Section 9 Crpc Notes

[John]

Theissues presented for decision are: (1) whether petitioner's distributive share of a limited partnership's income is exempt from taxation by virtue of the 1942 Income Tax Convention between the United States and Canada; and (2) if that income is not exempt, whether petitioner is subject to the addition to tax under section 6661(a) for making a substantial understatement of tax.

Petitioner, Robert Unger, was a resident of Salt Spring, British Columbia, Canada, at the time the petition in this case was filed. Petitioner is a dentist who during 1984 owned a limited partnership interest in the Charles River Park "C" Company (CRPC), a Massachusetts limited partnership.

CRPC was formed on October 23, 1964, when a Partnership Certificate was filed with the state of Massachusetts. CRPC's purposes are to construct, develop, and manage residential housing projects within the Commonwealth of Massachusetts. During the year at issue, CRPC sold certain real estate located in Boston, Massachusetts. The long-term capital gain resulting from that sale was distributed among CRPC's seven general partners and 22 limited partners. Petitioner's distributive share of that sale's gain as a limited partner of CRPC was $289,260.

Petitioner filed a United States Non-Resident Alien Income Tax Return, Form 1040NR, for the 1984 taxable year. That return did not include as taxable income petitioner's distributive share of CRPC's long-term capital gain from the sale of real estate. In response to the following questions posed by the Form 1040NR, petitioner provided the following information:

On a handwritten statement attached to the Form 1040NR, petitioner listed, among other things, the rental income and section 1231 gain he realized in relation to his investment in CRPC during 1984. At the bottom of that statement petitioner wrote, "Capital gains are exempt under Article VIII of the U.S. Canada Tax Treaty."

The first issue for decision is whether petitioner's distributive share of CRPC's income is taxable in the United States. Section 871(b)(1) provides that nonresident alien individuals engaging in a trade or business within the United States are taxable in this country on the income effectively connected with the conduct of that trade or business. Section 875(1) provides:

Petitioner contends his distributive share of the gains realized by CRPC are exempt from taxation, not under Article VIII of the Convention as asserted on his Form 1040NR, 2 but under Article I of the Convention. Article I generally provides an enterprise of Canada is not subject to taxation by the United States with respect to its industrial and commercial profits EXCEPT with respect to those profits allocable under the Convention to its "permanent establishment" in the United States. Pursuant to the Convention's first Protocol:

(f) the term "permanent establishment" includes branches, mines and oil wells, farms, timber lands, plantations, factories, workshops, warehouses, offices, agencies and other fixed places of business of an enterprise, but does not include a subsidiary corporation.

When an enterprise of one of the contracting States carries on business in the other contracting State through an employee or agent established there, who has general authority to contract for his employer or principal * * *, such enterprise shall be deemed to have a permanent establishment in the latter State.

The fact that an enterprise of one of the contracting States has business dealings in the other contracting State through a commission agent, broker or other independent agent * * * shall not be held to mean that such enterprise has a permanent establishment in the latter State. [56 Stat. 1407- 1408.]

Respondent asserts petitioner has a permanent establishment in the United States and, therefore, is subject to taxation in this country pursuant to the Convention. To support his position, respondent cites Donroy, Ltd. v. United States, 301 F.2d 200 (9th Cir. 1962).

Petitioner argues Donroy is factually distinguishable from the case at hand. If we find Donroy factually indistinguishable, petitioner argues Donroy should be disregarded as it is based upon a purportedly archaic interpretation of the law governing limited partnerships.

Donroy involved Canadian corporations which were limited partners in a Californian limited partnership. The issue presented was whether the Canadian corporate limited partners had a "permanent establishment" in the United States within the meaning of the Convention such that the corporations' distributive share of the Californian limited partnership's income was taxable in the United States. The Court of Appeals for the Ninth Circuit held:

Under this concept of partnership as an association of individuals, it follows that each partner, whether general or limited has an interest as such in the assets and the profits of the partnership, including the physical plant or offices at which the partnership conducts its business, so that the office or permanent establishment of the partnership is IN LAW, the office of each of the partners -- whether general or limited. * * *

So long as a limited partner, along with the general partners, constitute the partnership, it will have to be recognized that the general partners are the general agents of the limited partners for the general purpose of conducting the business -- subject only to the statutory exemption of limited partners from direct obligation to creditors beyond their stated financial commitment -- and that all the partners have an interest in the partnership assets, including its office.

* * * therefore, the office of the limited partnership is in effect the permanent establishment of the limited partner within the United States. [Donroy v. United States, supra at 206-208, emphasis added and footnotes refs. omitted.]

Petitioner's argument that Donroy should be disregarded because it is factually distinguishable from the case at hand lacks merit. The facts upon which petitioner relies as distinguishing are inconsequential. Further, the Ninth Circuit's holding -- that the office or permanent establishment of a partnership is the office of each of its partners, whether general or limited -- is A MATTER OF LAW. Accordingly, we hold Donroy should not be disregarded on the basis of its facts.

Petitioner next argues we should disregard Donroy because it "represents an archaic view of the law of partnerships which is simply inapplicable to todays' [sic] economic realities." Specifically, petitioner finds fault in the following Donroy holdings: (1) a general partner of a limited partnership acts as the limited partners' general agent when conducting business on the partnership's behalf and (2) a limited partner owns an undivided interest in the assets of the partnership. Petitioner posits a more modern view of limited partnerships has evolved under which: (1) general partners of a limited partnership are not viewed as general agents of the limited partners; and (2) limited partners are not considered to have an undivided interest in the assets of the partnership but rather are considered to have only an interest in partnership profits. In support of his position, petitioner cites several cases purportedly espousing this "modern" view of limited partnership law.

Petitioner cites Wroblewski v. Brucher, 550 F. Supp. 742 (W.D. Okla. 1982), as a case which "sharply criticized" Donroy. Wroblewski decided whether, for purposes of diversity jurisdiction, the citizenship of a defendant partnership's limited partners should be considered. In deciding the issue the District Court held, contrary to Donroy, a limited partner of a limited partnership created under California's version of the Uniform Limited Partnership Act does not have any interest or right in the assets, properties, or rights of the partnership. Based on that, the District Court reasoned a limited partner could not have any interest in defending the partnership's rights, and the citizenship of a limited partner should not be considered for purposes of determining diversity jurisdiction. In so holding, the Wroblewski court acknowledged the contrary holding in Donroy but stated Donroy was not persuasive authority on the issue. For that reason and that reason only, the court in Wroblewski chose not to follow Donroy.

Petitioner also cites Evans v. Galardi, 16 Cal. 3d 30, 546 P.2d 313 (1976), contending the California Supreme Court in that case declined to follow Donroy because that court found the Ninth Circuit to have misconstrued California law on the subject of limited partners when deciding Donroy. Evans decided the issue of whether the assets of a limited partnership may be levied upon to satisfy a judgment against a partnership's limited partners in their individual capacities. It was held, again contrary to Donroy, a limited partner had no interest in the partnership property by virtue of his status as a limited partner. For that reason the California Supreme Court ruled the assets of the limited partnership were not available to satisfy the judgment against the limited partners in their individual capacities. The court in Evans held Donroy was not persuasive authority because it was decided for purposes of interpreting a tax convention, and not for purposes of interpreting and applying state law. The California Supreme Court therefore disregarded Donroy. Evans v. Galardi, 546 P.2d at 319-320 n.11.

Petitioner also cites Estate of Meyer v. Commissioner, 58 T.C. 311 (1972), affd. per curiam 503 F.2d 556 (9th Cir. 1974), contending the Ninth Circuit in that case rejected its own rationale in Donroy. In Estate of Meyer, a father and son who were general partners in a partnership exchanged their partnership interests for a second partnership in which the son was a general partner and the father was a limited partner. The issue was whether those exchanges were of like kind property within the meaning of section 1031(a). The Ninth Circuit Court of Appeals held the father did not make a like kind exchange within the meaning of that section. Although in so holding the court recognized the differences between a general partnership and a limited partnership interest, the Ninth Circuit did not reject the rationale of Donroy. In fact the Ninth Circuit cited Donroy in Estate of Meyer as authority for the position that a limited partner may not participate in the running of the partnership business and that a limited partner's liability is generally limited to the amount of his investment. Estate of Meyer v. Commissioner, 503 F.2d at 558.

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