By Adam Sweet
July 20, 2017
Tax Court holds foreign company's gain from the disposition of a U.S. partnership interest not taxable US income.
In direct opposition to a 1991 Internal Revenue Service (IRS) Revenue Ruling (Rev. Rul. 91-32) on July 13, 2017, the Tax Court issued an opinion in Grecian Magnesite Mining, Industrial and Shipping Co., SA (Grecian) v. Comm'r (149 T.C. No. 3), holding that a foreign partner's gain realized from the redemption of its interest in a U.S. limited liability company was not effectively connected with a U.S. trade or business. Therefore, any gain realized on the redemption, except where a specific exception applies, is not recognized for U.S. tax purposes.
In making their decision, the Tax Court rejected the long standing IRS position on the issue, stating, the Tax Court will "decline to defer to the ruling" and will "instead follow the code and regulations" to determine whether the gain is effectively connected income.
In 2001, Grecian, a Greek mining company, acquired a 12.6% interest in a Delaware limited liability company (the LLC) that was treated as a partnership for U.S. federal tax purposes. Grecian had no business operations, office, or employees in the U.S., other than the LLC interest.
The LLC was a profitable venture for Grecian. So much so, that during 2008, the LLC redeemed Grecian's LLC membership interest for $10.6 million, resulting in $6.2 million of gain. However, Grecian, relying upon the advice of its tax advisor, reported no gain from the redemption when they filed their 2008 Form 1120-F (U.S. Income Tax Return of a Foreign Corporation) return.
When the IRS reviewed Grecian's reported position on the partnership interest redemption, the IRS challenged Grecian's position, asserting that gain realized from the redemption of the LLC interest was effectively connected with a U.S. trade or business, which would make it subject to U.S. tax, consistent with the government's position in Rev. Rul. 91-32. Grecian appealed the IRS challenge to the Tax Court.
Tax Court Holds for Grecian
The Tax Court, finding that the relevant statutory language and legislative history do not support the government's position, upheld Grecian's position that gain from the disposition of a partnership interest should be treated as the disposition of an interest in an entity, and not as the disposition of the underlying assets held by the entity, unless a specific statutory exception applies. Therefore, Grecian was not liable for U.S. tax on the gain realized from the redemption of its interest, except for gain related to certain U.S. real property held by the LLC. The Tax Court also found that Grecian's reliance on its tax advisor's advice was reasonable, resulting in no penalties.
The taxation of partnerships is complex. Some tax provisions view a partnership as a distinct entity, while other provisions view a partnership as an aggregate of its assets. However, foreign entities, as Grecian, owning interests in U.S. partnerships should now consider how this opinion may impact past, current, and future tax planning.
It is anticipated that the IRS will appeal this decision, but, in so doing, they will need to develop a defense for the position laid out by the Tax Court. However, foreign entities that have a fact pattern in line with the Grecian case should consider filing protective claims for any open tax years. In addition, the Tax Court's ruling may provide a basis for taxpayers to follow the results of the Grecian case for current and future reporting, pending the results of an IRS appeal.
Contact Adam Sweet or your Eide Bailly professional for more information or assistance concerning how the Grecian case may impact your tax profile.