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Recent US tax court ruling provides tax savings opportunity for foreign investors

The U.S. Tax Court rejected the IRS position about taxing foreign investments in a U.S. partnership, which can lead to the opportunity for tax savings.



US Tax Court

On July 13, 2017, the U.S. Tax Court in Grecian Magnesite Mining Industrial and Shipping Co., SA v. Commissioner (July 13, 2017) 149 T.C. No.3, rejected a long-held IRS position on the taxation of foreign investments in a U.S. partnership.

The court essentially held that a non-U.S. person is only taxable on gains attributable to the sale of a partnership interest to the extent the partnership interest relates to an interest in real property.

For example, an investment in a tech partnership that does not hold any interests in real property could be sold without triggering any U.S. tax.

Revenue Ruling 91-32

The IRS position is described in Revenue Ruling 91-32 which provides that the sale of a partnership interest is effectively connected with the U.S. trade or business to trigger U.S. taxation. The ruling concluded that the gain to be realized by the foreign partner or investor should be analyzed asset by asset.

Suburbs Tax court ruling

According to the U.S. Tax Court ruling, a foreign investment can only be taxed if the gains came from the partnership interest sale to the point that the partnership interest is linked to a real property interest. (Photo by Andreas Praefcke via Wikimedia Commons. CC BY 3.0)

To the extent that the sale of the assets by the partnership would trigger income if sold by the entity, then so too should the income received by the departing partner’s pro rate share of the gain on sale should be subject to U.S. tax.

Tax-free sale

The court rejected the IRS position and limited the gain taxable to the U.S. to the extent that the gain was restricted to U.S. real property.

In other words, a foreign investor in a tech business, holding little if any real property could sell his or her interest in that partnership or LLC tax-free so long as the entity did not hold U.S. real property.

Possibilities for non-US investors

Taxpayers that have filed returns and paid tax under the rule set forth in Revenue Ruling 91-32 should file claims for refund. The rest of us should stay tuned and watch for any IRS appeal.

If not appealed by the IRS or if the decision stands on appeal, this will represent a significant planning opportunity for non-U.S. investors.

DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation in writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.

John M. Goralka is the founder of the Goralka Law Firm. John is a California State Bar Certified Specialist in Taxation. John is also a California State Bar Certified Specialist in Estate Planning, Trusts and Probate. He is one of few attorneys in Sacramento County with both of these critical specializations in the State of CA. In addition, he successfully completed his Certified Public Accountants (CPA) exam, and holds a Master in Taxation Law (LLM). John received a Laureate Certification in wealth planning for high-net-worth clients from the Southern California Institute. John is a nationally recognized author with articles appearing in Kiplinger, NASDAQ, On Wall Street, The American Journal of Managed Care, Penton: Wealth Management, Yahoo Finance, Leimburg, ThinkAdvisor and Hospital Impact. John was recognized as a Northern California Super Lawyer in estate planning and probate, tax, and business law, as well as a Sacramento Top Lawyer in business and corporate law with Sacramento Magazine. The Goralka Law Firm was named a one of the Top 20 Boutique Law Firms in California for its tax and estate planning services. John is rated AV preeminent by Martindale-Hubbell and has the highest possible rating of 10.0 with Avvo, Inc.