Tax Court Overrides Revenue Ruling to Hold That Gain on Sale or Redemption of Partnership Interest is Not Effectively Connected Income: Tax Court Holds That the Character of Gain From the Sale or Redemption of a Partnership Interest as Effectively Connected or Not is Determined (Based on Statutory Analysis) by Reference to the Outside Partnership Interest, Not the Business Conducted by the Partnership

Sullivan & Cromwell LLP - July 18, 2017

In Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner of Internal Revenue, 149 T.C. No. 3 (July 13, 2017), the Tax Court held that a non-U.S. taxpayer’s gain from redemption of a partnership interest in a United States partnership that was engaged in a U.S. trade or business was the disposition of an indivisible capital asset, and therefore no part of the gain was effectively connected income. This decision rejects the reasoning of Revenue Ruling 91-32, which ruled that gain from the disposition of  such a partnership interest is effectively connected income to the extent a sale of the assets by the partnership itself would have given rise to effectively connected income. According to the court, “where a revenue ruling improperly interprets the text of relevant statutes and has inadequate reasoning, we afford it no deference at all.” Although the IRS may be expected to appeal the decision of the Tax Court, taxpayers who have sold interests in such partnerships in taxable years for which the statute of limitations has not yet closed should consider filing amended returns and claiming a refund.