Rev. Rul. 77-214

Advice has been requested whether a "Gesselschaft mit BESCHRANKTER Haftung", (GmbH) organized under German law will be automatically classified as an association taxable as a corporation for Federal income tax purposes.

A GmbH is a juridical person, formed pursuant to a memorandum of association, and which under applicable German law has the corporate characteristics of limited liability and centralization of management. In Germany the memorandum of association is a contract between two or more persons, who may be individuals or legal entities, citizens or aliens, or residents or nonresidents. After completion of the memorandum of association, the organizers of the GmbH must file for registration with the Commercial Register in the jurisdiction where the GmbH is located. When all statutory requirements are complied with, the judge in charge of the Commercial Register orders the registration of the company, which as of that date acquires legal status.

The GmbH, in the instant case, was formed by two wholly-owned United States domestic subsidiaries of a United States corporation. One of the subsidiaries owns 90 percent of the quotas (shares) of the GmbH, the remaining 10 percent of the quotas are owned by the other domestic subsidiary. The two subsidiaries were expressly formed by the parent to provide marketing and support services for the parent's operations in foreign countries. The GmbH in turn was formed by the subsidiaries to facilitate the providing of these services in Germany.

The memorandum of association of the GmbH, in the instant case, provides, among other things that the GmbH shall be dissolved by the death, insanity, or bankruptcy of any of the quotaholders. The memorandum of association also provides that the quotas of the GmbH are not freely transferable, and the sale, pledging, or disposal of the quotas or parts thereof requires the prior written approval of all quotaholders.

In determining whether an organization is a partnership or an association taxable as a corporation, section 301.7701-2(a) of the Procedure and Administration Regulations describes the characteristics of corporations which include: (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.

Section 301.7701-2(a)(3) of the regulations provides that an unincorporated organization will not be classified as an association unless such organization has more corporate characteristics than noncorporate characteristics. In determining whether an organization has more corporate characteristics than noncorporate characteristics, all characteristics common to both types of organizations shall not be considered. For example, if a limited partnership has centralized management and free transferability of interests but lacks continuity of life and limited liability, and if the limited partnership has no other characteristics that are significant in determining its classification, such limited partnership is not classified as an association. Although the limited partnership also has associates and an objective to carry on business and divide the gains therefrom, these characteristics are not considered because they are common to both corporations and partnerships.

Section 301.7701-1(c) of the regulations states, in part, that the term "partnership" is not limited to the common law meaning of partnership, but is broader in its scope and includes groups not commonly called partnerships.

Rev. Rul. 73-254, 1973-1 C.B. 613, holds that the local law of the foreign jurisdiction must be applied in determining the legal relationships of the members of the organization among themselves and with the public at large as well as the interests of the members of the organization in its assets.

German law on limited companies contains a great number of optional provisions that can be modified by the memorandum of association so that, in effect, depending on the construction of the memorandum of association, a GmbH can assume the characteristics of a corporation or of a partnership.

Accordingly, a GmbH will not be automatically classified as either a partnership or an association taxable as a corporation for Federal income tax purposes. The classification of a GmbH as a partnership or an association taxable as a corporation depends on all the relevant facts and circumstances of each case, including the memorandum of association filed with the judge of the Commercial Register having jurisdiction of such register.

Under German law a GmbH possesses the characteristics of associates and an objective to carry on business and divide the gains therefrom, which characteristics are common to both corporations and partnerships. It also has, under German law, the corporate characteristics of limited liability and centralization of management. Thus, a GmbH will be classified as an association if it possesses either one of the two remaining corporate characteristics enumerated in the regulations, free transferability of interests or continuity of life.

With respect to the corporate characteristic of free transferability of interests, since two wholly-owned domestic subsidiaries own 100 percent of the quotas of the GmbH, it is apparent that the controlling parent could make all the transfer decisions for its wholly-owned subsidiaries, despite any provision in the memorandum of association that might indicate otherwise. Thus the GmbH, in the instant case, possesses the corporate characteristic of free transferability of interests.

With respect to the corporate characteristic of continuity of life, the statement in section 301.7701-2(b)(1) of the regulations that continuity of life does not exist if the death, insanity, bankruptcy, retirement, resignation, or expulsion of any member will cause a dissolution of the organization, has significance only if there exist separate interests that could compel dissolution of the organization upon the occurrence of one of the listed events of dissolution. If, as in the instant case, both quotaholders are wholly owned by the same corporate parent, there are no separate interests to compel dissolution should an event of dissolution occur. Thus, the statement in the memorandum of association that the death, insanity, or bankruptcy of one of the quotaholders will result in the dissolution of the GmbH has no substantive effect and will be disregarded in determining whether the instant GmbH possesses the corporate characteristic of continuity of life. In the instant case, because control of a GmbH is exercised by a single corporate entity that has the power to dissolve or continue the GmbH in accordance with its own business objectives, the GmbH will possess the corporate characteristic of continuity of life.

Since the GmbH in the instant case possesses all six corporate characteristics, it will be classified as an association for Federal income tax purposes.