IRS Issues Rules On Share Sales By Foreign Partners

According to Law360, the U.S. Department of Treasury on December 20, 2018 proposed rules to treat income from the sale of a foreigner's interest in a U.S. partnership as taxable U.S.-sourced income, overturning a U.S. Tax Court decision that mandated the opposite result.

Section 864(c)(8) of the Tax Cuts and Jobs Act effectively re-establishes that the sale of a foreigner’s interest in a partnership owning U.S. trade or business assets is effectively connected income, a portion of which is taxable by U.S. authorities. That result was consistent with the Internal Revenue Service's position in a 1991 revenue ruling and contradicted the result in the 2017 Tax Court case Grecian Magnesite v. Commissioner of Internal Revenue.

The Tax Court had found the Greek mining firm was not liable for tax on $4 million of interest in a Pennsylvania magnesite company because the business was conducted through its foreign offices and thus was foreign-sourced.

The TCJA explicitly defined such income as U.S.-sourced, so long as the partner would have received a share of the gain had the overall partnership been sold.

The regulations specified the rule would only apply to partnership gain otherwise recognized in the code, although the law allows Treasury to go further. The tax code normally does not recognize gain or loss in a partnership from the contribution of property in exchange for interest.

Treasury solicited comments from stakeholders about whether to broaden the rules.

"The Treasury Department and the IRS recognize, however, that certain nonrecognition transactions may have the effect of reducing gain or loss that would be taken into account for U.S. federal income tax purposes," the department said in the regulations' preamble.

The proposed regulations also conform to double taxation treaties that might also cover partnerships held by a foreign entity, specifying that permanent-establishment clauses would not prevent the application of the section. But the regulations also stated assets exempted from taxation by tax treaties as a permanent establishment, such as ships or aircraft, would also not be taken into account for the determination of a partnership gain or loss.

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