On May 7, 2019, the IRS and the U.S. Treasury department released Proposed Regulations under IRC section 1446(f) that potentially have broad application to the transfer of any partnership interest. It’s important that transferees understand in what manner and to what extent the withholding provisions could apply to them, as well as the potential consequences of noncompliance. This article focuses specifically on the effect of these regulations on the transferee of nonpublicly traded partnership interests, even when withholding does not apply. 

Background

New IRC sections 864(c)(8) and 1446(f) were enacted as part of the Tax Cuts and Jobs Act of 2017.  When a nonresident alien individual or foreign corporation (referred to here as a “foreign person”) disposes of an interest in a partnership that is directly or indirectly engaged in a U.S. trade or business, IRC section 864(c)(8) generally applies to treat the gain or loss from such disposition as income effectively connected to a U.S. trade or business (aka ECI). New IRC section 1446(f) provides coordinating withholding requirements on the sale or disposition of partnership interests by foreign persons if any portion of the gain on the disposition would be treated as ECI under IRC section 864(c)(8).   Generally, under IRC section 1446(f), transferees (including some partnerships making distributions treated as transfers) are required to withhold 10% of the amount realized by a foreign person that transfers an interest in a partnership engaged in a U.S. trade or business on which gain is taxable under IRC section 864(c)(8). If a transferee fails to withhold under the general rule, the partnership is required to withhold on distributions to the transferee partner in the amount the transferee failed to withhold plus interest, according to IRC section 1446(f); this is known as “backstop withholding.”

Since the enactment of IRC section 1446(f), the Treasury department and the IRS have issued two notices in response to comments. First, on Dec. 29, 2017, Notice 2018-08 suspended withholding on the sale or disposition of publicly traded partnership (PTP) interests until future guidance is issued. Second, on Apr. 2, 2018, Notice 2018-29 provided several exceptions to withholding, procedures for reporting and paying withholding tax, procedures for determining liabilities in calculating the amount realized, a limitation to withholding where the cash/property transferred is less than the amount required to be withheld, a suspension of the backstop withholding required by IRC section 1446(f)(4), coordination with Foreign Investment in Real Property Tax Act withholding, and clarification on the application in tiered partnerships situations. 

Proposed Regulations

The Proposed Regulations, when finalized, would require withholding on the disposition of PTP interests and thus end the suspension on withholding under Notice 2018-08. In addition, they would end the temporary suspension under Notice 2018-29 of the backstop withholding required by IRC section 1446(f)(4). Furthermore, the regulations expand upon rules previously described in Notice 2018-29 and are largely consistent with those rules, with some notable additions and modifications.

The Proposed Regulations generally apply to transfers occurring 60 days after the regulations are finalized (or to taxable years and/or returns relating to years in which those transfers occur). Until the regulations are finalized, persons subject to IRC section 1446(f) may continue to rely upon Notice 2018-29 or may rely upon the Proposed Regulations in lieu of Notice 2018-29—provided that those rules are relied upon in their entirety.

Caution for the Unwary: Why Every Transferee Should Care

As discussed above, IRC section 1446(f) provides that a transferee of an interest in a partnership, engaged in a U.S. trade of business on which gain is taxable under IRC section 864(c)(8), from a foreign transferor is required to withhold 10% of the amount realized by such foreign transferor. Therefore, a transferee only has a duty to withhold if both of the following are true:

• The transferor is a foreign person.
• The partnership is engaged in a U.S. trade or business on which gain is taxable under IRC section 864(c)(8).

This might lead a transferee to assume that the rules can be ignored, as withholding is not applicable, when the transferor is domestic and/or the partnership is not engaged in a U.S. trade or business, transferees should consider the potential implications of the backstop withholding, which requires a partnership to withhold on subsequent distributions to a partner that did not withhold (or under withheld) on its acquisition of a partnership interest.

The Proposed Regulations require that within 10 days of the transfer of a non-PTP interest, a transferee partner must provide the partnership with a certification establishing that it has satisfied its withholding obligation or that an exception applies. This must include copies of any certifications upon which the transferee partner relied to apply an exception (i.e., a non-foreign affidavit or Form W-9 from the transferor partner) or to determine the amount to withhold (partner’s certification of its share of partnership liabilities). Thus, even where withholding is not required (e.g., the transferor is a U.S. person), it will be important that, every time a partnership interest is transferred, the transferee obtain some certification based on one of the exceptions provided below in order to provide the certification and documentation necessary to avoid the backstop withholding.   

A partnership that is itself a transferee, by reason of making a distribution to a partner, is not subject to the backstop withholding; however, such a partnership should also pay particular attention to the Proposed Regulations’ requirements if it intends to rely on its books and records for purposes of the application of an exception to withholding. Within 30 days of the transfer, a partnership that relies on its books and records in lieu of a transferor certification must identify the following:

• The date on which the transfer occurred.
• The information on which the partnership relied.
• The provisions of the Proposed Regulations supporting an exception from the partnership’s obligation to withhold.

The implication is that these rules will apply to every transferee of a partnership interest; they will need to understand which exception could apply to the transfer and what documentation will be required to secure that exception.

Exceptions to Withholding on Non-PTP Interests

Consistent with Notice 2018-29, the Proposed Regulations provide several exceptions to withholding, with some modifications, and add a new exception where gain is exempt under a treaty. A transferee is not required to withhold on the acquisition of a partnership interest if it receives one of the following certifications:   

• Non-foreign status. The transferor provides a non-foreign affidavit or a valid Form W-9 to the transferee, establishing that it is not a foreign person.
• No realized gain. The transferor certifies to the transferee that it did not realize any gain on the disposition, including any ordinary income arising from the application of IRC section 751.
• Partnership less than 10% ECI gain. The partnership certifies to the transferee that either (1) the ECI gain from a deemed sale of all its assets would be less than 10% of total net gain or (2) no gain would have been ECI.
• Partner less than 10% ECI. The transferor certifies that it has been a partner in the partnership for each of the last three years, that its allocable share of ECI from the partnership in each of the last three years was less than $1 million, and that its share of ECI was less than 10% of its total distributive share of the partnership's net income for each year. The transferor must also certify that it has met its U.S. federal tax return filing and tax payment obligations timely.
• Nonrecognition. The transferor certifies to the transferee that the transfer qualifies, in its entirety, for nonrecognition pursuant to a nonrecognition provision of the IRC.
• Treaty benefits. The Proposed Regulations add an exception for treaty-qualified taxpayers, whereby a direct transferor can certify that it is exempt from tax on any gain under the provisions of a treaty. The certification must include a valid W-8BEN or W-8BEN-E and must be mailed to the IRS. This rule is not available to a partner that owns its interest indirectly through one or more partnerships. This certification cannot be relied upon unless the transferee forwards a copy of the certification to the IRS within 30 days of the transfer. This is the only certification for an exception to withholding that must be forwarded to the IRS.

A partnership that does not receive a certification from a transferee will be required to withhold from any distributions made to the transferee. As discussed above, the transferee certification must include a copy of any certifications that the transferee relied upon in apply an exception to withholding.

What if No Exception to Withholding Applies to the Transfer?

Determination of withholding amount
If an exception to withholding does not apply to the transfer, a transferee is required to withhold at a rate of 10% of the amount realized by the foreign transferor. The term “amount realized” for non-PTP interests is defined to include cash paid or to be paid, the fair market value of other property transferred or to be transferred, the amount of liabilities assumed by the transferee or to which the partnership interest is subject, and the reduction in the transferor’s share of partnership liabilities.

While a transferee generally knows the amount of cash paid or to be paid and the fair market value of property transferred or to be transferred, it may have no knowledge of the transferor’s share of partnership liabilities (unless of course the partnership is the transferee, by virtue of making a partnership distribution). 

Consistent with Notice 2018-29, the Proposed Regulations provide rules to aid a transferee in making this determination. A transferee can rely upon a certification (based on the most recent Schedule K-1 issued by the partnership) of liabilities by a transferor, unless the transferor is a controlling partner. The term “controlling partner” is defined in Proposed Treasury Regulations section 1.1446(f)-1(b)(2) as any partner—together with persons related to such partner, pursuant to section 267(b) or 707(b)(1)—that “owns directly or indirectly a 50 percent or greater interest in the capital, profits, deductions, or losses of the partnership in the 12 months before the determination date.” The last day of the partnership taxable year for which the Schedule K-1 is provided cannot be more than 22 months from the date of the transfer. In lieu of a partner certification, a transferee can rely on a certification of liabilities from the partnership. If a transferee receives neither a partner nor a partnership certification and does not have actual knowledge of the transferor’s share of partnership liabilities, the rules provide that the amount subject to withholding is the amount realized without regard to liabilities. This would generally be the entire proceeds that the partner was to receive in the transaction. 

Maximum tax liability 
A transferee may reduce withholding to the transferor’s maximum tax liability if it receives a certification from the transferor. In addition to other requirements, the information required to be provided as part of the certification of transferor’s maximum tax liability includes the following:

• The amount of outside ordinary gain and outside capital gain that would be treated as ECI under IRC section 864(c)(8), supported by a certification from the partnership.
• A representation that the transferor determined the outside ordinary and capital gain based on a statement from the partnership.
• A representation that the transferor has provided the transferee with a copy of the partnership statement. In some circumstances, it may be difficult to obtain the partnership certification, making it challenging for the transferor partner to provide a maximum tax liability certification to reduce the withholding.

Look-through foreign partnership transferor
A transferee can limit the “amount realized’ in computing the amount to be withheld on the transfer by a foreign partnership transferor to the portion of the amount realized that is attributable to foreign persons (direct or indirect foreign partners of the foreign partnership transferor). Similar to look-through that is available for both IRC section 1446(a) as well as section 1441 and 1442 withholding, the foreign partnership is required to furnish a Form W-8IMY that includes a certification of nonforeign status for each partner treated as a U.S. person and a withholding statement that provides the percentage of gain allocable to each direct or indirect partner and indicates whether that person is U.S. or foreign.

Takeaway  

These are some of the highlights related to the transferee’s obligations to obtain documentation when it is not required to withhold and in determining the amount realized when it is. The Proposed Regulations suggest that they are not limited to transfers by foreign persons of interests in partnerships that have a U.S. trade or business, but potentially have a much broader application. Transferees should pay particular attention to the certification and documentation requirements set forth in these Proposed Regulations. 

About Deloitte

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This article contains general information only and Deloitte is not, by means of this article, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This article is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this article.

Christine Piar is the managing director in Deloitte’s Washington National Tax Office and brings 20 years of international tax experience for both U.S.-based and foreign-based multinationals, primarily in the areas of financing and repatriation strategies, acquisition and disposition planning, post-acquisition restructuring, withholding, treaties, and inbound investment into the U.S.  Christine is the firm expert on the Foreign Investment in Real Property Tax Act (FIRPTA) and is a regular speaker on the subject at both internal and external events.  Christine has authored several articles on FIRPTA, including an article on FIRPTA and renewables that appears in the International Tax Review’s Energy Industry Guide (3^rd Edition).  She has extensive experience addressing FIRPTA issues for clients in the oil and gas, energy, transportation, mining, automotive, manufacturing, retail, services, and real estate industries. Christine began her career with a Big Five firm in Houston serving a wide range of multinational clients in the oil & gas, energy, and waste industries.  Christine obtained her J.D. from the University of Houston School of Law and is a member of the Texas and Ohio Bars.