Rev. Rul. 56-134

Advice has been requested whether O. D. 140, C. B. 1, 174 (1919), has been overruled or modified by G. C. M. 13771, C. B. XIII-2, 229 (1934), and G. C. M. 17255, C. B. XV-2, 243 (1936).

O. D. 140, supra, holds that "income from a particular source can not be allocated to one partner of a partnership for income tax purposes, but must be divided pro rata among the several partners."

G. C. M. 13771, supra, holds in part that a nonresident alien partner's distributive share of the partnership income arising from business attributable to the United States office is subject to Federal income tax, while income arising from business attributable to the foreign branch office is income from sources without the United States and is not subject to Federal income tax.

G. C. M. 17255, supra, which modified G. C. M. 13771, supra, holds that the so-called "salary" of a nonresident alien member of a domestic partnership operating in the United States and a foreign country, who devotes his time solely to the foreign branch, is part of his distributive share of partnership profits and constitutes income from sources without the United States to the extent the income of the foreign branch is available to make such distribution.

O. D. 140, supra, merely states the fundamental proposition that the distributive share of a partner in partnership income represents his pro rata share of each and every type of partnership income, i. e., in dividing partnership income the partners will be considered as dividing all items of common income in the same proportion. For example, if one partner has a drawing account of $6,000 and the other partner a drawing account of $12,000 and they are to divide all remaining income on a 50-50 basis, $18,000 is divided between the partners 2 to 1, and any remaining income is divided between them 50-50 without regard to the source of any item included in the partnership income. In this and similar situations, it would be immaterial what services were actually performed by each partner and to what extent the source of the income was from services and to what extent it was from the employment of capital.

The stated view reflects the basic proposition that partnership income, as well as partnership property, is a single fund to be divided between the partners in the agreed ratio. Different items of income of a single partnership cannot be divided differently between the partners depending upon the source any more than can various items of property held by the partnership be conceived as being held in different ratios or being owned in different ratios by different partners. For example, if, in accordance with the partnership agreement, the partnership purchased certain assets at the direction of A from funds contributed by him to the partnership, and such assets were to be held for his account, it seems clear that the purchase money used to acquire such assets was, in effect, distributed to A and the assets so purchased were assets owned by A and not the partnership, notwithstanding the partnership agreement provided that such purchase money should be continued to be regarded as partnership capital.

In view of the above, if a partnership agreement purports to make the partnership hold and operate different assets for the benefit of the partners in different ratios, there is not just one partnership but two partnerships, each with a common fund in which the partners share in the agreed ratio. By treating what purports to be the foreign branch of a domestic partnership as a separate partnership, the conclusions reched in both G. C. M. 13771, supra, and G. C. M. 17255, supra, can be reconciled with O. D. 140, supra. In each of those cases, a separate partnership could have been expressly formed to conduct the foreign branch business with the results indicated consistent with those reached in the two cited opinions. In that case it would have been plain that there were two common funds consistent with the basic proposition of O. D. 140, supra.

Since the arrangement with respect to the drawing accounts in each of the cited G. C. M.'s, supra, in effect results in a different distributive share of the partners as respects the domestic and foreign branch, it becomes plain under the above discussion that there is not just one common fund shared identically by partners in agreed ratios but two common funds shared by identical partners in different ratios, thereby requiring the conclusion that there is in each of those cases in reality two partnerships rather than one for Federal income tax purposes.

G. C. M. 13771 C. B. XIII-2,229 (1934), and G. C. M. 17255 C. B. XV-2, 243 (1936), are modified accordingly.

The rulings referred to herein are applicable only to the years governed by the Internal Revenue Code of 1939.