The GOP’s final tax bill, which has passed Congress, retains a provision to overturn a highly publicized U.S. Tax Court decision that dealt with the tax consequences of a foreign investor selling its interest in a partnership engaged in a U.S. trade or business.
Under the measure—which was included in the original Senate bill but not the House bill—a foreign partner is generally subject to U.S. tax on gain from the sale of an interest in a partnership to the extent the gain is attributable to U.S. trade or business assets of the partnership. The provision effectively overrules the Tax Court's decision in a case involving Grecian Magnesite Mining, Industrial & Shipping Co. SA. The court held that the Greek mining company didn't have to pay tax on the gain it realized on the redemption of its partnership interest in a Pennsylvania-based company because the gain wasn't U.S.-source income.
Enactment of the GOP’s tax bill means “business as usual” for foreign investors in U.S. flow-through entities, said Jonathan Talansky, a partner at King & Spalding LLP in New York. For example, blocker corporations, which help foreign investors protect their investments from U.S. taxation, “will remain relevant, although now with a reduced tax drag what with the corporate rate reduction,” he told Bloomberg Tax in an email.
The bill codifies Internal Revenue Service Revenue Ruling 91-32, which has been controversial among practitioners for years and which the Tax Court in the Grecian Magnesite case rejected.
The IRS filed a notice of appeal in the Grecian Magnesite case Dec. 15, despite the GOP tax bill provision. Abraham N.M. Shashy Jr., tax practice group leader at King & Spalding and a former IRS chief counsel, said the agency likely wants to appeal the court’s decision to protect its position with respect to years that aren’t covered by the bill.
The final tax legislation closely follows the original Senate proposal but adds some clarifications, Aaron P. Nocjar, a partner at Steptoe & Johnson LLP who specializes in the taxation of pass-throughs, said in an email.
The bill provides that gain or loss from the sale or exchange of a partnership interest by a foreign partner would be effectively connected with a U.S. trade or business—and thus subject to U.S. tax—to the extent that the non-U.S. investor would have had effectively connected gain or loss if the partnership had sold all of its assets at fair market value as of the date of the sale or exchange. The provision excludes real property gain already classified as effectively connected under the Foreign Investment in Real Property Tax Act of 1980.
“This construct is similar to the current ‘hot asset rules’ applicable to partners who sell or exchange interests in partnerships with assets the disposition of which would generate ordinary income in some part,” Nocjar said.
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