“When I get drunk I make deals in mines”: Aristophanes, The Knights, 424 B.C.

At first I was hoping for enlightenment on a thirty-seven (count ‘em, thirty-seven) year old statute that has shown up at every closing I’ve done since 1980, the Foreign Investment in Real Property Tax Act of 1980. But not even that Obliging Jurist, Judge David Gustafson, can help me.

Grecian Magnesite Mining, Industrial & Shipping Co., SA, 149 T. C. 3, filed 7/13/17, concedes the FIRPTA hit, even though their trusty attorney turned them onto an equally-trusty and widely-experienced CPA (who had neither an LL.M. in Tax nor did he claim international tax expertise) who claimed they owed nothing.

I think maybe so I ran across said trusty attorney around thirty years ago, but in what context I haven’t a clue.

Inasmuch at Grecian Mag hadn’t a clue about US tax law, they dodge the additions for underreporting and underpaying.

And best of all, since the FIRPTA hit was only one-third of the $6.2 million Grecian Mag picked up in the years at issue, they owe zippo on the back end.

Grecian Mag is in the mag-mining business, but strictly in Greece. My geology-while-you-wait department tells me that the stuff is known as MgCO_3, a/k/a magnesium carbonate, when it’s at home. It’s useful for lining blast furnaces, making flooring, and all kinds other stuff (hi, Judge Holmes).

Cutting to the cliché, Grecian Mag partners with a US miner and some other like-mined dudes. One of the dudes decides to bail, invoking the everybody-bails clause in the LLC operating agreement, so the managing member of the LLC buys out Grecian Mag and distributes its share of the noncash goodies.

Trusty accountant picks up the goodies, but doesn’t report the cash gain on the buyout of Grecian Mag’s membership interest.

Well, the US LLC owned real property (mines, as the above-cited Greek playwright wrote),  so the part of the buyout relating to the mines involved interests in an entity owning US real property. Thus the tax.

But the buyout included other stuff. Grecian Mag had no business in the US of A except via the LLC deal.

It’s the old Section 882 effectively-connected US business. The buyout certainly wasn’t “fixed, determinable, annual or periodic” (FDAP), so Section 881 is out.

IRS claims that the partners in a partnership own interests in the partnership assets, so that when redeemed out, the partner sells its interest (either to the partnership or the other partners), it realizes gain on a sale of its partnership assets, not partnership interests.

Good try, IRS, except Section 897(g), the famous special partnership sale-of-real-property assets that FIRPTA tacked on, only applies to realty, not anything else.

Section 741 says sale of the partnership interest is a capital asset sale of the partnership interest, not the partnership’s property. IRS says that conflicts with Section 897(g), but that’s a special rule.

In short, generally (love that word!) sale of a partnership interest in redemption of that interest is sale of a single asset, not a sale of partnership assets.

So what, says IRS; Section 864(c)(3) makes the distribution Grecian Mag got effectively-connected with US trade or business, hence taxable. And IRS trots out Rev Rul. 91-32, 1991-1 C. B. 107, which nails Grecian Mag and to which IRS respectfully invites deference.

“The ruling holds that the gain realized by a foreign partner upon disposing of its interest in a U.S. partnership should be analyzed asset by asset, and that, to the extent the assets of the partnership would give rise to effectively connected income if sold by the entity, the departing partner’s pro rata share of such gain should be treated as effectively connected income.  In other words, the ruling essentially adopts the same analysis Congress prescribed in section 751 for inventory and receivables, except that the ruling applies that approach for a category of assets (i.e., effectively connected income-generating assets) different from the assets addressed in section 751.” 149 T. C. 3, at p. 33.

Now there are two types of deference. When an agency interprets its own ambiguous ruling, courts defer. But when the agency tries to rewrite the statute, it doesn’t even get “meh!” Here, IRS is trying to rewrite Section 751 to cover everything and it doesn’t. In any case, between deference and “meh!” falls the shadow “power to persuade,” and Rev. Rul. 91-32 gets left at the starting gate.

IRS then claims Grecian Mag’s gains comes from the “office” of the LLC. But the IRS conflates the ongoing mining operation income that derives from the “office” rather than the one-shot sale of the partnership interest.

Anyway, I think that the word “office” is misleading: maybe the EU idea of “establishment,” a business footprint that materially assists, even if not the major factor, in the trade or business, better suits today’s business world.

Grecian Mag doesn’t buy and sell partnership interests. It bought in once and sold out once, and that took place over seven (count ‘em, seven) years. So it’s not in the business of trading partnership interests. It paid US tax on the mining income.

And IRS gave up on the Section 864(c)(4)(B) specialty list of effectively-connected income types.

But whatever miscues Grecian Mag’s initial tax team may have made, their litigation team, from a very well-known and respected NYC law firm, really did a top-class job. Well done, R&H.