The U.S. Tax Court today issued an opinion holding that capital gain realized by a foreign company on the redemption of its interest in a U.S. limited liability company was not U.S.-sourced income and that it was not effectively connected with a U.S. trade or business.
The Tax Court specifically rejected the position in an IRS revenue ruling—Rev. Rul. 91-32—as to what is effectively connected income. The court stated that it “will not follow Rev. Rul. 91-32.”
The case is: Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner, 149 T.C. No. 3 (July 13, 2017). Read the Tax Court’s opinion [PDF 200 KB]
The following is intended to provide a summary overview of today’s opinion. A more complete analysis will be provided in a future report from KPMG.
A company—established and organized under the laws of Greece and having its principal place of business in Athens—in 2001 purchased what ultimately was a 12.6% interest in a Delaware limited liability company (LLC). The LLC was engaged in mining and extracting magnesite in the United States.
The Greek company otherwise had no office, employees or business operations in the United States.
In 2007, the Greek company agreed to allow the LLC to redeem its 12.6% interest for $10.6 million, with the redemption to be made in two liquidating payments. The payments were made in July 2008 and in January 2009, but were deemed to have been made on December 31, 2008.
The company realized over $6.2 million of gain, of which $2.2 million was deemed attributable to U.S. real property interests (and which the company ultimately conceded was taxable income). However, the company contended that the remainder—that is, the “disputed gain” of $4 million—was not taxable for U.S. purposes.
For 2008, the Greek company filed a Form 1120-F, U.S. Income Tax Return of a Foreign Corporation, and relying on the advice of a certified public accountant, reported its distributive share of the LLC’s income, gain, loss, deductions, and credits. However, the Greek company did not report any of the gain realized on the redemption of its interest in the LLC (neither the gain attributable to the U.S. real property nor the rest of the gain).
Relying on the advice from its CPA tax return preparer, the Greek company did not file a return for 2009 because the company’s entire interest was redeemed as December 31, 2008.
The IRS audited the company’s 2008 and 2009 tax years and determined deficiencies in U.S. income tax for both years. The IRS prepared a substitute for return for 2009, determining that the Greek company had U.S.-sourced capital gain net income of $1 million for 2008, and $5.2 million for 2009 from the redemption of the interest in the LLC.
The IRS determined that the Greek company had to recognize its gain on the redemption of its partnership interest for U.S. tax purposes as U.S.-sourced income that was effectively connected with a U.S. trade or business—consistent with the IRS position in Rev. Rul. 91-32.
The IRS also assessed an accuracy-related penalty for 2008 and additions to tax for 2009 for failing to file a return and timely pay the tax.
The Tax Court today held:
© 2019 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
KPMG International Cooperative (“KPMG International”) is a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.