Court Opinion

ID: 4405451
Source: CourtListenerOpinion
Date Created: 2019-06-11 15:00:55.907092+00
Date Added: 2024-06-11T12:20:41.273738
License: Public Domain

United States Court of Appeals
         FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued October 9, 2018                 Decided June 11, 2019

                         No. 17-1268

 GRECIAN MAGNESITE MINING, INDUSTRIAL & SHIPPING CO.,
                        SA,
                     APPELLEE

                              v.

      COMMISSIONER OF INTERNAL REVENUE SERVICE,
                     APPELLANT

               On Appeal from the Decision
               of the United States Tax Court

    Deborah K. Snyder, Attorney, U.S. Department of Justice,
argued the cause for appellant. With her on the briefs were
Travis A. Greaves, Deputy Assistant Attorney General, and
Gilbert S. Rothenberg and Richard Farber, Attorneys.

     Michael J. Miller argued the cause for appellee. With him
on the brief was Ellen Brody.

    Before: ROGERS and SRINIVASAN, Circuit Judges, and
GINSBURG, Senior Circuit Judge.

    Opinion for the Court filed by Circuit Judge SRINIVASAN.
                                2
     SRINIVASAN, Circuit Judge: Grecian Magnesite Mining, a
foreign corporation, realized substantial income when it
redeemed its interest in a U.S. partnership. At the time, Grecian
operated entirely outside the United States, save for its interest
in the partnership. The question we face is whether the
geographic origin of the redemption income—its “source”—is
within or without the United States.

    Under the Internal Revenue Code’s general rule, the
income would be sourced according to the residence of the
taxpayer. But that general rule is subject to an exception
known as the U.S. office rule. Under that exception, income
from any sale of personal property attributable to a
nonresident’s U.S. office is sourced in the United States. See
I.R.C. § 865(e)(2).

     The Tax Court held that the U.S. office rule is not satisfied
in this case, reasoning that the proper focus in the
circumstances is where the redemption itself occurred, as
opposed to where the activities causing appreciation of the
redeemed partnership interest occurred. The redemption itself,
the Tax Court determined, should not be attributed to Grecian’s
U.S. office, and the income therefore should be treated as
foreign source. We affirm the Tax Court’s decision.

                                I.

                               A.

    Appellee Grecian Magnesite Mining (Grecian) is a
privately held corporation organized under the laws of Greece.
Grecian’s business involves mining, processing, and selling the
mineral magnesite, and it conducts its business in Greece.
                               3
     In 2001, Grecian acquired a roughly 15% interest in
Premier Chemicals (Premier). Premier is headquartered in the
United States and is a Delaware limited liability company
classified as a partnership for U.S. tax purposes. Like Grecian,
Premier is in the business of mining and processing magnesite.
Unlike Grecian, Premier extracts its ore exclusively from sites
in the United States and conducts its operations entirely
through fixed places of business in the United States.

     On July 21, 2008, Grecian entered into an agreement with
Premier to redeem its interest in the partnership. The
redemption resulted in a gain of over $6 million for Grecian,
spread over 2008 and 2009. Grecian did not include any of the
gain on either its 2008 or 2009 tax returns. The Internal
Revenue Service (IRS) initiated an audit and determined, inter
alia, that the entire capital gain from the redemption was
subject to U.S. tax.

     Grecian brought suit in the Tax Court contesting the IRS’s
determination.       Before trial, Grecian conceded that
approximately $2 million of the $6 million gain derived from
U.S. real property interests and thus was subject to U.S. tax
under a section of the Internal Revenue Code not at issue in this
appeal. The present dispute concerns the remaining $4 million,
which we will refer to as the “disputed gain” consistent with
the practice of the Tax Court and the parties.

                               B.

      Under the Internal Revenue Code, a foreign corporation
such as Grecian may be subject to tax in the United States on
its “income which is effectively connected with the conduct of
a trade or business within the United States,” or ECI (for
“effectively connected income”). I.R.C. § 882; see also id.
§ 881. Not all U.S.-source income is ECI, and not all ECI is
U.S.-source income. Yet the parties agree that, in this case, the
                                4
disputed gain is within the class of income that is ECI (and
therefore taxable) if and only if it is U.S.-source income. As a
result, the sole question before us is the source of the disputed
gain.

     No specific sourcing provision governed income derived
from the disposition of a partnership interest at the time of the
redemption. Instead, the general sourcing rules for the sale of
personal property applied. See I.R.C. § 865. Under the general
rule, income realized on the sale of personal property is sourced
wherever the taxpayer resides. See id. § 865(a). But that
general rule is subject to several statutory exceptions, including
one known as the U.S. office rule. See id. § 865(e)(2)(A).

     Under the U.S. office rule, “if a nonresident maintains an
office or other fixed place of business in the United States,
income from any sale of personal property (including inventory
property) attributable to such office or other fixed place of
business shall be sourced in the United States.” Id. To
determine whether those conditions are met, the “principles of
section 864(c)(5) shall apply.” Id. § 865(e)(3). The
cross-referenced subsection, in turn, says in relevant part that
income “shall not be considered as attributable to an office or
other fixed place of business within the United States unless
such office or fixed place of business is a material factor in the
production of such income, gain, or loss and such office or
fixed place of business regularly carries on activities of the type
from which such income, gain, or loss is derived.” Id.
§ 864(c)(5)(B).

     The Commissioner raised two principal arguments before
the Tax Court. First, he contended that the disposition of a
partnership interest should be treated like a sale of the partner’s
distributive share of each of the partnership’s underlying
assets. That argument drew on the theory of partnerships
                                 5
known as the “aggregate theory,” under which partners are
viewed as directly owning the partnership’s assets. Second, he
argued in the alternative that the disputed gain was attributable
to Grecian’s U.S. office (Premier) under the U.S. office rule—
and therefore was U.S.-source income—because all activities
leading to the appreciation of the partnership share occurred in
the United States through Premier’s successful operations.

     Grecian countered that the partnership interest should be
viewed as a single, indivisible capital asset, building on a
competing theory of partnerships known as the “entity theory.”
Grecian further argued that the income was not attributable to
Premier because the relevant attribution rules focus on the
redemption transaction itself, not on the conduct generating the
asset’s appreciation. The transaction itself, Grecian contended,
was attributable to its offices in Greece rather than any U.S.
office.

     The Tax Court sided with Grecian on both arguments
advanced by the Commissioner. The court rejected the
application of the aggregate theory, holding that Grecian’s
interest in the partnership was a single, indivisible capital asset.
The Court also rejected the Commissioner’s alternative
argument, holding that the income from the redemption was not
attributable to the U.S. office under the U.S. office rule. It
adopted Grecian’s view that the attribution inquiry under the
U.S. office rule focuses on the redemption transaction rather
than the appreciation of the partnership’s value, and that
Grecian’s U.S. office neither was a material factor in that
transaction nor regularly carried on activities of that type.

     The Commissioner does not challenge the Tax Court’s
first holding on appeal. Consequently, the only question is
whether the disputed gain is attributable to a U.S. office of
Grecian under the U.S. office rule.
                                 6
                                II.

     “We review decisions of the Tax Court ‘in the same
manner and to the same extent as decisions of the district courts
in civil actions tried without a jury.’” Byers v. Comm’r, 740
F.3d 668, 675 (D.C. Cir. 2014) (quoting I.R.C. § 7482(a)(1)).
There are no disputed issues of fact in this appeal, and “we
apply de novo review to the Tax Court’s determinations of
law.” Byers, 740 F.3d at 675.

     At the outset, we note that the issue in this case is of little
prospective significance. After the Tax Court’s decision,
Congress enacted legislation establishing that the aggregate
theory (rather than the entity theory) governs the disposition of
a partnership interest. See Tax Cuts and Jobs Act of 2017
§ 13501(a)(1), I.R.C. § 864(c)(8). That legislation enshrines a
position the Commissioner (unsuccessfully) advanced before
the Tax Court but did not appeal here. The amended provision
will control the treatment of analogous income in future
disputes, but the parties agree that the provision applies only
prospectively and thus does not govern this case.

     With regard to the issue the Commissioner does appeal,
concerning the application of the U.S. office rule, we note that
the Tax Court assumed without holding that Premier should be
considered Grecian’s U.S. office, and Grecian has not
challenged that assumption. We thus bypass any inquiry into
whether Grecian maintains a U.S. office or fixed place of
business at all and proceed to consider whether, assuming
Grecian does, the disputed gain is attributable to that office.

                                A.

    1. The longstanding position of the Internal Revenue
Service, set out in Revenue Ruling 91-32, is that “[i]ncome
from the disposition of a [U.S.] partnership interest by [a]
                                7
foreign partner will be attributable to the foreign partner’s fixed
place of business in the United States.” Rev. Rul. 91-32,
1991-1 C.B. 107, 108. We defer to the Revenue Ruling’s
interpretation of the Revenue Code to the extent it has “the
‘power to persuade.’” Del Commercial Props., Inc. v. Comm’r,
251 F.3d 210, 214 (D.C. Cir. 2001) (quoting Christensen v.
Harris Cty., 529 U.S. 576, 587 (2000)); see also Mellow
Partners v. Comm’r, 890 F.3d 1070, 1077–79 (D.C. Cir. 2018).
The Ruling’s persuasive force “depend[s] upon the
thoroughness evident in its consideration, the validity of its
reasoning, [and] its consistency with earlier and later
pronouncements.” Skidmore v. Swift & Co., 323 U.S. 134, 140
(1944); see also Davis v. United States, 495 U.S. 472, 484
(1990) (“[W]e give an agency’s interpretations . . . considerable
weight where they involve the contemporaneous construction
of a statute and where they have been in long use.”). The
Revenue Ruling, if accepted, would dispose of this case, as it
specifically addresses the precise question before us.

      While the Revenue Ruling has the benefit of longevity—it
has been the IRS’s unchanged position for some thirty years—
little else militates in favor of deferring to it. The pertinent
portion comprises a single unreasoned sentence in a Ruling that
spans four pages of the Cumulative Bulletin. See 1991-1 C.B.
at 108. That sentence cites the relevant statute, § 865(e)(3), but
without any elaboration. And it also cites a Tax Court decision,
Unger v. Comm’r, 58 T.C.M. (CCH) 1157, 1159 (1990), which
neither involved nor purported to opine on the attribution of
income from the sale of personal property by a foreign partner.
See Kimberly S. Blanchard, Rev. Rul. 91-32: Extrastatutory
Attribution of Partnership Activities to Partners, 97 Tax Notes
Today 173–69 (Sept. 8, 1997) (calling the citation to Unger
“pointless” and the Revenue Ruling’s critical sentence “purely
tautological”). We thus do not defer to the Ruling and proceed
to consider the question afresh.
                                8
     2. The U.S. office rule provides: “if a nonresident
maintains an office or other fixed place of business in the
United States, income from any sale of personal property
(including inventory property) attributable to such office or
other fixed place of business shall be sourced in the United
States.” I.R.C. § 865(e)(2)(A). The interpretive dispute hinges
in large part on what conduct must be “attributable to such [i.e.,
the U.S.] office.” According to the Commissioner, it suffices
that the activity that generated the appreciation in Premier’s
value—namely, the successful operation of its magnesite
mining business—is attributable to the U.S. office. Grecian
responds that the transaction itself must be attributable to the
U.S. office and that the redemption here is not.

     The parties each seek to support their respective positions
with competing understandings of what is modified by the
central statutory phrase “attributable to such office or other
fixed place of business.” The Commissioner contends that the
phrase modifies the noun “income,” whereas Grecian reads the
phrase to modify the noun “sale.” Grecian’s interpretation
would tend to support its view that it is the redemption
transaction as the “sale,” rather than the appreciation of the
interest in Premier, that must be “attributable to” Grecian’s
U.S. office for the income to be U.S.-source income.

     We think Grecian has the better reading of the statute.
Grecian invokes the “rule of the last antecedent,” under which
“a limiting clause or phrase . . . should ordinarily be read as
modifying only the noun or phrase that it immediately
follows.” Barnhart v. Thomas, 540 U.S. 20, 26 (2003).
Technically, Grecian’s position is an application not of the last-
antecedent rule (which applies only to pronoun antecedents)
but rather of the related nearest-reasonable-referent canon. See
Antonin Scalia & Bryan A. Garner, Reading Law: The
Interpretation of Legal Texts 152 (2012). Labels aside, the
                                 9
point is the same: ordinarily, and within reason, modifiers and
qualifying phrases attach to the terms that are nearest.

     Grecian’s interpretation of the statute, one might note,
does not in fact point to the nearest possible referent. That is
because “personal property,” not “income” nor “sale,” is the
non-parenthetical term immediately preceding “attributable to
such office or other fixed place of business.” Neither party,
though, suggests that the latter phrase could modify “personal
property,” and common sense would preclude such an
interpretation. “Sale” thus is the nearest reasonable referent.

     To be sure, the nearest-reasonable-referent canon—like its
cousin, the last-antecedent rule—“is not an absolute and can
assuredly be overcome by other indicia of meaning.” Lockhart
v. United States, 136 S. Ct. 958, 963 (2016) (quoting Barnhart,
540 U.S. at 26). But here, other indicia of meaning all point in
the same direction, fortifying the conclusion that the sale is the
proper focal point of the attribution inquiry.

     Most tellingly, in setting out where to look for the relevant
rules of attribution when applying the U.S. office rule, the
statute again directs attention to the “sale”: “The principles of
section 864(c)(5) shall apply in determining . . . whether a sale
is attributable to such an office or other fixed place of
business.” I.R.C. § 865(e)(3) (emphasis added). The title of
the statutory section underscores the centrality of the sale,
reading: “Special rules for sales through offices or fixed places
of business.” Id. § 865(e) (emphasis added); see also id.
§ 865(e)(3) (“Sales attributable to an office or other fixed place
of business.”). And in establishing an exception to the U.S.
office rule, the statute provides that the rule “shall not apply to
any sale of inventory property which is sold for use . . . outside
the United States if an office . . . in a foreign country materially
participated in the sale.” Id. § 865(e)(2)(B) (emphasis added).
                               10
If the exception turns on a foreign office’s participation in the
“sale,” the rule presumably turns on a U.S. office’s
participation in the sale.

     In all those ways, the statute frames the rule as applying to
sales rather than income-generating activity. The statute’s
emphasis on the transaction, rather than on the appreciation of
the underlying asset, is manifest.

     Nothing in § 864(c)(5), the cross-referenced source of the
attribution rules, points in a different direction. According to
that provision, “income, gain, or loss shall not be considered as
attributable to an office or other fixed place of business within
the United States unless such office or fixed place of business
is a material factor in the production of such income, gain, or
loss and such office or fixed place of business regularly carries
on activities of the type from which such income, gain, or loss
is derived.” Id. § 865(c)(5)(B). The Commissioner claims that
“the production” of the disputed gain includes the mining
activities of Premier that led to the partnership’s change in
value. In our view, though, both the provision’s interaction
with the U.S. office rule and its context within § 864 weigh
against the Commissioner’s reading.

     As an initial matter, § 865(e)(3) incorporates by reference
not the text of § 864(c)(5) but rather its “principles.” Id.
§ 865(e)(3). For that reason, we are disinclined to clinically
parse § 864(c)(5) in search of any conceivable override of
§ 865(e)’s focus on the sale transaction. The better approach is
to read § 864(c)(5) at a higher level of generality, as supplying
a two-pronged test: first, the U.S. office must be a “material
factor” in the relevant activity, and second, the office must
“regularly carr[y] on activities of [that] type.”              Id.
§ 864(c)(5)(B).
                               11
     Even if we were inclined to dissect the provision’s text in
the manner urged by the Commissioner, his construction still
would not convince us. True, the word “production” is
capacious enough to encompass value creation as well as sales.
But it is capacious by design not because the provision compels
considering every kind of “production” in any given case, but
rather because, across cases, the provision applies to varied
contexts in which the relevant forms of income “production”
can differ. By its terms, § 864(c)(5) governs the attribution of
income from rents or royalties from intangible property;
“dividends, interests, or amounts received for the provision of
guarantees of indebtedness”; and certain sales of personal
property. Id. § 864(c)(4)(B). The sense in which a taxpayer
produces the income, gain, or loss differs across those contexts.
The specific terms of § 865(e)(5), including their focus on the
sale, thus carry considerably more weight than the umbrella
term “production” in § 864(c)(5).

     The regulations interpreting § 864(c)(5) confirm that the
provision does not mandate considering income production in
each and every sense in any given case. The regulations
provide that, in applying the material-factor test to “[r]ents,
royalties, or gains on sales of intangible property,” “[a]n office
or other fixed place of business in the United States shall not
be considered to be a material factor in the realization of
income, gain, or loss for purposes of this subdivision merely
because the office or other fixed place of business . . .
[d]evelops, creates, produces, or acquires and adds substantial
value to, the property which is leased, licensed, or sold, or
exchanged.” 26 C.F.R. § 1.864-6(b)(2)(i). By enabling the
attribution inquiry to focus on the site of the transaction rather
than the site of the value creation in the context of rents and
royalties, the regulation generally supports our understanding
that the provision it interprets—§ 864(c)(5)—does not
countermand the U.S. office rule’s focus on the sale.
                               12
      Finally, the U.S. office rule’s legislative history further
supports our interpretation. Under the preexisting regime, the
default rule for sales of personal property was the so-called
“title-passage rule.” That rule called for income from sales of
personal property to be sourced where title to the property
literally passed. See H.R. Rep. No. 99-426, at 359 (1985). That
formalistic regime was vulnerable to manipulation, id. at 360,
spurring Congress to replace the title-passage rule with
§ 865(a), which generally sources income according to the
residence of the taxpayer.

     In ordinary cases, a focus on the taxpayer’s residence
would be difficult if not impossible to manipulate. Yet the rule
left open a loophole in the special case in which a foreign
resident maintained a U.S. office or fixed place of business. In
that event, “some foreign corporations with U.S. branches”
could “engage in significant business operations through a
fixed place of business in the United States and avoid paying
U.S. tax.” S. Rep. 99-313, at 330 (1985). Congress evidently
responded with the U.S. office rule, sourcing income from sales
occurring through domestic offices according to the “location
of the economic activity” giving rise to the sale. H.R. Rep.
No. 99-426 at 359. The House Committee Report explains the
operation of the U.S. office rule in terms that support Grecian’s
interpretation: “If the seller maintains a fixed place of business
outside the seller’s country of residence which materially
participates in a sale, however, the committee generally
believes that the level of economic activity with respect to the
sale that is associated with that place of business is high enough
such that” the income should be sourced at that location. Id. at
360–61 (emphasis added); see also id. (showing concern with
“sales activities” and “selling activity”).

     The Commissioner submits that, if Congress sought to
create a regime less susceptible to manipulation, it would have
                                13
avoided a rule based on such formalisms as the locus of the
sale. But Congress’s evident desire to enact a less formalistic
regime does not necessarily mean it enacted the least
formalistic regime. And the provisions at issue apply not only
to the disposition of partnership interests but also to the sale of
myriad other personal property. It is doubtful that Congress
would have intended to source income according to the
innumerable forces that change the market value of most
personal property. In that light, Congress’s choice to
emphasize the sale struck an understandable balance between
its dual aims of administrability and avoiding manipulation.
Cf. id. at 360 (“[S]ource rules should operate clearly without
the necessity for burdensome factual determinations, limit
erosion of the U.S. tax base and . . . generally not treat as
foreign income any income that foreign countries do not or
should not tax.”).

     In sum, the U.S. office rule’s focus, as indicated by its text,
structure, regulations, and legislative history, is directed to the
transaction rather than the appreciation of the asset.

                                B.

     We now turn to the rule’s application in this case. The test
comprises three prongs: first, whether Grecian has a U.S. office
or fixed place of business; second, whether Grecian’s U.S.
office was a “material factor” in the redemption transaction;
and third, whether Grecian’s U.S. office “regularly carries on
activities of the type from which such income, gain, or loss is
derived.” I.R.C. § 864(c)(5). All three prongs must be satisfied
for the income to be treated as U.S.-source income.

     As noted, Grecian does not dispute that Premier is its U.S.
office, satisfying the first prong. Grecian contends that neither
the second nor third prong is met. We agree with Grecian as to
                               14
third prong and we therefore have no reason to consider the
second one.

     In assessing whether a U.S. office “regularly carries on”
an activity, both parties evidently understand the requirement
(as do we) to incorporate some sense that the activity in
question falls within the ambit of the office’s typical course of
business. The question, then, is whether the redemption
transaction was within the ordinary course of business for
Premier, Grecian’s U.S. office. Grecian argues that Premier is
in     the     magnesite-mining        business,      not     the
partnership-interest-redemption business. The Commissioner
responds that partnerships regularly carry on activities like
redemptions because partnerships are inherently engaged in the
business of managing transactions with members.

     We agree with Grecian’s approach.                It is not
Premier-as-partnership that matters. Instead, it is
Premier-as-office-or-fixed-place-of-business—i.e.,             its
headquarters, mines, and the other tangible, fixed places of
business in the United States—that matters. The U.S. office
rule speaks in terms of the concrete “office or fixed place of
business” and that office’s or place’s “activities,” not about its
corporate form. Under the Commissioner’s understanding, the
prong would do little work. Just as managing transactions with
partners inheres in the corporate form of a partnership, so too
does managing a business’s property inhere in the operation of
any business. Any sale of personal property thus could be said
to be the type of activity in which an office regularly engages.
We reject that understanding and instead opt for the
commonsense notion that Premier’s underlying business
activities should be the focus. Premier was engaged in the
business of magnesite mining, extraction, and processing, not
in the business of redemption. Because the third prong
                              15
therefore is unsatisfied, the disputed gain is unattributable to
Grecian’s U.S. office.

                      *   *    *   *    *

    For the foregoing reasons, we affirm the decision of the
Tax Court.

                                                    So ordered.