­­­Tax Treatment of Contributions into the Collective Exchange Fund

This article summarizes the reasons under current U.S. federal tax law why holders of shares in private growth companies (i.e., “unicorns”) recognize no U.S. federal taxable gain when exchanging shares into the Collective Exchange Fund (the “Fund”).

The Applicable Code Sections

Section 721(a) of the Internal Revenue Code (the “Code”) states as a general rule that “no gain or loss shall be recognized to a partnership or to any of its partners in the case of a contribution of property to the partnership in exchange for an interest in the partnership.” However, Code Section 721(b) provides an exception from this nonrecognition of gain for a “transfer of property to a partnership which would be treated as an investment company (within the meaning of Code Section 351) if the partnership were incorporated.”

Pursuant to Treasury Regulation Section 1.351-1(c), a transfer of property to a partnership will be deemed a transfer to an investment company if: (a) the transfer results, directly or indirectly, in diversification of the transferor’s interests, and (b) over 80% of the value of the partnership’s assets are held for investment and are “stock and securities.” Code Section 351 defines “stock and securities” generally as: (i) money, (ii) stock and other equity interests in a corporation including evidences of indebtedness, options, forward or futures contracts and derivatives, (iii) foreign currency, (iv) interests in REITs, regulated investment companies, publicly traded partnerships, (v) precious metals, and (vi) equity interest convertible into any of these assets.

Stock and securities are deemed “held for investment” unless they are: (i) held primarily for sale to customers in the ordinary course of business, or (ii) used in the trade or business of banking, insurance, brokerage or a similar trade or business.

Treasury Regulation Section 1.351-1(c)(2) provides that the determination of whether a corporation is an investment company will ordinarily be made by reference to the circumstances existing immediately after the transfer. However, where circumstances change pursuant to a plan in existence at the time of the transfer, the determination is made by reference to the later circumstances.

The Exchange Fund’s Qualifying Assets

The Collective Exchange Fund is committed to maintaining a legal structure that preserves the ability of “unicorn” shareholders to contribute their shares into the Fund without recognizing taxable gain from the contribution. Accordingly, upon any closing of a transfer of shares into the Fund, more than 20% of the value of the Fund’s gross assets will consist of “Qualifying Assets.” Qualifying Assets for these purposes are defined as assets that either are (i) not “stocks and securities” or (ii) not held for investment (each as set forth in Code Section 351 and described above). The holding of Qualifying Assets by the Fund is intended to make it so that over 80% of the value of the partnership’s assets are not stock and securities thereby preserving the tax-free nature of the exchange.

The Fund expects to hold investments in Qualifying Assets primarily through its ownership of limited partnership interests in funds that: (i) are classified as partnerships for tax purposes, (ii) are not publicly traded as defined under Code Section 7704(b), (iii) hold more than 80% of their gross assets at all times in the form of investments in real property after looking through any intermediate entities.

The Fund intends to have more than 20% of the Fund’s gross assets invested in these or other Qualifying Assets as of each closing of the Fund. Accordingly, the Fund does not plan to sell investments in Qualifying Assets or to purchase other investments if such sale or purchase would cause the Fund thereafter to hold less than 20% of its gross assets in Qualifying Assets.

Conclusion

Although the transfer of shares into the Collective Exchange Fund by an exchanger will result in diversification of the exchanger’s interest under the Treasury regulations, the Fund will not meet 80% of assets test of Treasury Regulation Section 1.351-1(c) and so will not be treated as an “investment company” within the meaning of Code Sections 721(b). Therefore, the exception to the non-recognition rule set forth in Code Section 721(b) does not apply, and the general rule set forth in Code Section 721(a) that no gain shall be recognized by a person contributing shares to a partnership in exchange for an interest in the partnership holds.

IMPORTANT DISCLOSURES

This information relating to the Collective Exchange Fund, LP (the “Fund”) has been prepared solely for informational purposes, is not complete, and does not contain certain material information about the Fund, including important disclosures and risk factors associated with an investment in the Fund, and is subject to change without notice. It does not constitute an offer to buy or sell an interest in the Fund, nor shall there be any sale of a security in any jurisdiction where such solicitation or sale would be unlawful.

The Fund’s limited partnership interest will not be registered with the U.S. Securities Exchange Commission or other regulatory authority. Investors will be required to verify their status as an “Accredited Investor” pursuant to Rule 501 of Regulation D to participate in any offering of the Fund’s limited partnership interests. No securities commission or regulatory authority has recommended or approved any investment or the accuracy or completeness of any of the information or materials provided by or through Collective Liquidity, Inc. or Collective Asset Management, LLC (collectively, “Collective Liquidity”).

Limited partnership interests in the Fund are not insured by the FDIC and are not deposits or other obligations of Collective Liquidity and are not guaranteed by Collective Liquidity. Limited partnership interests in the Fund are subject to investment risks, including possible loss of the principal invested.

Prospective investors should consider the investment objectives, risks, fees and expenses of the Fund carefully before investing in the Fund. This and other important information are contained in the Fund’s Confidential Private Placement Memorandum (“PPM”), which can be obtained by contacting Collective Liquidity.

Investment in the Fund involves substantial risk and any offering may only be made pursuant to the relevant PPM and the relevant subscription application, all of which must be read in their entirety. No offer to purchase securities will be made or accepted prior to receipt by the offeree of these documents and the completion of all appropriate documentation. The Fund intends to primarily invest in securities of private, late-stage, venture-backed growth companies. There are significant potential risks relating to investing in such securities. The Fund is not suitable for investors who cannot bear the risk of loss of all or part of their investment. The Fund is appropriate only for investors who can tolerate a high degree of risk and do not require a liquid investment. The Fund has no history of public trading and investors should not expect to sell limited partnership interests in the Fund. No secondary market exists for the Fund’s limited partnership interests, and none is expected to develop. The Fund has a limited operating history, and its performance is highly dependent upon the expertise and abilities of its manager. There is no assurance that the Fund’s investment objectives will be achieved, and results may vary substantially over time. This is not a complete enumeration of the Fund’s risks. Please read the Fund’s PPM for other risk factors related to the Fund. Although the manager of the Fund will value its portfolio using the Private Market Valuation Algorithm, it can be difficult to obtain financial and other information with respect to private companies, and even where the manager is able to obtain such information, there can be no assurance that it is complete or accurate. Because such valuations are inherently uncertain and may be based on estimates, the manager’s determinations of fair market value may differ materially from the values that would be assessed if a readily available market for these securities existed.

The information contained herein does not constitute a recommendation or advice by Collective Liquidity. You should consult your own tax, legal, accounting, financial or other advisers about the information discussed herein based on your specific risk profile and financial situation, including the suitability of an investment in the Fund, with Collective Liquidity, or any product offered or managed by Collective Liquidity.

Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission.