Sale of U.S. partnership interest by a foreign person.

• Author: Packard, Pamela

As the sale of a U.S. partnership interest by a foreign entity or person raises classic entity versus aggregate issues. This classification is critical because it can determine the source of the income; this, in turn, affects whether the gain is subject to U.S. income tax. This item examines the possibility that a reasonable position exists for a "middle of the road" approach between the entity and aggregate theories.

The IRS's View

Despite the fact that Subchapter K primarily adopts an entity approach to partnership taxation for the sale of partnership interests, Rev. Rul. 91-32 nonetheless applies the aggregate theory, concluding that (1) gain from the sale of a partnership interest was sourced to the U.S. because it was "attributable" to a foreign partner's fixed place of business in the U.S.; and (2) such gain was effectively connected income (ECI) under the Sec. 864(c)(2) "asset use test" because the value of the partnership's business activity affected that of the partnership interest.

In Rev. Rul. 91-32, the IRS's reasoning appears inconsistent in the application of the U.S. sourcing, ECI and partnership provisions. The Service cites Unger, 936 F2d 1316 (DC Cir. 1991), in which the business profits of a partnership with a U.S. permanent establishment were attributed to a foreign partner, in concluding that gain from the sale of the foreign partner's partnership interest is U.S.-source income.

Unlike Unger, the gain in Rev. Rul. 91-32 is from the sale of the partnership interest, not the partnership's business profits. The Service asserts that "[i]ncome from the disposition of a partnership interest by the foreign partner will be attributable to the foreign partner's fixed place of business" in the U.S., but does not provide any analysis to support this view beyond citing Unger and Sec. 865(e)(3) (which refers to Sec. 864(c)(5) in determining whether a sale of personal property is attributable to a U.S. fixed place of business). Under the Sec. 864(c)(5) attribution rules, gain is not attributable to a U.S. office unless the office is a material factor in the production of income and regularly carries on activities of the type from which the gain is derived. Thus, the disposition of the partnership interest should not be attributable to a U.S. office under Sec. 864(c)(5), assuming the partnership does not regularly sell partnership interests.

The IRS then applied the Sec. 864(c)(2) asset test to determine whether the U.S.-source gain...