Tax Court invalidates 1991 revenue ruling on taxation of foreign partners that sell or redeem interest in US partnership
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October 31, 2017 

Partnerships Can Now Be Used for US Inbound Investments

Hi There!,

The Tax Court decided a case on July 13, 2017 dealing with a foreign corporation that was a partner in a US partnership that redeemed the foreign corporation’s interest in the US partnership and determined that a portion of the capital gain was not taxable for US purposes.    This decision went against an IRS ruling that had been around for 25 years, and the court was even harsh in its criticism of the ruling’s analysis of the foreign provisions of the Code and stated:  “We decline to defer to the ruling” [Rev. Rul. 91-32].

Need help structuring your investments into the US? Contact us today.

The case is also interesting because it addressed the issue of penalties for failure to file and failure to pay, and what might constitute reasonable cause as a defense against them.  Reliance, especially by a foreign taxpayer, on a US attorney and CPA that advised the foreign taxpayer it was not subject to US tax and did not need to file a Form 1120-F was considered to be reasonable cause related to the portion of the capital gain that was subject to US tax.  This was the portion related to real estate owned by the US partnership (FIRPTA provisions).

Grecian Magnesite Mining, Industrial & Shipping Co., SA [“GMM”] v. Commissioner

The Tax Court case involved a Greek corporation that invested in a US partnership that was in the business of extracting, producing and distributing magnesite which it mined or extracted from mines in the US.  This was similar to the business that GMM was involved with in Greece.  However, GMM never had its own office, employees or business operations in the US.  GMM made an initial capital contribution, for which it received a 15% interest in the LLC that was treated as a partnership for US tax purposes.

After over seven years of ownership in the LLC, GMM entered into an agreement for the LCC to redeem its interest.  The redemption was to be completed in two transactions, which occurred over two taxable years.  GMM did not initially pay any tax related to the capital gain and did not file a Form 1120-F for the year the second distribution was made since it was not a member of the LLC for that year and did not have any US source effectively connect income (ECI).  However, due to the real estate owned by the LLC, the FIRPTA provisions applied and GMM ultimately conceded it owed US tax on the gain related to the real estate.

The partnership area has always had the two, sometimes conflicting, concepts of “aggregate” versus “entity” approach.  Because a partnership has its income flow through to the partners, there are situations under tax law where each partner looks to its share of the underlying activity of the partnership, and the type and source of the income and expenses are determined at the partner level. 

The entity concept, on the other hand, looks at the partnership as a separate legal entity owned by the partner and issues are determined at the partnership level.  This is where the outside basis of the partnership interest held by the partners may be different than the basis of the assets and liabilities held inside the partnership.  The IRS (and the position espoused by Rev. Rul. 91-32) tried to take the aggregate approach and treat the redemption (or a sale) as a sale of each of the underlying assets held by the partnership rather than as a sale of a partnership interest.  The Tax Court acknowledged the two concepts, but stated that in this situation, because of Sec. 741, this was an entity issue and decided for the taxpayer:  this was not subject to US taxation.

Reasonable Cause Issue

Because GMM did not initially file a return or pay any tax on the capital gain, including on the FIRPTA-related gain, the IRS assessed penalties for failure to file and failure to pay the tax.  GMM finally conceded it owed tax related to the gain from the real estate held by the partnership, but claimed it had reasonable cause because it had relied on its CPA, who had advised they did not owe any tax and did not have to file.  Reasonable cause has always been a very fact and circumstance issue that has often been difficult to overcome in arguments with the IRS.

Reasonable cause must also involve a showing that there was not willful neglect.  Ignorance of the rules is normally not a defense, especially where no action was taken to determine the correct tax impact of a transaction. 

There are three requirements for a taxpayer to use reliance on a tax professional to avoid a penalty as addressed in this case:

  1. The adviser was a competent professional who had sufficient expertise to justify reliance,
  2. The taxpayer provided necessary and accurate information to the adviser, and
  3. The taxpayer actually relied in good faith on the adviser’s judgment.

The IRS conceded the second requirement, but not the others, claiming the taxpayer should have hired someone with international tax expertise.  The Court responded with the following:

“Given what little GMM knew about the U.S. system of taxation, we cannot imagine GMM would have known how to conduct such an investigation, let alone what value such uninformed inquires would have added.  GMM acted reasonably, given its admitted inexperience:  It relied on the recommendation of its trusted adviser, Mr. Phufas, when it chose to hire Mr. Rose.”

Apparently, the attorney and CPA, Mr. Rose, had been preparing tax returns for 40 years, was a CPA and attorney and spent 30%-40% of his time preparing income tax returns for a wide variety of clients.  Therefore, the Court felt there was reasonable cause in this situation.

Refund Claims Possible

A number of tax practitioners have questioned the validity of Rev. Rul. 91-32 and the IRS position that a foreign partner of a US partnership had to pay US tax on the sale or redemption of its partnership interest, especially where the foreign partner was not involved in the affairs of the US partnership.  Before now, no one had challenged this position in court.  While the case is appealable by the IRS, it appears that it will be difficult for the IRS to overcome the reasoning of the court in this case. Also, the IRS could non-acquiesce in the case. 

There may be a refund opportunity for foreign partners who have paid US tax on sales of US partnerships if the statute of limitation is still open.  MSDM is available to discuss the facts that would allow for the filing of a refund claim in these situations. We can also assist with structuring investments into the US for investors. Contact us today.

Thank you.

Carrie Koshkin, JD
International Tax Director

Twitter: @MooreStephensDM

With nearly 15 years of experience in international tax law, Carrie’s international tax services background includes implementing tax-efficient organizations and helping clients enter new jurisdictions. Additionally, she focuses on inbound/outbound tax issues, U.S. tax implications of international restructuring, and more. Contact her at or +1.713.860.0219.

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