A portion of a foreign corporation’s capital gain on the redemption of its interest in a U.S. limited liability company (LLC), which was treated as a partnership for U.S. income tax purposes, was not taxable for U.S. purposes because it was not U.S.-source income and was not effectively connected with a U.S. trade or business. Regarding the undisputed portion of the gain that the corporation conceded was U.S. taxable income, the corporation was not liable for the accuracy-related penalty or the additions to tax for failure to file a return and failure to pay tax, because it reasonably relied on the erroneous advice of an experienced certified public accountant.
The disputed redemption gain was not U.S.-source income under Code Sec. 865(e)(2)(A) because it was not attributable to a U.S. office or other fixed place of business. The partnership’s U.S. office was not a material factor in the production of the foreign corporation’s disputed gain. To be a “material factor,” the partnership’s U.S. office must have been material to the redemption transaction itself and the gain realized from it, not simply a material factor in ongoing, distributive share income from the partnership’s regular business operations. The foreign corporation’s gain was not realized from the partnership’s trade or business of mining magnesite, but from the distinct sale of its partnership interest. Further, the partnership’s actions to increase its overall value were not an essential economic element in the realization of the income that the corporation received upon the sale of its interest. The redemption was a one-time, extraordinary event, not undertaken in the ordinary course of the partnership’s business.
The foreign corporation’s gain on the redemption was from the sale or exchange of an indivisible capital asset: i.e., its interest in the partnership. The argument that in this context the corporate partner’s sale of a partnership interest should be treated as the partner’s sale of separate interests in each asset owned by the partnership was rejected.
Comment: The Tax Court did not follow Rev. Rul. 91-32, 1991-1 CB 107, which held that the gain realized by a foreign partner upon disposing of its interest in a U.S. partnership should be analyzed asset by asset, and to the extent the assets of the partnership would give rise to effectively connected income if sold by the entity, the departing partner’s pro rata share of such gain should be treated as effectively connected income. The court pointed out that the ruling did not address when an office or other fixed place of business might be a material factor in the production of redemption gain, and did not mention the “ordinary course” prong of the “attributable to” analysis.
Further, the foreign corporation was not liable for the Code Sec. 6662 accuracy-related penalty or the additions to tax under Code Sec. 6651(a)(1) and (a)(2) on the undisputed portion of the gain. The corporation’s partnership investment was its only involvement in U.S. business, and its central financial officer did not understand the concept of a partnership for U.S. tax purposes or that the corporation would be subject to tax in the United States on income from real property located there. The corporation relied on the recommendation of its trusted adviser for to hire a tax professional to comply with U.S. tax laws. The CPA that advised the corporation to not report the gain it had realized on the redemption had sufficient credentials to justify the foreign corporation’s reliance. He was a licensed attorney and CPA who had spent nearly 40 years preparing income tax returns, and had accurately prepared the foreign corporation’s returns for several years before the tax years at issue.
Grecian Magnesite Mining, Industrial & Shipping Co., SA, 149 TC —, No. 3, Dec. 60,968
Code Sec. 741
CCH Reference – 2017FED ¶25,442.1285
Code Sec. 864
CCH Reference – 2017FED ¶27,189.40
Code Sec. 865
CCH Reference – 2017FED ¶27,201.30
Code Sec. 875
CCH Reference – 2017FED ¶27,383.20
Code Sec. 6651
CCH Reference – 2017FED ¶39,475.41
Code Sec. 6662
CCH Reference – 2017FED ¶39,651G.115
Tax Research Consultant
CCH Reference – TRC PART: 18,402
CCH Reference – TRC INTL: 3,452
CCH Reference – TRC INTLIN: 3,104
CCH Reference – TRC INTLIN: 3,106.15
CCH Reference – TRC INTLIN: 3,106.35