Rev. Rul. 57-138

Reconsideration has been given to Revenue Ruling 56-134, C.B. 1956-1, 649, which holds that where a domestic partnership is engaged in business in the United States and a foreign country and the arrangement with respect to the drawing accounts of the partners results in different distributive shares of the partnership in come with respect to the domestic and foreign branch, there are in each of such cases two common funds shared by the identical partners in different ratios and, therefore, two partnerships rather than one for Federal income tax purposes. This Revenue Ruling applies only to years governed by the Internal Revenue Code of 1939.

The question presented in Revenue Ruling 56-134, supra , is 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), as modified by G.C.M. 17255, C.B. XV-2, 243 (1936).

O.D. 140, supra , holds that `Income from a particular source cannot 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. 17255, supra , which modified G.C.M. 13771, supra , holds that where a nonresident alien member of a partnership operating in the United States and in a foreign country, devotes his time solely to the foreign branch, and the partnership agreement provides that he shall be paid a `salary' out of the profits of the foreign branch, the amount of the so-called salary is part of his distributive share of partnership profits and constitutes income from sources without the United States to the extent that income of the foreign branch is available to make such distribution.

The partnership agreement involved in O.D. 140, supra , unlike that involved in G.C.M. 17255, apparently contained no provision regarding the division of various items of partnership income. It follows, then, that O.D. 140, supra , stands only for the proposition that in the absence of such an agreement, partnership income must be divided pro rate among the several partners. Accordingly, since the cited rulings involve distinguishable factual situations, there is no apparent conflict between them.

Moreover, it is noteworthy that, while the 1939 Code is silent with respect to disproportionate sharing by partners of any item of partnership income, gain, loss, deduction or credit, the Internal Revenue Code of 1954 specifically recognizes that a partnership agreement may provide therefor.

It is stated in section 704(a) of the 1954 Code that a partner's distributive share of income, gain, loss, deduction or credit, except as otherwise provided in that section, is to be determined by the partnership agreement. Section 704(b) of the Code provides, in part, that, if the principal purpose of any provision in the partnership agreement determining a partner's distributive share of a particular item is to avoid or evade the Federal income Tax, the provision of the partnership agreement is to be disregarded and the partners' distributive shares of that item are to be determined in accordance with the ratio in which the partners divide the general profits or losses, that is, the taxable income or loss of the partnership as described in section 702(a)(9) of the Code. See section 1.704-1 of the Income Tax Regulations. Although, with the exception of subsection (e) of section 704 of the Code, all the provisions thereof are new, it is stated in Senate Report No. 1622, 83d Congress, Second Session, at page 379, that such provisions are substantially in accord with existing practice.

Accordingly, for taxable years to which the 1939 Code applies, partners may, in accordance with the partnership agreement, share various items of partnership profit and loss in different ratios, provided such agreement is not for the purpose of avoidance of income taxes by a partner. In such a case, there is only one partnership for Federal income tax purposes.

Revenue Ruling 56-134, C.B. 1956-1, 649, is revoked and O.D. 140, C.B. 1, 174 (1919), is distinguished.