US taxes when foreign investors exit
A foreign partner in a US mining business did not have to pay US taxes on most of its gain when it sold its share back to the mining company, the US Tax Court said in July.
The case is Grecian Magnesite Mining v. Commissioner.
Most foreign investors are careful to hold US investments through a US “blocker” corporation. The blocker might be a US limited liability company that the investor has chosen to treat as a corporation for US tax purposes. Foreign investors doing this should be able in most cases to avoid a US income tax when exiting a US investment by selling the blocker. Not so where the investor invests directly in a US partnership or limited liability company treated as a partnership.
The investor in the Grecian case invested directly in a US partnership. It eventually sold its partnership interest back to the partnership for a $6.2 million gain. The IRS said it should have been taxed on the full gain. The Tax Court said it should have been taxed on only $2.2 million of the gain.
Some foreign investors who paid full taxes in similar situations may be thinking about filing amended US tax returns requesting refunds of US taxes paid.
The IRS has not decided whether to appeal. The Obama administration proposed in 2013 that Congress change the US tax code to avoid the result the Tax Court reached. Congress could close the door in any corporate tax reform bill this fall.
Grecian, a Greek company in the business of mining magnesia and magnesite in Greece, bought a 15% interest directly in a US partnership, Premier, that mines magnesite in Nevada, Florida and Pennsylvania. Premier has its head office in Pennsylvania.
Another Premier partner, IMin Partners, approached Premier and offered to sell its interest back to the company in 2008 for $10 million. Premier accepted the offer and was then obligated to offer to purchase each other investor’s interest for an equivalent price.
Grecian was the only other partner who chose to sell.
Grecian agreed in July 2008 for Premier to redeem its interest for $10.6 million in two installments. It had a gain of $6.2 million.
The problem with owning an interest in a US partnership directly — rather than through a US blocker — is the foreign partner must pay US taxes at a minimum on any gain attributable to US real property owned by the partnership. Of the $6.2 million in gain, $2.2 million was attributable to real property. Grecian failed to file any US tax return on faulty advice from its US accountant.
On top of that, the IRS takes the position that the rest of the gain is also taxable, as if the partnership sold its assets and allocated a share of the income to the Greek partner. The IRS said the Greek investor should have reported the entire $6.2 million gain as ordinary income, citing a 1991 ruling (Revenue Ruling 91-32) that treats a foreign partner disposing of an interest in a US partnership as if the partnership sold all its assets and allocated the foreign partner its share of any gain at the partnership level.
Foreigners are subject to tax fully in the US on any “effectively connected US trade or business income” — basically income earned through a US office. A partner in a partnership is usually treated as engaged directly in whatever business the partnership is involved.
The Tax Court declined to follow this approach. It treated the partnership as if it were a separate company and treated Grecian as if it sold shares in the company. Any gain on sale of a partnership interest is normally taxed as capital gain. The only way a foreigner would be taxed on such a gain, the court said, is to the extent the gain can be traced to US real property or if the gain is considered from a US source. A partnership interest is “personal property,” the court said. Under US tax rules, gain from the sale of personal property has its source where the seller is located. Since this seller was in Greece, the court said, there should not have been any tax beyond the share of gain from US real property.