United States: Rejecting A Revenue Ruling, Tax Court Rules That Foreign Partner Is Not Subject To U.S. Tax On Redemption Of Partnership Interest

On July 13, 2017, in Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner, 149 T.C. No. 3 (2017), the U.S. Tax Court held that gain recognized by a nonresident partner on the redemption of its interest in a U.S. partnership was not taxable because it was not U.S.-source income, and was also not effectively connected with a U.S. trade or business. In its holding, the Tax Court rejected Revenue Ruling 91-32, which applies the aggregate theory of partnerships to treat foreign persons disposing of investments in partnerships as disposing of the underlying assets, producing effectively connected income.

The taxpayer in the case, Grecian Magnesite Mining (GMM), a Greek corporation, purchased an interest in a U.S. limited liability company, Premier Chemicals, LLC, which was taxed as a partnership for U.S. federal income tax purposes. Premier operated a mining business in the U.S. and allocated income to GMM from 2001 through 2008. In 2008, Premier redeemed GMM's partnership interest (making redemption payments in 2008 and 2009), and GMM realized gain totaling over $6.2 million. The IRS and GMM subsequently agreed that $2.2 million was attributable to U.S. real property interests and taxable under the Foreign Investment in Real Property Tax Act (FIRPTA) regime. However, GMM argued that the remaining $4 million was not taxable in the United States.

Consistent with its position in Rev. Rul. 91-32, the IRS argued that the "aggregate" approach to partnership taxation should be used to evaluate the redemption. Under the aggregate theory, GMM would be viewed as selling its share of each of the assets of the partnership, which were effectively connected to Premier's U.S. business. GMM, on the other hand, argued for an "entity" approach where the gain from the redemption on its partnership interest would be gain from the sale or exchange of an indivisible capital asset, i.e., GMM's interest in the partnership, and such gain would not be attributable to a fixed place of business in the United States.

The Tax Court agreed with GMM, holding that under the facts in the case, entity treatment should apply to the gain recognized as the result of the redemption of a partnership interest. Section 736(b) provides that payments in liquidation of a partner's interest made in exchange for the partner's interest in partnership property are considered as distributions from the partnership. Section 731(a) provides that gain or loss recognized in connection with a distribution is considered as gain or loss from the sale or exchange of the distributee partner's partnership interest. Finally, Section 741 provides that the transferor partner recognizes capital gain or loss on the sale or exchange of its partnership interest, except as otherwise provided in Section 751 (relating to unrealized receivables and inventory items). Pulling these provisions together, the Tax Court concluded that GMM's gain from the redemption of its partnership interest was gain from the sale or exchange of an indivisible capital asset—i.e., GMM's interest in the partnership.

Next, the Tax Court analyzed the rules governing U.S. taxation of international transactions to determine whether GMM's gain was subject to tax in the United States. That determination turned on whether, for purposes of Section 882, the gain of GMM was "effectively connected with the conduct of a trade or business within the United States." In Revenue Ruling 91-32, the IRS ruled that gain or loss realized by a foreign partner upon disposing of its interest in a partnership that is engaged in a trade or business through a fixed place of business in the United States will be U.S.-source effectively connected gain or loss. However, it will be U.S.-source effectively connected gain or loss only to the extent that the partner's distributive share of unrealized gain or loss of the partnership would be attributable to property of the partnership that produces effectively connected income.

The Tax Court found the IRS' position in Rev. Rul. 91-32 unpersuasive and declined to afford the ruling's aggregate approach deference. The Tax Court stated in its opinion that "Rev. Rul. 91-32 is not simply an interpretation of the IRS's own ambiguous regulations, and we find that it lacks the power to persuade."

The Tax Court also described Rev. Rul. 91-32's "treatment of the partnership provisions" as "cursory in the extreme." Instead, the Tax Court applied the sourcing rules under Section 865, which provides that, subject to exceptions, income from the sale of personal property (i.e., the partnership interest) by a nonresident shall be sourced outside the United States. The Tax Court found that an exception to this general rule under Section 865 did not apply. The Tax Court specifically addressed one such exception, which provides that the gain or loss from the sale or personal property may be U.S.-source if attributable to a U.S. office or fixed place or business, which it found not to be applicable under the facts presented. Thus, because (1) GMM's gain was foreign-source, (2) GMM was a nonresident, and (3) no other exception applied, the Tax Court found that GMM was not subject to tax on the redemption of its partnership interest.

Notably, the opinion's analysis does not address the potential applicability of Section 751(b), which might have resulted in the partnership being viewed as having purchased GMM's share of so-called "hot assets" from GMM, presumably because (as a footnote in the opinion indicates) the IRS did not assert that Section 751(b) should apply and had not raised it as an alternative position. Additionally, the IRS did not argue that the partnership anti-abuse regulation under Treas. Reg. Sec. 1.701-2(e) applied in this case. Also, it is worth exploring whether the court may have reached a different conclusion under different facts involving a foreign investor in a U.S. partnership, in particular where tiered partnerships or related parties were involved.  

Nevertheless, the result of Grecian Magnesite represents a significant development in the U.S. taxation of nonresident partners in partnerships engaged in a U.S. trade or business, and may present substantial planning opportunities. Taxpayers should consider whether it's possible to obtain a refund if they previously followed Rev. Rul. 91-32, and consider the Tax Court's opinion when planning future exits from partnership investments. Additionally, the Tax Court ruling may impact financial statements and accruals related to uncertain tax positions. However, taxpayers should be cautious (particularly those in the same circuit as GMM) as the case is subject to appeal by the IRS.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Kramer Levin Naftalis & Frankel LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions