United States

Tax Court tosses aside IRS guidance

TAX BLOG


The Tax Court recently ruled that the redemption of a foreign person’s interest in a U.S. partnership was neither U.S. source income, nor income effectively connected with a trade or business. As a result, the taxpayer in Grecian Magnesite Mining v. Commissioner, was largely not liable for U.S. tax. For a more detailed discussion of the facts of the case please see our prior coverage, Tax Court rules gain on sale of partnership not taxable in US.

In ruling for the taxpayer, the Tax Court found that the IRS’s position in Rev. Rul. 91-32 ran contrary to the clear language of section 741 of the Internal Revenue Code, which provides that gain or loss recognized on disposition of a partnership interest is treated as gain or loss from a capital asset. Practitioners have long criticized Rev. Rul. 91-32 for being inconsistent with the unambiguous language of section 741, which requires taxpayers to take an “entity” as opposed to an “aggregate” approach.  In contrast, Rev. Rul. 91-32 requires taxpayers to characterize gain on the sale of a partnership interest as effectively connected income where the partnership is engaged in a U.S. trade or business.

The Tax Court’s rejection of the ruling, and it dismissal of the IRS’s request for deference to its prior guidance, is a significant win for taxpayers.

Foreign based taxpayers who have recently had a redemption of a U.S. partnership interest subjected to U.S. tax should determine if the transaction occurred in a tax return year that is still open for amendment.  Similarly, foreign taxpayers holding interests in U.S. partnerships and possibly considering the sale of their interest should make sure to take note of this case. The ultimate impact of this case will depend on whether or not the IRS decides to appeal, and if so, on the result of any appeal. Previously, the Obama administration had considered pushing for an amendment to section 741 that would codify Rev. Rul. 91-32. While this specific issue has not been addressed by the Trump administration it is unlikely that any action will be taken given the administration’s distaste for burdensome tax rules and its hopes for comprehensive tax reform. 


Jamison Sites

Manager

jamison.sites@rsmus.com.

Areas of focus: Washington National TaxInternational Tax Planning