Under new IRS guidelines (Revenue Procedure 95-10) issued January 17, 1995, a foreign company qualifying as a partnership must have at least two shareholders. In Addition: It must lack two of the following four" corporate characteristics":Continuity of Life
A foreign company lacks continuity of life if local law or the operating agreement provides for automatic dissolution after the "death, insanity, bankruptcy, retirement, resignation, or expulsion" of any shareholder involved in management. This list must apply to all shareholders. If all the events on this list are not selected as triggers for dissolution, those that are must provide a "meaningful possibility" of dissolution.
The company's operating agreement need not call for dissolution because of one of these events if it states that continuance will depend on a "majority in interest" of the remaining shareholders. In the past, the IRS has interpreted this to mean that consent is required from shareholders holding a majority interest in terms of both company profits and capital.Free Transferability
Shares in a foreign company are not freely transferable if members owning at least 21 percent of company "capital, income, gain, loss, deduction, and credit" are unable to transfer their entire ownership rights without the consent of at least a majority of the managing shareholders. In this case, "majority" can be in terms of interest in company profits or capital or even a simple headcount of the managing shareholders. The managing shareholders must, however, be able to withhold their consent for any reason, even unreasonably.Centralized Management
A foreign company does not lack centralized management if all the shareholders participate directly in management unless they do so exclusively in their capacity as shareholders. For example, they cannot all be appointed to the role of managers; they must have the authority under local law to play that role simply by virtue of being shareholders. The managing shareholders must own at least 20 percent of the company, and the IRS will consider that they company has centralized management if they are under the control of the others-for example, if they are elected.Limited Liability
The foreign company lacks limited liability if at least one shareholder assumes personal liability for all the company's debts. The local statute under which the foreign company was incorporated must expressly authorize this. To avoid "close scrutiny," the shareholder(s) assuming this liability must have an expected collective net worth of at least 10 percent of total capital contributions to the company over its entire life. It may enough if the shareholders assuming liability have "substantial assets ... that could be reached by a creditor, but the IRS does not define "substantial."Other Shareholder Obligations
In addition, the foreign company's operating agreement must expressly provide that the managing shareholders collectively receive at least 1 percent of each item of company "income, gain, loss, deduction, or credit during the entire existence" of the company. The IRS will, however, permit this 1 percent to fall to as low as 0.2 percent as total capital contributions to the company increase from $50 to $250 million. The IRS will also allow temporary departures from the rule in some situations.
These shareholders, as a group, must have a "capital account balance" at all times of at least 1 percent of "total positive capital account balance" or $500,000, whichever is less. The operating agreement must require them to contribute additional capital at the same time as other shareholders to maintain this minimum balance. But managing shareholders need not maintain any particular capital account balance if at least one managing shareholder is contributing "substantial services" to the company for free. However, in such a case, the operating agreement "must expressly provide" that they, as a group, will pay in more capital "upon the dissolution and termination" of the company to cover any deficits in their capital accounts. The managing shareholders may be able to get away with less than a full deficit makeup; they may contribute as a group an amount equal to 1.01 percent of total capital put in by the other shareholders (with credit for any capital they contributed previously).
Keith Martin is an attorney with the Washington, DC, law firm of Chadbourne & Parke.
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