United States

Tax Court rules gain on sale of partnership not taxable in US


In a recent case, see Grecian Magnesite Mining, v. Commissioner, 149 T.C.No. 3, the U.S. Tax Court ruled that the majority of gain realized upon redemption of a foreign corporation’s interest in a U.S. partnership doing business in the United States was neither U.S. source income, nor income effectively connected with a trade or business. Accordingly, the foreign corporation was not liable for U.S. tax on such gains, except to the extent the gains were attributable to U.S real property interests.

In this case, Grecian Magnesite Mining (GMM), a Greek corporation, held an interest in a U.S. partnership that, during the years in question, was redeemed. The issue in the case was whether gain recognized by GMM on the redemption of its U.S. partnership interest was taxable in the U.S.

Generally, a foreign corporation is subject to tax on its U.S. source investment-type income and on its U.S. business income earned directly or through a U.S. partnership doing business in the U.S. Since 1991, the IRS took the position in a formal ruling (Revenue Ruling 91-32 or the Ruling), that a foreign taxpayer that recognized gain on the sale of an interest in a partnership engaged in a U.S. trade or business was taxable in the U.S. on such gain. The Ruling basically applied a so-called “aggregate” view of partnerships and treated such gain as “connected” with the U.S. office of the partnership even though it arose from the sale of the partnership interest.

In Grecian the IRS urged the court to give deference to the Ruling in reaching their conclusion, but the court refused in a detailed opinion. Siding with the taxpayers, the court held, among other things, that the sale of a partnership interest represented an “indivisible item of personal property” that could not be recast as the sale of an interest in the separate assets of the partnership except to the extent provided for in various statutory exceptions to this general rule, of which none applied. Accordingly, the Court disregarded the “lookthrough” approach set forth in the Ruling.

Instead the court applied general principles of federal tax law that apply to the sale of an interest in a partnership and concluded that the gain in question was attributable to neither the partnership’s U.S. office nor any other fixed place of business and therefore, not subject to U.S. tax. In making this determination the court ruled that, although the U.S. partnership maintained a U.S. office, it was not a “significant” or “essential” factor in the production of the gain in question and therefore, no amount of the such gain would be attributable to the U.S. office of the partnership. In addition, the Court concluded that the statutory tax rules governing dispositions of partnership interests required the parties to treat the gain as arising from the sale of a partnership interest. Because such gain is capital gain (and also U.S. source income) under the relevant statutory rules, the Court held that GMM could not be taxed on such gain.

This case firmly rejected the IRS’ long standing position on the treatment of sales of partnership interests, and therefore may provide compelling support for those taxpayers who wish to disregard the major tenets of the Ruling in preparing their returns. In particular this case may provide support for taxpayers who wish to take the position that gain recognized on a sale of a partnership interest isn’t subject to U.S tax. In addition, it may provide support for withholding agents to avoid having to withhold

Foreign taxpayers holding interests in U.S. partnerships should make sure to take note of this case, especially those considering the sale of their interest, as this case is in direct contradiction the IRS’s position established in Rev. Rul. 91-32 regarding a foreign partner’s sale of an interest in a U.S. partnership. 


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