Despite updated guidance the classification of foreign entities for tax purposes remains complex

ANGELA FLEMING analyses the new guidance from the Revenue Commissioners on the classification of foreign entities for Irish tax purposes, released on 18th May in TDM Part 35C-00-021 and notes Revenue’s decision to not follow the example of tax authorities in the UK in providing a list of examples foreign entities and their classifications, with its approach to look at each foreign entity on its own merits based on established principles set out in case law.

Unlike other jurisdictions such as the UK2, Revenue have chosen not to provide a list of examples of foreign entities and their classification for Irish tax purposes. It is understood that they considered such approach but decided against. This is on the basis that structures can be nuanced and can change over time. Thus, Revenue’s approach is to look at each foreign entity on its own merits and, based upon established principles set out in case law, determine whether the entity is more akin to an Irish company (tax opaque) or more akin to an Irish partnership (tax transparent).

The landmark case on the matter of foreign entity classification is the UK case of Memec plc v CIR3. In this case, the UK courts confirmed the common law approach to classifying a foreign entity as opaque or transparent for UK tax purposes. This common law approach was then confirmed in Irish law in the case of Quigley v Harris4. A short summary of each case is set out in Section 3 of the Revenue guidance and I have not recreated it here in the interest of brevity.

What is important to note, however, are the comments in the Revenue guidance regarding the Anson case5. This case concerned the interpretation and application of the DTA between the UK and the US, involving a US Limited Liability Company (LLC). The Revenue guidance notes that the approach taken in this case was specific to the particular facts and circumstances of that case, and thus should not be relied upon to have broad application. In that case, the court focussed almost exclusively on the particular question of whether members are entitled to a share of the profits as they arise. Revenue note that, although profit entitlement is an important factor, it is the overall pattern of a foreign entity’s characteristics that should be examined when considering classification.

The case law provides a set of guiding principles, or a two-stage test, to assist in determining the nature and characteristics of a foreign entity and therefore the Irish tax implications of a transaction involving such an entity.

The first stage in the process is to determine the characteristics, rights and obligations of the foreign entity by reference to the laws of the territory in which it is established. This will require an examination of the entity’s constitutional documents, and an understanding of the legal framework within which the entity is formed.

The second stage is to determine whether, applying Irish law, the characteristics, rights and obligations of the entity match the characteristics, rights and obligations of an Irish company or Irish partnership or are more aligned to one versus the other.

Factors which would be indicative of a foreign entity being classified as opaque for Irish tax purposes would include:
(i) The foreign entity has a legal existence separate from that of the persons who have an interest in it.
(ii) The foreign entity issues share capital or something else, which serves the same function as share capital.
(iii) The business is carried on by the foreign entity itself rather than jointly by the persons who have an interest in it.
(iv) The persons who have an interest in the foreign entity are not entitled to share in its profits as they arise, the amount of profits to which they are entitled depends on a decision of the entity or its members, after the period in which the profits have arisen, to make a distribution of its profits.
(v) The foreign entity is responsible for debts incurred as a result of the carrying on of the business.
(vi) The assets used for carrying on the business belong beneficially to the foreign entity and can be owned or transferred by the entity in its own right.
(vii) The foreign entity is capable of perpetual succession, its existence remains unaffected by the incapacity or death of its members.

When considering the factors, decisive importance cannot be attributed to any single characteristic. It is necessary to consider all of the factors and decide if, on balance, the characteristics are typical of an Irish company. Depending on the relevant taxing provision, some factors might have more significance than others.

While the publication of the guidance is to be welcomed, in practice, the classification of foreign entities is frequently complex. This is especially so when considering certain investment vehicles, such as investment funds, pensions, and trusts. The Revenue guidance confirms that where uncertainty remains, requests concerning the classification of a foreign entity should be submitted and dealt with using the RTS framework.

3Memec plc v CIR [1998] STC 754
4Quigley v Harris [2008] ITR 153
5Anson v HMRC [2015] UKSC 44

Content adapted from Finance Dublin - Irish Tax Monitor.

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