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Additional withholding requirements on nonresident transfers of partnership interests

September 5, 2019 / 6 min read

The IRS released proposed regulations under Section 1446(f) and 864(c)(8) relating to new withholding requirements with respect to certain transactions with non-U.S. partners of a U.S. partnership. Make sure you understand the details regarding these proposed regulations.

The IRS released proposed regulations under Section 1446(f) and 864(c)(8) relating to new withholding requirements with respect to certain transactions with non-U.S. partners of a U.S. partnership. Foreign partners must now be aware that additional withholding requirements exist during the disposition or transfer of their interest in a U.S. partnership. Importantly, it’s the purchaser that is required to perform the withholding so all parties to a transaction must coordinate to ensure that the rules are properly complied with. In addition, this new withholding is required in all partnership interest purchases unless a specific exception applies — so even a transaction where all parties are U.S. people still must follow specific processes in order to avoid these rules. This new withholding is in addition to navigating the withholding requirements of the Foreign Investment in Real Property Tax Act (FIRPTA) of 1980.



In addition, this new withholding is required in all partnership interest purchases unless a specific exception applies.

Sec. 864(c)(8), which was enacted as part of the Tax Cuts and Jobs Act (TCJA), treats a portion of the gain on the disposal of a partnership interest by a nonresident partner as income effectively connected with the conduct of a U.S. trade or business (ECI); thus making it taxable in the United States. In these cases, the ECI amount is determined through a hypothetical sale of the partnership’s assets at fair market value as of the date of the nonresident partner’s disposition. The partner’s distributive share of this hypothetical gain’s ECI is then applied to the partner’s gain on the disposition of their partnership interest to determine the amount of taxable gain on the sale.

The TCJA also enacted Sec. 1446(f), which institutes a 10 percent withholding requirement on the disposition of partnership interest by a foreign partner. Any tax withheld is creditable to the foreign partner’s U.S. income tax liability under Sec. 864(c)(8), and any excess amount is refunded to the extent the amount withheld exceeds the actual tax liability.

Six exceptions from withholding and reduction of amount to withhold

The proposed regulations provide six exceptions from the required 10 percent withholding:

  1. The partner disposing of the partnership interest certifies under penalty of perjury that they are a U.S. resident at the time of disposition.
  2. There is no taxable gain realized by the partner during the disposition of the partnership interest.
  3. The partnership is able to certify that, if under a hypothetical sale of all its assets at fair market value as of the “determination date,” no part of the hypothetical gain is considered ECI.
  4. The partner certifies the gain on disposition of partnership interest qualifies for nonrecognition under certain provisions of the Internal Revenue Code.
  5. The partner certifies the gain on disposition isn’t subject to tax under a relevant tax treaty between the United States and the foreign jurisdiction; or
  6. (a) The partner was a partner of the partnership for at least the prior three taxable years; (b) the partner’s share of effectively connected taxable income (ECTI) allocated from the partnership during the aforementioned tax years didn’t exceed $1 million in any year; (c) the percentage of partnership income that was ECTI was less than 10 percent of total partnership taxable income in each of the prior three taxable years; and (d) that all U.S. tax returns for the past three years were properly filed with IRS and that the partner paid any related income tax.

Purchasers are also allowed to withhold less than the required 10 percent in situations where the amount required to be withheld exceeds the amount of the seller’s tax liability related to the transaction, and certain documentation requirements are met. Note that in cases where the purchaser of the partnership interest fails to properly withhold, the partnership is required to withhold on any subsequent distributions made to the purchasing partner until the withholding liability is satisfied.

If FIRPTA withholding also applies to the disposition of a partnership interest, then the withholding set by Sect. 1446(f) will not apply. However, if FIRPTA applies but the taxpayer is able to avoid the withholding tax via a withholding certificate under Regulation Sec. 1.1445-2, then Sec. 1446(f) withholding tax may still apply.

An important consideration for all acquirers of a partnership interest, is that absent an exemption, such as a certification that a transferor is a U.S. person, the acquirer of the interest has an obligation to withhold.

To navigate these exceptions, and to better understand when the new withholding requirements are applicable, all purchasers should request Form W-9 from the selling partners.

To navigate these exceptions, and to better understand when the new withholding requirements are applicable, all purchasers should request Form W-9 from the selling partners; if the partnership doesn’t already have them on file.

Additional required compliance reporting and timing

The amount required to be withheld under Sec. 1446(f) must be calculated on the determination date, as defined by Regulation Sec. 1.1446(f)-1(c)(4). This date can generally be one of the following:

Additional guidance relating to the reporting requirements of the Sec. 1446(f) withholding tax is provided in Notice 2018-29, and is summarized as follows:

We will continue to update you as more information on these proposed regulations and IRS guidance becomes available. Please contact your Plante Moran international tax services team member if you have any additional questions.

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