This content is from: United States

US Inbound: Sale of partnership interest

Jim FullerDavid Forst

Revenue Ruling 91-32 holds that a foreign partner's gain from the sale or exchange of an interest in a partnership that conducts business in the US through a fixed place of business is effectively connected with the US business. The gain is so treated to the extent of the appreciation in value of the partnership's "effectively connected" assets, which involves a ratio approach. In the case of a treaty, the gain is treated as effectively connected to gain attributable to a US permanent establishment.

The Obama Administration has proposed to codify the ruling and to impose a withholding tax on the purchaser of the partnership interest, but those proposals have not been enacted. Many practitioners question the correctness of the ruling. It's contrary to § 741, which says that gain from the sale of a partnership interest is treated as gain on the sale of an indivisible item of intangible personal property (with certain exceptions involving the Foreign Investment in Real Property Tax Act (FIRPTA), unrealised receivables and inventory items).

The ruling is the subject of litigation in the Tax Court in Grecian Magnesite Mining, Industrial & Shipping Co SA v. Commissioner. The taxpayer is a privately-owned corporation organised under the laws of Greece. The taxpayer's interest in the US partnership was redeemed, giving rise to gain treated as though the taxpayer has sold or exchanged its partnership interest. Some of the gain was attributable to the partnership's US real property and was taxable under the FIRPTA rules. The balance of the gain is in issue, so the taxpayer has asserted that § 741 applies. The IRS, of course, asserts that the revenue ruling applies.

The IRS argues that § 865(i)(5), which requires that § 865 be applied at the partner level in the case of a partnership, was intended to treat partnerships as a collection of individual partners who jointly own the partnership property. The IRS also argues that application of the US-Greece tax treaty does not change the result. First, the Service argues that the taxpayer is deemed to have a US permanent establishment by reason of the partnership's permanent establishment in the US, citing Donroy v US and Unger v Commissioner. The IRS argues that even if the taxpayer did not have a US permanent establishment, it is still taxable on the gain. The US-Greece tax treaty lacks a capital gains article.

The case has not yet been decided, but it will be important when it is. The parties have filed 340 pages of briefs. Taxpayers are now waiting with interest to see how the court addresses the issue.

Jim Fuller ( and David Forst (
Fenwick & West
Tel: +1 650 335 7205; +1 650 335 7274

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