by Monte Jackel
The Grecian Magnesite case, discussed here recently, could have collateral effects on the international tax rules for partnerships that go way beyond the specific issue before the Tax Court in the case.
If the import of the case is limited to sales or exchanges of partnership interests (the “narrow view”), then many (could be most) of the items discussed below would not be potentially at risk.
However, if the import of the case is that a partnership interest is a separate indivisible capital asset unless the Code provides otherwise for all other purposes of the Code and Regulations (the “broad view”), then many more items than those discussed below could be potentially impacted.
Potential regulations affected
The following is a brief discussion of regulations, principally in the international area, that could be affected by Grecian Magnesite depending on whether the broad or the narrow view of the case is adopted.
Reg. section 1.367(a)-1T(c)(3) relating to outbound stock transfers. This regulation treats a partnership as an aggregate of its partners in determining the applicability of section 367(a) to an outbound transfer of property to a foreign corporation. And reg. section 1.367(e)-1(b)(2), relating to section 355 outbound distributions, is a corresponding regulation.
Reg. section 1.871-14(g)(3) relating to the portfolio interest exemption being tested at the partner level. This regulation applies aggregate principles to treat the owner as the partner in testing for eligibility for the portfolio interest exemption.
Reg. sections 1.956-1T(b)(4)(i)(C), 1.956-1T(b)(5)(i) and 1.956-2(a)(3). These regulations generally treat a partner of a partnership as owning its share of US property held through a partnership in applying section 956.
Reg. section 1.1248-1(a)(4) relating to the sale of CFC stock by a foreign partnership with US partners. This regulation treats the US partners of a foreign partnership as selling the CFC shares actually sold by the partnership.
Reg. section 1.1502-13(c)(7), example 9, relating to the intercompany sale of a partnership interest where the partnership has a section 754 election in effect. This regulation treats a partnership as an aggregate in applying the matching rule of reg. section 1.1502-13(c).
Reg. section 1.861-9T(e) relating to the allocation of interest expense of a partnership. This regulation generally treats a partnership as an aggregate of its partners in allocating and apportioning the interest expense of a partner.
Reg. section 1.705-2 relating to the coordination of basis adjustments under sections 705 and 1032. This regulation essentially treats a partnership as an aggregate in applying section 1032 to avoid distortions in tax basis.
Reg. section 1.751-1(a)(2) relating to gain or loss under section 751 measured by what would occur on the sale of partnership assets. The issue here is whether this method of measurement of hot asset gain violates the principles of Grecian Magnesite.
Reg. section 1.267(b)-1(b), relating to treating a partnership as an aggregate in applying section 267.
Potential revenue rulings and other guidance
The following is a brief discussion of IRS revenue rulings and private letter rulings that could be affected by Grecian Magnesite, depending on whether the broad or the narrow view of the case is adopted.
Rev. Rul. 72-172 relating to the application of section 1239 on the sale or exchange of a partnership interest. This ruling applies aggregate principles in treating a sale of a partnership interest to a related party as a sale of depreciable property triggering section 1239 because the ruling treats the partnership as an aggregate of its partners.
Rev. Rul. 89-108 relating to the installment sale of a partnership interest where the partnership holds hot inventory. The ruling relies on treating a partnership as an aggregate when disallowing use of the installment method because, if the partner owned the inventory directly, the installment method of section 453 would not be allowed.
Rev. Rul. 89-85 relating to the intercompany sale of a partnership interest where a section 754 election is in effect. The guidance relies on treating the partnership as an aggregate. Aggregate treatment then triggers the matching rule of reg. section 1.1502-13 because the depreciation generated by the section 743(b) special basis adjustment had to be matched to the gain on the sale of the partnership interest. The holding of this ruling is now incorporated as reg. section 1.1502-13(c)(7), example 9.
Rev. Rul. 90-112, relating to a partner treated as owning its share of US assets owned by a partnership for purposes of section 956. This is another ruling that relies on aggregate principles. This principle is now incorporated into the section 956 regulations.
Rev. Rul. 99-57 relating to the sale of partner stock held by a partnership and the application of section 1032. This ruling also relies on treating a partnership as an aggregate. Aggregate treatment results in a partner who issued the stock being treated as selling its own stock when the partnership actually sells the stock and then applies appropriate tax basis adjustments.
Rev. Rul. 60-352 relating to the donation of a partnership interest to charity where the partnership holds hot assets. This ruling also relies on treating the partnership as an aggregate. By doing so, the assignment of income doctrine can then be applied as if the partner actually owned its share of partnership assets.
PLR 9651001 (June 27, 1996) This private letter ruling holds that aggregate treatment applies on the sale of a partnership interest where the partnership is engaged in an unrelated trade or business. As a result, section 514 applied on the sale of a partnership interest.
PLR 9142032 (July 23, 1991). The private letter ruling applies aggregate principles in applying the sourcing rules of section 865. Under the logic of Grecian Magnesite, section 865 would be applied based on entity principles so that a sale by a US resident would be US source income, regardless of whether the partnership has a foreign office.
Potential Case Law affected by Grecian Magnesite
The reasoning applied in Grecian Magnesite could also change the results of several earlier court cases.
Casel, 79 T.C. 424 (1982). This Court applies section 267 by treating a partnership as an aggregate of its partners. The result of this case is probably wrong after Grecian Magnesite.
Coggin, 115 T.C. 349 (2000), rev’d, 292 F.3d 1326 (11th Cir. 2002). The Tax Court applied the section 1363(d) LIFO inventory rule by treating a partnership as an aggregate of its partners in converting from a C to an S corporation. After Grecian Magnestie, the result of the Eleventh Circuit, which reversed the Tax Court, would appear to now be the position of the Tax Court on this issue.
Mingo, 773 F. 3d 629 (5th Cir. 2014). Here the Court refused to apply section 453 where the partnership held unrealized service receivables by treating a partnership as an aggregate of its partners. After Grecian Magnesite that will no longer be the case because the only statutory exception to section 453 relating to partnerships is in section 453(i), relating to depreciation recapture and depreciation recapture was not at issue in the case.
Some statutory provisions
Exempt organizations. Section 512(c)(1) and reg. 1.512(c)-1 provide that the distributive share of an exempt organization partner from a partnership engaged in an unrelated trade or business shall be subject to UBIT in the hands of the exempt partner.
PLR 9651001 (June 27, 1996) holds that aggregate treatment applies on the sale of a partnership interest where the partnership is engaged in an unrelated trade or business. This should be compared to section 512(e)(1)(B)(ii), which includes the disposition of S corporation stock where the S corporation is engaged in an unrelated trade or business as UBIT.
Given the holding of Grecian Magnesite, it is highly likely that the disposition by an exempt organization partner of its interest in a partnership would not be subject to UBIT (assuming there is no issue under section 512(b)(5) because the partnership holds hot assets under section 751 where the issue is unclear as to whether that type of income is taxable to either exempt partners or foreign partners, and is not affected by the Grecian Magnesite case which noted the exception in the statute for section 751).
Section 865(a), (d), (e), (f) (h) and (j). Section 865 would most likely have to be applied in most cases by applying entity principles only. Possible exceptions to entity treatment could be sections 865(b) (inventory property) and (c) (depreciable personal property) because those subsections reflect the treatment of unrealized receivables under section 751(c) and section 751 is an express exception noted in section 741 as per the Grecian Magnesite court. Section 865(i)(5) does not provide to the contrary because that provision was intended to be applied for transactions at the partnership level that are treated as occurring at the partner level. See, e.g., reg. 1.865-1(a)(5).
Sales or exchanges of partnership interests should be treated as a single indivisible capital asset that is personal property under Grecian Magnesite and should be treated, under the logic of the case, as a nondepreciable capital asset with no attribution of the attributes of the partnership to the partners on the sale of a partnership interest although the result under sections 865(b) and (c), as noted above, is unclear.
Section 954(c)(1)(B)(ii). This section already prescribes entity treatment on the sale of a partnership interest with an express exception under section 954(c)(4) for a so-called 25 percent owned partnership. For parallel rules, see reg. 1.904-5(h)(3).
