This post is about artificial legal entities created by exercise of royal or state power, including the modern invention of non-corporate legal entities such as Limited Partnerships (LPs) and Limited Liability Companies (LLCs). Such non-corporate artificial legal entities began in 1977 in Wyoming, and have been driven by US federal tax classification considerations, and have resulted in corporate-like companies that are nevertheless unincorporated. This development has confounded the traditional categorisation that:
Speaking generally, corporate bodies are persons in law distinct and separate from their members; unincorporate bodies are not. (High Court, in Campbell v Scott  2 NZLR)
A similar development reached New Zealand in 2008 with the (non-corporate) Limited Partnership which is nevertheless ‘a separate legal person’.
It also identifies and documents the history and development of the ‘entity theory’ of partnerships and other associations and their eventual adoption by legislation by US states for partnerships generally. The theory behind this development sees associations as natural and real entities that the law should recognise, rather than create as a state-sponsored legal fiction.
The long standing and recognised status of Scottish partnerships as unincorporated separate legal entities is also covered.
Traditional Artificial Legal Persons: Corporations
The traditional English legal classification of persons was relatively simple: in addition to individual natural persons there are unincorporated bodies of persons (mere aggregates), corporations sole and corporations aggregate. This can be seen from the definition of person in legislation, for example, the Resource Management Act 1991 :
‘person includes the Crown, a corporation sole, and also a body of persons, whether corporate or unincorporate.’
Although unincorporated bodies such as general partnerships, trustees of trusts and other forms of association are not considered separate legal entities from their members, they are normally considered as entities for accounting purposes and are considered de facto legal entities that fall within the definition of ‘person’. Such unincorporated bodies can nevertheless suffer some difficulty in owning property, contracting with outsiders, suing and being sued, administering changes in the shifting membership of the body, and the potential for unlimited personal liability for debts incurred by or for the body. English law has traditionally been inflexibly fixed on the ‘aggregate theory’ of partnerships and similar unincorporated associations and bodies, and has not adopted the ‘entity theory.’ The traditional solution to all these problems has been incorporation:
- For business purposes, incorporation as a company under the Companies Act
- For not-for-profit associations, incorporation under the Incorporated Societies Act.
- Trustees of charitable trusts, incorporation as a board under the Charitable Trusts Act.
Corporations Meet The Tax Man
Of course if a corporation is a separate legal entity it is only natural to for it to be taxed separately from its members. The traditional platitude is that since corporations are creatures of the state they should pay taxes to the state for the privilege - and of course there is an element of truth in that: it does expose the original sin of the corporation in being the bastard offspring of the unholy union of private commerce with state power.
The additional legal personality of the corporation results in an additional layer of income tax: not only does the corporation pay tax on its income, the members of the corporation have to pay tax on the distribution of that income as dividends. This problem is referred to as double taxation. Of course the traditional way to tax separate legal persons is to define corporations and tax their income under the guise of a corporations tax. Because almost all business corporations are incorporated companies, the term ‘company tax’ rather than ‘corporation tax’ are used in many countries including New Zealand, but the definition of company in the Income tax Act 2007 is ‘a body corporate’ (YA1) and goes on from there to have various inclusions and exclusions that we will examine later.
Avoiding Taxation as a Corporation
The problem of double taxation of income derived through corporations can be avoided by structuring the entity through which the income is derived so that it is not taxed as a corporation, but rather as an individual, or as 2 or more individuals deriving shares of the income directly. There are 3 possible ways of doing this:
- Using the entity tax classification rules to structure the entity so that it is not a corporation for tax purposes,
- Using an election available under the tax rules to make a corporation be taxed as if it is not a separate entity, or
- Restructuring the tax system to eliminate double taxation of income derived through corporations. This can be done by a) exempting corporations from tax and taxing only the members and others on income derived from the corporation, b) taxing the corporation and exempting the members from taxation of the income when distributed, c) allowing a deduction to the corporation for dividends paid to members, d) allowing a credit to members against tax on dividends on account of the tax paid by the corporation.
With option 1., the legal structure of the entity is altered, with options 2. and 3. it is not. In New Zealand option 2. has been available since 1993 under the qualifying companies regime (now the Look Through Companies regime) and option 3. d) has been standard since 1989 under the imputation system. Unit trusts, the only significant non-corporate vehicle for the public to invest through in New Zealand, are included within the definition of ‘company’ for tax purposes and are taxed as companies in New Zealand. These factors have meant there has been little motivation or opportunity to use option 1. in New Zealand.
The US Limited Liability Company
The situation in the United States, however, has been quite different. The options described under 2. and 3. above have not been allowed or implemented, and so the problem has been more acute, and the entity classification rules have borne the brunt of the pressure. Because these rules are Federal, but the entities are mostly created or structured under State law, the State legislators have assisted in providing corporate-like non-corporate entities that can avoid classification as corporations for tax purposes, ultimately yielding the Limited Liability Company or LLC.
To help explain and confirm this development I now document the US Federal Tax entity classification rules and the US state legislatures response in creating the unincorporated Limited Liability Company (LLC). The rules and history are well explained by Kenan Mullis recent Special Report which I quote at length:
A business entity’s classification as either a corporation or a partnership is important for both tax and nontax reasons. Most fundamentally, a corporation provides for the limited liability of its owners, while a partnership does not. From the tax perspective, the income of a partnership is not taxed at the partnership level. Instead, the income is viewed as flowing through to the partners, and those partners are taxed on their shares of the partnership income, whether or not it is actually distributed. The income of a corporation, on the other hand, is subject to both a corporate-level tax and a tax at the shareholder level when that corporate income is distributed.
A. Pre-CTB [check the box] Regime
From 1960 to the passage of the CTB regulations, an entity’s tax classification as either a corporation or a partnership was determined by the multi-factor Kintner regulations, so named because they were a response to the Ninth Circuit’s decision in U.S. v. Kintner. The Kintner regulations enumerated six characteristics of a corporate venture:
• the presence of associates;
• an objective to carry on business;
• continuity of life;
• centralization of management;
• limited liability; and
• free transferability of interests.
Because the first two characteristics are common to both corporations and partnerships, the test turned on the remaining four factors — an entity possessing three or more was treated as a corporation, two or fewer was treated as a partnership. While the application of the Kintner regulations was theoretically simple, in practice there was significant complexity and uncertainty (as well as significant opportunity for tax planning) in determining whether an entity possessed any given factor.
Putting additional stress on the multi-factor test was the rise of the limited liability company and limited liability partnership, which narrowed the distinction between partnerships and corporations by offering both limited liability and taxation as a partnership. State LLC statutes would typically provide for both limited liability and centralized management, but not free transferability of interest or continuity of life. As a result, the LLC would meet only two Kintner factors and, consequently, would be classified as a partnership for federal tax purposes. These entities amplified taxpayers’ ability to effectively elect their federal tax status, and they provided this opportunity to a much wider population by virtue of greater simplicity and lower cost. After all 50 states enacted statutes permitting LLCs, an entity could choose to be taxed as a corporation by incorporating under state statute, or it could choose to be taxed as a partnership by organizing under, and tailoring operative documents to meet the requirements of, a state LLC statute.
B. Creation and Operation of CTB
Sensing the obsolescence of the Kintner regulations and concerned about the continued costs of entity classification for both taxpayers and the government, the IRS and Treasury issued Notice 95-14 in early 1995. Notice 95-14 recognized that LLCs had diminished the traditional distinctions between corporations and partnerships, which had provided the foundation for the Kintner regulations, and that taxpayers were able to
achieve partnership tax treatment with entities that more closely resembled the corporate form. As a result, the IRS and Treasury announced they were contemplating a move to an elective classification regime to replace what they viewed as an outdated, complex, and costly system that had become effectively elective anyway.
The result, effective January 1, 1997, was the CTB Treasury regulations under section 301.7701. Under the CTB regulations, domestic and foreign eligible entities are able to elect to be taxed as a partnership (or, if the entity has only a single member, as a disregarded entity) or a corporation for federal tax purposes. To be eligible, entities must meet three requirements:
• the entity must exist separately from its owners;
• it must be a business entity; and
• it must not be a deemed corporation.
The chief instances of deemed corporations are entities formed under state corporate statutes and foreign per se corporations, as defined by a comprehensive list in Treas. reg. section 301.7701-2(b)(8).
Although Mullis does not state so above, corporations formed under the domestic state legislation is also within the definition of a deemed corporation, as can be seen from this IRS form:
Corporation. For federal tax purposes, a corporation is any of the following:
1. A business entity organized under a federal or state statute, or under a statute of a federally recognized Indian tribe, if the statute describes or refers to the entity as incorporated or as a corporation, body corporate, or body politic.
So, to this day, a US entity must not be incorporated if it is to qualify for partnership or disregarded-entity US federal tax treatment. However, foreign corporate entities may elect partnership or disregarded entity status provided they are not on the list of per se corporations (which isn’t being regularly updated). Nevertheless, several non-US jurisdictions have enacted various forms of LLC statutes that are closely modeled on the popular US versions, and do not have corporate status (these would not be defined as corporations for US tax purposes even if they were domestic entities). These include the Cook Islands (Limited Liability Companies Act 2008), Samoa, Nevis and Belize (International Limited Liability Companies Act 2011).
As with LLCs, US State legislators have imported the separate legal entity concept into the partnership context, including for general partnerships, limited partnerships (LP), and the further US innovations the limited liability partnership (LLP) and limited liability limited partnership (LLLP). As general partnerships are not required to be registered or approved by the government to be formed, this separate legal entity status is treated as being innate rather than conferred by the statute as such. The statute can be fairly said to recognise rather than create the separate legal entity status, although it does so by displacing the historical English common law ‘aggregate theory.’
The movement to recognise separate legal entity status on associations, regardless of corporate status, had some influence in 1902 when the first Uniform Partnership Act was being drafted, however, the proponents of this approach did not prevail at at that time:
The National Conference of Commissioners on Uniform State Laws first considered a uniform law of partnership in 1902. Although early drafts had proceeded along the mercantile or "entity" theory of partnerships, later drafts were based on the common-law "aggregate" theory.
Economist David Gindis’s paper ‘From fictions and aggregates to real entities in the theory of the firm’ discusses and documents the legal theory and movement mentioned above that would result in native recognition of separate legal entity as ‘natural’ and ‘real’ rather than imposed legal fiction:
This paper argues that the two dominant economic perspectives on the firm, namely the ‘nexus of contracts’ (Jensen and Meckling, 1976) and the ‘collection of assets’ (Grossman and Hart, 1986) views, are variations on the same theme. These are ‘fictionalist’ and ‘aggregationist’ positions that rely on one of two moves: they either deny the existence of the firm by regarding it as a legal fiction and/or a shorthand form of expression, or they reduce the firm to an aggregate of its parts, be these contracts, individual owners of resources or nonhuman assets. In both cases, firms and similar social entities are said to be ‘nothing but’ aggregates of these parts. Furthermore, despite the fact that the legal personality is important in both accounts, everything is said to be achieved by private contract alone and the law’s role in creating legal entity status is not considered. Dissatisfaction with these views has prompted a search for new foundations for the theory of the firm (Blair, 1999; Zingales, 2000).
Although rarely acknowledged by economists, both views are modern revivals of old theories of the corporation that have been recurring in a cyclical fashion for many centuries (Avi-Yonah, 2005). ‘Fiction theory’, which dominated Roman law and medieval debates, regards corporations as simply names or imaginary legal persons that are nothing more than the individuals composing them. ‘Aggregate theory’, popular in the second half of the nineteenth century, is a variant of fiction theory that holds that corporations are simply aggregates of natural persons, usually shareholders. However, examination of the legal literature reveals that an alternative ‘real entity theory’ dominated debates from roughly 1900 to 1930. On this view, the corporation is neither a fiction nor an aggregate but a non-reducible real entity. Interestingly, Blair (1999) suggests that this forgotten view can provide new foundations for the theory of the firm. We follow this suggestion in this paper.
Later in the paper Gindis shows how separate legal entity status can be (or should be) applied on a functional basis to all associations, as a type of customary law, rather than in deference to statutory commands:
The business corporation is traditionally distinguished from unincorporated business forms such as partnerships by its separate entity status. However, in the United States at least, the Revised Uniform Partnership Act of 1997 explicitly defines a partnership as ‘an entity distinct from its partners’ (§201a). More generally, today’s new business entities combining aspects of both corporations and partnerships (limited liability companies, limited liability partnerships, limited limited liability partnerships) have made standard differences less obvious. Accordingly, discussions of legal entity status have shifted from corporations to most forms of business companies. Hansmann et al. (2005: 13) thus hold that new business forms are ‘generalizations’ of the corporation, and Blackwell (1999) and others have called for a ‘unified business entity code’ applying to most if not all legal forms of the firm.
These developments reinforce the relevance of real entity theory that applies to the firm in general and underlines the creation of legal entity status as an important role of the law.
For early entity theorists, the terms ‘real’ and ‘natural’ were equivalently used to oppose the then conflated terms ‘fiction’ and ‘artificial’. … all entity theorists regarded corporations and similar groups as real socioeconomic entities …
According to Dicey (1905: 154), ‘whenever men act in concert for a common purpose, they tend to create a body which, from no fiction of law, but from the very nature of things, differs from the individuals of whom it is constituted’. Given this concerted action and common purpose, Brown (1905: 369) argues, ‘the group becomes, or tends to become, a unit . . .A mere sum of individuals as such can no more become a unit than a heap of sand can become a statue’. In this spirit, one of the clearest statements made by entity theorists is Freund’s (1897: 47) list of three ‘salient characteristics of the body corporate: its unity, its distinctiveness, and its identity in succession’.
For Freund, if these features are in fact present in a given association, then one can speak of a real entity. The difficulty is to show how common purpose and collective action produce a level of unity, distinctiveness, and durability sufficient for the group to be a real entity without appealing to any literally volitional or moral features. It is important to notice that Freund, Dicey, and Brown clearly associate existence, identity, and unity of groups in general. Indeed, ‘the inquiry is one which leads us on from the subject of corporations to the wider subject of human association in general’ (Brown, 1905: 368).
Entity theorists repeatedly underlined the role played the law, claiming that the law should comply with the fact of the group’s socio-economic existence and attribute legal capacity to an already existing or a potential socio-economic capacity. Accordingly, Laski (1916: 422) argues that ‘the entities the law must recognize are those which act as such, for to act in unified fashion is – formality apart – to act as a corporation’. Legal entity status attributed by the law unifies and reinforces the socio-economic capacity created by concerted action and common purpose. It thus greatly increases the possibilities of collective action. Many entity theorists were political pluralists who believed in freedom of
association, and the increasing legal recognition of various groups (associations,
trade unions, political parties) sat well with their theory.
It is clear from the above that separate legal entity status need not derive from incorporation under statute, or from other statutory provisions, but as practical accommodations to voluntary associations, and viewing the role of the law as facilitative and responsive to the varied and dynamic forms of association in a civilised society, rather than a rigid doctrinally-conformist ontology system.
As noted by Gindis above, US partnership law has now shifted from the ‘aggregate theory’ to the ‘entity theory’ (although both theories apply in different contexts for the purpose of US Federal tax law):
In January of 1986, an American Bar Association subcommittee issued a detailed report that recommended extensive revisions to the UPA. See UPA Revision Subcommittee of the Committee on Partnerships and Unincorporated Business Organizations, Section of Business Law, American Bar Association, Should the Uniform Partnership Act be Revised?, 43 Bus. Law. 121 (1987) ("ABA Report"). The ABA Report recommended that the entity theory "should be incorporated into any revision of the UPA whenever possible." Id. at 124.
The entity theory was eventually incorporated into the Uniform Partnership Act simply as:
Drafting comments explaining this provision also explain some of its history, purpose and effect:
RUPA embraces the entity theory of the partnership. In light of the UPA’s ambivalence on the nature of partnerships, the explicit statement provided by subsection (a) is deemed appropriate as an expression of the increased emphasis on the entity theory as the dominant model. But see Section 306 (partners’ liability joint and several unless the partnership has filed a statement of qualification to become a limited liability partnership).
Giving clear expression to the entity nature of a partnership is intended to allay previous concerns stemming from the aggregate theory, such as the necessity of a deed to convey title from the “old” partnership to the “new” partnership every time there is a change of cast among the partners. Under RUPA, there is no “new” partnership just because of membership changes. That will avoid the result in cases such as Fairway Development Co. v. Title Insurance Co., 621 F. Supp. 120 (N.D. Ohio 1985), which held that the “new” partnership resulting from a partner’s death did not have standing to enforce a title insurance policy issued to the “old” partnership.
The jurisdiction of Scotland remains distinct to this day within the United Kingdom. The differences in institutions arise from a number of differing influences including different customs, and a minor, indirect, Roman civil law influence. The difference I will highlight here is the treatment of partnerships as separate legal persons from their partners - a difference UK legislation has been required to address.
Under Scots law, a firm is a distinct legal person, whereas under English law, it is merely an aggregation of the partners. In 1707 the legislature of Scotland was merged with England’s. The Partnership Act 1890 simply accommodates the Scottish position, within Scotland at least, by stating: ‘In Scotland a firm is a legal person distinct from the partners of whom it is composed … ’
According to this source, ‘In this respect, the  Act was confirming a long-established principle of Scots law.’
The Companies Act 2006, sec 1173 confirms that, notwithstanding its legal existence separate from its partners, a Scottish firm is not a body corporate under Scots law, nor under UK law:
(1) In the Companies Acts—
“body corporate” and “corporation” include a body incorporated outside the United Kingdom, but do not include—
(a) a corporation sole, or
(b) a partnership that, whether or not a legal person, is not regarded as a body corporate under the law by which it is governed;
The explanatory notes give the context and application to a Scottish firm:
The definitions of “body corporate” and “corporation”, and of “firm”, are new in part. They clarify the position of corporations sole and of partnerships that are legal persons but are not regarded as bodies corporate (as under Scots law)
The NZ Limited Partnership
In 2008 the New Zealand legislature created a new species of non-corporate separate legal entity out of whole cloth: the New Zealand Limited Partnership. Since the government can create legal persons by incorporation and call them corporations or bodies corporate, it can also create artificial legal persons and not make them corporations. The classification of an entity as a corporation is as arbitrary as its incorporation in the first place.
Limited Partnerships under the Limited Partnerships Act 2008 are ‘formed’ rather than ‘incorporated’ whereas overseas limited partnerships are recognised as being ‘formed or incorporated outside New Zealand.’ (some overseas limited partnerships are incorporated and others are formed as unincorporated entities.) Nowhere in the Act does it refer to New Zealand limited partnerships as being incorporated, corporations, bodies corporate or any similar term, even though a limited partnership is a separate legal person created under the Act. One can only conclude that a New Zealand limited partnership is an unincorporated body notwithstanding that its existence is created under statute and it is a separate legal person.
This is reinforced by its tax treatment. It is excluded from being a company for tax purposes by the definition in YA1, provided it is unlisted:
- (a) means a body corporate or other entity that has a legal existence separate from that of its members, whether it is incorporated or created in New Zealand or elsewhere:
- (ab) does not include a partnership:
- (ac) includes a listed limited partnership:
The definition of partnership includes a limited partnership:
- (a) a group of 2 or more persons who have, between themselves, the relationship described in section 4(1) of the Partnership Act 1908:
- (d) a limited partnership
Thus for New Zealand tax purposes unlisted New Zealand limited partnerships are treated as unincorporated.
The Limited Partnership Regulations 2008 also distinguish between a partner that is a body corporate and one that is an unincorporated overseas limited partnership for the purpose of defining the details that are required to be provided.
This is the only New Zealand example of an unincorporated artificial separate legal person of which I am aware. It should, however, be noted that the New Zealand legislation is not innovative in this respect, it follows the standard US pattern (which also applies to General Partnerships, Limited Partnerships (LPs), Limited Liability Partnerships (LLPs) and Limited Liability Limited Partnerships (LLLPs), rather than the UK pattern for its Limited Partnership (which has the same status as a general partnership (i.e. not a body corporate and not a separate legal person in England)) or Limited Liability Partnership (which provides limited liability to all partners and which is body corporate, but otherwise structured and taxed as a partnership).
Recognition of other Non-Corporate Separate Legal Persons in New Zealand Law
Some still hold the view that a corporation means a legal person separate from its members, and that all such separate legal persons must be considered corporations under New Zealand law. For example the Senior Solicitor at the Ministry of Economic Development last year wrote to me that:
if it is correct that a New Mexico LLC is a separate unincorporated legal person for the purposes of New Mexico law this does not mean that this is recognised under New Zealand law. Under New Zealand law, something is either a body corporate or an incorporated body of persons. …
The Act and New Zealand law do not recognise, as far as we can see, the entity New Mexico law creates.
It appears that, according to §53-19-10 of 2011 NMSA 1978, that a LLC is a body corporate as New Mexico's legislation states that "a limited liability company formed pursuant to the Limited Liability Company Act is a separate legal entity."
As a result, the Registrar is now satisfied that [a New Mexico LLC is a body corporate]
This view may be based on case law (Campbell v Scott  2 NZLR) that:
Speaking generally, corporate bodies are persons in law distinct and separate from their members; unincorporate bodies are not.
However, a closer look at this case shows that instead it found that unincorporated bodies may have separate legal personality, and that the second part of the generalisation does not hold to the extent this is otherwise provided for.
Firstly, this case confirms the position I detailed in my previous post ‘What is a ‘corporation’?:
From the legislation we can therefore infer that corporations are expressly created, rendered or incorporated as such by or under an Act of Parliament or similar instrument exercising state or royal power (either in New Zealand or outside New Zealand).
Where these are absent, for example in the case of registered Friendly Societies, the resulting entity is unincorporated, as can be seen from the decision:
It was common ground that the society was not a corporate body. It was an unincorporated body with a fluctuating membership. Speaking generally, corporate bodies are persons in law distinct and separate from their members; unincorporate bodies are not. Legal personality can be conferred upon an association of persons only by Royal Charter or by Act of Parliament or by incorporation under procedures established by Parliament - viz the Companies Acts 1955 and 1993 and the Incorporated Societies Act 1908. Corporate bodies are either corporations aggregate or
The Act does not expressly confer on a friendly society corporate status. There is no provision giving friendly societies perpetual succession or the right to use a seal, these being two conventional indicia of incorporation: see Williams v Hursey (1959) 103 CLR 30 at pp 52 and 54.
Secondly, the case confirms that a body may be a separate legal entity from its members without being a body corporate. This can be seen from the ways listed above for gaining separate legal personality: i.e. not only ‘by incorporation’, but alternatively ‘by Royal Charter or by Act of Parliament.’
The judgement also held:
An Act of Parliament may either expressly or by necessary implication treat an unincorporated society as being a legal entity distinct from its members, either generally or for specific purposes.
Although the judgment applied a range of oblique references to friendly societies acting or being treated as if they were separate legal persons, in order to imply that they gained some extent of separate legal entity status specifically thereby, this legal theory is neither the only possible solution to the issues at stake, nor the best solution in that case. The more obvious alternative would be to consider friendly societies as trusts for unincorporated associations of persons: section 28 requires the appointment of trustees who are referred to as doing acts (and not as agents) and section 29 vests the property in them. Any obligations on contracts made by such a society’s officers appear to be claims on and are payable out of the trust funds, and are unlikely to extend further than that. In fact, the Society and the trustees do not even have the power to enforce payment of membership dues (sec 38), so the only funds a Society and its trustees can obtain, in that capacity, is the funds already held (other than an exception listed in 56 (3)). It is only if there is a deficiency in those funds that the questions arise of whether the liability extends to the trustees’ personal estates, and whether the trustees have any rights of indemnity from the members of the society. The limits on recovering subscriptions from members has already been detailed as extremely limited. Recourse to the personal estates of trustees can and should prudently be expressly excluded in contracts and in the trust deed or society rules, and even absent such express terms, such terms could, and probably should, be implied (from this judgement, Tipping J would have implied such a limit should he have used this analysis).
Notwithstanding my quibble with the theory employed, the judgement clearly states that the Legislature can create separate legal entities that are not corporations. It has clearly done so with the Limited Partnerships Act 2008, and there is no reason why entities created under overseas legislation should not be recognised as valid under New Zealand law.
The Income Tax Act 2007 recognises the following possible types of entity that may have legal existence separate from that of its members:
- Bodies Corporate:
- Incorporated in New Zealand
- Incorporated elsewhere
- Other (i.e. unincorporated) Entity:
- Created in New Zealand
- Created Elsewhere
This can be inferred from the definition of company, as meaning:
‘a body corporate or other entity that has a legal existence separate from that of its members, whether it is incorporated or created in New Zealand or elsewhere’
So it appears we have, like the British in 1890 with the Scottish partnership, at least implicitly recognised unincorporated associations with legal existence separate from that of its members as valid.