes. We believe that the new ruling represents a positive first step in righting the imbalance between foreign and domestic entities that was created by Rev. Rul. 77-214.

We also commend the IRS for exercising its authority under section 7805(b) of the Code to apply rules and regulations prospectively. Rev. Rul. 93-4 provides that organizations existing prior to February 18, 1993, that reasonably relied upon Rev. Rul. 77-214 may maintain their current classification by reporting consistently with that classification on the first federal income tax return of the organization or member filed after that date. The new ruling is thus given prospective effect for entities that wish to retain their corporate status. Modifying Rev. Rul. 77-214 on a retroactive basis could have created more uncertainty in the international area by casting doubt on the corporate status of German entities. The prospective application of Rev. Rul. 93-4 for those taxpayers seeking to retain corporate status is a sensible approach.

In spite of the strides toward simplification and clarity made in Rev. Rul. 93-4, more needs to be done. Taxpayers need an entity classification system that yields clear and predictable results.(1) Since Rev. Rul. 77-214 was not revoked in its entirety, some remnants of its holding on the free transferability of interests and the application of the economic interests test remain. TEI believes it is time for the IRS to totally abandon the rationale set forth in the 1977 ruling since there is no potential for abuse that requires adherence to the single economic interest theory. Nor is any policy served by "looking behind" the legal restrictions set forth in an entity's memorandum of association.(2)

Moreover, taxpayers should be accorded substantial flexibility to structure a foreign entity as either a corporation or a partnership for U.S. tax purposes. TEI believes the rules relating to the classification of foreign entities should be readily adaptable to foreign legal requirements. Taxpayers filing consolidated returns that wish to achieve flow-through treatment for an overseas entity may currently do so by establishing a domestic subsidiary with a branch operation abroad. Such an approach, however, restricts taxpayers' flexibility under local law. Foreign procedural or administrative requirements (such as actions required to dissolve an entity) should not preclude taxpayers from achieving partnership classification. Finally, we suggest that the IRS issue general guidance for classification of all foreign entities.

The IRS Should Eliminate the Single Economic Interest Test and Withdraw Rev. Rul. 77-214

Section 7701(a)(3) of the Code provides that the term "corporation" includes "associations, joint-stock companies, and insurance companies." Treas. Reg. [paragraph] 301.7701-2(a) defines an association as having the following six corporate characteristics: (1) associates; (2) an objective to carry on business and divide the gains therefrom; (3) continuity of life; (4) centralization of management; (5) liability for corporate debts limited to corporate property; and (6) free transferability of interests.(3) For purposes of determining whether an entity is a corporation or a partnership, the first two factors are ignored. An association will be treated as a corporation if it possesses...