Indu Rawat v. Commissioner of Internal Revenue

United States Court of Appeals
FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued February 8, 2024 Decided July 23, 2024
No. 23-1142
INDU RAWAT,
APPELLANT
v.
COMMISSIONER OF INTERNAL REVENUE,
APPELLEE
Appeal from the United States Tax Court
Christopher S. Rizek argued the cause for appellant. With
him on the briefs were Leila D. Carney and Nathan J.
Hochman.
Douglas C. Rennie, Attorney, U.S. Department of Justice,
argued the cause for appellee. With him on the brief was Jacob
Earl Christensen, Attorney.
Before: SRINIVASAN, Chief Judge, MILLETT and WALKER,
Circuit Judges.
Opinion for the Court filed by Chief Judge SRINIVASAN.
SRINIVASAN, Chief Judge: In 2008, Indu Rawat, a foreign
businesswoman, sold her partnership stake in a U.S. company

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for $438 million. Approximately $6.5 million of that sum was
attributable to a gain on the company’s inventory. The
question in this case is whether that inventory gain is U.S.-
source income subject to U.S. taxes. We hold it is not.
I.
A.
When a nonresident alien sells an interest in a U.S.
partnership, the U.S. tax consequences of the transaction
implicate two bodies of rules: those governing the taxation of
transactions in partnership interests and those governing the
taxation of income earned by nonresident aliens.
We first outline the relevant rules governing partnership-
interest transactions. Under § 741 of the Internal Revenue
Code, when a partner sells her partnership interest, any gain or
loss she realizes on the sale is generally “considered as gain or
loss from the sale or exchange of a capital asset.” In other
words, any gain the partner realizes is taxed as a capital gain
rather than as ordinary income. The distinction matters
because the tax rate applicable to capital gains is often lower
than the rate applicable to ordinary income. See I.R.C. § 1(a)–
(d), (h), (j).
Section 741, however, includes an express exception to its
general treatment of gains from the sale of partnership interests
as capital gains. Namely, § 741’s rule applies “except as
otherwise provided in section 751 (relating to unrealized
receivables and inventory items).” I.R.C. § 741. The
referenced provision, § 751, contains a subsection entitled
“Sale or exchange of interest in partnership.” Id. § 751(a).
Under that subsection, when the sale of a partnership interest
produces income (what we will also call “gain”) “attributable
to” either “unrealized receivables of the partnership” or

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“inventory items of the partnership,” that income “shall be
considered as an amount realized from the sale or exchange of
property other than a capital asset.” Id. (emphasis added).
That is, gain from the sale of a partnership interest attributable
to “inventory items” or “unrealized receivables” is taxable as
ordinary income rather than as a capital gain.
We now turn to the relevant rules defining the tax
obligations faced by nonresident aliens. As a general matter,
and for purposes of this case, nonresident aliens must pay U.S.
taxes on income “received from sources within the United
States,” but need not pay U.S. taxes on income received from
sources outside the United States. See id. § 871(a)–(b). When
a nonresident alien sells an interest in a U.S. partnership, a
straightforward sourcing rule has governed since the enactment
of the Tax Cuts and Jobs Act of 2017 (TCJA), Pub. L. No. 115-
97, 131 Stat. 2054: income from the sale is U.S.-source (and
hence taxable). See I.R.C. § 864(c)(8). But the events in this
case predated the TCJA’s enactment. And prior to the TCJA,
“[n]o specific sourcing provision governed income derived
from the disposition of a partnership interest.” Grecian
Magnesite Mining, Indus. & Shipping Co. v. Comm’r, 926 F.3d
819, 821 (D.C. Cir. 2019). Instead, the Code provisions
governing the sale of personal property controlled. Id. at 822.
Those rules treat income from the sale of most personal
property by a nonresident alien as foreign-source income and
thus nontaxable. I.R.C. § 865(a)(2). There are exceptions,
though, including for inventory: income derived from the sale
of inventory might be U.S.-source or foreign-source,
depending on various context-specific considerations related to
the sale. See id. §§ 861(a)(6), 862(a)(6), 865(b). Such income
thus may be taxable even if the seller is a nonresident alien.
To sum up: (1) Gain on the sale of a partnership interest
is taxed as a capital gain, except that it is taxed as ordinary

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income to the extent the gain is attributable to § 751(a) property
(inventory and unrealized receivables). (2) For present
purposes, only a nonresident alien’s U.S.-source income is
taxable. (3) At the time of the relevant events in this case,
income from a nonresident alien’s sale of a partnership interest
was taxed according to the sourcing rules for personal property
sales. And (4), under those rules, income from a nonresident
alien’s sale of personal property generally is foreign-source
(and hence nontaxable), but income from a nonresident alien’s
sale of inventory can be U.S.-source (and hence taxable).
B.
Indu Rawat is a nonresident alien. During the early 2000s,
she made several investments in Innovation Ventures, LLC, a
Michigan business (and a partnership for tax purposes),
accumulating a 29.2% stake. Innovation Ventures owns
another company, Living Essentials, LLC, which sells the
popular energy drink 5-Hour Energy.
In 2008, Innovation Ventures bought back Rawat’s share
of the company in exchange for a promissory note worth
approximately $438 million. At the time of the transaction,
Innovation Ventures held inventory valued at $6.4 million,
which it later sold for a profit of $22.4 million. As a 29.2%
owner of that inventory at the time she sold her interest in
Innovation Ventures, Rawat was entitled to $6.5 million of the
inventory gain. All agree, therefore, that of the $438 million
Rawat received for her stake in Innovation Ventures, $6.5
million is attributable to a gain on Innovation Ventures’ sale of
inventory.
Rawat recognized ordinary income of $6.5 million
resulting from the inventory gain in the 2008 tax year. But she
never reached an agreement with the IRS on the source of that
income and, accordingly, whether it was subject to U.S. taxes.

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The Commissioner took the position that the inventory gain
was U.S.-source, taxable income and notified Rawat that she
owed approximately $2.3 million in taxes on it. While Rawat
eventually paid the requested amount (plus penalties, interest,
and other adjustments), she promptly petitioned the Tax Court
for a refund, contending that the inventory gain was foreign-
source income and therefore nontaxable.
The dispute turned on whether the inventory gain should
be understood as income Rawat earned from selling inventory.
If so, the sourcing rules governing the sale of inventory would
apply, under which income from the sale could be considered
U.S.-source (and taxable) depending on the particulars. But the
Commissioner conceded that if, by contrast, Rawat did not in
fact sell inventory, income from the sale would be treated as
nontaxable foreign-source income.
The parties’ competing positions revolved around
competing understandings of § 751(a). That provision, as
noted, states that gain from the sale of a partnership interest that
is “attributable to . . . inventory items of the partnership”—
inventory gain—“shall be considered as an amount realized
from the sale or exchange of property other than a capital
asset.” I.R.C. § 751(a). While the parties agreed that § 751(a)
requires inventory gain to be taxed as ordinary income, the
Commissioner argued that it does more than that: in his view,
§ 751(a) also deems gain on the sale of a partnership interest
attributable to inventory to be gain on the sale of inventory,
such that it can be taxable as U.S.-source income. Rawat,
however, contended that § 751(a) has a more limited scope.
She insisted that it does not give rise to a deemed sale of
inventory and thus does not render taxable what would
otherwise be nontaxable income. Rather, according to Rawat,
§ 751(a) merely subjects inventory gain to ordinary-income
taxation if the gain is otherwise taxable. And Rawat considered

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the inventory gain she realized to be nontaxable, as it arose
from the sale of a partnership interest, not from the actual sale
of inventory. Accordingly, she maintained, the gain constitutes
proceeds from the sale of general personal property (as
opposed to inventory) and is foreign-source income because
she is a nonresident alien.
The Tax Court agreed with the Commissioner, holding that
under § 751(a), Rawat must be taxed as though she actually
sold the inventory that gave rise to the inventory gain. Rawat
now appeals.
II.
“We review tax court decisions ‘in the same manner and
to the same extent as decisions of the district courts in civil
actions tried without a jury.’” Cross Refined Coal, LLC v.
Comm’r, 45 F.4th 150, 155 (D.C. Cir. 2022) (quoting I.R.C.
§ 7482(a)(1)). Because this appeal turns only on questions of
law, our review is de novo. Andantech L.L.C. v. Comm’r, 331
F.3d 972, 976 (D.C. Cir. 2003).
The question we must resolve is whether § 751(a) merely
establishes that inventory gain arising from the sale of a
partnership interest is taxed as ordinary income rather than as
a capital gain, or whether § 751(a) also deems inventory gain
from a partnership-interest sale to be income from a sale of
inventory. If the latter—i.e., if the inventory gain is understood
to be income from the sale of inventory—then the income can
be taxable as U.S.-source income. But if the former—i.e., if
the inventory gain is treated as income from the sale of a
partnership interest rather than income from the sale of

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inventory—then the Commissioner concedes for purposes of
this appeal that the income is foreign-source and nontaxable.
We conclude that § 751(a) does not treat inventory gain as
gain from the sale of inventory. As a result, the inventory gain
Rawat realized when she sold her partnership interest is
foreign-source income, as to which she owes no taxes.
A.
We agree with the parties that, under § 751(a), inventory
gain realized in a partnership-interest sale is treated as ordinary
income for taxation purposes. The reasons we reach that result
also lead us to conclude that § 751(a) does not go further and
deem Rawat’s inventory gain a gain from the sale of inventory.
Section 751(a) states:
The amount of any money, or the fair
market value of any property, received by
a transferor partner in exchange for all or
a part of his interest in the partnership
attributable to—
(1) unrealized receivables of the
partnership, or
(2) inventory items of the partnership,
shall be considered as an amount realized
from the sale or exchange of property
other than a capital asset.
The pivotal clause is the last one: “shall be considered as
an amount realized from the sale or exchange of property other
than a capital asset.” In construing that language, we find

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illuminating the Code’s definition of “ordinary income”: “any
gain from the sale or exchange of property which is neither a
capital asset nor property described in section 1231(b).” I.R.C.
§ 64. That definition’s operative language and § 751(a)’s key
clause are materially identical. Both describe an amount
realized (or a gain) “from the sale or exchange of property” as
not “a capital asset.” When considered in light of the statutory
definition of “ordinary income,” then, the words “shall be
considered as an amount realized from the sale or exchange of
property other than a capital asset” in § 751(a) effectively mean
“shall be considered as ordinary income.”
Statutory definitions are “virtually conclusive” of statutory
meaning. Sturgeon v. Frost, 587 U.S. 28, 56 (2019) (quoting
Antonin Scalia & Bryan A. Garner, Reading Law: The
Interpretation of Legal Texts 228 (2012)). We thus adhere to a
statutory definition unless it would be
“incompatible with . . . Congress’ regulatory scheme” to do so.
Digit. Realty Tr., Inc. v. Somers, 583 U.S. 149, 163 (2018)
(alteration in original) (quoting Util. Air Regul. Grp. v. EPA,
573 U.S. 302, 322 (2014)). There is no incompatibility here.
And although a definitional provision is typically used to give
meaning to a defined term, rather than, as here, to give meaning
to the language of the definition, such a provision works both
ways: if a statute defines “house” as “an enclosed structure
used as a residence,” one would be hard-pressed to say that the
statute’s use elsewhere of the phrase “an enclosed structure
used as a residence” means anything but “house.” Indeed,
Congress has many times replaced phrases functionally
identical to “an amount realized from the sale or exchange of
property other than a capital asset” with the words “ordinary
income,” reinforcing the inference that the latter is a substitute
for the former. Compare I.R.C. § 306(a)(1)(A), (a)(1)(B)(i),
(f) (1970), id. § 735(a) (1970), and id. § 1236(b) (1970), with

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I.R.C. § 306(a)(1)(A), (a)(1)(B)(i), (f) (2018), id. § 735(a)
(2018), and id. § 1236(b) (2018).
Reading § 751(a) alongside its companion provision,
§ 741, cements that understanding. Section 741 states in full:
“In the case of a sale or exchange of an interest in a partnership,
gain or loss shall be recognized to the transferor partner. Such
gain or loss shall be considered as gain or loss from the sale or
exchange of a capital asset, except as otherwise provided in
section 751 (relating to unrealized receivables and inventory
items).” Section 751(a) thus functions as a carve out to § 741’s
general rule. Said otherwise, § 741’s directive applies, except
as to assets within § 751(a)’s ambit. Consistent with that
instruction, § 751(a)’s language tracks that of § 741, only with
what amounts to a negative sign in front of it: instead of
treating a gain or loss “as gain or loss from the sale or exchange
of a capital asset,” § 751(a) treats it as “an amount realized from
the sale or exchange of property other than a capital asset.” In
substance, then, just as § 741 cross-references § 751(a),
§ 751(a) refers back to § 741.
The interlocking nature of those provisions, as well as their
conspicuously similar language, provides a strong indication
that they are alike in scope and effect. And all agree that § 741
mandates that a gain on the sale of a partnership interest be
taxed as a capital gain rather than as ordinary income. So it
stands to reason that § 751(a)’s parallel, but inverse, instruction
mandates that a gain attributable to inventory (or unrealized
receivables) be taxed not as a capital gain but instead as
ordinary income.
Section 751(a)’s history and purpose affirm that its
conformity with the ordinary-income definition is no accident.
Congress enacted § 751 in 1954 as part of a major overhaul of
the Code. Internal Revenue Code of 1954, Pub. L. No. 83-591,

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§ 751, 68A Stat. 1, 250 (“1954 Act”). It was by then well-
established that, in general, the sale of a partnership interest is
“the sale of a capital asset” as to which “any gain or loss
realized is treated as capital gain or loss.” H.R. Rep. No. 83-
1337, at 70 (1954). Section 741 simply codified that
understanding. See id. There had arisen, however, a practice
of partners using that rule to skirt ordinary-income taxes they
otherwise would owe by disposing of their partnership interests
before realizing income, in an effort to obtain more favorable
capital-gains treatment. See Swiren v. Comm’r, 183 F.2d 656,
658, 660 (7th Cir. 1950); Helvering v. Smith, 90 F.2d 590, 592
(2d Cir. 1937); Krist v. Comm’r, 12 T.C.M. (CCH) 801 (1953),
aff’d on other grounds, 231 F.2d 548 (9th Cir. 1956).
Congress put § 751(a) in place as a “prophylactic
provision” to quash those efforts to evade ordinary-income
taxes. William S. McKee, William F. Nelson & Robert L.
Whitmire, Federal Taxation of Partnerships and Partners
¶ 17.01 (4th ed. 2024). The aim, in the words of the House
Ways and Means Committee, was to “prevent the use of the
sale of an interest in a partnership as a device for converting
rights to income into capital gain” by mandating that gain on
the sale of a partnership interest attributable to inventory or
unrealized receivables “be treated as ordinary gain.” H.R. Rep.
No. 83-1337, at 70. Unsurprisingly, the text Congress enacted
tracks Congress’s stated intent: Section 751(a) says that gain
realized in a partnership-interest sale attributable to property
within its scope is taxed not as a capital gain but as ordinary
income.
B.
The Commissioner agrees that § 751(a) provides for
ordinary-income treatment of inventory gain. But he submits
that § 751(a) accomplishes that result by changing the

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character of the asset sold from a partnership interest to
inventory itself. As the Commissioner sees it, § 751(a) deems
the gain Rawat realized on the sale of her partnership interest
that is attributable to the partnership’s inventory to be income
from a sale of that inventory. If that were true, the inventory
gain would indeed be ordinary income. But there would be
other repercussions as well, including that the sourcing rules
applicable to sales of inventory property would apply,
potentially rendering the gain taxable as U.S.-source income.
We find little to recommend that interpretation of § 751(a) and
considerable reason to reject it.
To begin with, the Commissioner’s argument is difficult
to square with the text of § 751(a), properly understood. A
mandate that inventory gain be considered “ordinary income”
differs from a mandate that inventory gain be considered
income “from the sale of inventory.” If Congress had wanted
to convey something other (or more encompassing) than
“ordinary income,” it presumably would have said so
expressly. Instead, it used terminology that directly
corresponds to the definition of “ordinary income.”
Resisting that conclusion, the Commissioner urges us to
read § 751(a)’s critical language, “shall be considered as an
amount realized from the sale or exchange of property other
than a capital asset,” as a reference back to the two kinds of
property listed above it—inventory and unrealized receivables.
In his judgment, § 751(a) should be read to say that inventory
gain “shall be considered as an amount realized from the sale
or exchange of inventory.” That might be a plausible reading
of § 751(a) if the provision were considered in isolation. But
as we have explained, “considered as an amount realized from
the sale or exchange of property other than a capital asset,”
when construed in light of the Code as a whole, has a particular
meaning: ordinary income.

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There are further indications that Congress did not intend
the words “property other than a capital asset” to incorporate
“inventory” and “unrealized receivables.” In effect, the
Commissioner asks us to interpret the clause “shall be
considered as an amount realized from the sale or exchange of
property other than a capital asset” in § 751(a) to mean “shall
be considered as an amount realized from the sale or exchange
of such property,” with “such property” referring to the two
kinds of property listed in § 751(a). But Congress used exactly
that locution in the very next provision of the Code: Section
751(b)(1) says that if a partner exchanges partnership property
in which she has an interest for other partnership property and
the exchange occurs through a partnership distribution, then to
the extent the property exchanged is unrealized receivables or
substantially appreciated inventory, the transaction
“shall . . . be considered as a sale or exchange of such property
between the distributee and the partnership.” I.R.C.
§ 751(b)(1) (emphasis added). In other words, a transaction
fitting that description is not treated as a regular partnership
distribution but instead as “a sale or exchange of such property”
(i.e., of substantially appreciated inventory or unrealized
receivables).
It is a “familiar principle of statutory construction . . . that
a negative inference may be drawn from the exclusion of
language from one statutory provision that is included in other
provisions of the same statute.” Hamdan v. Rumsfeld, 548 U.S.
557, 578 (2006). Such an inference has particular force when
the “contrasting statutory sections” were “originally enacted
simultaneously,” Field v. Mans, 516 U.S. 59, 75 (1995),
because distinctions between provisions arising from
“Congress’ tandem review and approval” are more likely
intentional, Hamdan, 548 U.S. at 579. Not only were § 751(a)
and § 751(b)(1) enacted simultaneously, see 1954 Act,
§ 751(a), (b)(1), 68A Stat. at 250, but they are also directly

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adjacent in the Code and concern essentially the same sorts of
property. We cannot conclude that Congress intended to
convey elliptically in § 751(a) what it said far more directly in
the adjacent provision, § 751(b)(1).
The Commissioner also puts considerable weight on the
1954 Act’s legislative history, finding in it a congressional
design to use § 751(a) to treat inventory gain as gain from a
deemed inventory sale. After explaining that § 751(a) treats
gain realized on § 751(a) property as “ordinary gain,” the
House Report says that, “[i]n effect, the partner is treated as
though he disposed of such items independently of the rest of
his partnership interest.” H.R. Rep. No. 83-1337, at 70. The
Report later states: “The statutory treatment proposed, in
general, regards the income rights [from § 751(a) property] as
severable from the partnership interest and as subject to the
same tax consequences which would be accorded an individual
entrepreneur.” Id. at 71. The Senate Report repeats both
passages nearly verbatim. See S. Rep. No. 83-1622, at 98–99
(1954).
Those fragments of legislative history do not compel the
Commissioner’s reading of § 751(a). Not only does the
Commissioner’s reliance on legislative history run aground in
the face of the statutory definition of ordinary income, but the
sentences quoted by the Commissioner also do less work than
he supposes. It is undisputed that, if we treat a partner who
realizes inventory gain from a partnership-interest sale as if she
independently disposed of that inventory, her gain will be taxed
as ordinary income rather than as a capital gain. And as the
history recounted above and other passages in the committee
reports make plain, that consequence was Congress’s focus in
enacting § 751(a). See H.R. Rep. No. 83-1337, at 70. The cited
statements thus are naturally read to reiterate that object, rather
than to dictate that a partnership-interest sale be deemed an

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actual sale of inventory. After all, the second quoted sentence
says only that inventory gain is treated as the product of a
separate sale “in general,” not for every imaginable purpose.
Id. at 71.
The out-of-circuit decisions on which the Commissioner
relies serve him no better. See Mingo v. Comm’r, 773 F.3d 629,
634 (5th Cir. 2014); United States v. Woolsey, 326 F.2d 287,
291–92 & n.7 (5th Cir. 1963); Quick’s Trust v. Comm’r, 444
F.2d 90 (8th Cir. 1971) (per curiam), aff’g 54 T.C. 1336, 1343–
44 (1970). Those decisions do not turn on the interpretive issue
we confront here, and they speak to that issue, at most, only
indirectly.
The Commissioner looks last to the IRS regulations
implementing § 751(a). Those regulations direct that the
ordinary income recognized by a partner who sells her
partnership interest and realizes a gain on § 751(a) property
should be determined as though that property had been sold
separately from the partnership interest. 26 C.F.R. § 1.751-
1(a)(2), (g). If income from inventory gain must be calculated
consistent with a hypothetical sale of inventory, the
Commissioner reasons, that must be because the statute
requires the income to be treated for all purposes as though it
were in fact the product of such a sale. But while the regulation
is amenable to the Commissioner’s understanding, it is equally
amenable to Rawat’s. Even if all § 751(a) does is mandate that
inventory gain be taxed as ordinary income, the amount of
ordinary income still must be determined, as must the amount
of capital gain attributable to the rest of the transferred
partnership interest. Running a calculation based on a
hypothetical inventory sale would seem to be one way to do so.
Until recently, in fact, the Commissioner endorsed an
understanding parallel to the one we adopt today (albeit as to

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§ 741 rather than § 751(a)). See Grecian Magnesite Mining,
Indus. & Shipping Co., SA v. Comm’r, 149 T.C. 63, 78 (2017),
aff’d 926 F.3d 819 (D.C. Cir. 2019). True, the Tax Court
rejected that submission. Id. But rather than press the issue
further, the Commissioner acquiesced, appealing the Tax
Court’s decision to our court only on other grounds. See
Grecian Magnesite Mining, 926 F.3d at 822. Regardless, it is
notable that our construction of § 751(a) is consistent with a
basic approach the Commissioner himself once viewed as
interpretively correct and workable in practice.
The short of it is that § 751(a) does not of its own force
render Rawat’s inventory gain taxable because it does not
change the fact that she sold a partnership interest, not
inventory. Once we reach that conclusion, the parties agree
that the inventory gain from the sale is foreign-source income
as to which Rawat owes no U.S. taxes.
* * * * *
For the foregoing reasons, we reverse the judgment of the
Tax Court.
So ordered.

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