Many businesses that operate outside of the U.S. want to do business in the U.S. and they want to limit their exposure to U.S. income taxes. To do this, many in-bound investments are structured as U.S. partnerships with the parntership being formed in the U.S. to carry on the business activities in the U.S. This is a common arrangement. If the foreign owner wants to dispose of its partnership interest, there are often questions as to whether the payments to liquidate the partnership are suject to U.S. income tax. The court recently addressed this in Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner, 149 T.C. 3.
The Facts in the Grecian Magnesite Mining Case
The taxpayer is a privately-held foreign corporation that was formed and operated in Greece. It was in the mining industry. It had no U.S. offices or operations.
The taxpayer invested in a U.S. partnership by acquiring a small percentage ownership in the partnership entity. The U.S. partnership owned real estate in the U.S. and conducted mining activity in the U.S. It remitted partnership distributions (net profit) to the taxpayer each year.
In 2008, the taxpayer entered into an agreement whereby the partneship would redeem its partnership interests from the taxpayer. The payments were made to the taxpayer in 2008 and 2009 and the taxpayer was no longer a partner as of the 2009 payment. The taxpayer did not report the payments on its Form 1120F for 2008 and did not file a Form 1120F for 2009. The IRS determined that payments were income effectively connected with a U.S. trade or business and had to be reported on the Form 1120F in 2008 and 2009.
The Question Presented
The question for the court was whether the payments the taxpayer, a foreign corporation with no other connections to the U.S. other than its partnership interest, was subject to tax on the payments it received to redeem its partnership interest.
The parties agreed that the real estate held by the partnership was subject to U.S. tax under Sec. 897(g). This section is often referred to as Foreign Investment in Real Property Tax Act (“FIRPTA”). As noted by the court, FIRPTA was enacted to tax foreign corporations on the sale of partnerships that held real estate. The parties also agreed on the amount of the payments that were attributable to the real estate.
With these concessions, the remaining question was whether the payments the taxpayer received other than the real estate was income effectively connected with a U.S. trade or business under Sec. 882.
Why Redemption Payments are Not Subject to U.S. Tax
The IRS argued that the partnership redemption should be viewed as a liquidation of individual assets and not as an entity for appying Sec. 882. So the redemption payments would be determined separately according to the IRS.
The taxpayer argued that the partnership redemption should be viewed as a liquidation of a paratnership or capital asset. The court agreed with the taxpayer. The taxpayer’s position and the court’s conclusion are the general rule that is applied outside of the context of the U.S. international tax laws. The general rule is that a redemption of a partnership interest is a liquidation of the partnership and not of individual assets. This is set out in Sec. 731.
In this case, the IRS was attempting to create an exception to the general rule for foreign corproations given the U.S. internatioanl tax laws. The U.S. governmeht had a lot to gain with this argument. The IRS’s position would have obligated foreign corporations that have their U.S. partnership interests redeemed by the partnerships be subject to tax in the U.S. This would result in a signficant windfall for the U.S. fisc. It may also have impacted the amount of in-bound investment into the U.S.
It is not clear whether the IRS will appeal the decision.