In this series. The liability clause is where a foreign fund's U.S. default is set. Whether the fund and the class are the same entity changes how many times that default is applied. Inconsistent documents are graded by the job each sentence does. A later change is either an amendment or Form 8832. The seventy-five-day window is a filing rule, and an elective change is a deemed transaction. The practice page is Cayman funds.
Most sponsors can point to the sentence that says holders are not liable for the fund's debts. Fewer have read that sentence as a U.S. classification rule. Under the check-the-box regulations, it is one. For a foreign eligible entity, the default turns on limited liability. Where the organizing law lets the organizational documents specify that liability, those documents may be relevant. One operative sentence can decide whether the fund enters the U.S. system as a partnership or as a corporation.
The default is a liability test
Treasury Regulation section 301.7701-3(a) lets an eligible entity elect its classification. An eligible entity is a business entity that is not already classified as a corporation under section 301.7701-2(b)(1) or (b)(3) through (b)(8). Paragraph (b)(8) is the regulatory list of certain foreign entities that are corporations per se. A vehicle on that list cannot elect. Checking whether the vehicle is an eligible entity is the first step, and it is a U.S. question about the regulation, not a conclusion about the local statute.
If no election is filed, section 301.7701-3(b)(2) classifies a foreign eligible entity as a partnership if it has two or more members and at least one member does not have limited liability. It classifies the entity as an association, and therefore a corporation, if all members have limited liability. It disregards the entity if it has a single owner that does not have limited liability. A single owner who has limited liability is the case in which every member has limited liability. The default there is a corporation.
A member has limited liability if the member has no personal liability for the debts of or claims against the entity by reason of being a member. Creditors of the entity may seek satisfaction from the member as such, and if they may, the member has personal liability for this purpose. The determination is based solely on the statute or law under which the entity is organized. If that law allows the entity to specify in its organizational documents whether the members will have limited liability, the organizational documents may also be relevant. The regulation uses those words. It does not say that every document in the offering set is relevant, and it does not say the documents override a statute that fixes liability and does not allow the documents to vary it.
An indemnity does not remove the liability the regulation measures. A member who has personal liability still has it if another person, whether or not a member, assumes the liability or agrees to indemnify the member. A fund indemnity in favor of a general partner is a commercial term. Paragraph (b)(2) asks whether creditors may seek satisfaction from the member as a member, under the organizing statute and, where that statute allows the documents to specify the regime, under the organizational documents.
The clause is read when classification first matters
Section 301.7701-3(d)(2) provides that if a foreign eligible entity's classification has never been relevant, the initial classification is determined under the foreign default when the classification first becomes relevant. Relevance, under paragraph (d)(1), is the point at which the classification affects the federal tax or information liability of any person. The regulation's examples include withholding that depends on whether the recipient is a partnership or an association, and the date a U.S. person acquires an interest that will require an information return.
Paragraph (a) then holds that classification in place. An entity whose classification is determined under the default retains it, regardless of later changes in the members' liability during the time the classification is relevant, until the entity elects to change it. The operative sentence matters because it supplies the default at the moment of relevance. A later edit to the liability chapter does not, under that sentence of the regulation, reclassify the fund. The route for a later change is the election, discussed in Amending the Documents Versus Checking the Box.
A corporate default is the entry to the passive foreign investment company rules if the income test or the asset test is met. A partnership default keeps that vehicle from being a PFIC, because a PFIC is a foreign corporation. The same clause is therefore the starting point for why a QEF election at the top does not reach the bottom and for classifying lower-tier funds as partnerships.
The name on the cover is not the regime
The word “limited” in the vehicle's name is not the test. A limited partnership whose general partner has personal liability for the entity's debts will often default to partnership, because at least one member lacks limited liability. Whether that general partner in fact has personal liability is a reading of the organizing statute and the organizational documents. Counsel admitted in the fund's jurisdiction does that reading. Where the statute gives every member limited liability and does not let the documents provide otherwise, paragraph (b)(2) looks to the statute.
The useful time to read the clause with this question in mind is before classification becomes relevant. That is when the organizational documents, if the local statute lets them speak, still supply the default. A sentence in the liability chapter can turn a flow-through into a corporation, and a corporation that holds securities is the usual candidate for PFIC treatment. Reading it afterward tells you what the default already is. It does not, by itself, change it.
Recalde Law Firm, P.A. is a Florida law firm with an office in Miami, Florida. We advise on United States law only. We do not practice Cayman law (or the law of any other country). Formation of a Cayman (or other non-U.S.) vehicle, Cayman legal advice, and CIMA registration stay with qualified Cayman counsel. We coordinate; we do not replace them. This is general information, not an offer of fund interests, and not Cayman legal advice.
The firm works on the U.S. structure and documents. The tax adviser prepares the returns and models the numbers.