13 July 2017, the Tax Court declined to follow Revenue Ruling 91-32 and instead held that a foreign partner’s gain from the redemption of its interest in a partnership did not constitute effectively connected income (ECI) with a US trade or business.
In Grecian Magnesite Mining, Industrial & Shipping Co. v. Commissioner, 149 T.C. No. 3. , GMM was a Greek corporation that owned an interest in Premier Chemicals LLC, a Delaware limited liability company treated as a partnership for US income tax purposes. In 2008, Premier fully redeemed GMM’s interest for $10.6 million by making one payment in July 2008 and another payment in January 2009.
GMM realised a gain of $6.2 million on the redemption, approximately $2.2 million of which was attributable to Premier’s US real estate. Based on the advice of an experienced certified public accountant, GMM did not report any of the gain from the redemption as US taxable income on its 2008 tax return and did not file a 2009 US tax return.
The IRS asserted that GMM had US source gain in both 2008 and 2009 that was effectively connected with a US trade or business. The IRS based its position on Rev. Rul. 91-32, which applies an “aggregate” theory of partnerships to determine that the portion of any gain realised by a foreign partner on a sale of a partnership interest that is attributable to the partnership’s US trade or business assets is taxable as ECI under Code section 864.
The Tax Court disagreed. It initially determined that a redemption of apartnership interest should be treated the same as a sale, and that section 741 of the Code calls for an entity rather than an aggregate approach to sales of partnership interests. The court then applied the general rule that gain on a sale of personal property is sourced based on the residence of the seller under section 865. Because the taxpayer was a foreign corporation and a non-resident of the US, the gain was accordingly foreign source rather than US source income, and hence not ECI.
The court rejected the IRS’s argument that the gain should be US source under section 865 because it was attributable to a US office of the taxpayer. The court held that, even assuming the US office of the LLC was properly treated as a US office of the taxpayer, the gain from the redemption was not attributable to that office because the LLC’s office was not a material factor in the taxpayer’s realisation of income from the redemption transaction and the LLC was not regularly engaged in the business of transacting in its own LLC interests.