In Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner, 149 T.C. No. 3 (2017), the U.S. Tax Court recently held that where a domestic limited liability company (LLC) (which is treated as a domestic partnership for U.S. tax purposes) completely redeems a membership interest from a foreign investor, any gain the foreign investor realizes on the redemption is generally treated as “foreign source” income, which is not subject to U.S. federal income tax except to the extent the gain is attributable to appreciation in U.S. real property or in other limited circumstances.
In its decision, the Tax Court expressly rejected the IRS position set forth in IRS Revenue Ruling 91-32, a 1991 ruling in which the IRS ruled that a foreign partner in a U.S. partnership who sells his partnership interest is subject to U.S. federal income tax on any gain to the extent the gain is attributable to appreciation in those partnership assets that if sold directly would produce U.S. source income. If Revenue Ruling 91-32 had been applied in Grecian Magnesite Mining, the entire gain the foreign investor realized on the redemption apparently would have been treated as U.S. source income that is subject to U.S. federal income tax. The Tax Court held that only the portion of the gain the foreign investor realized on the liquidation that was attributable to appreciation in U.S. real property held by the LLC was subject to U.S. federal income tax, with the remaining portion of the gain not subject to U.S. income tax.
IRS Next Steps
At this stage, the IRS has a number of options, including:
- Choosing to appeal the Tax Court decision;
- Choosing not to appeal the Tax Court decision, but issuing a non-acquiescence to the decision – signaling a decision on the IRS’s part to continue to apply Revenue Ruling 91-32; or
- Choosing not to appeal the Tax Court decision, issuing an acquiescence to the Tax Court decision, and withdrawing Revenue Ruling 91-32.
Foreign Investor Next Steps
In light of the Tax Court decision, what should foreign investors in U.S. partnerships (or entities treated as partnerships for U.S. tax purposes) do now?
- Foreign investors who recently sold (or completely redeemed) interests in U.S. partnerships (or entities treated as partnerships for U.S. tax purposes) should consider filing protective refund claims for open tax years to attempt to recover all or a portion of U.S. federal income tax paid on the gain from the sale or redemption.
- Foreign investors who in the future sell (or completely redeem) their interests in U.S. partnerships (or entities treated as partnerships for U.S. tax purposes) should consider the impact of the Grecian Magnesite Mining decision (and any subsequent IRS or court action) on their U.S. tax reporting positions.