The 2017 Tax Act (Act) added new code Section §864(c)(8) which treats the portion of gain (or loss) from the sale or exchange of an interest in a partnership by a non-resident alien or foreign corporation that is engaged in a U.S. trade or business as effectively connected income (ECI) to the extent the gain (or loss) from a hypothetical sale or exchange of the underlying assets held by the partnership would be treated as ECI allocable to the selling partner. The newly enacted statute confirmed the Internal Revenue Service’s position in Rev. Rul. 91-32, which prospectively overrules a 2017 tax court case, Grecian Magnesite Mining, Industrial & Shipping Co. v. Commissioner (rejecting the government’s position in Rev. Rul. 91-32).
The Act also added a new withholding regime, §1446(f), which requires the transferee (i.e., the buyer of a partnership interest) to collect a 10 percent withholding tax from any seller of a partnership interest that does not provide an affidavit under penalties of perjury that it is not a foreign person and includes a U.S. Taxpayer Identification Number (TIN).
To the extent the transferee buyer fails to withhold any amount as required under §1446(f), the issuer partnership is secondarily liable for the unpaid withholding tax and is required to deduct and withhold from distributions to the transferee buyer an amount equal to the amount that the transferee buyer should have withheld, plus interest. The new §1446(f) withholding regime generally adopts the forms and procedures relating to withholding on dispositions of U.S. real property interests (USRPIs) under §1445 and the regulations thereunder. It applies to sales, exchanges and dispositions of partnership interests occurring after December 31, 2017.
It is critical, therefore, that buyers (i) obtain documentation from sellers showing that they are U.S. persons, and (ii) assess if any transfer of partnership interests by a foreign person may trigger a withholding obligation in respect of the foreign seller.
The IRS issued Notice 2018-29 (Notice), providing interim guidance to taxpayers under §1446(f) relating to non-publicly traded partnerships pending issuance of regulations. Earlier in the year, the IRS suspended the new withholding tax only in respect of transfers of interests in publicly-traded partnerships. The Notice provides on an interim basis that IRS Form W-9 is acceptable documentation to avoid the withholding obligation, provided that the form is signed under penalties of perjury and includes the U.S. TIN of the transferor seller.
In anticipation of the IRS issuing additional guidance in the future, we recommend that any purchasers of partnership interests include the following in the transfer documentation:
- A requirement that the seller deliver an affidavit signed under penalties of perjury certifying its U.S. status akin to the withholding regime under FIRPTA.
- Indemnification provisions to shield them from a 10 percent withholding tax liability exposure.
Distributions from a partnership to its partners (whether or not the distribution results in a redemption) are subject to these new provisions, including the withholding requirements. Partnerships should make sure they have received an IRS Form W-9 from each of their partners.