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Update on U.S. classification of German entity.

Rev. Rul. 93-4 reconsidered Rev. Rul. 77-214's classification of a GmbH, a German business entity, as an association taxable as a corporation for U.S. tax purposes.


The standards in Regs. Sec. 301.7701-2 must be applied to determine whether a domestic entity is classified as a corporation or partnership for U.S. tax purposes. To qualify as a corporation, an entity must have three of four corporate characteristics: centralized management, continuity of life, free transferability of interests and limited liability.

When classifying a foreign entity U.S. tax purposes, the applicable foreign law and the entity's organization agreements must be considered. Foreign law determines the legal relationships of the organization's members among themselves and with the members' interests in the organization's assets. However, the standards enunciated in Regs. Sec. 301.7701-2 also must be applied.

GmbH under German law

Under German law, a GmbH possesses the corporate characteristics of limited liability and centralized management. German law contains numerous optional provisions that can be modified by a GmbH's memorandum of association so that, depending on the memorandum's construction, the GmbH can assume the characteristics of either a corporation or a partnership.

Thus, the GmbH can be classified as a corporation if the momorandum of association provides for either of the two remaining corporate characteristics: continuity of life or free transferability of interests.

Rev. Rul. 77-214

In Rev. Rul. 77-214, a GmbH was formed by two wholly owned U.S. subsidiaries of a U.S. corporation. One subsidiary owned 90% of the GmbH's "shares" (called quotas), while the other subsidiary owned the remaining 10%. The two subsidiaries were expressly formed to provide marketing and support services for the parent's operation in foreign countries. The GmbH, in turn, was formed by the subsidiaries to facilitate the provision of these services in Germany.

The GmbH's memorandum of association provided that the GmbH would be dissolved on any shareholder's death, insanity or bankruptcy. It further provided that the GmbH's share were not freely transferable and that the sale, pledging or disposal of any shares required all shareholders' prior written approval.

The GmbH was classified as an association for U.S. income tax purposed because it possessed all four corporate characteristics.

Rev. Rul. 93-4

Rev. Rul. 93-4, effective Feb. 18, 1993, reaffirmed Rev. Rul. 77-214's holding of corporate classification. However, Rev. Rul. 93-4 determined that the same GmbH possessed only three of these corporate characteristics.

Rev. Rul. 77-214 held that the GmbH had continuity of life despite the provision for its dissolution on the happening of certain events, because there were no separate interests to compel dissolution; the only two shareholders were wholly owned by the same corporation. Apparently, there must be competing or adversarial interests for a separate interest to exist.

However, Rev. Rul. 93-4 superseded Rev. Rul. 77-214's separate interests" requirement by holding that the presence or absence of separate interests is not relevant to the determination of whether an entity possesses continuity of life. Because the GmbH's memorandum of association required dissolution on the bankruptcy of either shareholder, without further action, the GmbH lacked continuity of life.

Effect on prior returns

Organizations existing before Feb. 18, 1993 that reasonably relied on Rev. Rul. 77-214 can maintain their current classification by reporting consistently with that classification on the first relevant U.S. income tax return of the organizations or member filed after Feb. 18,1993.
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Article Details
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Author:Blum, Richard A.
Publication:The Tax Adviser
Date:May 1, 1993
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