rr-04-3.pdf

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Part I

Section 894.—Income Affected By Treaty

26 CFR 1.894-1: Income affected by treaty

Rev. Rul. 2004-03

ISSUE
Whether a nonresident partner in a service partnership that has a fixed base in
the United States is subject to U.S. tax on income attributable to that fixed base under
Article 14, Independent Personal Services, of the Convention Between the United
States of America and the Federal Republic of Germany for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and
Capital and to Certain Other Taxes, signed on August 29, 1989, as amended by the
Protocol signed on the same date (the “Treaty”).

FACTS
P is a service partnership that is organized under the laws of Germany. P has
offices in Germany and the United States. Its U.S. office is a fixed base under Article 14
of the Treaty. P is comprised of two partners: A, a nonresident alien individual who is a
resident of Germany under Article 4 of the Treaty, and B, a U.S. resident. A performs
services solely at P’s office in Germany and B performs services solely at P’s office in
the United States. A and B agree to divide the profits of the partnership equally.

LAW AND ANALYSIS
Under section 701 of the Internal Revenue Code (the “Code”), a partnership is
not subject to income tax; rather, the persons carrying on the business of the
partnership as partners are liable for income tax in their separate or individual
capacities. Code section 702 requires a partner to determine its income tax by
separately taking into account its distributive share of the partnership’s income. Under
section 702(b), the character of an item of income, gain, loss, deduction, or credit is
determined as if such item were realized directly from the source from which it was
realized by the partnership, or incurred in the same manner as incurred by the
partnership. Under Code section 704, a partner’s distributive share generally is
determined by the partnership agreement unless an allocation under the agreement
does not have substantial economic effect.

Under section 875(1) of the Code, a nonresident alien individual who is a partner
in a partnership that is engaged in a U.S. trade or business is himself considered to be
so engaged. Section 871(b)(1) of the Code provides that a nonresident alien individual
is taxable under Code sections 1 or 55 on his taxable income that is effectively
connected with the conduct of a U.S. trade or business.

Section 894(a)(1) states that the provisions of the Code shall be applied to any
taxpayer with due regard to any U.S. treaty obligation that applies to such taxpayer. In
Donroy, Ltd. v. United States
, 301 F.2d 200 (9
th
Cir. 1962), the court held that the U.S.
permanent establishment of a partnership was attributable to a foreign person that was
a limited partner under the 1942 U.S.-Canada income tax treaty. In Unger v.
Commissioner, 936 F.2d 1316,1319 (D.C. Cir. 1991), the court followed the holding in
Donroy
, noting that it stood for the proposition that the office or permanent
establishment of a partnership is, as a matter of law, the office of each of the partners—
whether general or limited. See also Johnston v. Commissioner, 24 T.C. 920 (1955)
(holding that a partnership’s permanent establishment is deemed to be a permanent
establishment of its partners); Rev. Rul. 90-80, 1990-2 C.B. 170 (same).

Article 14 of the Treaty provides:

1. Income derived by an individual who is a resident of a
Contracting State from the performance of personal services
in an independent capacity shall be taxable only in that
State, unless such services are performed in the other
Contracting State and the income is attributable to a fixed
base regularly available to the individual in that other State
for the purpose of performing his activities.

2. The term "personal services in an independent
capacity" includes but is not limited to independent scientific,
literary, artistic, educational, or teaching activities as well as
the independent activities of physicians, lawyers, engineers,
economists, architects, dentists, and accountants.

Applying Article 14 in the partnership context requires a determination of whether
an individual partner in a service partnership who derives income attributable to the
fixed base of the service partnership in the other Contracting State is taxable on that
income even though the partner does not perform any services in the other Contracting
State. Consistent with section 875 and the case law discussed above, the fixed base of
a partnership is attributed to its partners for purposes of applying Article 14 of the
Treaty. Accordingly, A is treated as having a fixed base regularly available to him in the
United States. A is subject to U.S. net income taxation on his allocable share of income
from P to the extent that such income is attributable to the fixed base in the United
States without regard to whether A performs services in the United States.

HOLDING
A is treated as having a fixed base regularly available to him in the United States
and is subject to U.S. net income taxation on his allocable share of income from P to the
extent that such income is attributable to P’s fixed base in the United States, without
regard to whether A performs services in the United States. This holding also is
applicable in interpreting other U.S. income tax treaties that contain provisions that are
the same or similar to Article 14 of the Treaty.

DRAFTING INFORMATION
The principal author of this revenue ruling is Nina Chowdhry of the Office of
Associate Chief Counsel (International). For further information regarding this revenue
ruling, contact Nina Chowdhry on (202) 622-3880 (not a toll-free call).