[00:00:00] Speaker 00:
case number 23-1142, Indu Rawat at balance versus commissioner of internal revenue.

[00:00:07] Speaker 00:
Mr. Rizek for the balance.

[00:00:09] Speaker 00:
Mr. Rennie for the appellate.

[00:00:12] Speaker 04:
Good morning, council.

[00:00:13] Speaker 04:
Mr. Rizek, please proceed when you're ready.

[00:00:17] Speaker 01:
Morning, your honor.

[00:00:20] Speaker 01:
My name is Chris Rizek.

[00:00:21] Speaker 01:
I am council for the fund, Indu Rawat.

[00:00:26] Speaker 01:
At the council table is my co-council, Leila Carney.

[00:00:31] Speaker 01:
This is a federal tax case involving the source of income when a foreign person sells a U.S.

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partnership interest.

[00:00:37] Speaker 01:
In that respect, it's very similar to the, involves the same general rule as this court's opinion in Grecian Magnicide in 2019.

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That general rule being that income from the sale of personal property is sourced to the residence of the seller.

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And at this time in 2008, Mrs. Rawat was a resident

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of India.

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Like the taxpayer in Grecian Magnesite, Mrs. Rawat was not engaged in the U.S.

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trade or business involving the purchase or sale of partnership interests.

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Consequently, the proceeds of the sale are not effectively connected income, just as in Grecian Magnusite, and thus not subject to US sourcing and taxation.

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Unlike Grecian Magnusite, however, which involved the US office exception to the general rule, this case involves no clearly applicable exception.

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Instead, because of an income characterization rule that's in the partnership provisions of the Internal Revenue Code,

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The commissioner contends that Mrs. Rawat is deemed to have sold inventory and that it's therefore effectively connected with her business rather than with the partnerships.

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And they claim that the sourcing exception applicable to actual sales of inventory therefore applies.

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Commissioner's contention in the tax court adoption of it are the error we're contesting here.

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Now to get there.

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You have to understand a little bit about the way that tax law works.

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There are a whole series of steps in deciding how something is taxed, whether there is an income realization, whether it's recognized, how it's calculated, what the source, what the character of that income is, and then ultimately what the source of it is.

[00:02:25] Speaker 01:
It's only this last question that is really in dispute because this in a short centers on what was sold.

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All those original questions have been stipulated.

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It's what was sold that determines whether the resulting income from the sale is sourced US or foreign, and consequently, whether Mrs. Rawat is taxable on it.

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The key point here, in fact, the tax court referred to this as the most important point, which we were correct about, is that Mrs. Rawat sold a partnership interest, not inventory.

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Because factually, there seems to be no dispute

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That's what the transaction documents say.

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That's what she got consideration for.

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She never sold inventory.

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The inventory in question always remained in the partnership, which it's actually an LLC named Innovation Ventures, but it's taxable as a partnership.

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She never sold inventory.

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And I don't think the commissioner contests this point.

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Instead, the commissioner says there is a deemed sale.

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Commissioner's brief uses deemed or deemed by our count.

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24 times, which is exactly 24 more times than that word is used in the applicable statutes.

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Most of the cases- The statute does say shall be considered.

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I'm sorry?

[00:03:42] Speaker 04:
The statute does say shall be considered.

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Shall be considered, yes.

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Shall be considered in some sense means, could mean the same thing as deemed.

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Well, deemed is actually a word that Congress uses intentionally.

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If you look at footnote eight of our reply brief, for example, in response to the commissioner's argument,

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All the cases they cite that they use the word deemed those actually have the word deemed in fact the later provision even in section 7.51 has the word deemed in anything that if 7.51 a. Had the word deemed instead of shall be considered and that it would be more than just the income characterization rule.

[00:04:21] Speaker 01:
shell if it said is there is deemed to be a sale of the inventory receivables yes i think that would be the case your honor it's not what it says 751 or 740 i'm sorry were you talking about 751 or 740 751 741 doesn't doesn't it doesn't really apply here except to say that the gain is it's a partnership interest single property that is sold

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and that the gain is generally in a character capital gain.

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And then 751 says, the amount of money received that's attributable to inventory, the amount of money or property received shall be considered as received for the exchange, sale or exchange of a capital asset.

[00:05:06] Speaker 03:
And that language- Maybe I misunderstood, but I thought your argument was that 741 is what controls here.

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Well, we agree that a portion of the gain is, we agree that a portion of the gain is subject to section 751.

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What we don't agree is that that therefore makes it an actual sale of, or even a deemed sale of inventory to which 865B, the sourcing rule exception applies.

[00:05:33] Speaker 03:
I thought that for the purposes of whether you win this appeal and for the purposes of whether this money is going to be taxed or not,

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I thought 741 says, OK, do we do asset theory or do we do aggregate theory?

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And then once we have picked the theory and decided on the thing that has been sold, then we look to 751 to say, OK, that gain that we're talking about, we're going to count some of it as capital and some of it as ordinary.

[00:06:06] Speaker 01:
That's a correct analysis, your honor.

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But 741 also says in general that gain is capital, except to the extent 751 makes it ordinary in nature.

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And that language that it used shall be considered as an amount realized from the sale of exchange of property other than a capital asset.

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That is language that was used throughout the code prior to the 1970s when it was changed to just mean ordinary in nature.

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You know of another provision in the tax code that does what you're doing here.

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In other words, another provision that says, OK, we take the asset theory.

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We're talking about one thing.

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And then once we've figured out the gain, then we're going to classify part of that gain as ordinary and part of that gain as capital.

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I have a hard time thinking of one in the partnership provision 751 is the only one that I'm aware of.

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There are certainly situations in the code where the character is differentiated usually based on the holding period, whether it's long-term capital gain or short-term capital gain.

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Short-term capital gain is then treated as ordinary income in most cases and netted with ordinary losses.

[00:07:22] Speaker 03:
I mean, there's a lot of rules like that, but nothing that says- Your reading of this statute might make it something of an anomaly within the partnership tax

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part of the code but not so much an anomaly within the larger tax code.

[00:07:37] Speaker 01:
Well yeah I mean even the provision it's in says this is part subject or common to other parts parts of subchapter k which is a partnership rule.

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Their subchapter n of the code which is the sourcing provisions is completely different.

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There's really not an awful lot of overlap between them.

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Subchapter k tells you what the character of the income is

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And particularly in 741 and 751, when you sell or redeem, as the case may be, 731, a partnership interest.

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And that was the issue in Grecian Magnusite.

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They redeemed a partnership interest.

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And the court there said, it's a single interest.

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It was capital in nature in that case.

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The issue there was whether there was a sourcing exception that applied to it.

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And the court said, well, she wasn't in a trade or business of selling, or the partner there, Grecian Magnesite, wasn't in the business of selling the underlying Magnesite.

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And the partnership wasn't in the business of trading partnership interests.

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They're different.

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So there's nothing that's effectively connected to her trade or business.

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It would be, if the partner, if they sold proprietor, for example, sold inventory,

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that would be subject to U.S.

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source.

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But that's not what happened here.

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The problem is the government has to make this leap between, the court would have to make this leap, between a character provision implying that there's a sourcing rule that goes with it.

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Because there's no language that does that.

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If the partnership had sold the inventory here, but it had done it before Ruat left the partnership,

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then would she have paid taxes on it?

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She would have gotten what the code refers to as a distributive share of that amount received of the income net, obviously.

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And that would be a US source because that's what 875 says that a partner is in that trader business to the extent of those distributive shares.

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It doesn't say that that she's in that trader business when she sells her own property.

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So that's the distinction.

[00:09:58] Speaker 04:
Can I ask about 751B?

[00:10:01] Speaker 04:
This hasn't been talked about in the briefing, but 751B deals with distributions and treats certain distributions as sales.

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And it specifically talks about inventory, like 751A does.

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And then it says that such transactions, where a partner receives in a distribution inventory, for example, such transactions shall, under regulations prescribed, be considered as a sale or exchange of such property between the distributor and the partnership.

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And such property, I take it, means the inventory.

[00:10:40] Speaker 01:
It would be the inventory defined in the preceding paragraphs.

[00:10:43] Speaker 01:
Yes.

[00:10:44] Speaker 04:
So 751B, it does use such property and 751A does not.

[00:10:49] Speaker 04:
So that's a point that you would likely make.

[00:10:51] Speaker 04:
Absolutely, Your Honor.

[00:10:52] Speaker 04:
Let me just finish this and then you can get your response.

[00:10:55] Speaker 04:
I take that point, but 751B treats the inventory as itself a piece of property.

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And what would be the reason for doing that?

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And you don't think 751A does that.

[00:11:10] Speaker 01:
751A doesn't do that.

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It uses very different language.

[00:11:15] Speaker 04:
Right.

[00:11:15] Speaker 04:
I mean, you think it doesn't.

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The other side disagrees.

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I mean, so to get past

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the conclusory point that you think 751A doesn't do what 751B does, what would be the rationale for a different treatment as between 751A and 751?

[00:11:32] Speaker 01:
It's the same as Grisha and Magnus said.

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She's not in the trade or business of partnerships.

[00:11:36] Speaker 01:
For a distribution or a redemption, that is very much akin to an allocable share, distributive share kind of transaction.

[00:11:47] Speaker 01:
If you look at the subject

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But what's getting treated in 751A, it's the amount of money.

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It doesn't sever the product.

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And what 751B is doing is saying if they actually sold inventory or distributed out inventory, it's treated as if it's sold.

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And there's a good policy reason for that.

[00:12:09] Speaker 01:
They're just different trades or businesses.

[00:12:15] Speaker 04:
I guess the thing is, nobody disagrees that 751A does the work that you think it does, which is the income characterization work.

[00:12:24] Speaker 01:
Everyone agrees to that, I believe.

[00:12:25] Speaker 04:
Right.

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The question is whether it does more.

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It's not clear to me what in 751A conclusively shows that it doesn't do the more that the commissioner thinks it does.

[00:12:36] Speaker 01:
Well, again, I think it's just the language they use.

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It's the character of the income that is at issue, because the subject of the sentence is the amount of money or fair market value of the property.

[00:12:46] Speaker 01:
And it says it, we get through all of what it comes from, it shall be considered as ordinary income or as an amount realized from the sale exchange of property other than a capital asset.

[00:12:57] Speaker 04:
So it's the fact that it starts out by saying the amount of any money that's doing.

[00:13:01] Speaker 01:
Yeah, that's what it's about.

[00:13:02] Speaker 04:
Then the fact then if shall be considered a replacement deemed that still wouldn't do it for you.

[00:13:07] Speaker 04:
It still wouldn't get you there, I think, but it's certainly out by saying that it would get you.

[00:13:12] Speaker 01:
Well, I don't think it gets you there.

[00:13:13] Speaker 01:
I don't think it gets you to saying there's an actual sale of inventory property that therefore gets sourced U.S.

[00:13:19] Speaker 04:
Right.

[00:13:19] Speaker 04:
It's treated as if there were an actual sale of inventory.

[00:13:22] Speaker 04:
Well, I take it that's the commissioners.

[00:13:24] Speaker 01:
The gain is considered as if it were from that.

[00:13:27] Speaker 01:
Yes.

[00:13:28] Speaker 01:
That's what 751 says.

[00:13:30] Speaker 04:
Right.

[00:13:30] Speaker 04:
It definitely does that.

[00:13:31] Speaker 04:
And then the question is, does it do more?

[00:13:35] Speaker 01:
There's no evidence anywhere that I can see that it does.

[00:13:39] Speaker 01:
I had reserved some time, so I think unless there's further questions.

[00:13:43] Speaker 00:
Oh, I'm sorry.

[00:13:46] Speaker 00:
The nature of this sale was very, maybe it's not unusual, but it doesn't look like a sale that I do.

[00:13:52] Speaker 00:
It is a 20 promissory note with 20 years of just interest payments.

[00:14:00] Speaker 00:
And that 20 years means as it takes it,

[00:14:04] Speaker 00:
not just through the period issue here, but passed the 2018 amendments.

[00:14:10] Speaker 00:
Does the tax status change for the years after the 2018 amendments?

[00:14:16] Speaker 01:
That would be a different year that we don't have in front of us, but it actually was, I think it's a moot point here because the balloon payment on the note has already been made.

[00:14:31] Speaker 00:
Was it made before 2018?

[00:14:32] Speaker 01:
I don't know for sure.

[00:14:34] Speaker 01:
I think it was 2016, but I'd have to go back and check.

[00:14:37] Speaker 00:
And the 2018 amendments did adopt the commissioner's approach?

[00:14:45] Speaker 01:
They're fully prospective.

[00:14:47] Speaker 00:
I'm not saying it covers here, but the 2018 amendments that Congress said, we want this to be treated like a sale of inventory.

[00:14:55] Speaker 01:
Yes.

[00:14:55] Speaker 01:
When Congress decided to adopt the rule that this court had rejected in Grecian Magnesite and that the commissioner had advocated for, it wrote a very clear rule that does that.

[00:15:04] Speaker 01:
Very extensive rule.

[00:15:07] Speaker 00:
But we shouldn't take from that an indication that that's what Congress meant all along?

[00:15:13] Speaker 01:
Well, they didn't include no adverse inference language in their legislative history.

[00:15:17] Speaker 01:
And the fact that this court thought it was wrong and that they were responding to the tax court when they enacted that indicates to us that the rule was what this court enunciated.

[00:15:30] Speaker 01:
And they were reacting to it by saying, no, we want to do something else.

[00:15:35] Speaker 00:
And are there other parts of the tax code building on Judge Walker's question?

[00:15:41] Speaker 00:
where Congress changes the character of the game without changing how it considers the underlying transaction.

[00:15:54] Speaker 00:
So here, your argument is they just changed the character of the game, but they still are looking at the underlying transaction as the exact same unitary sale of personal property.

[00:16:03] Speaker 01:
There are a bunch of provisions in the code dealing with items that are other than a capital asset, as defined in section 1221A, and dealing with them in all sorts of different matters.

[00:16:15] Speaker 01:
Self-created property, intellectual property, for example.

[00:16:18] Speaker 00:
And in doing that, are they speaking as much to the

[00:16:23] Speaker 00:
Income character as they are to the nature of the transaction itself.

[00:16:28] Speaker 00:
This seems it seems a lot here that they have chosen to change the character.

[00:16:31] Speaker 00:
But in your theory, leaving the nature of the underlying transaction the same.

[00:16:38] Speaker 00:
for both the non-inventory and inventory parts of the partnership sale.

[00:16:43] Speaker 00:
And it seems a little odd to go to all the trouble of changing the character without conceptualizing in any different way what it is that's being sold.

[00:16:51] Speaker 00:
I assume that's the point of changing character.

[00:16:54] Speaker 01:
Properties in the trade of business is an example of non-capital property that there are extensive provisions on how you can depreciate or amortize it, for example.

[00:17:06] Speaker 01:
And those don't change the underlying transaction in any way.

[00:17:11] Speaker 01:
In many cases, not even a transaction, it's just a tax treatment.

[00:17:15] Speaker 01:
But the code is replete with those sorts of things that don't, therefore, change the underlying asset.

[00:17:22] Speaker 00:
And there's other provisions within the partnership provisions, specifically that do this?

[00:17:28] Speaker 01:
Is it the code?

[00:17:30] Speaker 01:
Yeah, the distribution provision that Judge Srinivasan mentioned, 731, none of those things affect sourcing directly or change the underlying transaction.

[00:17:40] Speaker 00:
The latter that I'm interested in?

[00:17:42] Speaker 01:
Right.

[00:17:42] Speaker 00:
Okay.

[00:17:43] Speaker 00:
Thank you.

[00:17:44] Speaker 01:
Thank you, Yvonne.

[00:17:45] Speaker 01:
Thank you.

[00:17:46] Speaker 04:
We'll give you a little time for rebuttal.

[00:17:54] Speaker 02:
Mr. Rennie.

[00:17:58] Speaker 02:
Good morning, Your Honors.

[00:17:59] Speaker 02:
I'd like to start by directing your attention to Section 865, because that is what ultimately controls the sourcing issue here.

[00:18:10] Speaker 02:
There are three relevant subparts, subsection A, B, and I. A provides that income from the sale of personal property is generally sourced by residents.

[00:18:22] Speaker 02:
then subsection B provides that income quote derived from the sale of inventory property is not sourced according to residents.

[00:18:30] Speaker 02:
So we have a key difference in the phrasing here this phrase derived from which in this sense I would submit means a to take its origin or to arise out of

[00:18:44] Speaker 02:
Combine that with the fact that under subsection I, which is the definition section, a sale can mean any other type of disposition.

[00:18:55] Speaker 02:
That can include things beyond a formal sale, like abandonment of property.

[00:18:59] Speaker 02:
This all suggests that income indirectly generated by inventory is not sourced at the taxpayer's residence, like personal property, under 865A.

[00:19:10] Speaker 02:
So we would submit that that means that 865B applies in a situation like this where you have a rule like 751A indicating that this part of the partnership assets are treated separately as a separate sale of different property.

[00:19:28] Speaker 04:
I guess I'm not quite clear on why you're starting with 865 because

[00:19:32] Speaker 04:
I assume that it's common ground that unless 751A does the work that you think it does, it doesn't matter what 865 says.

[00:19:43] Speaker 02:
Well, that's fair.

[00:19:44] Speaker 02:
But part of the other side's argument here is that you need an actual sale.

[00:19:49] Speaker 02:
That's their whole point, right?

[00:19:51] Speaker 02:
There can't be some other type of sale.

[00:19:54] Speaker 02:
Our point is that 751 does make a different type of sale.

[00:19:58] Speaker 04:
Well, it might.

[00:19:59] Speaker 04:
And that's the question.

[00:20:00] Speaker 04:
I guess it's just the way you started it made it sound like we should read 751A in the context of sourcing issues to potentially work differently than we'd read it

[00:20:13] Speaker 04:
in other context, because that's not what I'm suggesting.

[00:20:16] Speaker 04:
OK, then I apologize.

[00:20:17] Speaker 04:
Then it does.

[00:20:18] Speaker 04:
There's no need to apologize.

[00:20:20] Speaker 04:
I just want to make sure I understand why you started with 865, because it seems to me that the whole question boils down to whether 751A does the work that you think it does or does more limited work that you think that the taxpayer

[00:20:33] Speaker 04:
Yes, that's right.

[00:20:34] Speaker 04:
And 865 is just going to be a follow on to that.

[00:20:36] Speaker 04:
It's not that 865 is actually helping us decide what works 751.

[00:20:40] Speaker 04:
That's right.

[00:20:41] Speaker 04:
We start with 751A and decide what work it does.

[00:20:43] Speaker 04:
That's fair.

[00:20:44] Speaker 04:
I just want to make sure I'm not misunderstanding.

[00:20:46] Speaker 04:
No, you're not misunderstanding.

[00:20:47] Speaker 04:
OK.

[00:20:48] Speaker 04:
So then on 751, then that takes 751A, I think.

[00:20:51] Speaker 04:
Yes.

[00:20:52] Speaker 04:
And then the question becomes,

[00:20:54] Speaker 04:
Why do we read 751A to do not just a characterization, as the taxpayer argues, but to do more, to say that actually we should treat this as if it was a sale of the inventory?

[00:21:11] Speaker ?:
Right.

[00:21:12] Speaker 02:
They were in the reply brief.

[00:21:15] Speaker 02:
Ms.

[00:21:15] Speaker 02:
Rwatt relies heavily on a plain language argument here.

[00:21:19] Speaker 02:
But if you look at the language of 751A, characterization is not there.

[00:21:23] Speaker 02:
Ordinary income is not there.

[00:21:26] Speaker 02:
Ordinary income appears in 751C.

[00:21:29] Speaker 02:
So Congress could have used that phrase if that's what it wanted to do, if it wanted to suggest that this was restricted to a characterization

[00:21:38] Speaker 00:
And if you look at the 1976, sorry, but I mean, 741 is just by its very title about character.

[00:21:47] Speaker 00:
And that is where you get the 750 reference has the cross reference to 751.

[00:21:52] Speaker 00:
And so it's such gain or loss will have the words, the character of capital gain.

[00:22:01] Speaker 00:
uh, taxation, capital gains for purposes of taxation, except under 751.

[00:22:06] Speaker 00:
So it tells us that 7051 is talking about the character for inventory sales.

[00:22:11] Speaker 02:
So doesn't it?

[00:22:13] Speaker 00:
It does, but we know that 740 have the word character in 751 to understand that 751, at least 751A, which is relevant here, is talking to us about the character.

[00:22:24] Speaker 02:
And we don't dispute that it does that.

[00:22:25] Speaker 00:
OK, I thought you just said the words are not here.

[00:22:27] Speaker 02:
I know, but all I'm saying is it's not restricted to that by its language.

[00:22:35] Speaker 00:
OK, all right.

[00:22:36] Speaker 00:
So are you disputing that the language realized from the sale or exchange of property other than a capital asset means something other?

[00:22:46] Speaker 00:
Do you think it means something other than ordinary income?

[00:22:48] Speaker 00:
Because that was old phraseology Congress had used throughout the tax code.

[00:22:55] Speaker 00:
Yes.

[00:22:55] Speaker 00:
More recently, it's updated.

[00:22:56] Speaker 00:
So you dispute that realized from the sale or exchange of property other than a capital asset in 751A means ordinary income?

[00:23:04] Speaker 02:
We agree.

[00:23:04] Speaker 02:
It does mean that, but it can mean more.

[00:23:07] Speaker 00:
And we would note that Congress... Is there any... Where else in the tax code when Congress has used that phrase has meant more than ordinary income?

[00:23:16] Speaker 02:
I can't point you to an example of that, but I would note that Congress did not change that phrasing here when it changed it elsewhere.

[00:23:24] Speaker 00:
So maybe it was deliberate, or maybe it's a great big tax code that got missed.

[00:23:29] Speaker 02:
Well, they did change other provisions within section 751.

[00:23:32] Speaker 02:
They changed other provisions.

[00:23:35] Speaker 00:
That's a fair point.

[00:23:35] Speaker 00:
So then are you arguing that realized from the sale or exchange of property other than a capital asset, you're saying it means ordinary income plus?

[00:23:43] Speaker 02:
Yes.

[00:23:44] Speaker 00:
Is does this phrase exist anywhere else in the US code anymore?

[00:23:47] Speaker 00:
Is this the only place where they left it in?

[00:23:49] Speaker 02:
It exists.

[00:23:50] Speaker 02:
It definitely exists in sections 64 and 65, which were the provisions added to talk about ordinary income and ordinary loss.

[00:23:59] Speaker 00:
So does it?

[00:23:59] Speaker 00:
Does it?

[00:24:00] Speaker 00:
Does it do something more there or does it not?

[00:24:03] Speaker 02:
No, we would suggest it does more there.

[00:24:06] Speaker 02:
Because that's does you don't know.

[00:24:08] Speaker 00:
So.

[00:24:08] Speaker 00:
No, I'm getting OK, so.

[00:24:12] Speaker 00:
Historically, this phrase men ordinary income.

[00:24:15] Speaker 00:
And Congress replaced it in many parts of the US code with the phrase ordinary income.

[00:24:20] Speaker 00:
It left it for whatever reason, we aren't quite sure, in a few different places.

[00:24:25] Speaker 00:
But other places where that phrase has been left, it still just means ordinary income.

[00:24:29] Speaker 00:
Everyone knows that's what the language meant.

[00:24:31] Speaker 00:
It's what it always meant.

[00:24:32] Speaker 02:
Right.

[00:24:32] Speaker 02:
Although it was added as part of those changes into that provision.

[00:24:37] Speaker 00:
In the other provisions?

[00:24:38] Speaker 02:
Yeah, in 64 and 65.

[00:24:39] Speaker 00:
But you're not arguing that it means anything different.

[00:24:43] Speaker 02:
No, but I'm not saying it can't.

[00:24:45] Speaker 00:
This is the one time, is this the only time you're aware of that you have this leftover mouthful of language for ordinary income that the government, the commissioner is of the view that by leaving it there, Congress changed its meaning from ordinary income to ordinary income plus

[00:25:10] Speaker 00:
nature of the transactions.

[00:25:12] Speaker 02:
I don't think that Congress changed its meaning by leaving it there.

[00:25:15] Speaker 00:
So, okay, so then it had the same meaning when it was left and everything else, when they changed it in other parts of 751 and left it here, it didn't change its meaning?

[00:25:25] Speaker 02:
I think part of it is, yes, it was intended to talk, indicate that there was ordinary income here, but there was also set up as a contrast with section 741.

[00:25:36] Speaker 02:
In other words, 741 says essentially a partnership interest is regarded as a sale of capital asset.

[00:25:43] Speaker 02:
Then you have 751A, which in contrast to that, says that the sale of this other property is considered a sale or exchange of property other than a capital asset.

[00:25:56] Speaker 02:
So we know what's being sold in the sale discussed here is not the partnership interest.

[00:26:03] Speaker 02:
It's something else.

[00:26:04] Speaker 00:
So what's being sold is different.

[00:26:06] Speaker 00:
We just know the income treatment.

[00:26:08] Speaker 00:
So prior to Congress, I'm not a tax lawyer expert like you at all.

[00:26:14] Speaker 00:
So I'm just trying to understand how this language has been used by Congress through the tax code.

[00:26:19] Speaker 00:
Prior to the time when Congress substituted in most places phrase ordinary income for this longer realized from the sale or exchange of property other than a capital asset, prior to the time it made that change, did this phrase in 751 mean something other than ordinary income?

[00:26:43] Speaker 02:
We think that the consistent way to read this, of course, the commissioner's position under the revenue ruling prior to Grecian Magnusite was different.

[00:26:56] Speaker 02:
We took the position that 741 and 751 were both restricted to characterization.

[00:27:03] Speaker 02:
The tax court rejected that position in Grecian Magnusite and said no.

[00:27:08] Speaker 02:
Looking at 741, the partnership interest is a unitary interest.

[00:27:13] Speaker 02:
And it applies when we apply the sourcing rules here.

[00:27:18] Speaker 02:
And consequently, when you're asking what our position was, how we read it back then, it might have been different.

[00:27:30] Speaker 02:
But to give you a consistent reading, our position is in the Grecian magnesite world.

[00:27:38] Speaker 02:
we believe it must be something.

[00:27:43] Speaker 00:
In the pre-Grecian magma site world, did the commissioner consistently read this phrase to mean ordinary income?

[00:27:53] Speaker 02:
I can't give you an answer on that because I believe the revenue ruling came out in the 1990s.

[00:28:00] Speaker 02:
The changes we were talking about were made in the 1970s.

[00:28:04] Speaker 02:
The statute came out in the 1950s.

[00:28:08] Speaker 02:
So we're talking about at least four decades before the revenue ruling came out and two decades before Congress made the change to ordinary income in most places.

[00:28:21] Speaker 02:
So if there isn't a lot of indication as to what Congress originally meant when it

[00:28:30] Speaker 02:
use this language other than the legislative history we have from 1954, which does talk about this being the inventory and unrealized receivables being severed from the rest of the partnership interests, suggesting it could apply more broadly than just being restricted to ordinary income.

[00:28:50] Speaker 00:
I think a simple question maybe just doesn't fit in here, but that's my problem.

[00:28:55] Speaker 00:
Is the reading that the commissioner today

[00:28:59] Speaker 00:
is giving to this language realized from the sale or exchange of property other than a capital asset as ordinary income plus more.

[00:29:11] Speaker 00:
Is there anywhere else in the tax code where the commissioner has given that same language that meaning?

[00:29:24] Speaker 02:
I'm not aware of a particular instance to cite to you.

[00:29:27] Speaker 00:
Are there other instances in the tax code where the commissioner has read that language as meaning just ordinary income?

[00:29:42] Speaker 00:
I thought you said at the beginning that was how you read this language.

[00:29:45] Speaker 02:
It's part of how we read it.

[00:29:47] Speaker 00:
But you're asking it- You said you're not aware of other places where you've read it as ordinary income plus, but you're not even sure you've read it as ordinary income in other places?

[00:29:55] Speaker 02:
No.

[00:29:57] Speaker 02:
Fair point.

[00:29:58] Speaker 02:
Yes, we understand that that's what it has been read as.

[00:30:02] Speaker 02:
That's what Congress was reading it as.

[00:30:04] Speaker 02:
That's why I changed it.

[00:30:05] Speaker 00:
So this is the only place in the tax code where it's being read as ordinary income plus.

[00:30:11] Speaker 00:
And you have your arguments, tax relief, for why that's happening.

[00:30:13] Speaker 00:
I just want to make sure the same phraseology has a different meaning here.

[00:30:20] Speaker 00:
than anywhere else in the US tax code that you're aware of?

[00:30:22] Speaker 02:
I'm not aware of a specific instance to cite to you.

[00:30:25] Speaker 02:
The only other place that I'm aware of off the top of my head where that same line, which appears, is in section 64 and section 65, which were the provisions added by the 1976 changes.

[00:30:39] Speaker 00:
Right.

[00:30:39] Speaker 00:
And there, the commissioner, as far as you know, has just read that as ordinary income.

[00:30:45] Speaker 02:
Yes, but characterization can have other effects throughout the tax code.

[00:30:50] Speaker 02:
That doesn't mean it's some self-contained thing that never works through.

[00:30:54] Speaker 00:
I'm just asking the power of this language.

[00:30:55] Speaker 00:
There could be other things in the tax code that will affect how that ordinary income is treated.

[00:31:00] Speaker 00:
But you're not saying that there's anything in that phrase ideology as it appears in 64 and 65 that says ordinary income plus.

[00:31:12] Speaker 02:
I'm not aware of any interpretation of that.

[00:31:18] Speaker 03:
Can I ask you a question similar to what I asked your opposing counsel?

[00:31:21] Speaker 03:
I think Rawad did not file U.S.

[00:31:24] Speaker 03:
taxes before 2008.

[00:31:26] Speaker 03:
Under your theory, should she have expected to be taxed each year before then when inventory was sold?

[00:31:39] Speaker 02:
Yes, yeah.

[00:31:41] Speaker 02:
She should have been.

[00:31:43] Speaker 02:
I believe that's correct because the inventory sales would flow through the partnership to the partners.

[00:31:52] Speaker 03:
If you win here, are you planning to dismiss the innovation venture suit?

[00:31:59] Speaker 02:
No, Your Honor.

[00:32:00] Speaker 03:
Why not?

[00:32:01] Speaker 03:
Why not?

[00:32:03] Speaker 02:
Because that case is still being litigated.

[00:32:07] Speaker 02:
So the issue is there's a whipsaw assessment here because our primary position in that case is that there's no economic substance to the sale of the transaction.

[00:32:21] Speaker 02:
But we asserted this whipsaw position to make sure that the commissioner is not left without a taxpayer.

[00:32:28] Speaker 02:
We requested multiple times in the tax court.

[00:32:31] Speaker 03:
Whip's opposition is when the IRS argues one thing in one court and then the exact opposite thing in the other court.

[00:32:38] Speaker 02:
Right.

[00:32:38] Speaker 02:
It's essentially to ensure that you don't have two different taxpayers saying the other person owes money who win in two separate venues and under inconsistent theories.

[00:32:51] Speaker 03:
OK.

[00:32:51] Speaker 03:
And then was that your whole answer?

[00:32:53] Speaker 03:
Yes.

[00:32:55] Speaker 03:
OK.

[00:32:55] Speaker 03:
Do you know if there are other cases similar to ReWATS where a pre-2017, 18 sourcing rule would govern that are still pending?

[00:33:08] Speaker 02:
Pre-2007 sourcing rule.

[00:33:12] Speaker 03:
2017 or 18, that's when the new taxes are.

[00:33:15] Speaker 03:
Right, right.

[00:33:15] Speaker 03:
But do you know if there are any cases where that pre-2017 regime applies

[00:33:22] Speaker 03:
that are still pending.

[00:33:24] Speaker 02:
I'm not aware of a specific case that has been filed publicly.

[00:33:29] Speaker 02:
I believe there may be cases in the pipeline within the IRS system that still are within that regime.

[00:33:45] Speaker 02:
Okay.

[00:33:45] Speaker 02:
And I see I'm out of time, Your Honors, unless you have any other questions.

[00:33:51] Speaker 02:
Thank you.

[00:33:51] Speaker 02:
We were restaurant briefs.

[00:33:52] Speaker 04:
Thank you.

[00:33:52] Speaker 04:
Thank you, Council.

[00:33:56] Speaker 04:
Mr. Reza, we'll give you three minutes for rebuttal.

[00:33:58] Speaker 01:
Thank you.

[00:33:59] Speaker 01:
I just want to address a couple of the questions earlier.

[00:34:02] Speaker 01:
Judge Millett asked if there's other provisions in the code that change the character of the resulting income without disaggregating the property or changing the property.

[00:34:13] Speaker 01:
So we actually cited one in our brief.

[00:34:16] Speaker 01:
It's in our opening brief, page 16, note 5, for section 306A1A.

[00:34:24] Speaker 01:
It was just an example.

[00:34:25] Speaker 01:
I think that we could probably come up with other examples, but that's the answer to that question.

[00:34:31] Speaker 01:
It's certainly out there.

[00:34:38] Speaker 01:
just focus on why this has to be about the character of the income rather than the underlying property.

[00:34:42] Speaker 01:
If you look, not only does the regulation first paragraph say it's about character and the IRS thought Section 751 was just about character for a long time and even said so in subsequent reg that we cited in our reply brief in 861 reg.

[00:35:00] Speaker 01:
The computation of how you do this indicates that they have to be allocating some of the gain, not the underlying property.

[00:35:09] Speaker 01:
The REG provides you take all of the partnership inventory, add it up, figure out how much that is, and then you add up its fair market value.

[00:35:21] Speaker 01:
And then that delta is allocated by the percentage of the partnership interest that's being sold.

[00:35:27] Speaker 01:
So in that case, Mrs. Rawat got 29.2% of the amount of gain.

[00:35:33] Speaker 01:
She didn't get 29%, 2.2% of the inventory.

[00:35:37] Speaker 01:
She didn't get the yellow bottles while somebody else took the red bottles.

[00:35:40] Speaker 01:
She sold a partnership interest, and part of her gain is treated as ordinary income.

[00:35:46] Speaker 01:
That's all we have here.

[00:35:48] Speaker 01:
We do not have an actual sale of inventory.

[00:35:52] Speaker 01:
As to your question, Judge Falker, about prior years, she certainly got partnership distributive shares on those.

[00:36:00] Speaker 01:
In fact, there's one very small amount for this year.

[00:36:03] Speaker 01:
For 2008, there wasn't much there because the transaction occurred on the fourth day of the year.

[00:36:11] Speaker 01:
But in prior years, she did.

[00:36:13] Speaker 01:
And she paid US tax on those because she is, by virtue of Section 875A,

[00:36:17] Speaker 01:
Those are treated as in connection with the U.S.

[00:36:20] Speaker 01:
trader business of innovation ventures.

[00:36:22] Speaker 01:
There's nothing similar and just as ingredient in Magnesite, just by virtue of the fact that the partnership is in a trade or business and your distributive share is sourced accordingly, doesn't mean that you're in that trader business and what you generate when you sell a partnership interest is effectively connected income.

[00:36:41] Speaker 01:
It's the exact same general principle there.

[00:36:44] Speaker 01:
I just want to last address the whipsaw point.

[00:36:47] Speaker 01:
There's no whipsaw here.

[00:36:50] Speaker 01:
Innovation Ventures was taxed on this transaction, and that's the whole issue in that other case, and Mrs. Rawat was taxed on this transaction.

[00:37:00] Speaker 01:
Holding for Mrs. Rawat does not create a whipsaw.

[00:37:05] Speaker 00:
Can I ask you the same question I asked Council on the other side?

[00:37:07] Speaker 00:
This phrase realized from the sale or exchange of property other than capital asset.

[00:37:17] Speaker 00:
You've argued it means ordinary income.

[00:37:19] Speaker 01:
You're talking about the last clause of section 751.

[00:37:22] Speaker 00:
751A2.

[00:37:26] Speaker 01:
Well, it's actually it's A, but it follows A2 because it's flush line.

[00:37:30] Speaker 00:
751, so A.

[00:37:33] Speaker 00:
That used to be replete through the code was replaced most places by the phrase ordinary income.

[00:37:39] Speaker 00:
This one was not for some reason.

[00:37:41] Speaker 00:
Right.

[00:37:41] Speaker 00:
So there's only a couple others places where this old language or maybe it was even newly put in this language appears in the US in the tax code.

[00:37:50] Speaker 01:
Oh, I think it's quite prevalent in the code.

[00:37:53] Speaker 00:
So why didn't Congress

[00:37:55] Speaker 01:
Change it everywhere?

[00:37:57] Speaker 00:
Why didn't it replace it here when you have references elsewhere in 751 to it?

[00:38:01] Speaker 00:
Are we supposed to, does that support their argument that it must now mean ordinary income plus something more?

[00:38:08] Speaker 01:
Your honor, we all wish Congress was more consistent in its drafting, but when they changed, when they added sections, I think it's 64 and 65 and said ordinary income means these things, they didn't go back through the code and make conforming amendments anyway.

[00:38:22] Speaker 01:
They just didn't.

[00:38:24] Speaker 01:
I wish they had.

[00:38:25] Speaker 00:
But they do use ordinary income in 751.

[00:38:27] Speaker 01:
They do.

[00:38:28] Speaker 01:
They use it in other places in the code.

[00:38:30] Speaker 01:
Numerous other places.

[00:38:31] Speaker 00:
The difficulty for us is that within the same statutory section, they use the phrase there and they didn't use it here.

[00:38:39] Speaker 00:
And so that must have meant something more.

[00:38:43] Speaker 01:
It's in a long list of provisions that are treated as other kinds of income and they used ordinary income.

[00:38:53] Speaker 01:
It is true next to the last line of that.

[00:38:57] Speaker 01:
But I don't know if that was added subsequently post the 1975 change in the statute.

[00:39:06] Speaker 01:
I haven't researched that issue, but it's very clear that

[00:39:11] Speaker 01:
before they changed the law to say, we mean ordinary income, that's what that phrase from the other than a capital sale or exchange of property other than a capital asset, that's what that meant.

[00:39:25] Speaker 00:
Are you aware of any other place in the US code where this language still exists?

[00:39:29] Speaker 00:
Yes, there's other places.

[00:39:32] Speaker 00:
Where it still exists and where either the commissioner or a court has held that it means something more than ordinary income.

[00:39:39] Speaker 01:
I don't know any place where it does what the latter part of your question suggests, Your Honor.

[00:39:46] Speaker 00:
You're not aware of any courts giving it that meaning?

[00:39:48] Speaker 01:
No.

[00:39:49] Speaker 01:
Thank you.

[00:39:50] Speaker 01:
You know, you'd have to go through word search.

[00:39:53] Speaker 01:
It's great for that to see if it's still in other places or where it's used, but I'm quite confident it is.

[00:40:00] Speaker 04:
Thank you, counsel.

[00:40:01] Speaker 04:
Thank you to both counsel.

[00:40:02] Speaker 04:
We'll take this case others.

[00:40:03] Speaker 04:
Thank you, Your Honor.