Rawat v. Comm’r, T.C. Memo. 2023-14| February 7, 2023 | Gustafson, J. | Dkt. No. 15340-16

Summary: This case arises at the confluence of two areas of tax law—partnership taxation (subchapter K of the Code) and U.S. taxation of international transactions (Subchapter N of the Code).

Ms. Rawat was a nonresident alien individual for federal income tax purposes during 2008 and 2009. She did not file returns for the 2008 and 2009 tax years. Innovation Ventures, LLC (“IV LLC”), is a U.S. business that manufactures and sells popular consumer products including 5-hour Energy drinks. IV LLC was treated as a partnership for federal income tax purposes. Ms. Rawat owned a 30% interest in IV LLC. In January 2008, Ms. Rawat executed a note for the sale of her interest in IV LLC to Manoj Bhargava for $438 million. The note provided for interest-only payments until 2028, when the note would mature. At the time the note was executed, IV LLC had inventory items with a basis of $6.4 million, which it held for future sale in the U.S. IV LLC later sold those inventory items for a profit of $22.4 million, and Ms. Rawat’s share of income “attributable to the inventory” was $6.5 million. Of the $438 million sale price, $6.5 million was allocable to inventory held in the U.S. for sale therein (“Inventory Gain”).

The IRS conducted an examination of IV LLC for the 2007 and 2008 tax years. The IRS issued Form 5701, “Notice of Proposed Adjustment”, to IV LLC and to Ms. Rawat, proposing to include in Ms. Rawat’s income for 2008 $6.5 million arising from the Inventory Gain issue. Ms. Rawat and the IRS signed an IRS Form 870–LT, “Agreement for Partnership Items and Partnership Level Determinations as to Penalties, Additions to Tax, and Additional Amounts and Agreement for Affected Items”. The Form 870-LT included a “Schedule of Adjustments” that included, under “Other income (loss)”, an adjustment of $6,523,176, with the explanation that “[o]ther income relates to unrealized receivables as defined under Section 751.”

In February 2012 the IRS issued to Ms. Rawat a Notice of Computational Adjustment for her 2008 tax year, based in part on the Form 870-LT. The notice included Form 4549–A, “Income Tax Discrepancy Adjustments”, that listed a $6.5 million increase in income and a tax liability of $2.3 million. Additionally, the IRS determined nearly $1 million in additions to tax under section 6651(a)(1) and (2) and section 6654. The IRS assessed these amounts and issued a Notice of Deficiency (“NOD”). The NOD reflected the previously determined income for 2008 (from the Inventory Gain issue, as stated in the Notice of Computational Adjustment) and further determined additional taxes owed under section 453A(c)(2)(B) as interest on the deferred tax liability attributable to the installment obligation (“Non-Inventory Gain”). The NOD indicated a $3.8 million deficiency in tax for 2008 and a $2.6 million deficiency in tax for 2009. In June 2016 Ms. Rawat paid $2.9 million in tax, interest, and additions to tax attributable to the initial assessments for the 2008 tax year (i.e., arising from the computational adjustments for the Inventory Gain issue). Ms. Rawat filed her petition with the Tax Court in order to challenge the items in the NOD and to invoke the Court’s overpayment jurisdiction under section 6512(b) with respect to her $2.9 million payment for the computational adjustment.

Key Issues: Whether the inventory exception in section 741 of the Code calls for distinct treatment of the inventory-related portion of sale proceeds when the selling partner is a nonresident alien individual?
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