DC Circuit Interprets the § 751 Inventory Exception to Achieve a Result Congress Cannot Have Intended (7/29/24)

In Rawat v. Commissioner, 108 F.4th 891 (D.C. Cir. 2024), DCCir here and GS here, the Court held that the portion of a foreign person’s gain from sale of a partnership interest attributable to partnership inventory taxed under § 751 as other than capital gain is not U.S. sourced and therefore not subject to U.S. tax. The opinion really has nothing to do with tax procedure, except on the picky point that I note at the end of this blog.

As I see the issue (perhaps not from the same literalist reading of the statutes as the Court but as a high level overview of what I think Congress was trying to do), the purpose of recharacterizing what would be capital gain into ordinary income for the underlying appreciated inventory in the partnership is to give the partner treatment as if the partnership had sold the inventory, realized the gain, and allocated it to the foreign partner for U.S. tax. Judge Gustafson in the Tax Court reached that result well within the constraints of the language in the Code. See Rawat v. Commissioner, T.C. Memo. 2023-14 , here. Only by fixating on certain text does the D.C. Circuit panel avoid that result. The whole purpose of all judicial interpretive methodologies is to be the faithful agents interpreting the will or intent of Congress. Foregoing U.S. tax on the gain attributable to inventory certainly was not the intent of Congress.

I post on this case because it seems to me to be of the same genre of resolution as Gitlitz v. Commissioner, 531 U.S. 206 (2001), here, Justice Thomas' infamous literalist / textualist opinion oblivious to the overall design of the Code. I discuss in general terms the interpretive methodologies in the Federal Tax Procedure Book 2024 versions (Student Ed. at pp. 6-11) and (Practitioner Ed. at pp. 8-17). Specifically, in another part of the book (Practitioner Ed.  at p. 109 n. 505), I discuss Gitlitz as follows in a footnote regarding the chaos some Supreme Court opinions:

   n505Charles I. Kingson, How Tax Thinks, 37 Suffolk U. L. Rev. 1031 (2004) (critiquing two leading Supreme Court cases: Frank Lyon Co. v. United States, 435 U.S. 561 (1978) and Commissioner v. Brown, 380 U.S. 563 (1965)); see also Charles I. Kingson, Confusion Over Tax Ownership, 93 Tax Notes 409 (Oct. 8, 2001) (critiquing the same). I also cite Gitlitz v. Commissioner, 531 U.S. 206 (2001) as a prime example of Supreme Court’s mischief in this area. See René Matteotti, Struggling With Words in Tax Jurisprudence -- A Plea for an Equal Treatment Mode of Analysis in Construing Tax Statutes, 2005 TNT 130-30. My quip, not much of an overstatement, is that tax cases are too important to let the Supreme Court decide them.

 The Rene Matteotti article (bold-faced in quote above) is particularly good. Matteotti’s bio is here. I don’t have a link to the article, but here is the relevant conclusion (one footnote omitted):

          The interpretative approach taken by the Supreme Court in Gitlitz cannot be reconciled with the long tradition of intentionalist-purposivist interpretation of the Code by the federal courts. It is a relapse into the tax jurisprudence of the nineteenth century. Since the Supreme Court simply ignores the tax jurisprudence developed as since the 1930s without giving any reasons, Gitlitz increases the confusion about whether and when a nonliteral interpretation of the Code is permissible. The Supreme Court's Gitlitz opinion creates an unbearable uncertainty which affects all players in the tax field, the Service, the lower federal courts, the tax bar and -- last but not least -- the taxpayers. This uncertainty in the current tax jurisprudence creates the risk that the different players on the tax field will not apply an objective standard when interpreting the Code but will elect the interpretation method which most likely produces the result which reflects their personal notion of "sound" tax policy and tax justice. The lack of a coherent interpretation method brings the tax system as a whole into disrepute and finally fosters unethical behaviour of taxpayers as the ethical crisis which has recently overcome the tax bar n143 illustrates. 

    n143 See, e.g., Staff of the Joint Committee on Taxation, Report of Investigation of Enron Corporation and Related Entities Regarding Federal Tax and Compensation Issues, and Policy Recommendations, Vol. I, Washington 2003, 22 ("Remarkable in many respects was Enron's ability to parse the law to produce a result that was contrary to its spirit and not intended by Congress . . .")

         The equal treatment mode of analysis in statutory interpretation serves to justify non-literal statutory interpretation by respecting the separation of powers principle and the basic constitutional value of equal treatment. It takes into account that the goal of perfectly drafted statutory provisions is unattainable. It is neither always group interest pressure nor sloppy drafting that prevents Congress from attaining the ideal, i.e., the coincidence of language and legislative purpose; it is the nature of the process and the enormity of the task. No one can predict what transactions may occur in the future. An unreasonable burden would be placed on Congress if it were forced to anticipate every conceivable transaction and "failure" of the interplay of different regimes in the Code.

          It is not an adequate discharge of duty for courts to interpret statutes mechanically, such as the Supreme Court did in Gitlitz, knowing that the result in the case at hand perverts the discernible logic underlying the statute. The objection to a strict literal construction in such cases is that it represents in large part the abrogation by the courts of one of their greatest and most legitimate functions, the best possible ascertainment of the meaning of legislative acts. The equal treatment mode of analysis prevents courts from frustrating Congress. If one takes democracy seriously, the application of the plain language canon must be rejected. The equal treatment mode of analysis fosters fairness with respect to the relationship between taxpayers and government and tax justice among the taxpayers by treating those who are similarly situated similarly.

Minor, Picky Tax Procedure Issue in Rawat:

Rawat concludes (Slip Op. 15):

For the foregoing reasons, we reverse the judgment of the Tax Court.

JAT Comment: There is no judgment in the Tax Court. The judgment equivalent document is the “Decision.” An appeal is taken from the decision. § 7482(a)(1), here. The parties’ briefs in Rawat referred to either reversal or affirmance of the decision. The D.C. Circuit opinion author, other panel judges, their clerks and others in the court somehow tasked with catching such mistakes were just not paying attention. (This is not an uncommon mistake.)