1 4 9 T.C. No . 3

UNITED STATES TAX COURT

GRECIAN M AGNESITE M INING, INDUSTRIAL & SHIPPING CO., SA, Pet i t i o n er v . COM M ISSIONER OF INTERNAL REVENUE, Res po n d en t

Do ck etNo . 1 9 2 15 -1 2
. Fi l edJ u l y 1 3, 2 0 17
.

In 2 0 0 1 P, a fo rei g n co rp o rat i o n , p u rch as edan i n t eres ti n PS, a U.S. l i m i t edl i ab i li ty

co m p an y th atwas treat edas a p artn ers h i p fo r U.S. i n co m e t ax p u rp o s es . Fro m 2 00 1 t o 2 0 0 8 i n co m e was al lo cat ed t o P fro m PS, an d P p ai di n co m e t ax i n th e Un i t edSt at es . In 2 0 0 8 P’ s i n t eres twas red eem edb y PS, an dP recei v edtwo l i qui d at i n g p aym en t s , o n e i n J u l y

2 0 0 8 an dth e s eco n d i n J an u ary 2 0 0 9 b ut d eem edt o h av e b een m ad e o n Decem b er 3 1 , 2 0 0 8 . P real i zedg ai n t o t al i n g o v er $ 6
. 2 m il l io n , o f wh ich $ 2 .2 m il l i o n was d eem ed at tri bu tab l e t o U.S. real p ro p ert y i n t eres t s (an dwh i ch P n o w co n ced es i s t ax ab l e i n co m e). P co n t en ds th at th e rem ai n d er--“ d i s p u t edg ai n” o f $ 4 m i l l i o n--i s n o t t ax ab le fo r U.S. p u rp os es . P t im el y fi l eda Fo rm 1 1 2 0 -F, “ U.S. In co m e Tax Retu rn o f a Fo rei g n Co rp o rat i o n ”, fo r 2 0 0 8 , wh erei n i t rep o rt edi t s d i s tri b u t i v e s h are o f PS’ s i n co m e, g ai n, l o s s , d edu ct i on s , an dcred i t s , b u td i d n o trep o rtan y i n co m e i trecei v ed fro m th e red em

p t i o n o f i t s p artners hi p i n t eres t(i
. e., n ei th er t h e n o w co n ced ed real es t at e g ai n n o r t h e d i s p u t ed g ai n). P d idn o t fi l e a retu rn o r p ay

an y i n co m e t ax i n th e Un i t edSt at es fo r 2 00 9 . P’ s- 2
-

rep o rt i n g p o s i t i o n was reco m m en d edt o i tb y

an ex p eri en cedcert i fi ed p ub l i c acco u n tan t(“ C.P.A.”) wh o was reco m m en d edt o P b y

i t s U.S. l awy er. R p rep areda s ub s t i tu t e fo r retu rn p u rs u an tt o I.R.C. s ec. 6 0 2 0 (b ) fo r P’ s 2 0 0 9 y ear, an di s su eda n o t i ce o f d efi ci en cy fo r 2 0 0 8 an d 2 0 09 , d et erm i n i n g , i n t er al ia, t h atP m u s treco g n i ze i ts g ai n o n th e red em

p t i o n o f i t s p art n ers hi p i n teres tfo r U.S. t ax p u rp o s es as U.S.-s o u rce i nco m e t h atwas effect i v el y co nn ect edwi th a U.S. trad e o r b u s i n es s , co n s i s t en twi t h Rev . Ru l
. 9 1 -3 2 . P t i m el y fi l eda p et i t i o n wi th thi s Co u rt
. Hel d : P’ s d i sp u tedg ai n was cap i t al g ai n th atwas n o t U.S.-s o u rce i nco m e an dth atwas n o t effect i v el y co nn ect edwi th a U.S. trad e o r b u s i n es s . Th i s Co u rtwi l l n o t fo ll ow Rev
. Ru l . 9 1 -3 2 . P i s th erefo re n o tl i ab l e fo r U.S. i n co m e t ax o n th e d i sp u tedg ai n . Hel d , fu rt h er, as t o th e n o w-co n ced edt ax l i ab i l i ty fo r g ai n o n th e real es t at e, P i s n o tl iab l e fo r t h e I.R.C. s ec. 6 6 6 2 (a) p en al ty fo r 2 0 0 8 o r t h e ad di t i o n s t o t ax u n d er I.R.C. s ec. 6 6 51 (a)(1 ) an d (2 ) fo r 2 0 0 9 , b ecau s e P reas on ab l y rel i edo n th e erro n eo u s ad v i ce o f t h e C.P.A.

M i ch ael J . M i l l er an d El l en S. Bro dy , fo r p et i t i o n er. Gret ch en A. Ki n d el an dEm i l y J . Gi o m et t i , fo r res p o n d en t
.- 3
- CONTENTS FINDINGS OF FACT
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 GM M
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Prem i er . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 Red em p t i o n o f GM M ’ s m em

b ers h i p i n t eres t i n Prem i er . . . . . . . . . . . . . . . 7 Pro fes s i o n al ad v i ce. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Tax retu rn s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 0 IRS’ s d et erm i nat i o n o f i n co m e t ax l i ab i l i ty . . . . . . . . . . . . . . . . . . . . . . . . . 1 1 OPINION
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2 I. Bu rd en o f p ro of
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 2 II. Gen eral l eg al p ri n ci p les
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 3 A. Bas i c p ri n ci p l es o f U.S. t ax at i o n o f i n t ern at i o n al tran s act io n s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 3 B. Bas i c p ri n ci p l es o f p art n ers h i p t ax at i o n . . . . . . . . . . . . . . . . . 1 4 III. An al y s i s as t o g ai n fro m real es t at e . . . . . . . . . . . . . . . . . . . . . . . . . . 1 7 IV. An al y s i s as t o d is p u tedg ai n . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 9 A. Th e n atu re o f t h e i n co m e u n d er s ub ch ap t er K
. . . . . . . . . . . . 2 0 B. Effect i v e co n n ect i o n o f d i s p u t edg ai n . . . . . . . . . . . . . . . . . . . 3 1 1
. Rev . Ru l . 9 1 -3 2
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 3 2
. Th e d efau l ts o u rce ru l e an dth e “ U.S. o ffi ce ru l e” ex cep ti o n . . . . . . . . . . . . . . . . . . . . . 3 5 3
. At tri b u t i on o f t h e red em p t i o n o f GM M’ s i n t eres t
. . . . 3 7
a. Wh et h er Prem ier’ s U.S. o ffi ce was a m at eri al fact or i n th e p ro du ct i o n o f GM M ’ s d i s p ut edg ai n . . . . . . . . . . . . . . . . . . . . . 3 8 b
. Wh et h er GM M ’ s d i sp u tedg ai n was real i zed i n th e o rd i n ary co urs e o f Prem i er’ s b u s in es s . . . 4 4 V. Pen al t ies
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 7- 4
- A. Ap p li cab i l i ty

o f accu racy -rel at edp en al ty fo r 2 0 0 8
. . . . . . . . 4 8 B. Ap p li cab i l i ty

o f fai l u re-t o-fi l e an dfai l u re-t o-p ay ad d i t i o n s t o t ax fo r 2 00 9
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 8 C. Reas on ab l e cau s e d efen s es . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 0 1
. Reas on ab l e cau s e fo r fai l u re t o fi l e an d fai l u re t o p ay . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 0 2
. Reas on ab l e cau s e fo r an u n d erp aym en t
. . . . . . . . . . . . 5 1 3
. GM M ’ s rel i an ce o n p ro fes s i o n al ad v i ce . . . . . . . . . . . . 5 3 GUSTAFSON, Jud ge: Pu rs u an tt o s ect i o n 6 2 12 (a), 1 th e In t ern al Rev en u e Serv i ce (“ IRS”) d et erm i n edd efi ci en ci es i n i n co m e t ax fo r p et i t i o n er, Greci an M ag n es it e M i n in g (“ GM M ”), o f $ 3 2 2 ,0 5 6 fo r 2 0 0 8 an d$ 1 ,7 8 0 ,5 6 3 fo r 2 0 0 9 . Th e
s t atu to ry n o t i ce o f d efi ci en cy

(“ SNOD”) i s s u edt o GM M o n M ay 3 , 2 0 1 2 , res u l t ed fro m th e IRS’ s d et erm i n at i on th atGM M m u s treco g n i ze as i n co m e, fo r t h e p u rp os e o f t ax at io n wi th i n th e Un i t edSt at es , th e g ai n i treal izedo n th e red em p t io n
o f i t s i n t eres t i n Prem i er Ch em i cal s , LLC (“ Prem i er”). Th e IRS al s o d et erm i n ed th atGM M i s l i ab l e fo r an accu racy -rel at edp en al ty u n d er s ect io n 6 66 2 (a) fo r 2 0 0 8
an d i s l i ab le fo r ad d i t i o n s t o t ax fo r fai l ure t o t i m el y fi l e an dp ay

u n d er

1 Un l es s o th erwi s e i nd i cat ed , al l s ect i o n referen ces are t o th e In t ern al Rev enu e Co de (2 6 U.S.C., “ the Co d e”) i n effect fo r t h e y ears ati s s u e, an dal l Ru l e referen ces are t o th e Tax Co u rtRu l es o f Pract i ce an dPro cedu re. Do l lar an d p ercen t ag e am o u n t s are b ro ad l y ro u n d ed
.- 5
-

s ect i on 6 6 5 1 (a)(1 ) an d (2 ) fo r 2 0 0 9 . GM M t i m el y p et i t i o n edthi s Co u rt , p u rs u an t t o s ect io n 6 2 1 3 (a), fo r red et erm i n at i o n o f th es e l i ab i l i t i es . A p o rt io n o f t h e g ai n th atGM M real i zed fro m th e red em

p t i o n o f i t s p art n ers hi p i n t eres ti n Prem i er p ert ai n edt o Prem i er’ s U.S. real p ro p ert y i n t eres t s , an d GM M h as n ow co n ced edth atth i s p o rt i o n i s s ub ject t o U.S. i n co m e t ax . St i l l i n d i s p u t e, h o wev er, i s t h e rem ai n d er o f t h e g ai n , wh i ch i s n o tat tri b ut ab l e t o real p ro p erty (“ th e d i s pu t edg ai n ”). Acco rd in g l y , th e i s s u es fo r d eci si on are: (1 ) wh et h er t h e d i s pu t edg ai n was U.S.-s o u rce i n co m e an d was effect i v el y
co n nect edwi th a U.S. trad e o r b u s i n es s (we h o l dth ati twas n o t U.S.-s o urce i n co m e an d was n o t effect i v el y co nn ect edwi th a U.S. trad e o r b u si nes s ) an d(2 ) wh et h er, t o th e ex t en tGM M i s s ub jectt o t ax , GM M i s l i ab le fo r ad d it i on s t o t ax
u n d er s ect i o n 6 6 5 1 (a)(1 ) an d(2 ) an dfo r a p en al ty p u rs uan tt o s ect i o n 6 6 62 (a) (we h o l dth atGM M i s n o tl i ab l e fo r an y ad d i t i o n s t o t ax o r p en al ty ). 2

2 W e n eedn o t d eci d e t h e effect o f t h e U.S.-Greece t ax treat y --Co n ven t i o n fo r th e Av o i d an ce o f Do ub l e Tax at i o n an d th e Prev en t i o n o f Fi s cal Ev as i o n wi th res p ectt o Tax es o n In co m e, Greece-U.S., Feb ru ary 2 0 , 1 95 0 , T.I.A.S. No . 2 9 0 2. GM M co n t en d s thatev en i f U.S l aw o th erwi s e i m p o s es the t ax l i ab i l i t i es ati s s ue h ere, t h e t reat y

s upers ed es an del i m i n at es th e l i ab il i t i es . Becau s e we h o ldth atth e d i s p u t edg ai n i s n ott ax ab l e b y th e Un i t ed St at es u nd er o u r d o m es t i c l aw, we n eed n o tco ns i d er GM M ’ s treat y -b as edarg u m en t . Th e Co m m i s s i on er d o es n o tco n t en d th atth e treat y

i m p o s es an y U.S. t ax b ey o n d wh ato u r d o m es t i c l aw i m p o s es .- 6
- FINDINGS OF FACT GM M Atth e t im e GM M fi l edi t s p et i t i on , i t s p ri n ci p al p l ace o f b u s in es s was Ath en s , Greece. GM M i s a p ri v at el y o wn ed fo rei g n co rp o rat i o n thatwas
es t ab l i s h edi n 1 9 5 9 an d was o rg an i zedu n d er t h e l aws o f Greece (o ffi ci al l y th e Hel l en i c Rep ub li c). GM M ’ s b u s i nes s i n cl ud es ex tract i n g , p ro du ci n g , an d
co m m erci al i zi n g m ag nes i a an dm ag n es i t e, wh i ch i ts el l s t o cu s t o m ers aro u n dth e
wo rl d . M ag n es i t e i s a m i n eral th ati s u s edi n a v ari et y o f co m m erci al ap p l icat i o n s . GM M o wn s m ag n es i t e d ep o s i t s i n Greece, h as a res earch an dd ev el o p m en tfaci l i t y i n Greece, an dh as an o ffi ce i n Greece. Ot h er t h an th ro u gh i t s o wn ers h i p i n t eres t i n Prem ier, GM M h ad n o o ffi ce, em p l o y ees , o r b u s i n es s o p erat io n i n the Un i t ed St at es . Fo r U.S. t ax pu rp o s es , GM M u s eda cas h b as i s m et h o do f acco u nt i n g . Prem ier Prem i er 3 i s a l i m i t edl i ab i l i ty co m p an y fo rm edi n the St at e o f Del aware. Prem ier i s i n th e b u s in es s o f ex tract i n g, p ro du ci n g , an dd i s tri b u t i n g m ag n es i t e wh i ch i tm i n es o r ex tract s i n th e Un i t edSt at es . Duri ng th e y ears i n i s s u e, th e
o ffi ce o f Prem i er’ s h ead qu art ers was i n Pen n s y l v an i a, an di to wn edm i nes o r

3 Prem i er was o rg an i zedas Prem i er Ch em i cal s , LLC, i n J an u ary 2 0 0 1 , an di t i s n o w kn o wn as Prem i er M ag nes i a, LLC.- 7
-

i n du s tri al p ro p ert i es i n v ari o u s St at es , i n cl u d in g Nev ad a, Fl o ri da, an d Pen ns y lv an i a. Fo r al l th e y ears i n i s s u e, Prem i er was treat edas a p art ners h i p fo r U.S. i n co m e t ax p u rp o s es . GM M en tered i n t o an o p erat in g ag reem en twi th Prem i er an dPrem i er’ s o t h er
m em b ers i n M arch 2 0 0 1 . GM M m ad e an i n it i al cap i tal co n tri b u t i o n t o Prem i er o f $ 1 .8 m i l l i o n i n ex ch an g e fo r a 1 5 % i n t eres ti n Prem ier. Acco rd i n g l y , fro m M arch 2 0 0 1 t o Feb ru ary

2 00 7 Prem i er al l ocat edt o GM M a d i s tri b u ti v e s h are o f 1 5 % o f Prem ier’ s i n co m e, g ai n , l o s s, an dd educt i o n s . In2 0 07 an o th er co rp o rat i o n
co n tri b u t edp ro p ert y

t o Prem ier i n ex ch an g e fo r a 1 5 % m em b ers h ip i n t eres t , an d th ereaft er GM M ’ s m em

bers h i p i n t eres ti n Prem i er (an dco n s equ en t l y GM M ’ s d i s tri b u t i v e s h are) was redu cedt o 1 2 .6 %. Red em p t i o n o f GM M ’ s m em

b ers h i p i n t eres t i n Prem i er In 2 0 0 8 o ne o f Prem i er’ s m em bers , IM i n Part n ers (“ IM i n”) ap pro ach ed Prem ier an d o ffered t o s el l Prem i er i t s en t i re m em b ers h i p i n t eres tfo r $ 1 0 m i l l i o n . Prem ier accep t ed IM i n ’ s o ffer. As a res u l t o f accep t i n g IM i n ’ s o ffer, Prem i er was
o b l i g at edt o o ffer t o p u rch as e each m em b er’ s i n t eres tfo r t h e s am e p ro rat a p ri ce th atPrem i er h adp ai dt o IM i n. GM M was th e o nl y o th er p art n er t h at ch o s e t o s el l i t s i n t eres t
.- 8
-

OnJ u ly 2 1 , 2 0 08 , GM M en t eredi n t o an ag reem en t fo r Prem ier t o red eem i t s 1 2 .6 % i n t eres ti n Prem i er fo r $ 1 0 .6 m i l l i o n ; th e red em pt i o n was t o b e effect edb y two equ al tran s act i o n s . GM M recei v edth e fi rs tp aym en to f $ 5
. 3 m i ll i on o n J u l y 3 1 , 2 0 0 8 , i n ex ch an g e fo r h al f o f i t s m em b ers h i p i n t eres t. On J ul y 3 1 , 2 00 8 , GM M’ s ad

ju s t edb as is i n i t s m em

b ers h i p i n t eres twas $ 4
. 3 m i ll i on , 4 an di treal i zed $ 1 m i l l i o n o f g ai n o n th e fi rs t red em p t i on p aym en t . Al s o o n J u l y 3 1 , 2 0 08 , Prem ier red eem edIM i n ’ s en t i re m em bers hi p i n t eres t --wh i ch cau s ed the rem ai n i n g p art n ers ’ m em

bers h i p i n t eres t s (i n cl u d i n g GM M ’ s ) t o i n creas e p ro p o rt i o n al l y . As o f Decem

ber 3 1 , 2 0 0 8 (ju s tb efo re t h e ex ch an g e o f i t s rem ai n i n g
m em b ers h i p i n t eres ti n Prem i er), GM M ’ s ad ju s t edb as is i n the rem ai n in g p o rt i o n
o f i t s i n t eres t was $ 5 5 , 0 0 0 . OnJ anu ary 2 , 2 0 0 9 , GM M recei v edth e s eco n d p aym en t o f $ 5 .3 m i l l i o n fro m Prem i er i n ex ch an g e fo r i t s rem ai n i n g m em b ers h i p i n t eres t , real i zi n g g ai n o f o ver $ 5 .2 m i l l i o n . Prem i er an d GM M ag reedth atth e effect i v e d at e o f t h e fi n al tran s fer o f GM M ’ s i nt eres t i n Prem i er was d eem edt o b e

4 GM M ’ s ad

ju s t edb as i s i n i ts m em

bers h i p i nt eres t i n creas ed an d d ecreas ed b et ween 2 0 0 1 an d2 0 0 8 o n t h e b as i s o f t ax i t em s wh i ch fl o w edth ro u g h fro m Prem ier t o GM M , an d o n acco u n to f a d eb to f Prem i er’ s thatGM M g u aran t eed
. GM M’ s fu ll b as i s i n i t s m em b ers h i p i n t eres t was $ 4 .3 m i l l i o n o n J ul y 3 1 , 2 0 0 8 , an d th e ad d i t io n al $ 5 5 ,0 0 0 o f b as i s wh i ch was s ub seq u en t l y u s ed ag ai ns tth e s eco n dred em

p t io n p aym en twas a res u l to f i nco m e Prem i er real izedi n t h e s eco n d h al f o f 2 0 0 8 an d al l o cat edt o GM M i n acco rd an ce wi th th e l at t er’ s equi ty i n t eres t p ercen t ag e.- 9
-

Decem b er 3 1 , 2 0 08 , an dth atGM M wo u l dn o tth ereaft er s h are i n an y p ro fi t s o r l o s s es i n Prem i er o r o th erwi s e b e d eem eda m em b er o f Prem i er. 5 Th e p art i es al s o ag ree t h at , o f the $ 6.2 m i l li o n o f g ai n th atGM M real i zedi n th e t wo p aym en t s , $ 2 .2 m i l l i o n (i .e., th e en t i re $ 1 m i l l i on o f t h e fi rs tp aym en tan d$ 1 .2 m i l l i o n o f t h e
s eco n d ) was at tri b u t ab le t o Prem i er’ s U.S. real es t at e. Pro fes s i on al ad v i ce In 2 0 0 1 GM M h i redat t orn ey J o hn Ph u fas t o h an dl e al l o f i t s l eg al b u s i n es s
an d t ax o b li g at i o n s i n t h e Un i t edSt at es , i n cl u d i n g i ts i n v es t m en t i n Prem i er. M r. Ph u fas l at er referred GM M t o El i h uRo s e fo r t ax retu rn p rep arat i o n . M r. Ro s e was a cert ifi edp ub l i c acco u n t an twi th n u m ero u s p artn ers h i p cl i en t s wh o s e ret u rn s h e reg u l arl y p rep ared , b u t GM M was h i s fi rs tn on -U.S. cl ien t . M r. Ro s e t h ereaft er p rep aredGM M ’ s U.S. i nco m e t ax retu rn s fo r 2 0 0 3 th ro u g h 2 0 0 8 . M r. Ro s e recei v edfro m

Prem i er Sch edu les K-1 , “ Part n er’ s Sh are o f In co m e, Dedu ct i o n s , Cred i t s , et c.”, o n b eh al f o f GM M an dco n s u l t edwi th Prem i er reg ard i ng th os e fo rm s . Wh en n eces s ary , M r. Ro s e as k edPrem i er fo r s up p lem en t al i n fo rm at i o n i n
o rd er t o p rep are GM M ’ s retu rn s .

5 As b et ween GM M an d Prem ier, t h e s eco n dp aym en t was d eem edm ad e i n Decem b er 2 0 0 8
. Bu ti n fact th e p aym en twas m ad e i n J an uary2 0 0 9; an dGM M an d th e Co m

m i s s i o n er ag ree t h at , t o th e ex t en tth e s eco n dp aym en t i s t ax ab l e i n co m e t o GM M , i t i s t ax ab l e fo r 2 0 0 9
.- 1 0 -

Tax retu rn s W i th i t s 2 0 0 8 Fo rm

1 0 6 5 , “ U.S. Return o f Part n ers h i p In co m e”, Prem i er i n cl u d eda Sch edu l e K-1 fo r GM M th atrep ort edGM M ’ s s h are o f Prem i er’ s i n co m e, g ai n , l o s s , d edu ct i on s , an dcred i t s fo r 2 0 0 8 . Co n s i st en twi th th at Sch edu l e K-1 , M r. Ro s e p rep aredan dGM M t i m el y fi l eda Fo rm 1 1 2 0 -F, “ U.S. In co m e Tax Return o f a Fo rei g n Co rp o rat i on ”, fo r 2 0 08 , o n wh i ch GM M rep o rt ed i t s d i s tri b u ti v e s h are o f Prem i er’ s i n co m e, g ai n , l o s s , d edu ct i o n s, an d cred i t s . Ho wev er, p u rs uan tt o M r. Ro s e’ s ad v i ce, GM M d i d n o trep o rto n that2 0 0 8 retu rn
an y o f t h e g ai n i th adreal i zedth aty ear o n t h e red em p t i o n o f i t s i nt eres ti n Prem ier--t h ati s , n ei th er t h e g ai n at tri b u t ab le t o th e U.S. real es t at e n o r t h e res to f th e g ai n . W i th i t s 2 0 0 9 Fo rm

1 0 6 5 , Prem i er i n cl u d eda Sch edu le K-1 fo r GM M th at rep o rt eda zero b al an ce i n GM M ’ s cap i tal acco un tan d , co n s i s t en twi th th e ag reem en tb et ween GM M an dPrem i er t h at th e red em p t i o n o f GM M ’ s en t i re i n t eres twas effect i v e as o f Decem b er 3 1 , 2 0 0 8 , d i dn o tat tri b u te t o GM M an y i n co m e, g ai n , l o s s , d edu ct i on s , o r cred i t s fo r 2 0 09 . Pu rs u an tt o M r. Ro s e’ s ad v i ce, GM M d i d n o t fi le a ret u rn fo r 2 0 0 9
.- 1 1 -

IRS’ s d et erm i nat i o n o f i n co m e t ax l i ab i l i ty Th e IRS co ndu ct edan au d i tfo r GM M ’ s 2 0 0 8 an d2 0 0 9 t ax y ears . Pu rs u an t t o s ect io n 6 2 1 2 (a), t h e IRS d et erm i n edd efi ci en ci es i n GM M ’ s U.S. i n co m e t ax fo r th o s e y ears . Fo r 2 0 0 9 th e IRS p rep ared a s ubs t i tu te fo r retu rnp u rs u an tt o
s ect i on 6 0 2 0 (b ); an do n M ay 3 , 2 0 1 2 , the IRS i ss u edan SNOD t o GM M fo r b o t h y ears . Th e SNOD d et erm i n edth atGM M s h ou l dh av e reco g n i zedU.S.-s ou rce cap i t al g ai n n eti n co m e o f $ 1 m i l l i o n fo r 2 0 0 8 an d $ 5 .2 m i l l i o n fo r 2 0 0 9 fro m th e red em pt i o n o f i t s i n t eres ti n Prem i er. Th os e d et erm i n at i o n s were b as edo n th e IRS’ s co n cl u s i o n th at , as a res u l to f GM M 's m em b ers h i p i n t eres ti n Prem i er, GM M’ s cap i tal g ai n was effect i v el y co n nect edwi th a t rad e o r b u s i n es s en g ag edi n wi th i n th e Un i t edSt at es . 6 Th e SNOD al s o d et erm in edth atfo r 2 0 08 GM M was l i ab l e fo r an accu racy -rel at edp en al ty an dfo r 2 0 0 9 was l i ab l e fo r ad d i t i o n s t o t ax
u n d er s ect i o n 6 6 5 1 (a)(1 ) an d(2 ) fo r fai l ure t o t i m el y fi l e a ret u rn an dfai l u re t o t i m el y pay

th e t ax s ho wno n t h e SFR. Th e p art i es n o w ag ree t h atth e $ 1 m i l l i o n g ai n t h atGM M real i zedfo r 2 0 0 8 fro m th e fi rs tp aym en t an d$ 1 .2 m i l l i o n o f th e g ai n i t real i zedfo r 2 0 0 9 fro m th e

6 Th e o n ly o th er ad j u s t m en t th e IRS m ad e t o GM M ’ s Fo rm 1 12 0 -F fo r 2 0 0 8 (ap artfro m

th e p ro p o s edg ai n o n the red em p t i o n o f i ts p art n ers hi p i n t eres t ) was an i n creas e i n al l o wab l e d edu ct i o n s u n der s ect io n 1 99 th atari s es au t o m at i cal l y o n acco u n t of an i n creas e i n t ax ab l e i n co m e fro m th e g ai n o n th e red em

p t io n .- 1 2 -

s eco n dp aym en tare at tri b u t ab l e t o th e s al e o f U.S. real p ro p erty p u rs uan tt o
s ect i on 8 9 7 (g ) an dare t h u s co ns i d eredU.S.-s o u rce i n co m e effect i v el y co nn ect ed wi th GM M ’ s U.S. trad e o r b u s i n es s . Th e p art i es d i s p u t e wh et h er th e rem ai n i n g g ai n fro m th e red em

p t i o n o f GM M ’ s i n t eres t i n Prem i er, ap p ro x im at el y $ 4 m i l li o n, i s U.S.-s o u rce i n co m e t h at is effect i v el y co n n ect edwi th a t rad e o r b u si n es s i n th e Un i ted St at es an dth ereb y s ub j ectt o t ax at i o n i n t h e Un i t edSt at es . OPINION I. Bu rd en o f p ro of In g en eral , th e IRS’ s n ot i ce o f d efi ci en cy i s p res u m edco rrect , “ an d th e p et i t i o n er h as th e b u rd en o f p ro v i n g i tt o b e wro n g ”. W el ch v . Hel v eri n g , 2 9 0 U.S. 1 1 1 , 1 1 5 (1 9 3 3 ); s ee al s o Ru l e 1 4 2 (a). 7 In cas es i n v o l v in g u n rep o rt ed i n co m e, “b efo re t he Co m m is s i o n er can rel y

o n th i s p res u m

p t i o n o f co rrect n es s , th e Co m m i s s i o n er m

u s to ffer s o m e s ubs t an ti v e ev i d en ce s ho wi n g th atth e t ax p ay er recei v edi n co m e fro m

th e ch arg edact i v i ty .” W ei m ers k i rch v . Co m m i s s i o n er, 5 9 6 F.2 d3 5 8 , 3 6 0 (9 th Ci r. 1 9 7 9 ), rev ’ g 6 7 T.C. 6 7 2 (1 97 7 ). Th e p art i es h av e
s t ip u l at edth atthe am o u nt s l i s t edas cap i t al g ai n o n th e SNOD are t h e am o u n t s

7 Th e Co m

m i ss i o n er s eem s t o as s ertth atu n der s ect i o n 7 4 9 1 (c) h e b ears th e b u rd eno f p ro du ct i o n as t o p en al ty ; b u t thatp ro v is i on ap p l i es o n l y “ w i th res p ect t o th e l i ab i l i ty

o f an y i n d i v i du al fo r an y

p en al ty ”. (Em

p has i s ad d ed .) See NT, In c. v . Co m m i s s i o n er, 1 2 6 T.C. 1 9 1 , 1 9 4 -1 9 5 (2 0 0 6).- 1 3 -

GM M real i zedo n th e red em p t i o n fo r b ot h y ears , s o the Co m m i s s i o n er h as m ad e th e req u i red s ho w i n g , an dthe b u rd en o f p ro o f i s o n GM M
. II. Gen eral l eg al p ri n ci p l es Th i s cas e ari s es atth e i n t ers ect i o n o f t w o areas o f t ax l aw--i
. e., p art n ers h i p t ax at io n (s ub ch ap t er K o f t h e Co d e) an dU.S. t ax at i o n o f i n t ern at i on al tran s act i o n s (s ub ch ap t er N o f t h e Co de). W e s t at e fi rs tth e rel ev an t g en eral p ri n ci p l es o f each
o f t h o s e areas b efo re an al y zi n g th ei r i n t eract i o n i n th e ci rcu m s tan ces o f t hi s cas e. A. Bas i c p ri n ci pl es o f U.S. t ax at i o n o f i n t ern at i o n al tran sact i o n s Th e Co d e p ro v i d es fo r U.S. t ax at i o n o f t h e i n co m e o f a fo rei g n co rp o rat i o n 8 i f ei th er: (1 ) u n der s ect i o n 8 8 1 th ati n co m e i s “ recei v ed fro m s o urces wi th i n th e Un i ted St at es ” (i .e., i s “ U .S.-s o u rce i n co m e”), s ec. 8 8 1 (a), an d i s o n e o f s ev eral k i n d s o f i n co m e, i n cl u d in g “ fi x edo r d et erm i n ab l e an n u al o r p eri o d i c” i n co m e (i
. e.,

“ FDAP i n co m e”), s ec. 8 8 1(a)(1 ) o r (2 ) u n d er s ect i o n 8 8 2 the i n co m e o f a “ fo rei gn
co rp o rat i o n en gag ed i n trad e o r b u s i n es s wi th in th e Un it edSt at es duri n g the

8 Sect i o n 7 7 0 1(a)(5 ) d efi n es a fo rei g n co rp o rat i o n as o n e t h ati s “ no t d o m es t ic.” Sect i o n 7 7 0 1(a)(4 ) ex p l ai n s th at“ ‘ d o m es t i c’ wh en ap p l i edt o a co rp o rat i o n o r p artners h i p m ean s creat edo r o rg an i zedi n th e Un i tedSt at es o r u n d er t h e l aw o f the Un i t edSt at es o r o f an y St at e u n l es s , i n th e cas e o f a p art n ers hi p , th e Secret ary p ro v i d es o th erwi s e b y

reg u l at i o ns .”- 1 4 -

t ax ab l e y ear” i s “ effect i v el y co n n ect edwi th th e co n du cto f” th attrad e o r b u s i n es s . 9 Th e Co m m i ss i o n er d o es n o tco n t en dth atth e d i s pu t ed g ai n i s i nco m e o f th e s o rt ad dres s edb y

s ect io n 8 8 1, an dwe can th erefo re fo cu s o n s ect i o n 8 8 2 an dth e qu es ti o n wh et her GM M ’ s g ai n was effect i v el y co n n ect edwi th a U.S. trad e o r b u s i n es s o f GM M. B. Bas i c p ri n ci pl es o f p art n ers h i p t ax at i o n Sect io n 7 0 1 p ro v i d es : “ A p art n ers h i p * * * s h al l n o tb e s ub jectt o th e i n co m e t ax i m

p os edb y th i s ch ap t er. Pers on s carry i n g o n b u s i n es s as p art n ers s h al l b e l i ab l e fo r i n co m e t ax o n l y i n th ei r s ep arat e o r i n d i v i du al cap aci t ies .” In d et erm i n i n g i t s i n d i v i du al i nco m e t ax , each p art n er m u s ts ep arat el y

i n cl ud e i t s d i s tri b u t i v e s h are o f th e en t i ty ’ s t ax ab l e i n co m e o r l o s s , s ec. 7 0 2 (a), an dth e p art n ers hi p ’ s i nco m e i s t ax ab l e t o th e p art n er t o the ex t en to f i t s d i s tri b ut i ve s h are,
s ec. 7 0 2(c). In th is co n t ex t , th e p art n ers h i p i s co n cei vedo f n otas h av i n g i t s o wn d i s t i n ctl eg al ex is t en ce b u ts i m p l y as b ei n g an “ ag g reg at io n ” o f t h e p art n ers .

9 Sect i o n 8 7 5 (1 ) p ro v id es : “ [A] n o n res i d en tal i en i n d i vi du al o r fo rei g n co rp o rat i o n s h al l b e co n s i d eredas b ei n g en g ag ed i n a t rad e o r b u si n es s wi th i n th e Un i ted St at es i f t h e p art n ers h i p o f wh i ch s u ch i n d iv i du al o r co rp o rat i o n i s a m em b er i s s o en g ag ed ”. GM M d o es n o td i s p u t e t hatu n d er s ect i o n 8 7 5 (1 ) i twas “ en g ag edi n a t rad e o r b u si n es s wi thi n th e Un it edSt at es ” wi th i n th e m ean i n g o f s ect i on 8 8 2 (a)(1 ).- 1 5 -

GM M p ai di n co m e t ax u n d er th o s e p ri nci p l es b efo re t h e red em p t io n tran s act i o n at i s su e h ere. Wh en a p art n ers h i p red eem s a p artn er’ s i n t eres ti n th e p art n ers h i p b y
m ak i n g a p aym en tt o th e p art n er, s ect i o n 7 3 6 (b )(1 ) 1 0 p ro v id es th ats u ch l i qu i d at in g p aym en t s “ b e co n s id eredas a d i s tri b u t i o n b y th e p artn ers h ip ”. (Em

p h as i s ad d ed .) Sect i o n 7 3 1 (a) i n tu rn p ro vi d es : “ In th e cas e o f a d i s tri b u ti o n b y a p artn ers h i p t o a p art n er-- * * * [a] n y g ai n o r l o s s reco g n i zedu n der t h i s s ub s ect io n s h al l b e
co n si d eredas g ai n o r l os s fro m th e s al e o r ex ch an g e o f t h e p art n ers h i p i n t eres to f th e d i s tri b u t ee p art n er.” (Em p h as i s ad ded .) Sect i o n 7 4 1 p ro v i d es , as a g en eral
ru l e, t h at“ [i ] n th e cas e o f a s al e o r ex ch an ge o f an i n t eres ti n a p art n ers hi p , g ai n o r l o s s s h al l b e reco gn i zed t o th e t ran s fero r p artn er. Su ch g ai n o r l os s s h al l b e
co n si d eredas g ai n o r l os s fro m th e s al e o r ex ch an g e o f a cap i t al as s et ”. (Em p h as is ad d ed .) Th i s s t atut e thu s s u g g es t s th at , i n t h i s co n t ex t , the p art ners h i p i s
co n cei v edo f as an en t it y

d i s ti n ctfro m

th e i n d i v i du al p art ners , an da p art n er p ay s t ax o n th e s al e o f i ts p artn ers h i p i n t eres t , i n a m an n er b ro ad l y s i m i l ar t o t h e
m an n er i n wh i ch i t m i g h t p ay t ax o n th e s al e o f an i n t eres t i n a co rp o rat i o n . (Fo r
reas on s we d i s cu s s b el o w, th i s co n cep t i o n affect s th e t ax ab i l i ty o f s u ch g ai n .)

1 0 Th e p art i es ag ree t hats ect i o n 7 3 6 (a) d o es n otap p l y t o th e d is p u t edg ai n .- 1 6 -

Th e Co m m is s i o n er s ees i to th erwi s e, h owev er, an d o ne wayo f d es cri b i n g th e d i s p u t e i n th i s cas e i s t o s ay i trai s es th e qu es ti on wh et her, as t o a fo rei gn p art n er’ s l i qui d at io n o f i t s i n t eres ti n a U.S. p art ners h i p , th e “ en t i ty ” ap pro ach ap p li es (as GM M co n t en d s ) s o th atth e g ai n ari s es fro m th e s al e o f a s i ng l e as s et (i
. e., GM M ’ s i nt eres t i n th e U.S. p art n ers h ip ), o r i n s teadth e “ ag greg at i on ” ap p ro ach ap pl i es (as th e Co m m i s s i o n er co n t en d s ), s o thatth e g ai n ari s es fro m th e
s al e o f GM M ’ s i n t eres t i n th e as s et s t h atm ak e up th e p art n ers h i p ’ s b us i n es s , i n wh i ch b u s i n es s GM M i s co n cei v edo f as h av i n g b een en g ag ed
. Th e Co d e refl ect s b o th ap p ro ach es , i n d i fferen tco n t ex t s . Th e ag g reg at e ap p ro ach ari ses fro m th e
o b s erv at i o n th ata p art n ers h i p i s an ag g reg at io n o f i n di v i du al s , wh i l e t h e en t i ty ap p ro ach ap pl i es wh ere t h e Co d e fo cu s es o n th e d i s t i n ctl eg al ri g h t s th ata p art n er h as i n i t s i n t eres ti n the p artn ers h i p en t i ty , d i s t i n ctfro m th e as s et s th e p artn ers h i p i t sel f o wn s . See 1 W i l l i am S. M cKee, et al ., Fed eral Tax at i o n o f Part n ers h i p s an d Part ners , p ara. 1 .0 2 , at1 -8 (4 th ed . 2 0 0 7 ). Sub ch ap t er K ad o p ts th e en t i ty o r t h e ag g reg at e ap p ro ach d ep en d i n g o n th e co n tex t , an d“ [t ] he en t i ty ap p ro ach * * * p red o m i n at es i n th e t reat m en to f t ran s fers o f p art n ers h ip i nt eres t s as tran sfers o f i n t eres t s i n a s ep arat e en t it y rat h er t h an i n th e as s et s o f t he p art n ers h i p .” Id . at1 -9
.- 1 7 -

III. An al y s i s as t o g ai n fro m real es t at e Th e i n teract i o n of t h e fo reg oi n g p ri n ci pl es i s eas i es tt o d es cri b e i n
co n nect io n wi th an i ss u e as t o wh ich th e p art i es n o w ag ree: No twi th st an d in g th e g en eral i ty o f s ect i o n 7 4 1 th atthe s al e o f a p art n ers h i p i n t eres t i s th e s al e o f a cap i t al as s et , i n wh ich th e p art n er an dth e p art n ers h i p are d i s t i n ct en ti t ies , GM M i s
n o n et h el es s co nced ed l y

s ub jectt o t ax o n th e p ort i on o f i t s g ai n th ataro s e fro m Prem ier’ s real p ro p erty , u nd er p ro v is i o n s thatcl earl y refl ectth e “ ag g reg at i o n ” ap p ro ach . Inp as si n g t h e Fo rei g n In v es t m en ti n Real Pro p ert y Tax Acto f 1 9 8 0 (“ FIRPTA”), 1 1 Co n g res s s o u g h t , i n t er al ia, t o i m po s e i n co m e t ax o n fo rei g n
co rp o rat i o ns th ats el l i n teres t s i n p art n ers h i ps th ato wn U.S. real p ro p ert y i n t eres t s . Acco rd in g ly , s ect i o n 8 9 7 (g ) p ro v i d es :

1 1 Th e Fo rei g n In v es t m en ti n Real Pro pert y Tax Acto f 1 9 8 0 (“ FIRPTA”) i s s ub t i t le C o f Ti tl e XI o f t h e Om n i b u s Reco nci l i at i on Acto f 1 9 80 , Pub. L. No . 9 6- 4 9 9 , s ec. 1 12 2 , 9 4 St at . at2 6 8 2
.- 1 8 - SEC. 8 9 7(g ). Sp eci al Ru le fo r Sal es o f In teres ti n Part n ers h i p s, Tru s t s , an dEs t at es . --Un d er reg u l at i o n s p res cri b edb y th e Secret ary , th e am o u nto f an y

m o n ey , an dth e fai r m ark et v al u e o f an y p ro p erty , recei v edb y

a n o n res i d en tal i en i n d i v i du al o r fo rei g n co rp o rat i o n i n ex ch an g e fo r al l o r p arto f i t s i n t eres ti n a p artn ers h i p , tru s t , o r es t at e s h al l, t o th e ex t en tat tri b u t ab l e t o Un i tedSt at es real p ro p ert y i n t eres t s , [ 1 2 ] b e co n s i d eredas an am ou n trecei v ed fro m th e s al e o r ex ch an g e i n th e Un i t edSt at es o f s u ch p ro pert y . [Em ph as i s ad d ed .] Th e p art i es h av e s t ip ul at ed th at$ 2 .2 m i l l i on o f t h e g ai n GM M real i zedo n th e red em pt i o n o f i t s p art n ers h ip i n t eres twas at tri bu t ab le t o U.S. real p ro p ert y i n t eres t s an dth u s U.S.-s o u rce i n co m e p u rs u an tt o s ect i o n 8 97 (g ). Th u s , i n effect , th e l aw d i s reg ard s t h e p art ners h i p en t i ty t o th i s ex t en t , treat s i tas a m ere ag g reg at i o n o f i t s p art n ers , an dt ax es the p art ner n otas i f i th ad s ol di t s p art n ers h i p i n t eres tb u tas i f i th ads o l di t s p o rt i o n o f t h e real p ro pert y i n teres t s h el di n th e p art n ers hi p .

1 2 W e n o te t h at , b y

i t s ex p res s t erm s , s ect i on 8 9 7 (g ) i s , as i t s h ead i n g s t at es , a “ Sp eci al Ru l e”, an di t s t ex tm an d at es an ag g reg at i o n ap p ro ach fo r ch aract eri zi n g g ai n o nl y “ t o th e ex t en tat tri b u t ab l e t o Un i tedSt at es real p ro pert y i n t eres t s ”. Th e h ead in g th u s “ co rres p o n d [s ] t o th e t ex t ” an d“ co n fi rm [s ] o u r read i n g o f t he t ex to f th e s t atu t e.” Ab d el -Fat t ah v. Co m m i s s i o ner, 1 3 4 T.C. 1 90 , 2 0 5 (2 0 10 ) (co n s tru i n g s ec. 8 9 3). Th i s s t atu t e p res u m es th e ex i s t en ce o f a g en eral ru l e t o wh i ch th i s ag g reg at i o n ap p ro ach i s an ex cep t i o n . Sect i o n 8 97 (g ) d o es n o tp ro v i d e (an dth e Co m m i s s i o n er d o es n ot co n t en dth ati tp ro v id es ) a g en eral ru l e t h atal l g ai n fro m a fo rei gn p art n er’ s s al e o f i t s p art n ers h i p i n t eres ts h al l b e co n s id eredan am ou n t recei v edfro m

the s al e o f th e p artn ers h ip ’ s p ro pert i es o f wh at ev er t y p es . Th e ch al l en g e t h at th e Co m

m i s s i on er faces i n th i s cas e i s t o fi n ds o m ewh ere i n th e Co d e ei ther a g en eral “ ag g reg at i o n th eo ry ” ru le o r a rel ev an tex cep t io n t o th e g en eral “ en t i ty

th eo ry ” ru l e t hatwe d i s cern , as ex p l ai n edi n p artII.B ab o v e.- 1 9 -

GM M ackn o wl ed g es th atwh en , u n der s ect i o n 8 9 7 (g ), we l o o k th ro u g h th e
en t i ty o f t h e p art n ers h ip an dco n s i d er GM M as th e o wn er (an ds el l er) o f i t s p o rt i o n
o f Prem ier’ s real p ro pert y i n teres t s , th e FIRPTA g ai n at tri b u t ab l e t o th os e i n t eres t s
was treat edas “ effect i v el y co n n ect edwi th th e co n du cto f” GM M ’ s trad e o r b u s i n es s . Un d er s ect i o n 8 8 2, then , th i s g ai n was s ubjectt o U.S. i nco m e t ax , an d GM M s o co n ced es . Su ch FIRPTA g ai n i s th u s an i n st an ce i n wh i ch a p art n ers h i p i s treat edas an ag g reg at i o n , an dth i s treat m en td em o n st rat es th atth e “ en t it y ” g en eral it y o f
s ect i on s 7 3 1 , 7 3 6 , an d 7 4 1 ad m i t s ex cep t i o n s . W e m u s td eci d e wh et h er t here
ex i s t s an equ iv al en t ex cep t i o n rel ev an tt o th e d i s p u t edg ai n . IV. An al y s i s as t o d is p ut edg ai n As t o GM M ’ s n on -FIRPTA, d i s p u t edg ai n , we m u st d et erm i n e wh et h er,
u n d er s ect i o n 8 8 2 (a)(1 ), th e g ai n was “ effect i v el y co n nect edwi th th e co n du cto f a trad e o r b u si n es s wi th i n th e Un i t ed St at es ”. To b eg i n , h owev er, we d et erm i n e t h e
n atu re o f t h atg ai n b y

l o o ki ng ag ai n atth e p ro v i s io n s o f s ub ch ap t er K as t o th e ch aract er o f t h e g ai n fro m th e l i qu i d at i o n o f a p art n ers h i p i n t eres t , an d we t h en l o o katth e effect o f t h e p ert i n en tp ro v i s i o n s t o d et erm i n e wh eth er t h atg ai n i s

“ effect i v el y

co n n ect ed ” t o th e trad e o r b u s i n es s o f Prem i er (wh i ch i s at tri b ut edt o GM M).- 2 0 -

A. Th e n atu re o f t h e i n co m e u n d er s ub ch ap t er K Th e p art i es ag ree t h atth e t ran s act i o n b et ween GM M an dPrem i er was a red em pt i o n . Th e p aym en t s GM M recei v ed i n th e l i qu i d at i o n o f i t s p art n ers h i p i n t eres twere, i n th e wo rd s o f s ect i o n 7 3 6 (b )(1 ), “ m ad e i n ex ch an g e fo r t h e i n t eres t
o f s u ch p art n er [i .e., GM M ] i n p art n ers h i p p ro p ert y ”, an d t h erefo re t h ey are t o “b e
co n si d eredas a d i s tri bu t i o n b y th e p art n ers h i p ”. (Em

p has i s ad d ed .) Th e effect o f
s u ch a “ d i s tri b ut i o n ” i s g o v ern edb y s ect io n 7 3 1 (a), wh ich p ro v i d es : “ In th e cas e
o f a d i s tri b u t i o n b y

a p art n ers h i p t o a p art ner-- * * * [a] ny g ai n o r l o ss reco g n i zed
u n d er t h i s s ub s ect i on s h al l b e co n s i d eredas g ai n o r l o s s fro m th e s al e o r ex ch an g e
o f t h e p art n ers h i p i n t eres to f t h e d i s tri b u t ee p art n er.” (Em p h as i s ad d ed .) Th ati s , wh en a p art n er l i qu i d at es i t s p artn ers h ip i n t eres t an di s p ai dfo r i t s i n t eres ti n th e p art n ers hi p ’ s p ro p ert y , th en u n d er s ect i on 7 3 6 (b )(1 ) th e p aym en ti s “ co n s i dered as a d i s tri b u t i o n ”; an du n d er s ect io n 7 3 1 (a) t h e g ai n i s co n s id eredt o ari s e fro m “ t h e
s al e o r ex ch an g e o f t h e p art n ers h i p i n t eres t ”, i .e., n ot fro m th e s al e o r ex ch an g e o f th e p art n er’ s p ort io n o f i n di v i du al i t em s o f p artn ers h i p p ro p ert y . 1 3

1 3 Ap p l i cat i o n o f t h e en t i ty ap p ro ach i n th i s co nt ex ti s fu rt h er s up po rt edb y th e g en eral ru l e t h ati f a p art n ers h i p d i s tri b u tes en o u g h m o n ey t o a p art n er t o g en erat e g ai n, th en th atg ai n i s cal cu l at edb y s ub tract i n g th e p art n er’ s b as i s i n i t s p art n ers hi p i n t eres tfro m

th e am o u n t o f m o n ey

d i s tri b u t ed --rat h er t h ans ubt ract i n g th atp art n er’ s s h are o f b as i s i n a fract i o nal s h are o f m u lt i pl e en t i ty -o wn edas s et s fro m th e am o u n t o f m o n ey

d is tri b u t ed . See s ec. 7 3 1 (a)(1 ). (Fo r d i fferen t (co n ti n u ed ...)- 2 1 -

GM M ackn o wl ed g es th at , fo r p u rp o s es o f s ect i o n 7 3 1 , i treco g n izedg ai n as
a res u l to f t h e d i s tri bu t i o n s b y Prem i er, an di t p o i n ts t o s ect io n 7 4 1 t o d em o n s trat e th ats u ch g ai n o n l i qu i d at i o n i s cap i t al , ju stas i f GM M h ads o ldth e p art ners h i p i n t eres t . Sect i on 7 4 1 p ro v i des : SEC. 7 4 1. RECOGNITION AND CHARACTER OF GAIN OR LOSS ON SALE OR EXCHANGE. In th e cas e o f a s al e o r ex ch an g e o f an i n t eres ti n a p art ners h i p , g ai n o r l o ss s h al l b e reco g n i zedt o th e t ran s fero r p art n er. Su ch g ai n o r l o s s s h al l b e co n s i d eredas g ai n o r l o s s fro m th e s al e o r ex ch an g e o f a cap it al as s et , ex cep tas o therwi s e p ro v id edi n s ect i o n 7 5 1 (rel at i n g t o u nreal i zed recei v ab l es an di n v en t o ry i t em s ). GM M ci t es o u r d eci s i on i n Po ll ackv . Co m m i s s i o n er, 6 9 T.C. 1 4 2 (1 9 7 7), an d arg u es th ati n th i s cas e, as i n Po l l ack , we m u s tap p l y th e “ en t i ty

th eo ry ”, wh i ch g en eral l y g i v es i n d ep en d en tt ax effect t o tran s act i o n s b etween a p art n er an da p art n ers hi p , o r t o tran s act i o n s i n v o l v in g a p art n ers h ip i n t eres t . InPo l lacki twas th e t ax p ay er wh o as s ert ed th e “ ag g reg at i on th eo ry ”, b ecau s e l o ss es (n o t g ai n s ) o f th e p art n ers h i p ’ s b u s i n es s were ati s s u e, an dth e t ax p ay er wan t edt o cl ai m n o t cap i t al l o s s es b u to rd i n ary l o s s es , as i f h e h im s el f h ad b een en g ag edi n th e b u s i n es s . “ Res p o n d en t , o n th e o t h er h an d , co n t en d s t h at ex cep tfo r s peci fi c

1 3 (...co n t i nu ed ) treat m en ti n d i fferen t ci rcu m s t an ces , s ee s ec. 7 5 1 (b ) (“ co ns i d ered as a s al e o r ex ch an g e o f s u ch p ro p ert y b et ween th e d i st ri b u t ee an dth e p art n ers hi p ”) an d 2 6 C.F.R. s ec. 1
. 7 5 1 -1 (g ), Ex am p le (2 )(d )(1 ), In co m e Tax Reg s . )- 2 2 -

ex cep t i o n s n o trel ev an th erei n , s ect i o n 7 4 1 m an dat es th e l o s s b e ch aract eri zedas a cap i t al l o s s .” Id . at1 4 5 . W e h el dfo r t h e Co m m i s si o n er an d ex p l ai n ed : [B] o th th e l eg is l at i ve h i st o ry o f s ect i o n 7 4 1 an di t s l an g u ag e i n d i cat e th atCo n g res s i n ten d edi tt o o p erat e i n d ep en d en tl y o f s ect i o n 1 2 21 s o as t o b e d i s po s it i v e o f t h e ch aract er o f p et i t i o n er’ s l o s s. Sect io n 7 4 1 was en act edb y Co n g res s as p arto f s ub ch ap t er K o f t h e In t ern al Rev enu e Co d e o f 1 9 5 4 . * * *

* * * * * * * Pri o r t o 1 95 0 the Go v ern m en tt o okth e p o s it i o n , u n der t h e s o-cal led ag g reg at e t heo ry

o f p art n ers h ip , th atthe s el l i ng p art n er act u al l y s o l d h i s u n d i v i d edi n t eres t in each o f th e p artn ers hi p’ s as s et s , an d the ch aract er an dam o u n ts res u lt i ng fro m th e d is po s it i on o f t h o se as set s s h o u l d b e co n s i d eredi n d i v i du al ly . * * *

* * * * * * * Th i s p o s i t i o n , h o wev er, fo u n d n o accep t an ce i n t h e co u rt s , wh i ch co ns i st en t l y

h el d a p art n ers h i p i n t eres tt o b e a cap i t al as s eti n i t s en t i ret y

reg ard les s o f t h e n atu re o f t h e u n d erl y i n g p art ners h i p as s et s . Inres p o ns e, t h e Go v ern m en t i n 1 9 5 0 rev ers edi t s p o si t io n i n G.C.M . 2 6 3 7 9 , [ 1 4 ] 1 9 50 -1 C.B. 5 8 * * *

1 4 In G.C.M
. 2 6 3 7 9 , 1 9 5 0-1 C.B. 5 8 , th e Co m m i s s io n er h el dth at“ th e s al e o f a p art ners h i p i n teres ts h ou l db e treat edas th e s al e o f a cap i t al as s et ” an d ack n owl ed ged :

Th e o v erwh el m i n g wei g h to f au th o ri ty i s co n traryt o t h e p o s i t i o n h eret o fo re t ak en b y th e Bu reau , v iz., t h atth e s al e o f a p art n ers h i p i n t eres ti s a s al e o f t h e s el l i n g p art ner’ s u n d iv i d edi n t eres t i n each s p eci fi c p artn ers h i p as s et
.- 2 3 - * * * * * * * Co n gres s , i n th e 1 9 54 Co d e, s o u g h tt o el i m i n at e t h e co n fu s i o n o n thi s p o i n tb y co di fy i n g th e Go v ern m en t ’ s co n ces s i o n i n G.C.M . 2 6 3 7 9 an d , atth e s am e t i m e, redu ce t h e av ai l ab i l i ty o f th e co l l ap s i b l e p art n ers h i p as a t ax av oi d an ce d vi ce. Co n g res s acco m p l i s hedi t s du al p u rp o s e b y

en act m en to f s ect io n 7 4 1 , wh i ch treat edthe s al e o f a p art n ers h i p i n t eres tas th e s al e o f a cap i t al as s et , an ds ect i on 7 5 1 , wh i ch s p eci fi cal l y

ex cl u d edfro m

cap i t al g ai n o r l os s treat m en tth at p o rt io n o f t h e p art n ers h i p i n t eres t rep res en ti n g i n co m e fro m u n real i zed recei v ab l es an ds ubs t an t i al l y ap p reci at edi nv en t o ry

i t em s . In v i ew o f t h e fo reg o i n g l eg i s l at i v e reco rdan dth e p l ai n l an g uag e o f t h e s t atu t e i t s el f, we co n cl ud e t h at Co n gres s i n t en ded s ect i o n 7 4 1 , i f ap p l i cab l e, t o p ro v i d e cap it al g ai n o r l o s s treat m en to n th e s al e o r ex ch an g e o f a p art n ers h i p i n t eres tb y a p art n er wi tho u t reg ardt o s ect i o n 1 2 2 1. In d eed , co n g res si o n al u s e o f t h e p h ras e “ sh al l b e co n s i d eredas ” i n s ect i o n 7 4 1 i s u n am b i g u o u s an d m an d at o ry o n i t s face. * * * Id . at1 4 5 -1 4 7 (ci t at i o n s an d fn . refs . o m i t t ed ). GM M arg u es that“ th e s al e o f a p art ners h i p i n t eres ti s res p ect edas th e s al e
o f an i n d i v i s i b l e i tem

o f i n t an g i b l e p ers o nal p ro p erty , an dm ay n o tb e rech aract eri zed* * * as th e s al e o f s ep arat e i n t eres t s i n each as s eto wn edb y th e p art n ers hi p .” Th at i s , GM M arg u es th atth e g en eral p ri n ci p l e o f s ect i o n 7 4 1 , effect i n g th e “ en t it y

th eo ry ”, s ho u l dap pl y h ere.- 2 4 -

Th e Co m m is s i o n er ackn o wl ed g es th e g en eral p ri n ci p l e b u targ u es 1 5 th ati n th i s co n t ex twe s h o u ldn o net h el es s em pl o y th e “ ag g reg at e t h eo ry ”, t hati s , th atwe
s h o u ldtreat the p artn er’ s s al e o f a p art n ers h i p i n t eres tas the p art ner’ s s al e o f
s ep arat e i n t eres t s i n each as s eto wn edb y the p art n ers h i p . As fo r s ect i o n 7 4 1 , th e Co m m i s s i o n er arg u es th atth e s t atu t e can n o tb e i nt erp ret edt o req u i re t h atth e s al e (o r l i qui d at i o n ) o f a p art n ers h i p i n t eres tb e t reat edas the s al e o f an i n d i v i s ib l e
as s et i rres p ect i v e o f t h e co n t ex t , b ecau s e t h en s ect i o n 8 9 7(g )--wh o s e o p erat i o n i s
co n ced edh ere, s ee s up ra p artIII.A--wo u ldb e i n o perab l e. Th e Co m m i s s io n er
s t at es : Th e s al e o f a p artners h i p i n t eres tcan n ot s im u l t an eo u s l y

b e b o th (a) a s al e o f ani n d i v i s i b l e as s et , as p et i t i o n er arg u es i s req u iredb y s ect i on 7 4 1 , an d(b ) a s al e o f U.S. real p ro pert y i n teres t s an da s al e o f a p art n ers h i p i n t eres t , as req u i redb y s ect i o n 8 9 7 (g ). Th e Co m m i ss i o n er p o s i ts th atth e o n l y way t o reco nci l e t h e t w o p ro v i s i o n s i s t o i n t erp rets ect i o n 7 4 1 as ap p l icab l e o n l y t o th e ch aract er o f t h e g ai n reco g n ized

-- i .e., as cap i t al rat h er t h an o rd i n ary . Th at i s , th e Co m m i s s i o n er m ai n t ai ns th at wh i le s ect i o n 7 4 1 ex p res s l y req u i res th atth e g ai n “ s h al l b e co ns i d ered as g ai n o r

1 5 Th e Co m

m is s i o n er d oes n o t arg ue t h atth e p art n ers h i p an t i -ab u s e reg u l at i o n , 2 6 C.F.R. s ec. 1 .7 0 1 -2 (e), In co m e Tax Reg s ., ap p l i es i n th i s cas e. Th at reg u l at i o n p ro vi d es th at th e IRS can “ treat a p art n ers h i p as an ag greg at e o f i t s p art n ers i n wh o l e o r i n p art as ap pro p ri at e t o carryo u t th e p u rp os e o f an y p ro v is i o n o f t h e In t ern al Rev en u e Co d e o r t h e reg u l at io n s ”. See i d.- 2 5 -

l o s s fro m th e s al e o r ex ch an g e o f a cap i t al as set ”, t h e s t atu te d o es n o tp recl u d e treat i n g th e (cap i t al ) g ai n as ari s i n g n o t fro m th e s al e o f t h e p art n ers h i p i nt eres t p er
s e (wh i ch th e en t i ty

th eo ry wo u l dy i el d ) b u t fro m

th e p art n ers h i p ’ s u n d erl y i n g
as s et s t h atg i v e v al u e t o th e p art n ers h i p i n t eres t(wh i ch th e ag g reg at i o n th eo ry
wo u l dy i el d ). It is tru e th at , i n p ro v i d i n g th at th e g ai n “ s h al l b e co ns i d ered as g ai n * * * fro m th e s al e o r ex ch an g e o f a cap i t al as s et ”, s ect io n 7 41 d o es n o ts p eci fy wh i ch
as s et
. Ho wev er, t h ere are fo u r fl aws i n th e Co m m i s s io n er’ s ap p ro ach thatcau s e u s t o rejecti t . Fi rs t, h e ex ag g erat es th e co n fl i ctb et ween an “ en t i ty th eo ry ”
co n st ru ct i o n o f s ect i o n 7 4 1 an d t h e ex i s t en ce o f an ex cep ti o n i n s ect i o n 8 9 7 (g ). In i t s o wnt erm s , s ect i o n 7 4 1 ackno wl ed g es o n e ex cep t i o n (“ ex cep t as o th erwi s e p ro v id edi n s ect i o n 7 5 1 ”), 1 6 s o s ect i o n 7 4 1 i s o n l y a g en eral ru le, n o ta ru l e o f

1 6 Sect i o n 7 5 1 i s a s p eci fi c ex cep ti o n t o s ect i o n 7 4 1 t h atcau s es u n real i zed recei v ab l es an d i nv en t o ry i tem s t o b e ad dres s eds ep arat el y fro m th e rem ai n d er o f th e p art n ers h i p i nt eres t wh en th at i n t eres ti s s o l do r l iqu i d at ed . In th e co nt ex to f l i qu i dat i n g d i s tri b u t i o ns , th e p art n ers hi p i s d eem edt o h av e b o u g htth e l i qu i d at ed p art n er’ s s h are o f t h o s e as s et s fro m th atp artn er, s o t h atth atp artn er h as g ai n o f a ch aract er an dam o u n t co n si s t en twi th s u ch a h y p o th et ical s al e. Th e IRS d i dn o t as s ertap p l i cat i o n o f s ect i o n 7 5 1 (b ) i n th e SNOD, an d t h e Co m m is si o n er h as n o t as s ert ed i tas an al t ern at i v e p o si t i o n i n th i s cas e. Co ns equ en t l y , we d o n ot co n si d er s ect i o n 7 5 1 fu rt h er. W e n o t e t h at b y th e ex p res s t erm s o f s ect io n 7 4 1 , s ect i on 7 5 1 i s (l i k e s ect i o n 8 97 (g ); s ee s up ra n o te 1 1 ) an ex cep t i o n, an di t m an d at es an “ ag g reg at i o n ” ap pro ach fo r ch aract eri zi n g o nl y g ai n “ at tri b u t ab l e t o” u n real i zed recei v ab l es o r i n v en t o ry i t em s ”. Th is s t atut e t h u s p res u m es the (co n ti n u ed ...)- 2 6 -

ab s o lu t e an du n iv ers al ap p li cat i o n . Co ng res s i s al way s free, h av i n g en act eda g en eral ru l e, t o en actex cep t i o n s . Seco n d , th e Co m

m i s si o ner’ s read i n g o f s ect io n 7 41 g i ves i n s uffi ci en teffect t o o n e wo rdi n the s t atu te. Sect i o n 7 4 1 p ro v i des th ati n co m e real i zedo n th e s al e
o f a p art n ers h i p i n t eres t “ s h al l b e co n s i d eredas g ai n * * * fro m th e s al e o r
ex ch an g e o f a cap i tal as s et ”. (Em p h as i s ad d ed .) Co n gres s u s ed the s i n g ul ar

“ as set ”, rat h er t h an the p l ural “ as s et s ”. Th i s s i n g u l ar wo rd in g i s m o re co n si s t en t wi th th e t reat m en to f t h e s al e o f a p art n ers h i p i n t eres tacco rd i n g t o t h e en t i ty th eo ry , u n d er wh i ch th e s el l i n g p art n er i s d eem edt o h av e s ol do nl y o n e as s et(i t s p art n ers hi p i n t eres t ) rat h er t h an b ei n g d eem ed t o h av e s o l d i t s i nt eres t i n th e
m u lt i p l e u n d erl y i n g as s et s o f t h e p art n ers h i p . See al s o P.B.D. Sp ort s , Lt d . v . Co m m i s s i o n er, 1 0 9 T.C. 4 2 3 , 4 3 8 (1 9 9 7) (“ G en eral l y , s ub ch ap t er K em pl o y s th e
en t i ty ap pro ach i n treat i n[g ] tran s fers o f p art n ers h i p i n teres ts
. Th e s al e o f a p art n ers hi p i n t eres ti s treat edas th e s al e o f a s i ng l e cap i t al as s etrat h er t h an as a tran s fer o f t h e i n d i v i du al as s et s o f t h e p art n ers h ip
. See s ecs . 7 4 1 an d7 4 2 .”);

1 6 (...co n t i nu ed ) ex i s t en ce o f a g en eral ru l e t o wh i ch th i s ag g reg at i o n ap p ro ach i s an ex cep ti o n . Sect i o n 7 5 1 d o es n o tp ro v i d e (an dth e Co m m i s s i o n er d o es n otco n t en dth ati t p ro v id es ) a g en eral ru l e t h atal l g ai n fro m a p art n er’ s s al e o f i t s p art n ers h i p i n t eres t s h al l b e co ns id eredan am o un trecei vedfro m th e s al e o f t he p art n ers h i p ’ s p ro p ert i es o f wh at ev er t y p es .- 2 7 -

Un g er v . Co m

m i s si o ner, T.C. M em o . 1 9 9 0 -1 5 (l i s t i ng s ect i o n 7 4 1 as an ex am p l e
o f t h e en t i ty

th eo ry i n t h e In t ern al Rev enu e Co d e), aff’ d, 9 3 6 F.2 d1 31 6 (D.C. Ci r. 1 9 9 1 ). An dab s en t s om e o verri d i n g m an dat e, s ect io n 7 3 1 d i rect s th atg ai n o r l o s s
o n a d i st ri b u t i o n (s u ch as th e o n e ati s s u e) “ s h al l b e co ns i d ered as g ai n o r l o s s fro m th e s al e o r ex ch an g e o f t h e p art n ers h i p i n teres to f t h e d i s tri b ut ee p art n er” (t hat is , as d i rect edb y

s ect i on 7 4 1). Th i rd , Co n g res s h as ex p l i ci t l y carv edo u t a few ex cep t i o n s t o s ect i o n 7 4 1 th at , wh en th ey

ap p l y , d o req u i re t h atwe l oo kthro u g h th e p art n ers h i p t o th e
u n d erl y i n g as s et s an dd eem s u ch a s al e as th e s al e o f s ep arat e i n teres ts i n each
as s et o wn ed b y

th e p art n ers h i p . If Co n g res s h ad i nt en d eds ect i o n 7 4 1 t o b e i n t erp ret edas a l o o k -th ro u g h p ro v i s i o n , th es e ex cep t i o ns i n s ect i o n s 7 5 1 an d 8 9 7 (g ) wo u l d b e s up erfl uo u s . See TRWIn c. v . An drews , 5 3 4 U.S. 1 9 , 3 1 (2 0 0 1 ). Acco rd i ng l y , th e en act m en to f s ect i o n 8 9 7 (g ) actu al l y rei n fo rces o ur
co n cl u s i o n th atth e en t i ty th eo ry i s th e g en eral ru l e fo r t h e s al e o r ex ch an g e o f an i n t eres ti n a p art n ers hi p . W i th o u t s uch a g en eral ru l e, t h ere wo u l db e n o n eedt o
carv e o u t an ex cep ti o n t o p rev en tU.S. real p ro pert y i n teres t s fro m

b ei n g s wep t i n t o th e i n d i v i s i b l e cap i t al as s ettreat m en tth at s ect i o n 7 4 1 o th erwi s e p res cri b es .- 2 8 -

Fo u rt h , s ect i o n 7 3 1 (a)--b ro u g h t i n t o th i s an al y s is b y the ex p res s wo rd i n g o f
s ect i on 7 3 6 (b )(1 )--m ak es ex p l i ci tth atth e “ en t i ty th eo ry ” g en eral ly

ap p l i es t o a p art n er’ s g ai n fro m

a d i s tri bu t i o n : An y g ai n o r l o s s reco g n izedu n d er t h i s s ub s ect i o n s hal l b e co n s id ered as g ai n o r l os s fro m

th e s al e o r ex ch an g e o f t h e p art n ers h i p i n t eres to f th e d i st ri b u t ee p art n er. Sec. 7 3 1(a) (em

p has is ad d ed ). Th is wo rd i n g co u ldh ard l y b e cl earer. Th e p art n ers hi p p ro v i s i o n s i n s ub ch ap t er K o f t he Co d e p ro v i d e a g en eral ru l e t h atth e

“ en t i ty theo ry ” ap p li es t o s al es an dl i qu i d at i n g d i s tri b u t i o n s o f p art ners h i p i n t eres t s --i .e., th ats u ch s al es are t reat edn o tas s al es o f u n d erl y i n g as set s b u tas
s al es o f t h e p art n ers h i p i n t eres t . Of co u rs e, Co ng res s m ay en actex cep t i o ns o r d i fferen t ru l es , s u ch as fo r fo rei g n p art n ers , an dwe co n s i der t h atp o s si bi l i ty b el o w; b u twe b eg i n o ur an al y s i s wi th th i s g en eral i ty fro m s ub ch ap ter K. Th e Co m m is s i o n er’ s i nt erp ret at i o n o f t he Co d e ack n o w l ed g es th e s am e
s equ en ce we h av e fo l l o wed --i .e., thats ect i o n 7 3 6 (b )(1 ) l ead s t o s ect i on 7 3 1 , wh i ch i n turn l ead s t o s ect io n 7 4 1 , b u th e ev i d en t l y th i n k s s uch an an al y s is s t op s s h o rt
. Th e Co m m i ss i o n er ap p aren t ly

m ai n tai n s th at , aft er ap p ly i n g th o s e s ect i o n s i n th at
o rd er, o n e m

u s t s ti l l retu rn t o s ect i o n 7 3 6(b )(1 )--s o th at , wh i l e s ect i on 7 4 1
m an d at es th e cap it al ch aract er o f t he i n co m e, i n t h e en dth e d i s tri b u t i on i s s t i l l ch aract eri zedas “p aym en t s * * * m ad e i n ex ch an g e fo r t h e i n t eres to f s u ch p art n er- 2 9 -

i n p art ners h ip p ro p erty ”. Sec. 7 3 6 (b )(1 ) (em p h as i s ad ded ). Th e em

p h as i zed p h ras e cert ai n l y d o es ap p ear i n s ect i o n 7 36 (b )(1 ), an dth e an al y s i s i n thi s cas e b eg in s th ere p reci s el y

b ecau se GM M d i d i n d eedrecei v e p aym en t s t h at , g i v en th e
n atu re o f a p art n ers h ip , can b e s ai dt o h av e b een m ad e u l t i m at el y i n ex ch an g e fo r GM M’ s i n t eres ti n t h e p art n ers h i p ’ s v ari o u s i t em s o f p ro p ert y . Ho wev er,
s ect i on s 7 3 6 (b )(1 ), 7 3 1 (a), an d7 4 1 t el l u s wh att o d o wi th s u ch p aym en t s fo r t ax p u rp os es ; an das we h av e s ho wn , th ey d irect u s t o a co n cl us i o n: “ g ai n o r l o s s fro m th e s al e o r ex ch an g e o f t h e p art n ers h i p i n teres t ”, s ec. 7 3 1 (a), wh i ch i s “ a [s i n g u l ar] cap i t al as s et ”, s ec. 7 4 1 . W e s ee n o reas o n t o ab an d o n th atco n cl u s i o n , retu rn t o s ect i o n 7 3 6 (b )(1 ), an d h al t at th e p hras e t hatm o s tn earl y co i n ci d es wi t h th e Co m m i s s i o n er’ s p os i ti o n. 1 7 Th e Co m m is s i o n er al s o arg u es th ats ect i o n 7 41 s h o ul dn otb e ap p l i edt o ch aract eri ze t h e i nco m e ati s s u e b ecau s e ap p ly i n g i ti n th atm an n er wo ul d

1 7 In d eed , wh en we reads ect i on 7 3 6 (a) an d(b ) t o g et h er, i t b eco m es cl ear th atth e ro l e o f t he wo rd s “part ners h i p p ro p ert y ” i n s ect i on 7 3 6 (b ) i s t o d i st i n g u i s h d i s tri b u t i o n s m ad e fo r s u ch p ro p ert y fro m th o s e m ad e o u to f a p art n er’ s “ d i st ri b u t i v e s h are” o f en ti ty -l ev el p art n ers h i p i n co m e (as i n s ect io n 7 36 (a)(1 )) o r as a “ g u aran teedp aym en t ” (as i n s ect i o n 7 3 6 (a)(2 )). A p art n er’ s “ di s tri b u t i v e s h are”, s ec. 7 3 6 (a)(1 ), i s g o v ern edb y s ect i o n s 7 04 (b ) an d7 0 1 ; th e t ax treat m en t o f a “ g u aran t eedp aym en t”, s ec. 7 3 6 (a)(2 ), i s p ro v i d edi n s ect i o n 7 0 7 (a); an d p aym en t s fo r p art n ers h i p p ro pert y , s ec. 7 3 6 (b ), are “ co n s i d ered as a d is tri b u t i o n b y th e p art n ers h i p ”--i .e., are t reat edas p ro vi d edi n s ect i on 7 3 1
. Inn o n e o f t h es e i n s t an ces i s th e u l t i m at e t ax treat m en to f t h e t ran s fer o f m o n ey o r p ro p erty fro m a p art n ers hi p t o a p art n er p res cri b eds o l el y b y referen ce t o s ect i o n 7 36
.- 3 0 -

co n trad i ct“ Co n gres s ’ i n t en ti n en act i n g s ect i o n 8 6 5 ”, t h e s o u rci n g ru l e we d i s cu s s b el o w i n p artIV.B. Th e Co m m i s s i o n er arg u es th at , wh en ad dres s i ng a p art n ers h i p qu es ti o n u n d er s ub ch ap t er K o f t h e Co d e (wh i ch d eal s p ri m ari l y wi th p art n ers an d p art n ers hi p s ) an d ap p l y i n g a Co d e s ect i o n (s u ch as s ect i on 8 6 5 ) th ati s o u ts i d e o f
s ub ch ap t er K, o n e m

us t l o o k t o “ th e n ature o f t h e p art n ers h ip i n t eres ti n v ol v ed , t o g et h er wi th t h e i n t en tan dp u rp o s e o f t h e n o n-s ub ch ap ter K s ect i o n b ei n g ap p li ed .” Us i n g th i s ru l e, t h e Co m m i s s i o ner ex p l ai n s th atn o ts ect i o n 7 4 1 b u t rat h er s ect i o n 7 3 6 (b )(1 ) m o re ap p ro p ri at el y ch aract eri zes th e t y

p e o f i n co m e h ere-- i .e., as a p aym en tfo r GM M ’ s i n t eres ti n th e “ part ners h i p p ro p ert y ”. W e s ee n o b as i s fo r t h e Co m

m i ss io n er’ s s el ect io n o f t h i s p art i cu l ar p h ras e fro m s ect io n 7 3 6 (b )(1 ) as the g u i d in g s t ar fo r n av i g at i n g th e i n ters ect i o n o f p art n ers h i p t ax at i o n
an d th e t ax at io n o f i n t ern at i o n al tran s act i o n s , an dwe h av e al read y ex p l ai n edwh y th i s p h ras e i s atth e b eg i n n in g an d n o tth e en do f th e an al y s i s . M o re i m po rt an t , th e Co m m i s s i o n er ci t es n o au th o ri ty fo r h i s p o s i t edru l e, wh i ch s eem s (at l eas t as h e
u s es i t h ere) t o s h o rt cu t o r d i st o rtthe s ubch ap t er K an al y s i s b y i n v o k in g a p u rp o s e (n o tex p l i ci t l y

en act ed ) th ath e d i s cern s i n s ubch ap t er N. Th e Co m m i s si o n er h as
n o tco nv i n ced u s t o reco n s i d er t h e arg u m en tth atwe reject ed3 8 y ears ag o wh en i t
was ad v an cedb y

th e t ax p ay er i n Po ll ack . Ad dres s i n g o u rs el v es t o t h e s t atu t o ry t ex t , we co n cl u d e t h ats ubch ap t er K m an d at es treat in g th e d is p u t edg ai n as cap i t al- 3 1 -

g ai n fro m th e d i s p o s i t i o n o f a s i n g l e as s et , an di n p artIV.B b el o w we ap p ly th e p ro v is i o n s o f s ect i o n 8 6 5 acco rd i n g ly
. In s u m , s ect i o n 7 3 6 (b )(1 ) p ro vi d es th atp aym en t s s u ch as th o s e g i vi n g ri s e t o the d i s p u t edg ai n “ s hal l * * * b e co n s id eredas a d is tri b u t i o n b y th e p art n ers hi p ”; s ect i o n 7 3 1 (a) p ro v i des th at s uch g ai n “ s h al l b e co n s i dered as g ai n
* * * fro m th e s al e o r ex ch an g e o f t h e p artn ers h ip i n t eres to f t h e d i s tri b u t ee p art n er”; an ds ect i o n 7 4 1 p ro v i d es th ats u ch g ai n “ s hal l b e co n s i d eredas g ai n
* * * fro m th e s al e o r ex ch an g e o f a cap i t al as set ”. (Em p h as is ad d ed
. ) Acco rd in g ly , GM M ’ s d i s p u t edg ai n fro m th e red em

pt i o n o f i t s p art ners h i p i n t eres t i s g ai n fro m

th e s al e o r ex ch an ge o f an i nd i vi s i b l e cap it al as s et --i .e., GM M’ s i n t eres ti n th e p art n ers h i p . B. Effect i v e co n n ect i o n o f d i s p u t edg ai n Hav i n g es t ab l i sh edth atGM M ’ s d i s p u t edg ai n ari s es fro m p ers o n al p ro p erty 1 8 i n th e fo rm

o f an i n d i v i s i bl e cap it al as s et , we n o wtu rn t o t h e ru l es g o v ern i n g t ax at i o n o f i n t ern at i o n al tran s act i o n s t o d et erm in e wh et h er t h atg ai n
was t ax ab l e. Th atd et erm i n at i o n tu rn s o n wh et h er, fo r p u rp o ses o f s ect i o n 8 8 2 , th atg ai n was “ effect i v el y co n n ect edwi th th e co n du cto f a t rad e o r b u s i n es s wi t h i n

1 8 Th e Co m

m is s i o n er d oes n o t d en y

th atth e d i s p u t edg ai n co n s t i tu t es i n co m e fro m a s al e o f p ers o n al p ro p ert y .- 3 2 -

th e Un i t edSt at es ”--i .e., wh et h er th at g ai n was effect i v el y co n n ect edwi th th e t rad e
o r b u si n es s o f GM M ’ s p art ners h i p , Prem i er, wh i ch trad e o r b u s i n es s i s at tri b u t ed t o GM M as a p art ner b y s ect i o n 8 7 5 (1 ). See s up ra n o t e 9 . “ Effect i v el y co n n ect ed i n co m e” i s d efi n edi n s ect i on 8 6 4 (c), an di ti n cl u d es s o m e i n co m e s o u rcedwi th i n th e Un i t edSt at es , s ee s ec. 8 6 4 (c)(2 ) an d (3 ), an ds o m e s o u rced wi th ou tth e Un i t ed St at es , s ee s ec. 8 6 4 (c)(4 ). As t o “ g ai n o r l o s s * * * fro m the s al e o r ex ch an ge o f cap i tal as s et s” (i .e., th e t y pe o f g ai n rel ev an th ere), s ect i o n 8 64 (c)(2 ) p ro v i d es th at s uch g ai n m ay b e

“ effect i v el y

co n n ect edwi th th e co n du cto f a t rad e o r b u s i n es s wi thi n th e Un i t ed St at es ” (d ep en d i n g o n fact o rs s eto u ti n th e s t atu t e); b u ts ect i on 8 6 4 (c)(2 ) ap p l i es
o n l y t o “ g ai n o r l o s s fro m

s o u rces wi th i n the Un i t edSt at es ”. (Em p h as i s ad d ed .) So m e t y p es o f fo rei g n-s o u rce i n co m e are s ti l l treat edas effect i v el y co n n ect ed i n co m e u n d er s ect i o n 8 6 4 (c)(4 )(B), b u tthe Co m m i ss i o n er ack n o wl ed ges th at“ t h e i n co m e ati s s u e d o es n o tfal l wi th i n th e l i m i tedcat eg o ri es o f s ect io n 8 6 4 (c)(4 )(B).” Ab sen t ap p li cat i o n o f s ect i o n 8 6 4 (c)(4 )(B), t h e d i sp u tedg ai n m u st b e U.S.-s o u rce i n co m e t o b e effect i v el y co n n ect ed , an dth u s s ub

ject t o t ax u n d er
s ect i on 8 8 2
.- 3 3 - 1
. Rev . Ru l . 9 1 -3 2 Th e Co m m is s i o n er wo ul dm ak e t h is “ effect i v el y co n n ect ed ” an al y s i s s i m

p l e fo r t h e Co u rtb y

h av i n g u s d efer t o h i s co n cl us i o n i n Rev en u e Ru l i n g 9 1 -3 2 , 1 9 9 1- 1 C.B. 1 0 7 , wh i ch h o l d s th at g ai n l i k e GM M ’ s d i s pu t edg ai n i s effect i v el y
co n nect edwi th a U.S. trad e o r b u s i n es s. Th e Co m m i s s i o n er arg u es thatwe s h o u l d g i v e t h e ru li n g “ ap pro pri at e d eferen ce”. Th e ru l i n g co n t ai n s three fact p at t ern s , b u tth e es s en ti al fact s o f al l three m i rro r t h o se o f t h i s cas e. No ne o f t he t hree
ex p li ci t l y co ncl u d es wi th a l i qu i d at i n g d i s tri b u t i o n t o th e fo rei g n p art n er (t wo en d wi th a s al e, an d o n e en d s wi th a “ d i s p o s i t i o n ” o f t h e i nt eres t ), b u t th i s i s n o ta
m at eri al d i s t i n ct i o n . Th e ru l i n g h o ld s t hatthe g ai n real i zedb y a fo rei g n p art n er up o n d i s po s i n g
o f i t s i n t eres t i n a U.S. p art n ers h i p s h o ul d b e an al y zedas setb y as s et , an dth at , t o th e ex t en tth e as s et s o f t h e p art n ers h i p wo u l dg i v e ri se t o effect iv el y co n n ect ed i n co m e i f s o l d b y

th e en t i ty , th e d ep art i ng p art n er’ s p ro rat a s h are o f s u ch g ai n
s h o u ldb e t reat edas effect i v el y co n n ect edi n co m e. In o th er wo rd s , the ru l i n g
es s en t i al l y ad o p t s th e s am e an al y s i s Co n g res s p res cri b edi n s ect i o n 7 5 1 fo r i n v en t o ry an drecei v ab l es , ex cep tth atth e ru li n g ap pl i es th atap p ro ach fo r a cat eg o ry o f as set s (i .e., effect i v el y co n n ect edi n co m e-g en erat i n g as s et s ) d i fferen t fro m th e as s et s ad dres sed i n s ect i o n 7 51
.- 3 4 -

Ou r l ev el o f d eferen ce t o ag en cy i n t erp ret at i o n s o f l aw v ari es . Wh ere t h e i n t erp ret at io n co n s tru es an ag en cy ’ s o wnam b ig u o u s reg u lat i o n , th ati n t erp ret at i o n i s acco rd edd eferen ce, Ran d v . Co m m i s si on er, 1 4 1 T.C. 3 7 6 , 3 8 0 -3 8 1 (2 0 1 3 ) (ci t i n g Au er v . Ro b b i n s , 5 1 9 U.S. 4 5 2 , 4 61 (1 9 9 7 )). Onth e o th er h an d , wh ere a
rev en u e ru l i ng i m

p ro p erl y i n t erp ret s th e t ex to f rel ev an ts t atu t es an d h as i n ad equ at e reas o n i n g , we affo rdi tn o d eferen ce atal l . PSB Ho l d i n g s , In c. v . Co m m i s s i o n er, 1 2 9 T.C. 1 3 1 , 1 4 5 (2 0 0 7). Bet ween th es e p o les , we fo l l o w
rev en u e ru l i ng s t o th e ex t en tthatth ey h av e t h e “ po wer t o p ers u ad e”. See i d . at 1 4 4
. Rev . Ru l . 9 1 -3 2 i s n o ts i m p l y an i n t erp ret at i o n o f t h e IRS’ s o wnam b i g u o u s reg u l at i o n s , an dwe fi n dth ati tl ack s th e p o wer t o p ers u ad e. It s t reat m en t o f t h e p art n ers hi p p ro v i s i o n s d i s cu s s edab o v e i n p artII.B i s cu rs o ry i n th e ex trem e, n o t
ev en ci t i n g s ect io n 7 31 (wh i ch , as we s eto ut , y i el d s a co ncl u s io n o f “ g ai n o r l o s s fro m th e s al e o r ex ch an g e o f t h e p art n ers h i p i n teres t ” (em p h as i s ad ded )). Th e
ru l i n g’ s s ub ch ap t er K an al y s is es s en t ial l y b eg i n s an den d s wi th th e o bs erv at i o n th at“ [s ] ub ch ap t er K o f th e Co d e i s a b l en d o f ag greg at e an den t i ty treat m en tfo r p art n ers an d p art ners h i p s .” W e cri t i ci ze t h e ru li n g ’ s treat m en t o f t h e s ub ch ap t er N i s su es i n n o t es 2 2 an d 2 4 b el o w. W e d ecl i n e t o d efer t o th e ru l i n g . W e wi l l i n s t ead- 3 5 -

fo l l o wth e Co d e an dth e reg u l at i o n s t o d et erm i n e wh et h er t h e d is p u t edg ai n i s effect i v el y

co n n ect edi n co m e. 2
. Th e d efau l ts o u rce ru l e an dth e “ U.S. o ffi ce ru l e” ex cep t i o n Fo l l owi n g th e p ro g res si o n o f s ect i o n 8 6 4 (c), we b eg i n b y ex am i ni n g wh et h er t h e d i s p u t edg ai n i s U.S. s o u rce. Sect io n s 8 6 1 -8 6 3 an d8 6 5 m ak e up m o s t
o f t h e s o u rci n g ru les i n th e Co d e. Th ere i s n o Co d e s ect i o n thats p eci fi cal l y p ro v id es th e s o u rce o f a fo rei g n p artn er’ s i n co m e fro m th e s al e o r l i qu i d at i o n o f i ts i n t eres ti n a p art n ers hi p . Sect i o n 8 6 5 p ro v i d es th e d efau l ts o urce ru l e fo r g ai n real ized on th e s al e o f p ers o nal p ro p ert y . Th e d efau l ts o u rce ru l e fo r i n co m e fro m the s al e o f p ers on al p ro pert y i s fo u n d i n s ect io n 8 6 5 (a), wh i ch p ro v i des :

SEC. 8 6 5(a). Gen eral Ru l e.--Ex cep tas o th erwi s e p ro v id edi n th i s s ect io n , i n co m e fro m th e s al e o f p ers on al p ro pert y -- (1 ) b y a Un i t edSt at es res id en ts h al l b e s ou rcedi n th e Un i t edSt at es , o r (2 ) b y a n on res id en ts h al l b e s o urced o u t s id e t h e Un i ted St at es . Th e Co m m i ss i o n er d o es n o td i s p u t e t h atGM M i s a n o n res i den to f t h e Un it ed St at es , an d GM M arg u es th at , u n d er t h i s d efau l tru l e, t h e d i s p u t edg ai n i s t h erefo re fo rei gn s o u rce. GM M i s ri gh t , u n l es s an ex cep t i o n i n t erv en es .- 3 6 -

Th e Co m m is s i o n er arg u es , h o wev er, t h atth e d i s pu t ed g ai n fal ls u nd er an
ex cep t i o n t o th e d efau l tru l e--n am el y , th e “ U.S. o ffi ce ru l e” o f
s ect i on 8 6 5 (e)(2 )(A), wh i ch p ro v i des : “ [I] f a n on res i d en t m ai n t ai n s an o ffi ce o r
o th er fi x edp lace o f b u s i n es s i n th e Un i t ed St at es , [ 1 9 ] i n co m e fro m an y s al e o f p ers o n al p ro p ert y

(i n cl u d i n g i n v en t o ry

p ro p ert y ) at tri b u t ab l e t o s u ch o ffi ce o r
o th er fi x edp lace o f b u s i n es s s hal l b e s o u rcedi n th e Un i t edSt at es .” (Em p h as i s ad d ed .) Th u s , th e d i s p u t edg ai n m i g h tb e t ax ab l e u n der t h i s ex cep t i o n i f t h e g ai n
was at tri bu t ab l e t o Prem i er’ s o ffi ce, wh i ch we as s u m e s h o ul db e d eem edt o h av e b een G M M ’ s U.S. o ffi ce. Th e Co m m i s s io n er arg u es : Th e g ai n Greci an real i zedi n 2 0 0 8 an d 2 0 0 9 rep res en t s Greci an ’ s s h are o f t h e ap p reci at i o n i n v al u e o f Prem i er’ s b u s i n es s res u l t in g fro m Prem i er’ s effo rt s t o i m

p ro v e Prem i er’ s p ro fi t s du ri n g Greci an ’ s t en ure as a p art n er. As s uch , th e g ai n i s at tri bu t ab l e t o Greci an ’ s U.S. o ffi ces an d i s s ub

jectt o U.S. t ax . Th e Co m m i ss i o n er’ s arg u m en tap p ears t o b e t h at , b ecau s e t h e ap p reci at i o n i n th e
v al u e o f GM M ’ s p art n ers h i p i n t eres tth at y i el d edthe d i s p u t edg ai n wh en th e

1 9 Sect i o n 8 6 4 (c)(5 )(A) p ro v i d es ru l es reg ard i n g at tri b u t i o n o f U.S. o ffi ces o r o th er fi x edp laces o f b us i nes s fro m U.S. ag en t s t o fo rei g n p ri n ci p al s . Th e p art i es d i s p u t e wh et h er s u ch at tri b ut i o n o f Prem i er’ s o ffi ce t o GM M i s ap p ro p ri at e h ere. W e as s u m e, wi th o u t h o l d i n g, thatGM M d i d h av e an o ffi ce o r o th er fi x edp l ace o f b u s i n es s wi th i n t h e Un i t ed St at es --i .e., Prem i er’ s . Becau s e we h o l dth ati n an y ev en t th e d i s p u t edg ai n was n o t“ at tri b u tab l e t o ” an y s u ch o ffi ce, we n eedn o t res o l ve t h i s d i s p u t e.- 3 7 -

red em pt i o n o ccu rredwas u l t im at el y g en erat edb y

act i vi t i es en g ag edi n at Prem ier’ s o ffi ces , th e t ax l aw o u g h tt o at tri bu t e t h atg ai n t o t h o se o ffi ces .

3
. At tri b u ti o n o f t h e red em p t i o n o f GM M’ s i n t eres t Sect io n 8 6 5 (e)(3 ) p ro v i d es th at , i n o rd er t o d et erm in e wh et h er i n co m e fro m
a s al e i s at tri b u t ab l e t o a U.S. o ffi ce o r fi x edp l ace o f b u s i n es s , we m u s tl o o kt o

“ [t ] h e p ri n ci p l es o f s ect i o n 8 6 4(c)(5 )”, wh i ch p ro v i d es ru l es fo r ap p l y i ng s ect i o n 8 6 4 (c)(4 )(B) t o d et erm i ne wh att ax i t em s are “ at tri b ut ab l e t o” a U.S. o ffi ce. 2 0 Un d er s ect i o n 8 64 (c)(5 )(B), i n co m e, g ai n, o r l o s s i s at tri b u tab l e t o a U.S. o ffi ce
o n l y i f: (a) t h e U.S. o ffi ce i s “ a m at eri al fact o r i n th e p ro du ct io n o f s u ch i n co m e”,
an d (b ) th e U.S. o ffi ce “ reg u l arl y carri es o n act iv i ti es o f t h e t y pe fro m wh i ch s u ch i n co m e, g ai n , o r l o ss i s d eri v ed .” 2 1 (Em p h as is ad d ed
. ) 2 6 C.F.R. s ect i o n 1 .8 6 4 -6 , In co m e Tax Reg s ., refers t o th es e t wo el em en t s t o g et h er as th e “ m at eri al fact o r” t es t , ex p l ai n i n g “ reg u l arl y carri es o n act iv i t i es o f t he t y p e”, s ee s ec. 8 6 4 (c)(5 )(B),
as “ real i zedi n the o rd i n ary co urs e”. Becau s e t h e reg u l at io n em p l oy s t h e p h ras e

2 0 By i t s t erm s , s ect i on 8 64 (c)(4 )(B) an d(c)(5 ) d oes n o t ap p l y t o g ai n s fro m d i s p o s i t i on s o f p art n ers h i p i n t eres t s , b ecau s e s u ch g ai n s are n o t o n e o f t h e t h ree ty p es o f i n co m e d en o t edi n s ect i o n 8 6 4 (c)(4 )(B)(i )-(i i i ). Th u s , s ect io n 8 65 (e)(3 ) d o es no ti n co rp o rat e s ect i o n 8 6 4 (c)(5 ) p er s e b utrat h er i n v o k es o n l y “ [t ] h e p ri n ci p l es o f s ect i o n 8 6 4(c)(5 )”. (Em p h as i s ad d ed .)
2 1 Th e p art i es h av e n o td irect edu s t o an y cas el aw ap p l y i n g th es e “ m at eri al fact or” an d“ o rd i n ary

co u rs e” s t an d ard s , an dwe fi n d n o n e.- 3 8 -

“ i n th e o rd i n ary

co u rs e” i n i t s ap p l i cat io n o f t h e s t atu t e, we al so u s e “ o rd i n ary
co u rs e” h ere as a s yn o n y

m fo r “ reg u l arl y

carri es o n act i v it i es o f t h e t y p e”.
a. Wh et h er Prem ier’ s U.S. o ffi ce was a m at eri al fact o r i n th e p ro du ct i o n o f GM M’ s d is p u t edg ai n Th e reg u l at i o n d efi ni n g wh att ax i t em s are “ at tri b u t ab l e t o ” an o ffi ce o r
o th er fi x edp lace o f b u s i n es s i n th e Un i t ed St at es d o es n o ts eta cl ear, o bject i v e
s t an d ard . Sh ed d i n g s o m e l i g h t o n wh ati s co n si dered t o b e a m at eri al fact o r, th e reg u l at i o n p ro vi d es : Fo r t h is p urp os e, t h e act iv i t i es o f t h e o ffi ce o r o th er fi x edp l ace o f b u s i n es s s h al l n o tb e co n s i d eredt o b e a m at eri al fact o r i n t h e real i zat i o n o f t h e i n co m e, g ai n , o r l o s s u n l es s t h ey p ro v i d e a s i gn i fi can t co n tri bu t i o n t o , b y b ei n g an es s en t i al eco n o m ic el em en ti n , th e real i zat io n o f th e i nco m e, g ai n , o r l o ss . * * * Iti s n o tn eces s ary th atth e act i v it i es o f t h e o ffi ce o r o ther fi x edp l ace o f b u s i n es s i n th e Un i t edSt at es b e a m ajo r fact o r i n t h e real i zat i o n o f t he i n co m e, g ai n , o r l o s s. * * * 2 6 C.F.R. s ec. 1
. 8 6 4 -6 (b )(1 ), In co m e Tax Reg s . (em p h as i s ad d ed ). Th u s , u n d er th i s reg u l at i o n , a “ m at eri al fact o r” m u s tb e “ s i g ni fi can t ” an d“ es sen t i al ” b u tn o t
n eces s ari l y

“ m ajo r”. Th e reg u l at i o n th u s l eav es m an y u n an s w eredqu es t i o n s . Th e Co m m is s i o n er’ s arg u m en ti n th i s reg ardh as two s tran d s : fi rs t , th at Prem ier’ s o ffi ce was m at eri al t o th e d eem eds al e o f GM M ’ s p o rt i o n o f p art n ers h i p
as s et s; an ds eco n d , th atPrem i er’ s o ffi ce was m at eri al t o th e i n creas edv al u e o f- 3 9 -

Prem ier t h atGM M real i zedi n th e red em p t io n . 2 2 W e wi l l ad dres s thes e
co n ten t i o n s i n turn . Fi rs t , th e Co m

m i s s i o n er co n t en d s th atGM M ’ s red em p t i o n o f i t s p art n ers h i p i n t eres ti n Prem i er was equ iv al en tt o Prem i er’ s s el l i n g i t s u n d erl y i ng as s et s an d d i s tri b u t i n g t o each p art n er i ts p ro rat a s h are o f t h e p ro ceed s . If we were t o v i ew th e red em p t i o n tran s act io n as a h y

po th et i cal s al e b y

Prem ier o f GM M ’ s i n teres ti n each i t em o f Prem i er’ s p ro p ert y

an dth e rem i t t an ce t o GM M o f t h e p ro ceed s fro m th ats al e, t h en i tm i gh tm ak e s en s e t o v i ew t h e act i v i t i es o f Prem i er’ s U.S. o ffi ce (wh ich we as s um e at tri b u tab l e t o GM M) as a m at eri al fact o r i n th e p ro du ct i o n o f th e i n co m e t o GM M
. Ho w ev er, i f t he Co m m i s s i on er’ s v i ew were co rrect , th en i t
wo u l dy i el dan “ ag g reg at i o n th eo ry ” g en eral ru le t h at wo u l d ren d er s up erfl u o u s
s ect i on s 7 5 1 an d8 9 7 (g ), b o th o f wh i ch p res um e a co n trary , “ en t it y th eo ry ” g en eral
ru l e t o wh i ch s ect i on s 7 5 1 an d8 9 7 (g ) are “ ag greg at i o n th eo ry ” ex cep t i o n s . M o reo v er, i n o rd er t o v i ew t h e red em p t io n tran s act i o n as a h y

po th et i cal s al e o f

2 2 Th e Co m

m is s i o n er’ s arg u m en twas es s en ti al l y fi rs tex pl ai n edi n th i s l i ti g at i o n . Rev . Ru l . 9 1 -3 2 , 1 9 91 -1 C.B. 1 0 7 , d o es n otad dres s o r an al y ze t h e qu es ti o n wh en an o ffi ce o r o th er fi x edp l ace o f b u s in es s m i g ht b e a m at eri al fact o r i n the p ro du ct i o n o f red em pt io n g ai n . Rat h er, i t s u m m ari l y s tat es th atth e reg u l at i o n s wh i ch i n th e n o n -red em p t i o n co n t ex t d et erm i n e wh et her i nco m e i s real ized fro m

th e act i v e co n du cto f a U.S. trad e o r b u s i n es s, s ec. 1 .8 64 -4 (c)(3 ), In co m e Tax Reg s ., an dwh et her an as seti s u s edi n th e act i v e co n du cto f a U.S. trad e o r b u si n es s , s ec. 1 .8 6 4 -4 (c)(2 ) ap p l y . Th i s ex p l an at i o n i s cu rs o ry atb es t
.- 4 0 -

GM M’ s p o rt i o n s o f p art n ers hi p p ro p ert y , o n e wo u l dh av e t o ab an d o n , fo r n o
reas on ev i d en t i n th e s t atu t e o r th e reg ul at i on s , th e co n cl u s i on s cal l edfo r b y
s ub ch ap t er K, s ee s up ra, p artII.A--i .e., th atth e d is p u t edp o rt i o n o f t he red em p t i o n p ro ceed s i s t o b e t reat edas “ g ai n o r l o ss fro m th e s al e o r ex ch an g e o f th e p art n ers hi p i n t eres t ”, s ec. 7 31 (a), wh i ch i s “ a [s i n g u lar] cap i t al as s et ”, s ec. 7 4 1
. As i s ex pl ai n edab ov e i n p artII.B.2 , th e s o u rce o f i n co m e fro m th e s al e o f
an as s et , i n cl u d i n g a cap i t al as s et , i s d et erm i nedb y s ect i o n 8 6 5. Sect i o n 8 6 5 (a) p ro v id es th atth e s o u rce o f s u ch i n co m e as U.S. o r fo rei g n fo ll o ws th e res i den cy o f th e t ax p ay er, u n l es s o n e o f t h e s ub s equ en ts ub s ect i o n s i n s ect i o n 8 6 5 p ro v id es
o th erwi s e. Un d er s ect i o n 8 6 5 (e)(1 )(A), t h e i n co m e t h atthe U.S. o ffi ce ru le
ren d ers U.S. s ou rce i s “ i n co m e fro m s al es * * * at tri b ut ab l e t o s uch o ffi ce”, an di n th e red em p t i o n GM M ’ s i n co m e was i n co m e o n th e ex ch an g e o f i t s p art n ers h i p i n t eres t . Iti s thati nco m e--t h e i n co m e real izedi n th e red em p t i o n --t h atm

u s tb e at tri b u t ab l e t o th e o ffi ce. Co ns i s t en tth erewi th , b u t ev en m o re fo cu s ed , s ect i o n 8 6 5 (e)(3 ) i n di cat es th atth e i s s u e i s “ wh et h er a s al e i s at tri b ut ab l e t o s uch an
o ffi ce”. Th e act u al “ s al e” t h ato ccu rredh ere was GM M ’ s red em p t i o n o f i ts p art n ers hi p i n t eres ti n Prem i er. W e co n cl u d e t h at , fo r t h e p art ners h i p ’ s U.S. o ffi ce t o b e a “ m at eri al fact o r” i n th e rel ev an ts en s e, th ato ffi ce m u s tb e m at eri al t o th e red em pt i o n tran sact i o n i t s el f an dthe g ai n real i zedth erei n , rat h er t h an s i m p l y- 4 1 -

b ei n g a m at eri al fact o r i n o n g o i n g , d i s tri b ut i v e s hare i n co m e fro m reg u l ar b u s i n es s
o p erat i o n s . Co ns equ en t l y , the Co m m i s s i on er’ s arg u m en t th atPrem i er’ s U.S.
o ffi ce wo u l dh av e b een a m at eri al fact o r fo r a h y p o th et i cal s al e o f u nd erl y i n g p art n ers hi p as set s m is s es th e m ark
. Seco n d , fo cu s in g o n th e m em b ers h i p i n t eres ti t s el f, th e Co m m i s si on er arg u es i n the al tern at iv e t hatb ecau s e Prem i er i n creas edth e v al u e o f i t s u nd erl y i n g
as s et s an di n creas edi t s o v eral l v al u e as a g o i ng co n cern du ri n g t h e p eri o dth at GM M was a p art n er, t h ereb y i n creas i n g th e v al ue o f GM M ’ s i n teres t , Prem i er’ s U.S. o ffi ces were an es s en t ial eco n o m i c el em en ti n GM M ’ s real i zat i o n o f g ai n i n th e red em p t i o n . Ins o arg u in g , th e Co m m i s s i o n er co n fl at es th e o ng o i n g v al u e o f a b u s i n es s o p erat i o n wi th g ai n fro m th e s al e o f an i nt eres t i n th at b u s i nes s . As we h av e ex p l ai n edp rev i o us l y , GM M ’ s g ai n i n th e red em pt i o n was n o treal izedfro m Prem ier’ s t rad e o r b u s i n es s o f m i n i ng m ag n es i te, t h ati s , fro m act i vi t i es atth e p art n ers hi p l ev el ; rat h er, GM M real izedg ai n atth e p art n er l ev el fro m th e d i s t i n ct
s al e o f i ts p art n ers h i p i n t eres t. See s up ra p artII.A.1
. GM M p o in t s t o 2 6 C.F.R. s ect i o n 1
. 8 64 -6 (b )(2 )(i ), In co m e Tax Reg s . (ad dres s i n g “ m at eri al fact o r” an al y s i s i n t h e cas e o f “ [r] en t s , ro y al t i es , o r g ai n s o n
s al es o f i n t an g i b l e p ro p erty ”), an d arg u es th atPrem i er’ s effo rt s t o i n creas e i t s
v al u e as a g o i n g co ncern d o n o t , wi th ou tm o re, es tab l i s h th at GM M ’ s real i zat i o n- 4 2 -

o f g ai n o n th e red em

p t i o n i s at tri b u t ab le t o Prem i er’ s o ffi ce. Th e reg ul at io n p ro v id es : Ano ffi ce o r o th er fi x edp l ace o f b u si n es s i n th e Un i t edSt at es s h al l n o tb e co n si d eredt o b e a m at eri al fact o r i n th e real i zat io n o f i n co m e, g ai n , o r l o s s fo r p urp os es o f t h i s s ub d i v i s i o n m erel y b ecau s e t h e o ffi ce o r o th er fi x edp l ace o f b u s i n es s co n du ct s o n e o r m ore o f t h e fo l l o wi ng act i vi t i es : (a) Dev el o ps , creat es , p ro du ces , o r acq u i res an d ad d s s ub s t an t i al v al u e t o , th e p ro pert y wh ich i s l eas ed , l i cen s ed , o r s o l d , o r ex ch an ged , (b ) co l l ect s o r acco u n t s fo r t h e ren ts , ro y al t i es , g ai n s, o r l o ss es , (c) ex erci s es g en eral s up erv i s i o n o v er t h e act iv i t i es o f t h e p ers o n s d i rect ly

res p o n s i b l e fo r carry i n g o n th e act i v i t ies o r s erv ices d es cri b edi n th e i m m ed i at el y p reced in g s en ten ce, (d ) p erfo rm s m erel y

cl eri cal fu n ct i on s i n ci d en t t o th e l eas e, l i cen s e, s al e, o r ex ch an g e o r (e) ex erci s es fi n al ap p ro v al o v er t h e ex ecu t i o n o f th e l eas e, l i cen s e, s al e, o r ex ch an g e. * * * [Id .; em p h as i s ad ded
. ] Th e Co m m i ss i o n er d i s m i ss es th i s arg u m en twi th th e o bs erv at i o n , co rrect as far as i t go es , th atthe reg u lat i o n co n cern s “ [r] en ts , ro y al t i es , o r g ai n s o n s al es o f i n t an g i b l e p ro p ert y ”, wh ereas h ere t h e i n co m e ati s s u e i s d i fferen t --i .e., p ro ceed s fro m th e red em

p t i o n o f a p art n ers h i p i n t eres t
. Th e Co m m i s s i o n er i s co rrect i n th e
s en s e t h atth i s reg ul at i o n i s n o td i rect l y o n p oi n t ; h o wev er, i n d et erm in i n g wh et h er
a s al e i s at tri b u t ab l e t o an o ffi ce, we are d irect edb y s ect i o n 8 6 5(e)(3 ) t o co n s u l t
n o t“ s ect io n 8 64 (c)(5 )” (wh i ch b y i t s t erm s d oes n o t ap p l y

h ere, s ee s upra n o t e 1 9 ) b u trat her “ th e p ri n ci p l es o f s ect i on 8 6 4 (c)(5 )”. (Em p h as is ad d ed
. ) Itth erefo re
s eem s we m

u s tt ak e g u i d an ce as ap p ro p ri at e fro m s ect i o n 8 6 4(c)(5 ) an d th e reg u l at i o n s p ro m

u l g at edthereu n d er wi th o u td i s m i s si ng , as th e Co m m i ss i o ner- 4 3 -

wo u l d , p ro vi si o ns th atare n o t d i rect l y o n p o i nt , s i n ce t h e s eto f p ro v is io n s th atare d i rect l y o n p o in t i s an em

p ty s et . W e ack n owl ed g e i t i s fai r t o o bs erv e t h ata p ro v is i o n ap p l icab l e t o o n e k i n do f i n co m e m i g htn o t b e s u i t edt o a “ m at eri al fact or” an al y si s fo r an ot h er k i ndo f i n co m e. Bu twe s ee n o reas o n t o d i s reg ardth i s

“ [r] en t s , ro y al t i es ”, et c., p ro v i s i o n i n s o far as i t p ro v i d es an i n s t an ce i n wh i ch a U.S. o ffi ce t h at“ [d ] ev el o p s ” an d“ ad d s s ub st an t i al v al u e t o ” an i nco m e-g en erat i n g
as s et i s n o net h el es s n o ta “ m at eri al fact o r” i n the real i zat i o n o f i n co m e fro m th at
as s et
. GM M reas on ab l y

d eri v es fro m

th i s reg u l at i o n the p ri n ci p l e t h atth e creat io n
o f u n derl y i n g v al ue i s s i m p l y a d is t in ctfu n ct i o n fro m

b ei n g a m at eri al fact o r i n th e real izat i on o f i n co m e i n a s p eci fi c t ran sact io n . Th e m at eri al fact o r t es t is n o ts at i s fi edh ere b ecau s e Prem ier’ s act io n s t o i n creas e i t s o v eral l v al u e were n o t“ anes s en t i al eco n o m i c el em en t i n th e real izat i on o f t h e i n co m e”, 2 6 C.F.R. s ec. 1
. 8 6 4 -6 (b )(1 ), th atGM M recei v edup o n th e s al e o f i t s i n t eres t . In creas in g th e v al u e o f Prem i er’ s b u s i n es s as a g o i n g
co n cern , wi th o u t a s ub s equ en ts al e, wo u l dn o th av e res u l t edi n th e real i zat i o n o f g ai n b y GM M. To b e s u re, GM M ’ s i n v es t m en ti n Prem i er i ncreas edi n v al u e, p res u m ab l y fro m Prem i er’ s b u s in es s act i v i ti es ; b u t GM M d idn o t real i ze g ai n fro m h o l d i n g i t s i n t eres ti n Prem i er u n t il th atam o u ntb ecam e l i qu i d , th ati s , u n t i l i t s p art n ers h i p- 4 4 -

i n t eres twas red eem ed . Th e reg u l at i o n s cal l fo r t h i s fo cu s i n two way s --b y p ro v id i n g th atad d i n g val u e al o n e i s n o ta m at eri al fact o r, s ee i d . s ub p ara. (2 )(i )(a),
an d b y p ro v i d in g t hatp erfo rm in g m erel y cl eri cal fu n ct i o ns i n ci d en tt o t h e s al e o r
ex ch an g e (i .e., a reas on ab l e d es cri p t i o n o f Prem i er’ s ro l e i n effect i n g t h e l i qu i dat i o n ) 2 3 i s n o ta m at eri al fact o r, s ee i d . s ub di v . (i )(d ). Th us , Prem i er’ s effo rt s t o d ev el o p , creat e, o r ad d s ub s tan t i al v al u e t o th e p ro p ert y s o l dare n o tco n s i d ered t o b e a m at eri al fact o r i n t h e real i zat i on o f t h e d i s p u t edg ai n p u rs u an tt o 2 6 C.F.R.
s ect i on 1 .8 6 4 -6 (b )(1 ), an dthe Co m m i s s i o n er t h erefo re fai l s t o s h o w th atth e fi rs t t es tfo r at tri b ut i n g th e d i s p u t edg ai n t o a U.S. o ffi ce--“ m at eri al fact or”--i s m et
.

b
. Wh et h er GM M ’ s d i sp u tedg ai n was real i zedi n t h e o rd i naryco u rs e o f Prem i er’ s b us i n es s Th e s eco n dp arto f t h e U.S.-s o urce at tri b u t i o n i n qu iry --“ o rd i n ary co u rs e”-- i s fo u n di n 2 6 C.F.R. s ect i o n 1 .8 6 4 -6 (b )(1 ), wh ich p ro v i d es : [I] n co m e, g ai n , o r l o s s i s at tri b u tab l e t o an o ffi ce o r o th er fi x ed p l ace o f b u s i n es s wh i ch * * * a fo rei g n co rp o rat i o n h as i n th e Un it edSt at es o n l y * * * i f t h e i n co m e, g ai n , o r l o s s i s real i zedi n th e o rd i n ary co u rs e o f t h e t rad e o r b u s i n es s carri edo n th ro u g h t h ato ffi ce o r o th er fi xedp l ace o f b us i n es s . * * * [Em p h as i s ad d ed .]

2 3 Th e Co m

m is s i o n er wo u l dd i s p u t e th e reas o nab l en es s o f t hatd es cri p t i o n , b u ti n p art IV.B.3 .b b el o w we d i s cu s s th e n ature an d m o d es tqu an tu m o f Prem i er’ s act i vi ty i n t h e red em

p t io n .- 4 5 -

Ev en i f we were t o d eci de t h atPrem i er’ s o ffi ce was a “ m at eri al fact o r” i n th e p ro du ct i o n o f t h e d i s p u tedg ai n (wh i ch we d o n o t ), we wo u l dal s o n eedt o fi n d th atth e d i s p u t edg ai n was real i zedi n the o rd i n ary co u rs e o f Prem ier’ s b u s i n es s
co n du ct ed th ro u g h i t s U.S. o ffi ce i n o rd er fo r t h e g ai n t o b e at tri b u t ab l e t o t h at
o ffi ce, an d th ereb y t o b e U.S.-s o u rce i n co m e. 2 4 As req u i redb y

i ts b y l aws , Prem i er ex ten d ed t o GM M an o ffer t o red eem i t s i n t eres tacco rd i n g t o th e t erm s o f Prem i er’ s p ri or t ran s act i o n wi th IM i n. GM M accep t edPrem i er’ s o ffer wi th o u tan y n eg o t iat i o n o f t h e t erm s o f t h e d eal
. Acco rd i ng t o GM M , th e red em p t i o n o f i t s i n teres ti n Prem i er was a
o n e-t i m e, ex trao rd i n ary

ev en t an dth erefo re was n otu n dert ak en i n th e o rd i n ary
co u rs e o f Prem i er’ s b u s in es s . GM M arg u es th at Prem i er’ s U.S. o ffi ce i s i n th e b u s i n es s o f s el l i ng an dp ro duci n g m ag nes i t e, n o tb uy i n g an ds el l i n g p art n ers h i p i n t eres t s . Becau s e th e d i sp u t edg ai n was real i zed i n th e red em pt i o n o f GM M ’ s p art n ers hi p i n t eres ti n Prem i er, n o tfro m Prem ier’ s o rd i n ary

b u s i n es s--m ag n es i t e p ro duct i o n an ds al e--i td o es n o ts at i s fy th e o rd i naryco u rs e req u i rem en tan di s n o t U.S. s o u rce.

2 4 Rev
. Ru l . 9 1 -3 2 s up ra,m ak es n o m en t i o n o f t he “ o rd i n ary co u rs e” p ro n g o f th e “ at tri bu t ab l e t o ” an al y si s , an d th i s d et ract s fro m the p ers u as i ven es s o f i t s co n cl u s i o n th atg ai n s u ch as th e d i s p u t edg ai n i s at tri b u t ab l e t o U.S. o ffi ces .- 4 6 -

Th e Co m m is s i o n er d i s ag rees wi th GM M ’ s ch aract eri zat i o n o f Prem i er, an d p o i n t s t o Prem i er’ s o th er act i o ns --ad m i t t i n g a n ew p art n er an dred eem in g IM i n ’ s i n t eres t --t o s h o w th atPrem i er’ s red em pt i o n o f GM M ’ s i n t eres twas n o tan i s o l at ed
ev en t. Th e Co m

m i ss i o n er t ak es the p o s i ti o n t h atth e wo rd i n g o f
s ect i on 8 6 5 (e)(2 )(A) (“ an y s al e o f p ers o n al p ro p ert y ”) i s b ro aden o u g h t o co v er al l
s al es o f p ers o nal p ro p ert y , i n cl u d i n g o ccas i o n al s al es . Th e Co m m i s s i o n er
ex p lai n s : Th e l an g u ag e o f s ect i o n 8 6 4 (c)(5 )(B) d oes n ot req u i re t h atth e s al e o f p ers on al p ro p ert y

o ccu r reg u l arl y ; i treq u i res th atth e ty p e o f act iv i t i es g i v i ng ri s e t o th e i n co m e o ccu r reg u l arl y . Inth i s reg ard , th e l an g u ag e i s am p ly b ro adt o s up p o rtat tri bu t i o n t o an o ffi ce o f i n co m e fro m an o ccas i o n al s al e o f p ers o n al p ro p ert y , i f t h e g ai n o n t h e s al e i s d eri ved fro m th e b u s i n es s act i vi ti es reg u l arl y co n duct edth ro ug h the o ffi ce o r o th er fi x edp lace o f b u s i n es s . [Em p h as i s ad d ed .] Th e Co m m is s i o n er ag ai n co n fl at es the o n g o i ng i n co m e-p ro du ci ng act i v i t i es
o f Prem ier (m ag n es i t e p ro du ct io n an ds al e), wh i ch cert ai nl y o ccu rredi n th e
o rd i n ary co u rs e, an dth e red em

p t i o n o f GM M’ s p artn ers h i p i n t eres ti n Prem i er, wh i ch was an ex trao rd i n ary ev en t ; an d h e t hereb y

wo u ldeffect iv el y

el im i n at e t h e

“ o rd i n ary co u rs e” t es tan dwo u l dal l o wth e “ m at eri al fact o r” t es tt o s t an d fo r b o t h t es t s . Prem i er’ s b u s i nes s d i dreg u l arl y p ro du ce i n co m e (an dGM M p ai dt ax o n i t s d i s tri b u t i v e s h are o f th ati n co m e each y ear). Ho wev er, co n traryt o the Co m m i s s i o n er’ s as s ert i o n , Prem i er was n o ten g ag ed i n th e b u s i n es s o f b uy i n g o r- 4 7 -

s el l i n g i n t eres t s i n i t s el f an dd i dn o td o s o i n th e o rd in ary co u rs e o f i t s b u s in es s . Prem ier en gag ed in o n ly

two s uch tran s act io n s (o th er t h an th e red em p t i o n o f GM M’ s i n t eres t ) o v er t h e co u rs e o f s ev en y ears , an d t h i s quan tu m o f act i v it y i s n ot
s u ffi ci en tt o s h o w th atPrem i er was i n th e b u s i n es s o f red eem in g an d s el l i ng p art n ers hi p i n t eres t s . Rat h er, Prem ier i s o f co u rs e i n th e b u si n es s o f p ro du ci n g
an d s el l i n g m ag n es i t e p ro du ct s, an d th erefo re GM M ’ s g ai n real i zedo n the red em pt i o n o f i t s p art n ers h ip i n t eres ti n Prem i er was n otreal izedi n the o rd i n ary
co u rs e o f the t rad e o r b u s i n es s carri edo n th ro u g h Prem i er’ s U.S. o ffi ces . Si n ce we h av e h el dthatGM M ’ s d i s p u tedg ai n o n i t s red em p t i o n was n o t at tri b u t ab l e t o a U.S. o ffi ce o r o th er fi x edp l ace o f b us i n es s , i ti s th erefo re n o t U.S.-s ou rce i nco m e u n d er s ect i o n 8 6 5 (e)(2 )(A). As n o t ed ab o v e, t h e Co m m i s s i o n er co n ced es th atth e d i s p u tedg ai n i s n oto n e o f t h e ty p es o f fo rei g n s o u rce i n co m e t reat edas effect i v el y co n n ect edb y

s ect i o n 8 6 4 (c)(4 )(B). Co n s equ en t l y , th e d i sp u tedg ai n i s n o teffect i v el y co nn ect edi n co m e. V. Pen al t i es Aft er au d itth e IRS d et erm i n edth atGM M i s l i ab le fo r ad d it i on s t o t ax u n d er
s ect i on 6 6 5 1 (a) an dan accu racy -rel at edp en al ty u n der s ect i o n 6 6 6 2 (a). GM M
as s ert s a d efen s e, wh i ch we s u s t ai n .- 4 8 -

A. Ap p li cab i l i ty

o f accu racy -rel at edp en al ty fo r 2 0 0 8 Sect io n 6 6 6 2 (a) an d(b )(1 ) an d(2 ) i m p o s es an “ accu racy -rel at edp en al ty ” o f 2 0 % o f t h e p ort io n o f t h e u n derp aym en to f t ax th ati s at tri bu t ab le t o th e t ax p ay er’ s
n eg li g en ce o r d i sreg ardo f ru les o r reg u l at i o ns o r t h ati s at tri b u t ab le t o an y
s ub s t an t i al u n ders t at em en to f i nco m e t ax . Anu nd ers t at em en to f a co rp o rat i o n ’ s i n co m e t ax i s s ub s t an t i al i f i tex ceed s th e g reat er o f 1 0 % o f th e t ax req u i redt o b e
s h o wno n t h e ret u rn o r $ 1 0 ,0 00 . Sec. 6 6 6 2 (d )(1 )(B). Th e Co m m i s s i on er as s ert s th atGM M ’ s u n d ers t at em en t s o f i n co m e t ax were s ub s tan t i al an dth atGM M was
n eg li g en ti n th e p rep arat i o n o f i t s retu rn s fo r 2 0 0 8 an d 2 0 0 9
. Si n ce GM M h as co nced edth ato n the red em p t i o n o f i t s p art n ers hi p i n t eres t i t real i zedFIRPTA g ai n o f o v er $ 1 m i ll i o n fo r 2 0 0 8 b u trep o rt edzero o f t h atg ai n
o n i t s 2 0 0 8 t ax retu rn , th e s ub st an ti al u n d ers t at em en tp en al ty i m p o s edb y
s ect i on 6 6 6 2 (d ) i s ap p l i cab l e h ere (s ub ject t o th e d efen s e d es cri b edb el o w). B. Ap p li cab i l i ty

o f fai l u re-t o -fi l e an dfai l u re-t o-p ay ad d i t i o n s t o t ax fo r 2 0 09 Sect io n 6 6 5 1 (a)(1 ) au tho ri zes th e i m p o s i t io n o f anad d i t i on t o t ax fo r fai l u re t o fi l e a t i m el y

retu rn (u n l es s th e t ax p ay er p ro v es thats u ch fai l u re i s du e t o
reas on ab l e cau s e an di s n o tdu e t o wi l l fu l n eg l ect ). Sect i o n 6 65 1 (a)(2 ) p ro v i d es fo r an ad d i ti o n t o t ax fo r fai l ure t o t i m el y p ay “ th e am o u n ts h o wnas t ax o n an y- 4 9 -

retu rn s p eci fi edi n p arag rap h (1 )” u n l es s th e t ax p ay er es t ab l i s h es thatth e fai l u re
was due t o reas o n ab l e cau s e an dn o twi l l fu l n eg l ect . Th e am o un to f th e ad d i t i o n t o t ax u n d er s ect i on 6 6 5 1 (a)(2 ) redu ces th e ad d i t i o n t o t ax u n d er
s ect i on 6 6 5 1 (a)(1 ) fo r an y m o n th fo r wh i ch b o th ad d it i o n s t o t ax ap p l y . See
s ec. 6 6 51 (c)(1 ). Wh en a t ax p ay er h as n o t fi l eda retu rn , th e s ect io n 6 6 5 1(a)(2 ) ad d it i o n t o t ax m ay n o tb e i m p o s edu nl es s th e Secret ary h as p rep aredan SFR t hat
m eet s th e req u irem en t s o f s ect i o n 6 0 2 0 (b ). Wh eel er v . Co m m i ss i on er, 1 2 7 T.C. 2 0 0 , 2 0 8 -2 0 9 (2 0 06 ), aff’ d , 5 2 1 F.3 d1 2 8 9 (1 0 th Ci r. 2 0 08 ). Pu rs u an tt o
s ect i on 6 6 5 1 (g )(2 ), an SFR p rep aredb y th e Co m m i s s i o n er u n d er s ect i o n 6 0 2 0 (b ) i s treat edas a t ax pay er ret u rn fo r p u rp o s es o f d et erm i ni n g the ad d i t i o n t o t ax u nd er
s ect i on 6 6 5 1 (a)(2 ). Al th ou g h we h av e fo u n dth atth e d i s p u tedp o rt i o n o f GM M ’ s g ai n o n th e red em pt i o n o f i t s p art n ers h ip i n t eres twas n o tt ax ab l e i n th e Un i t edSt at es , GM M h as co nced edth at$ 1
. 2 m il l i o n o f i t s 2 0 0 9 g ai n was t ax ab l e, p u rs u an tt o th e FIRPTA ru l es o f s ect i on 8 9 7 (g ). GM M d i d n o tfi l e a 2 0 0 9 Fo rm 1 1 2 0 -F rep o rt i n g th i s g ai n n o r p ay

th e t ax o n th atg ai n (as rep o rt edo n t h e IRS’ s SFR). Th erefo re, as a t hres h o l dm at t er, t h e ad di t i o n s t o t ax i m po s edb y s ect i o n 6 6 5 1 (a)(1 ) an d(2 ) are ap p li cab l e h ere (s ub

jectt o th e d efen s e d es cri b edb el o w).- 5 0 -

C. Reas on ab l e cau se d efen s es Th e s ect i on 6 6 6 2(a) accu racy -rel at edp en al ty an dthe ad d it i o n s t o t ax p u rs u an t t o s ect io n 6 65 1 (a)(1 ) an d(2 ) are each s ub jectt o a “ reas o n ab le cau s e” d efen s e. Th e d efen s es ari se fro m d i s t in cts t atu t o ry s o u rces , b u twh ere a t ax p ay er
as s ert s reas o n ab l e cau s e as a d efen s e fro m l i ab i l i ty fo r al l th ree b ecau s e h e rel i ed
o n th e ad v ice o f a co m

p et en tad v i s er, t h e d efen s es o v erl ap s ig n i fi can t l y . W e th erefo re d i s cu s s th em

i n co n jun ct i o n b el o w. 1
. Reas on ab l e cau s e fo r fai l u re t o fi l e an dfai lu re t o p ay Th e fai l u re-t o -fi l e an d fai l u re-t o -p ay ad d i t i o n s t o t ax are ap p l i ed“ u n l es s i ti s
s h o wnth ats u ch fai l u re i s due t o reas o n ab l e cau s e an dn otdu e t o wi ll fu l n eg l ect ”. Sec. 6 6 51 (a)(1 ) an d(2 ). 2 6 C.F.R. s ect i o n 3 01 .6 6 5 1 -1 (c), Pro ced . & Ad m in
. Reg s., p ro v i des : If t h e t ax p ay er ex erci s edo rd i n ary b u s i n es s care an dp ru d en ce an d was n ev ert h el es s u n ab le t o fi l e t he ret u rn wi thi n th e p res cri b edt i m e, th en the d el ay

i s du e t o a reas o n ab le cau se. A fai lu re t o p ay wi l l b e co n s i d eredt o b e du e t o reas o n ab l e cau s e t o th e ex t en t th at th e t ax p ay er h as m ad e a s at i s fact o ry s h owi n g th ath e ex erci s edo rd in ary b u s i n es s care an dp ru d en ce i n p ro v i d in g fo r p aym en to f h i s t ax l i ab i l i ty * * *
.

“ Wh et h er t h e el em en t s thatco n s t i tu t e ‘ reas o n ab l e cau s e’ are p res en ti n a g i v en
s i tu at i o n i s a qu es t i o n o f fact ”, an s weredo n th e b as is o f t h e ci rcu m s t an ces o f t h e i n d i v i du al cas e. Un it edSt at es v . Bo y l e, 4 6 9 U.S. 2 4 1 , 2 4 9 n
. 8 (1 98 5 ). “ [W ] i l l fu l- 5 1 -

n eg lect ” i s d efi n ed as “ a co n sci o u s , i n t en ti o n al fai l u re o r reck l es s i n di fferen ce.” Id . at2 4 5
. Ci rcu m s t an ces th at co n s t i tu t e reas o n ab l e cau s e i n cl u d e g o od -fai th rel i an ce
o n a m i s t ak en l eg al o p i n i o n o f a co m p et en tt ax ad v i ser t h atn o l i ab i l i ty was du e
an d th ati twas u n n eces saryt o fi l e a ret u rn . Id
. at2 5 0 -2 5 1 ; M cM ah an v . Co m m i s s i o n er, 1 1 4 F.3 d3 6 6 , 3 6 9 (2 dCi r. 1 9 9 7 ) (“ [R] el ian ce o n a m i s t ak en l eg al
o p i n i o n o f a co m

p et en t t ax ad v i s er--a l awy er o r acco u n tan t --t h ati twas
u n n eces saryt o fi l e a return co n s t i tu t es reas o n ab le cau s e”), aff’ g T.C. M em o . 1 9 9 5 -5 4 7 . As th e Sup rem e Co u rtart i cu lat edi n Bo y le, 4 69 U.S. at2 5 1 : Wh en an acco u n t an to r at t o rn ey ad vi ses a t ax p ay er o n a m at ter o f t ax l aw, s u ch as wh et h er a l i ab i l i ty ex i s t s , i ti s reas o n ab le fo r t he t ax p ay er t o rel y o n t h atad v i ce. M o s tt ax pay ers are n o tco m p et en tt o d i s cern erro r i n th e s ub st an t i ve ad v i ce o f anacco u n t an t o r at t o rn ey . To req u ire t h e t ax p ay er t o ch al l en g e t h e at t o rn ey , t o s eeka “ s eco n d o p i n i o n ,” o r t o try

t o m o n i t o r co u n s el o n th e p ro v i s io n s o f t h e Co d e h i m s el f wo u ldn u ll i fy

th e v ery p u rp o s e o f s eek i n g the ad v i ce o f a p res um edex p erti n t h e fi rs tp lace. * * * “ Ord i n ary b u si nes s care an d p ru d en ce” d o n o td em an ds u ch act i o n s . 2
. Reas on ab l e cau s e fo r an u n d erp aym en t Si m i l arl y , u n d er s ect i o n 6 6 6 4 (c)(1 ), i f a t ax p ay er wh o i s o th erwi s e l i ab l e fo r th e accu racy -rel at edp en al ty can s h o w, fi rs t , “ th atth ere was a reas o nab l e cau s e” fo r t h e u n d erp aym en tan d , s eco n d , th ath e “ act edi n g o o dfai th wi th res pect t o ” t he
u n d erp aym en t , th enn o accu racy -rel at ed p en al ty “ s h al l b e i m

p o s ed ”. Wh et h er t h e- 5 2 -

t ax p ay er act edwi th reas o n ab le cau s e an d i n g o o d fai th d ep en ds o n th e p ert i n en t fact s an dci rcu m s t an ces , i n cl u d i n g h i s effo rt s t o as s es s h i s p ro p er t ax l i ab i l i ty , h i s kn o wl ed g e an d ex p eri en ce, an dthe ex t en t t o wh i ch h e rel i edo n th e ad vi ce o f a t ax p ro fes s i on al . 2 6 C.F.R. s ec. 1
. 6 6 6 4 -4 (b )(1 ), In co m e Tax Reg s . “ Rel i an ce o n * * * p ro fes s i on al ad v i ce, o r o ther fact s , h o wev er, co n st i tu t es reas o n ab l e cau se an d g o o dfai th i f, u n der al l th e ci rcu m s t an ces , s u ch rel i an ce was reas o n ab le an d t h e t ax p ay er act edi n g oo dfai th.” Id
. Th e Co u rt ’ s cas el aw s et s fo rt h th e fo ll o wi n g th ree req u irem en ts fo r a t ax p ay er t o u s e rel i an ce o n a t ax p ro fes s io n al t o av oi dl i ab i l i ty fo r a
s ect i on 6 6 6 2 (a) p en al ty : “ (1 ) Th e ad v i s er was a co m p et en tp ro fes s i o nal wh o h ad
s u ffi ci en tex p ert i s e t o ju st i fy rel i an ce, (2 ) th e t ax p ay er p ro v i d edn eces s ary an d
accu rat e i n fo rm at i o n t o th e ad v i s er, an d (3 ) t h e t ax p ay er act u al l y rel iedi n g o o d fai th on th e ad vi s er’ s ju dg m en t .” Neo n at ol og y As so cs ., P.A. v . Co m m i s s i on er, 1 1 5 T.C. 4 3 , 9 9 (2 0 0 0 ), aff’ d , 2 9 9 F.3 d2 21 (3 dCi r. 2 00 2 ). Th e Co m m i s s i o n er d o es no tco n t en d t h atGM M d i dn o tp ro v i d e n eces saryan daccu rat e i n fo rm at i o n t o th e ad v i s er; acco rd i n g ly

we tu rn t o th e o ther el em en t s o f t h e reas o n ab l e cau s e d efen s e.- 5 3 - 3
. GM M ’ s rel i an ce o n p ro fes s i o n al ad v i ce GM M i s a Greekco rp orat i o n wh o s e p art n ers hi p i n v es t m en t i n Prem i er was i t s o n l y i n v o l v em en ti n U.S. b u s i n es s . GM M ’ s cen tral fi nan ci al o ffi cer, M r. Lo m vard o s , d i d n o t u n d ers t an dth e co n cep t o f a p art n ers h i p fo r U.S. t ax p u rp os es , n o r t h at GM M wo u l db e s ub jectt o t ax i n the Un i t edSt at es o n i nco m e fro m real p ro p erty

l o cat edth ere. He an d GM M were g en eral l y i gn o ran t o f U.S. t ax l aws . To h i re a t ax p ro fes s i o n al t o co m p l y wi th U.S. t ax l aws , GM M rel i edo n t h e
reco m m en d at i o n o f i t s tru s t edad v i s er, M r. Ph u fas , wh o reco m m en d ed M r. Ro s e. M r. Ro se h as a b ach el or o f art s d eg ree fro m Co l u m b i a Co l l eg e, a m as t er o f b u s i n es s ad m i n i s trat io n d eg ree fro m Co l um b i a Un iv ers i ty

Gradu at e Sch o o l o f Bu s i nes s, an da ju ri s d o ct o rat e fro m St . J o h n ’ s Un i v ers i ty

Sch o ol o f Law; an dh e i s a cert i fi edp ub l i c acco u nt an tl i cen s edi n th e St at e o f New Yo rk
. Atthe t i m e GM M h i redh i m , M r. Ro s e h adb een p rep ari n g U.S. i n co m e t ax retu rn s fo r 4 0 y ears . M r. Ro se s p en t3 0 % t o 4 0 % o f h i s t i m e p rep ari n g i n co m e t ax retu rn s fo r a wi d e v ari et y

o f cl i en t s , i n cl u d i n g p art n ers h ip s . M r. Ro se b el i ev edth ath e was qu al i fi edt o p rep are t he Fo rm s 1 1 20 -F fo r GM M , an d GM M l i k ewi s e b el i ev edh e
was s o qu al i fi ed
.- 5 4 -

Th ereaft er GM M rel i edco m p l et el y o n M r. Ro s e t o p rep are i t s t ax retu rn s . M r. Ro se m ad e t h e d eci s i on th atGM M d i dn o th av e t o rep o rtan y o f i t s g ai n o n th e red em pt i o n o f i t s m em

b ers hi p i n t eres ti n Prem i er o n ei th er i t s 2 0 0 8 o r 2 0 0 9 t ax retu rn , an d n o o ne fro m

GM M qu es t i on edth at d eci si on . Th e Co m m is s i o n er arg u es th atGM M’ s rel ian ce o n M r. Ro s e was n oti n g o o dfai th . Th e Co m

m i s s i on er fi n d s fau ltwi th th e factth atGM M rel i edo n M r. Ph u fas ’ reco m

m en d at i o n o f M r. Ro se wh en GM M h i redh i m t o p rep are i ts t ax retu rn s , rat her t h an co n du ct i n g an i n v es t i gat i on o f M r. Ro s e’ s b ack g ro u n dan d
ex p eri en ce i n t ax retu rnp rep arat i o n atth e t im e. Gi ven wh atl i tt l e GM M kn ew ab o utth e U.S. s y s t em

o f t ax at i o n , we can n o ti m ag i n e GM M wo u l dh av e kn o wn h o w t o co n du cts u ch an i n v es t ig at i o n , l etal o n e wh atv al u e s u ch u n in fo rm ed i n qu i ri es wo u l dh av e ad d ed . GM M act edreas o n ab l y , g i v en i t s ad m it t ed i n ex p eri en ce: Itrel i edo n th e reco m m en d at i on o f i t s tru s t ed ad vi s er, M r. Ph u fas , wh en i tch o s e t o h i re M r. Ro se. Th e Co m m is s i o n er al s o m ak es m

u ch o f t h e fact th atGM M d i d n o th i re an
ex p ertwh o s p eci al i zedi n i n t ern at i o nal t ax l aw o r an at t o rn ey wi th an LL.M
. d eg ree. Iti s tru e t h atM r. Ro se d o es n o th o l d an LL.M . d eg ree i n t ax at i o n , n o r d i d h e cl ai m t o b e ani n t ern at io n al t ax l aw ex p ert . Bu tth i s i s n o tth e s t an d ardfo r t h e
reas on ab l e cau s e d efen s e. To d et erm i n e wh et h er a t ax pay er can av o i dl i ab i l i ty fo r- 5 5 -

a p en al ty o n th e b as i s o f h i s rel i an ce o n th e ad v i ce o f a t ax p ro fes s i o n al , we l o o k t o s ee t h at“ [t ] h e ad v is er was a co m pet en t p ro fes s i o nal wh o h ads u ffi ci en t
ex p ert i s e t o ju s t i fy

rel ian ce”. Neo n at o l o gy

As s o cs ., P.A. v . Co m

m i s s i o n er, 1 1 5 T.C. at9 9 . M r. Ro s e was a l i cen s edat t o rn ey an dcert i fi edp ub l i c acco u n t an twh o h ad s pen tn earl y

4 0 y ears p rep ari n g i n co m e t ax retu rn s , an dh e h adaccu rat el y p rep aredGM M ’ s return s fo r 4 y ears b efo re t he y ears h ere i n i s s u e. W e fi n dth at M r. Ro se h ads u ffi ci en t cred en t i al s t o ju s t i fy GM M ’ s rel ian ce. W e fi n dth atGM M h adreas o n ab le cau se fo r i t s fai lu re t o rep o rt th e FIRPTA g ai n o n i t s 2 0 0 8 ret u rn an dfo r i t s fai l u re t o fi l e a 2 0 0 9 retu rn an d p ay the 2 0 0 9 t ax , o n th e b as i s o f i t s rel i an ce, i n g o odfai th, o n th e ad v i ce o f i t s co m p et en t p ro fes s i on al t ax ad vi s er. W e t herefo re h o ldth atGM M i s n otl i ab l e fo r t h e
s ect i on 6 6 6 2 accu racy -rel at ed p en al ty fo r 2 00 8 n o r th e ad di t i o n s t o t ax u n d er
s ect i on 6 6 5 1 (a)(1 ) an d (2 ) fo r 2 0 0 9
. To refl ectthe fo reg o i n g an d th e p art ies ’ co n ces s i o n s ,

Deci s i o n wi ll b e en t eredu n d er Ru l e 1 5 5
.