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TAX TRENDS

to the inventory gain. Rawat challenged … shall be treated as effectively con- of Sec. 865(b); it may therefore be U.S.-
the IRS’s determination in Tax Court. nected,” while under Sec. 864(c)(4)(A), source income.
In Tax Court, Rawat moved for sum- “no income … from sources without the Rawat contended that the inventory
mary judgment, arguing that under the United States shall be treated as effec- gain portion should be treated the same
decisions of the Tax Court and the D.C. tively connected.” as the noninventory portion because
Circuit in Grecian Magnesite Mining, With regard to the sourcing of the both portions were not “effectively con-
Industrial & Shipping Co., SA, 149 T.C. nonresident’s income, under Sec. 865(a) nected” to the energy drink business in
63 (2017), aff’d, 926 F.3d 819 (D.C. Cir. (2), “income from the sale of personal the United States. She claimed that this
2019), a nonresident alien individual is property [such as a partnership interest] result was dictated by “the most impor-
not subject to U.S. income tax on the … by a nonresident shall be sourced tant point in her motion,” which was
sale of the individual’s interest in a U.S. outside the United States.” However, that she sold a partnership interest and
partnership because those gains would inventory property is excepted from did not sell inventory. The IRS argued,
be sourced outside the United States this rule. Under 865(b)(2), in the case and the Tax Court agreed, that this was
under the general rule of Sec. 865(a)(2), of inventory property, “such income not true because the general approach
regardless of whether any portion of the shall be sourced under the rules of sec- of Sec. 741, which calls for the sold
gains would be attributable to inven- tions 861(a)(6), 862(a)(6), and 863.” partnership interest to be analyzed not
tory items under Sec. 751(a)(2). The Under Secs. 861(a)(6), 862(a)(6), and asset by asset but rather as a singular
IRS countered that the sourcing of the 863, income from the sale of inventory “capital asset,” gives way to the specific
inventory gain should instead be made property is sourced to the United States provision in Sec. 751(a)(2) that the
under the rules of Sec. 865(b). if it is sold within the United States. portion of the sold partnership interest
In Grecian Magnesite, the Tax attributable to inventory items must be
Applicable law Court and the D.C. Circuit held that, separately “considered” as pertaining
In general, if the owner of a partner- as a general rule, an entity approach to “other than a capital asset.” There-
ship interest sells that interest, Secs. should be taken in the sourcing analysis fore, the inventory gain was subject to
741 and 751 determine the income tax of gain realized by a foreign partner Sec. 751.
treatment of the sale. Sec. 741 provides upon disposing of its interest in a U.S. Rawat argued that the IRS’s argu-
that the owner’s gain or loss “shall be partnership and that the asset to be ment made unwarranted use of Sec.
considered as gain or loss from the sale considered in the analysis is the part- 751, which she asserted was not a
or exchange of a capital asset.” How- nership interest itself (which is the sub- sourcing rule. Rather, where the section
ever, Sec. 741 provides an exception to ject of the sale) and not the underlying applied, its only effect was to assure
this rule: “except as otherwise provided partnership assets. The IRS had argued noncapital treatment to the proceeds
in section 751 (relating to … inven- in that case that an aggregate approach of a sale if the proceeds are taxed at all.
tory items).” Sec. 751(a)(2) provides should be taken, that the gain should be The court noted that this was correct
an exception for inventory items of the analyzed asset by asset, and that, to the but that both Secs. 741 and 751 only
partnership. The amount of any money extent that the assets of the partnership defined the character of the property
received by a transferor partner in would give rise to effectively connected sold and the proceeds, and, to deter-
exchange for all or a part of its interest income if sold by the partnership, the mine the source, the sourcing rules in
in the partnership attributable to inven- departing partner’s pro rata share of Secs. 861 to 865 must be applied.
tory items of the partnership is consid- such gain should likewise be treated as The Tax Court explained that this
ered to be an amount realized from the effectively connected income. interpretation was supported by the
sale or exchange of property other than difference in language between Sec. 741
a capital asset. The Tax Court’s decision (which refers to the sale or exchange
U.S. federal income tax is imposed The Tax Court denied Rawat’s motion of a capital asset) and Sec. 751 (which
on nonresident alien individuals by for summary judgment. It held that refers to the sale or exchange of property
Sec. 871. Under Sec. 871(b)(2), a because the inventory gain was attrib- other than a capital asset). As it had ex-
nonresident alien is only taxable on utable to inventory items for purposes plained in its analysis in Grecian Mag-
income that is “effectively connected of Sec. 751(a)(2), it was excepted from nesite, this difference in language leads
with the conduct of a trade or business the general rule of Sec. 741. Therefore, to the conclusion that inventory gain
within the United States.” Under Sec. it was, for purposes of the sourcing is treated as the proceeds of the sale of
864(c)(3), “[a]ll income, gain, or loss rules, “income derived from the sale of separate interests in each asset of the
from sources within the United States inventory property” under the exception partnership under Sec. 751. According

52 April 2023 The Tax Adviser