Foreign Partners in US Business Get Tax Relief in New ECI Ruling

August 23, 2017

A major US tax court handed a victory to foreign investors in US business this summer, when it rejected the controversial IRS Ruling 91-32. The ruling, issued in 1991, allowed the IRS to treat a non-US partner’s gains from the disposition of an interest in a US partnership as ECI (income effectively connected to the trade or business).  ECI of a non-US person is subject to US income tax and an additional 30 percent branch profits tax.

In Grecian Magnesite Mining, Industrial & Shipping Co. SA v. Commissioner, the court ruled that treating the redemption gains of a non-US partner as ECI directly contradicts the general rule of Section 741, which states that capital asset dispositions by non-US persons are not subject to US tax.

Entity vs. Aggregation

At the core of the Grecian case was the question of whether a foreign partner’s liquidation of its interest in a US partnership should be governed by the “entity” approach (gains arise from the sale of a single asset) or the IRS’s long-held “aggregation” approach.

The court agreed with the taxpayer’s “entity” argument that redemption gain relates to a single asset, not effectively connected to a US trade or business. Therefore, the disposition of the partnership interest should be treated as a capital gain, not ECI.

IRS Appeal Uncertain

It is important to note that the “aggregation” theory, supported by the IRS, has no statutory basis and relies solely on section 865(e)(2)(A).  If the IRS appeals the Grecian decision, it would need to establish a statutory basis to support its position.

The results will have far-reaching consequences beyond the issue of foreign partner redemption gains, as the IRS relies on the aggregate principle for the majority of their rules and regulations, particularly those that affect international tax.

Exceptions to the Ruling

The Grecian findings do not apply to gains from the disposition of a partnership interest in US real property, which will continue to be treated as ECI under statutory guidance.  Partnership profits that flow through to a non-US partner are also unaffected and will remain subject to ECI rules.

Unprecedented Tax Strategies

Prior to Grecian, adverse tax consequences for non-US partners were usually avoided by interposing a US corporation between the foreign investor and the US partnership. While this strategy protects the foreign investor from US income tax and filing obligations, the exit tolls (in the form of US corporate income taxes) are significant.

If the court’s decision is not challenged by the IRS or is upheld on appeal, non-US partners and private equity funds with foreign investors will realize unprecedented tax planning opportunities, as well as greater after-tax returns.

For more information, please contact Curtis Best, Partner in the Marks Paneth International Tax Group, at

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