U.S. Tax Court Ruling May Lead to Increased After-Tax Returns for Foreign Investors That Invest in U.S. Partnerships

On July 13, 2017, the U.S. Tax Court issued a ruling that when a non-U.S. investor realizes a gain through the disposition of an interest in a partnership engaged in a U.S. trade or business, that gain is not “effectively connected income” (ECI) and therefore is not subject to U.S. federal income tax. The ruling has potentially monumental significance for investors around the world with interests in U.S. partnerships and for U.S. managers seeking to raise capital abroad, as certain investment opportunities may become more attractive from a tax perspective to foreign investors. Conversely, the decision’s future and long-term impact are uncertain, given that the Internal Revenue Service (IRS) will likely contest the ruling and the U.S. Treasury Department may implement regulations that effectively render it meaningless. To help our readers understand the potential impact of the Tax Court’s decision, this article summarizes the ruling and presents insight from attorneys and tax practitioners at the forefront of interactions between the financial services sector and the IRS. For background on ECI, see “Key Tax Issues Facing Offshore Hedge Funds: FDAPI, ECI, FIRPTA, the Portfolio Interest Exemption and ‘Season and Sell’ Techniques” (Jan. 22, 2015); and “Tax Experts Discuss Provisions Impacting Foreign Investors in Foreign Hedge Funds During FRA/HFBOA Seminar (Part Two of Four)” (Jan. 23, 2014).

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