U.S. tax relief for foreign partners.

• Author: Mezzo, Louis J.

The IRS's focus on the U.S. taxation of foreign individuals and foreign corporations has attracted much attention. The issues have ranged from transfer pricing and earnings stripping to treaty shopping and generation-skipping transfer taxes, with generally consistently bad news for foreign taxpayers. But don't despair, not all news is bad news. IRS Letter Ruling 9331012 may provide certain foreign taxpayers with relief from U.S. taxation. Although the letter ruling does provide a breath of fresh air, its application will be limited and will probably require some advance planning to benefit from its findings.

The letter ruling involved a German law partnership with a branch in the United States since 1988. The partnership has filed U.S. partnership tax returns reporting the operating results of the activities conducted through the U.S. branch. The partnership has had a partner resident in the United States. The resident partner has filed U.S. income tax returns. In addition, the nonresident partners filed nonresident U.S. income tax returns.

The U.S. resident partner performed services only in the United States and not in Germany on behalf of the partnership. A ruling was obtained from the German tax authorities informing the resident partner that he was taxable only in the United States while residing in the United States because his services were performed only in the United States and not in Germany. Further, the partnership and the resident partner have executed an agreement allocating all of the profits of the U.S. office to the resident partner.

Under Sec. 875, a nonresident alien individual or a foreign corporation that is a partner in a partnership engaged in a trade or business in the United States is considered engaged in a trade or business within the United States nonresident alien individual engaged in a trade or business in the United States is taxable in the United States on the income effectively connected with the conduct of a trade or business in the United States (Sec. 871(b)(1)). Thus, the nonresident partners in the German partnership would generally be treated as engaged in a trade or business in the United States and would be taxable on income effectively connected with that trade or business, i.e., their share of the partnership's income from the U.S. branch. This is consistent with the approach taken by the nonresident partners for the years preceding the ruling request when the nonresident partners filed nonresident...