Classification of "Series" and "Cells" as Entities for U.S. Federal Income Tax Purposes: IRS Proposes Regulations on the Classification of a “Series” or “Cell” of a Single Juridical Entity for U.S. Federal Income Tax PurposesSullivan & Cromwell LLP - September 20, 2010
On September 13, 2010, the Internal Revenue Service (“IRS”) and Treasury Department proposed regulations (the “Proposed Regulations”) on the classification for U.S. federal income tax purposes of a series or cell (a “series”) of a domestic entity and a series of a foreign entity if its activities would make it an insurance company for U.S. federal income tax purposes. The Proposed Regulations generally provide that a series of a domestic entity will be treated as an entity formed under local law for U.S. federal income tax purposes, regardless of whether it is a juridical person under local law. Whether a series that is treated as an entity will be treated as a “separate” entity will then be determined under applicable tax principles, and an entity so treated will generally be classified under the check-the-box regulations as a partnership, disregarded entity, or corporation for U.S. federal income tax purposes, notwithstanding the different classification of other series of the same juridical entity. A series formed under foreign law will be accorded the same treatment as an entity formed under local law if the series’ activities, had they been conducted by a domestic entity, would result in its classification as an insurance company.
The Proposed Regulations are intended to provide greater certainty to both taxpayers and the IRS regarding the tax status of domestic series and foreign series that conduct an insurance business. The Proposed Regulations were preceded by a notice (Notice 2008-19, or the “Notice”), in which the IRS announced that it would propose guidance as to the U.S. federal income taxation of protected cell companies, and that the proposed guidance would include a rule to the effect that a cell of a protected cell company would be treated as an insurance company separate from any other entity if certain conditions were satisfied. In the Notice, the IRS also requested comments on a number of items, including what guidance, “if any, would be appropriate concerning similar segregated arrangements that do not involve insurance”.
The Proposed Regulations will generally apply on the date final regulations are published in the Federal Register (the “Effective Date”). Subject to a transition rule discussed below, on the Effective Date, taxpayers that are treating series differently for U.S. federal tax purposes than series are treated under the final regulations will be required to change their treatment. General tax principles will apply to determine the U.S. federal tax consequences of the conversion from one entity to multiple entities. Under a transition rule, a taxpayer that has treated a “series organization” (i.e., a juridical entity that establishes series) and series of such series organization as a single entity may continue to do so if, among other things, the series were established and conducted business or investment activity before September 14, 2010, and the series and series organization had a reasonable basis for claiming single-entity classification.