In this series. The liability clause classifies an entity. This note asks how many entities the documents describe. Inconsistent documents are a separate grading exercise. The practice page is Cayman funds.
A share class and a segregated portfolio are different objects. One is a term of an interest in a single pool. The other can be its own portfolio, its own valuation, its own audit, and, where the organizing statute allows it, its own creditors. For U.S. tax purposes the question is whether the entity is the fund or the class. That answer changes the number of classifications, the number of reporting positions, and whether any compartment can be disregarded. It is a federal question. Counsel in the fund's jurisdiction decides what the local statute does with assets and liabilities. We do not.
An ordinary class is an interest
Different fees, a different currency, or a separate net-asset-value calculation on one portfolio are terms of shares or of partnership interests. They do not, by those features alone, create a second business entity. There is one classification under Treasury Regulation section 301.7701-3. If that entity is a foreign corporation and it meets the passive foreign investment company tests, there is one PFIC, and the classes are interests in it.
Sharing among those classes is then a question about the terms of one entity. If the entity is a partnership, it is an allocation question for the tax adviser. If it is a corporation, it is a question about the rights of stock. Either exercise assumes the entity has already been counted. This note stops at the count.
The federal question is whether an organization exists
Treasury Regulation section 301.7701-1(a)(1) provides that whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law, and does not depend on whether local law recognizes the organization as an entity. Paragraph (a)(2) provides that a joint venture or other contractual arrangement may create a separate entity if the participants carry on a trade, business, financial operation, or venture and divide the profits. A compartment with its own assets, its own books, and a division of the profits of that compartment is the arrangement that raises the question. The word “class” on a cover page does not.
Local counsel's opinion is the input, not the conclusion. The opinion that matters from that counsel is whether the statute and the documents segregate assets and liabilities so that creditors of one compartment are confined to that compartment, and whether the documents are permitted to do that. We take that reading and ask the federal question. We do not give the local-law answer, and we do not treat a local label as a U.S. classification.
What the regulations have not closed
In 2010 the Treasury Department proposed regulations on series limited liability companies and cell companies. The proposal is at 75 Federal Register 55699 (September 14, 2010). It would treat certain series and cells as separate entities for federal tax purposes. The preamble states that the proposed rules generally do not apply to a series organized under the laws of a foreign jurisdiction, with an exception for certain foreign series conducting an insurance business. Those proposed regulations have not been adopted as final regulations in the Code of Federal Regulations. They are not a ruling on a fund compartment, and they are not authority for treating every segregated portfolio as its own entity.
Section 1298(b)(4) is a different, narrower sentence. It says that under regulations prescribed by the Secretary, where necessary to carry out the purposes of the PFIC rules, separate classes of stock or other interests in a corporation shall be treated as interests in separate corporations. The current regulations under section 1298 do not contain a general rule that does this for classes of a fund. The statute's condition is “under regulations prescribed by the Secretary.” We do not treat a share class as its own PFIC on the strength of that sentence alone.
The two open points should stay separate. One is whether federal tax law recognizes a compartment as an entity under section 7701. The other is whether, inside one corporation, PFIC regulations treat classes as separate corporations. Neither point is answered by the fund's marketing description of a class. We describe both questions. We do not adopt, for every statute, the position that each compartment is a separate entity, and we do not adopt the opposite position.
What the count changes
If a compartment is a separate entity, section 301.7701-3 classifies it on its own. Each compartment is a partnership, a corporation, or, in the single-owner case the regulation describes, an entity disregarded from its owner. A compartment with several holders, all of them with limited liability, is a corporation by default. It is not disregarded. Each corporate compartment that meets the PFIC tests is its own PFIC, with its own qualified electing fund election and its own annual information statement. The number of reporting positions follows the number of entities.
If the umbrella is the only entity, there is one classification. Classes do not multiply the elections. They also do not create a look-through that the holder can elect once and be finished with, which is the subject of why a QEF election at the top does not reach the bottom. The liability regime of each entity, if there is more than one, is read under the liability clause.
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.