Appeals court sides with taxpayer in U.S. office rule case

Tax Hot Topics newsletter The D.C. Circuit Court of Appeals affirmed the Tax Court in Grecian Magnesite Mining v. Commissioner (No. 17-1268) on June 11, holding that for purposes of the U.S. office rule, the redemption of a U.S. partnership interest should be deemed to have taken place where it occurred rather than the location of the activities underlying appreciation of the redeemed interest.

The taxpayer in the case, Grecian Magnesite Mining (Grecian), is a privately held company incorporated and operated in Greece. In 2001, it acquired a 15% stake in Premier Chemicals, a Delaware limited liability company (LLC) which is classified as a partnership for federal tax purposes. Both companies specialize in mining, processing, and selling mineral magnesite, but Premier operates solely in the U.S. In July 2008, Grecian entered into an agreement with Premier to redeem its interest in the partnership. The redemption resulted in a gain of more than $6 million for Grecian, which was realized over two years. Grecian did not include any of the gain on its 2008 or 2009 tax returns. The IRS determined all of the gain was subject to U.S. tax and Grecian contested.

At issue in the Tax Court was whether the disputed gain was U.S.-source income and thus subject to U.S. tax. Under the Section 865(a), income from the sale of personal property is generally sourced where the taxpayer resides. However, the “U.S. office rule” exception under Section 865(e)(2)(A) provides that if a nonresident maintains an office or fixed place of business in the United States, income from the sale of personal property that is attributable to an office or fixed place of business is sourced domestically. Under Section 865(c)(5)(B), determining if income is attributable to an office or fixed place of business depends on whether the fixed place or business is a material factor in producing such income, gain or loss, or if it regularly carries on the type of activities from which such income, gain or loss is derived.

The Tax Court rejected the IRS’s argument that the disputed gain was attributable to Grecian through Premier’s U.S. office under the U.S. office rule since all of the activities that produced the gain occurred through Premier’s U.S. operations. Grecian did not dispute that it had a U.S. office through Premier. However, it countered that the partnership interest was a single, indivisible capital asset and thus not subject to the U.S. office rule. The Tax Court agreed. It also held for Grecian on a separate, alternative theory, but the IRS appealed only the holding related to the U.S. office rule.

In reviewing the decision, the D.C. Circuit determined that the focus of the U.S. office rule is transactions, not the appreciation of the assets. In applying this to the facts in the case, it held that the redemption transaction was unrelated to activity that Grecian’s U.S. office regularly carries on because Premier was in the mining business, not in the business of redemption. It acknowledged that although partnerships regularly carry on activities like redemptions, the U.S. office rule is concerned with the activities of the actual, physical office or fixed place of business rather than those of the corporate form.

The Tax Cuts and Jobs Act (TCJA) generally overturned the result of Grecian Magnesite with the enactment of Section 864(c)(8), which treats a non-resident alien’s gain of a partnership interest as effectively connected income. As a result, the decision’s impact may generally be limited to any sale, exchange, or disposition occurring before Nov. 27, 2017. For more coverage on the enactment of Section 864(c)(6), see our coverage here and here.
David Sites
Washington National Tax Office 
T +1 202 861 4104

David Zaiken
Managing Director
Washington National Tax Office 
T +1 202 521 1543

Cory Perry
Senior Manager
Washington National Tax Office 
T +1 202 521 1509

Mike Del Medico
Washington National Tax Office 
T +1 202 521 1522
Tax professional standards statement 
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.