Notification and Reporting Requirements Under Section 864(c)(8) (Prop. Reg. 1.864(c)(8)-2)
For foreign partners (or domestic partnerships with foreign partners) to determine the amount of tax owed under Section 864(c)(8), the Proposed Regulations require a foreign partner that transfers an interest in a partnership engaged in a U.S. trade or business to notify the partnership of such transfer within 30 days. Any partnership receiving such a notification is required to provide the transferring partner with certain information necessary for it to determine the amount of gain required to be recognized under Section 864(c)(8) on or before the due date (with extensions) for Schedule K-1.
Withholding on Transfers of Non-PTP Interests (Prop. Reg. 1.1446(f)-2)
Exceptions from Withholding. The Proposed Regulations generally require transferees to withhold 10 percent of the amount realized on any transfer of a partnership interest, unless:
i. The transferor certifies that one of the following is true:
a. The transferor is not a foreign person (e.g., by providing an IRS Form W-9);
b. the transferor will not realize any gain on the transfer, including any ordinary income required to be recognized under the “hot assets” rules of Section 751;
c. the transferor was at all times during the three preceding taxable years (ending with the most recent year for which a Schedule K-1 was due or received) a partner in the partnership, the effectively connected taxable income of the partnership allocated to it and certain related persons during each such taxable year was both less than $1 million and less than 10 percent of the transferor’s total distributive share of net income from the partnership and the transferor’s share of such effectively connected taxable income was properly reported to the IRS and tax thereon properly paid;
d. by reason of the operation of a nonrecognition provision of the Code, the transferor is not required to recognize any gain or loss with respect to the transfer; or
e. the transferor is not subject to tax on any gain from the transfer pursuant to an income tax treaty; or
ii. The partnership certifies that if it sold all of its assets for their fair market value as of the “determination date,” either:
a. less than 10 percent of the total net gain would have been ECI, or
b. no gain would have been ECI.
In cases where a partnership is treated as a transferee by reason of a partnership distribution, it may rely on its own books and records in lieu of certain of the foregoing certifications. The determination date of a transfer generally can be any of (i) the date of the transfer, (ii) a date not more than 60 days before the date of transfer or (iii) the later of the first day of the partnership’s taxable year in which the transfer occurs or the most recent date on which an event occurred that would permit the partnership to revalue its property for capital account purposes under Section 704(b).
Determining the Amount to Withhold. Solely for purposes of determining the required withholding, the Proposed Regulations confirm that the amount realized includes the amount of cash paid (or to be paid), the fair market value of other property transferred (or to be transferred), the amount of any liabilities assumed by the transferee or to which the partnership interest is subject and the reduction in the transferor’s share of partnership liabilities. The Proposed Regulations allow a transferee to rely on certain certifications from the transferor or the partnership to determine the reduction in the transferor’s share of liabilities. In cases where the amount required to be withheld exceeds the amount realized without regard to this reduction in partnership liabilities, or where the reduction in liabilities cannot be determined, the amount required to be withheld is the full amount realized without regard to any reduction in partnership liabilities. Where a transferor is a foreign partnership with both foreign and U.S. partners, the Proposed Regulations provide that the amount realized may be reduced on the basis of an IRS Form W-8IMY provided by the transferor establishing the percentage of gain that would be allocated to U.S. rather than foreign partners.
The Proposed Regulations allow the amount of required withholding to be reduced in certain cases where the maximum tax liability arising from the transfer is less than the required withholding amount (including cases where a nonrecognition provision or income tax treaty reduces, but does not eliminate, the tax on the gain). Such reduction generally must be based on either a certification from the transferor containing certain information and representations establishing a lower maximum tax liability (which must be based, in part, on a statement provided by the partnership) or, in the case of a partnership treated as transferee by reason of a partnership distribution, similar information in the partnership’s own books and records.
Reporting and Paying Withheld Amounts. The Proposed Regulations generally require withheld amounts to be reported and paid by the 20th day following the date of transfer and require a transferee to certify to the partnership the extent to which it satisfied its obligation to withhold (referred to below as a “withholding certification”) no later than 10 days following the transfer.
Commentary. A number of the provisions described above represent important changes or additions to the guidance included in Notice 2018-29. Notably:
- In Notice 2018-29, the 10 percent thresholds applicable to certain of the exceptions to withholding were 25 percent thresholds, which meant that the exceptions were available to more transfers. In Notice 2018-29, the IRS signaled that those exceptions would be narrowed when regulations were finalized, so the reduction in those thresholds is not surprising.
- The provisions described above allowing (i) the amount realized by a foreign partnership to be reduced by amounts allocable to U.S. partners and (ii) the withholding amount to be reduced in cases where the maximum tax liability under Section 864(c)(8) is lower than the withholding otherwise required were not included in Notice 2018-29. Each of those changes reduces the risk of overwithholding in a manner similar to the withholding certificate procedures included in the FIRPTA regulations but without the need to obtain IRS consent required under those procedures. In this regard, the Proposed Regulations represent a significant improvement to Notice 2018-29, which provides no means of obtaining relief in cases where it can be established that the required withholding would exceed the amount of tax that would be payable by the transferring partner (or its owners) under Section 864(c)(8).
- Finally, the rule described above that caps the required withholding amount at the amount realized without regard to the reduction in partnership liabilities is extended by the Proposed Regulations to cover partnership distributions as well as third-party transfers. This represents a helpful change to Notice 2018-29, which expressly limited the application of this rule to third-party transfers, creating scenarios in which a partnership would potentially be required to withhold amounts in connection with redemptions significantly in excess of the amount of cash otherwise payable to the partner.
Partnership’s Requirement to Withhold on Distributions to Transferee (Prop. Reg. 1.1446(f)-3)
Section 1446(f)(4) provides that if a transferee fails to withhold any amount required to be withheld under Section 1446(f), the partnership must deduct and withhold from distributions made to the transferee a tax equal to the amount the transferee failed to withhold (plus interest).
The Proposed Regulations provide that in determining the amount required to be withheld by the partnership under Section 1446(f), the partnership may rely on the withholding certification provided by the transferee unless it knows or has reason to know that the certification is incorrect or unreliable. In cases where no withholding certification is provided by the transferee, the partnership must withhold the full amount of any distribution to the transferee until it receives such a certification. If the partnership receives a notice from the IRS that the withholding certificate provided by the transferee included incorrect information regarding the amount realized or the amount withheld, the partnership must withhold the amount specified in the notice. Withholding made by a partnership under Prop. Reg. 1.1446(f)-3 does not relieve a transferor from its obligation to pay tax under Section 864(c)(8) and is not credited against that liability. However, the preamble to the Proposed Regulations and various provisions of the Proposed Regulations state that tax will not be recollected if paid by another person.
Commentary. As noted, in a context where a partnership withholds amounts from a transferee under Prop. Reg. 1.1446(f)-3, the Proposed Regulations indicate that the amounts so withheld from the transferee will not be credited against the transferor’s tax liability under Section 864(c)(8). At the same time, however, the Proposed Regulations indicate that tax will not be recollected if paid by another person. Given the lack of any credit against the transferor’s tax liability in such a scenario, the transferor would presumably be required to pay the full amount of its tax liability without regard to any withholding made by the partnership. Accordingly, scenarios could arise in which the partnership withholds amounts from the transferee under Prop. Reg. 1.1446(f)-3, while the transferor simultaneously pays its tax liability under Section 864(c)(8). To achieve the Proposed Regulations’ expressed intent to avoid double collection in such a scenario, the transferee (or the partnership on behalf of the transferee) should be entitled to a refund of the amounts withheld from the transferee by the partnership. To obtain such a refund, however, the transferee (or the partnership) will presumably need to provide evidence that the transferor properly paid the tax. In light of the foregoing, consideration should be given to whether the partnership’s operating agreement and the tax covenant and cooperation provisions included in the relevant transfer agreement between the transferor and transferee adequately address this scenario.
Withholding on the Transfer of a PTP Interest (Prop. Reg. 1.1446(f)-4)
Notice 2018-08 temporarily suspended withholding on transfers of PTP interests. The Proposed Regulations would end that suspension but provide special rules for transfers of PTP interests. Under those rules, if a transfer of a PTP interest is effected through one or more brokers, the transferee is not required to withhold under Section 1446(f). Rather, any broker who either (i) pays amounts realized on the transfer to another broker that is a foreign person that has not assumed primary withholding responsibility with respect to the payments or (ii) is effecting the transfer on behalf of the transferor as its customer generally will be required to withhold 10 percent of the amount realized unless
i. the transferor certifies that (A) the transferor is not a foreign person or (B) a treaty exempts the transferor from tax on the entirety of any gain from the transfer;
ii. the PTP has provided a “qualified notice” stating that (A) on the relevant date, had the PTP sold all of its assets at their fair market value, either (1) less than 10 percent of the total net gain would have been ECI or (2) no gain would have been ECI, or (B) with respect to a PTP distribution, the entire amount of the distribution is a distribution of current income; or
iii. the amount realized is subject to withholding under the backup withholding regulations.
A broker is not required to withhold to the extent the withholding obligation has already been satisfied by another broker.
Determining the Amount to Withhold. For purposes of determining the required withholding on a transfer of a PTP interest, the Proposed Regulations generally define the amount realized as the amount of gross proceeds paid or credited to the transferor or other broker or, in the case of a distribution with respect to a PTP interest, the amount of cash plus and fair market value of property distributed (or to be distributed). Where a transferor is a foreign partnership with both foreign and U.S. partners, the amount realized may be reduced on the basis of an IRS Form W-8IMY provided by the transferor establishing the percentage of gain that would be allocated to U.S. rather than foreign partners. Unlike the rules applicable to non-PTPs, however, a transferor of a PTP interest cannot reduce the required withholding by certifying that the maximum tax liability is a lesser amount.
If a transfer of a PTP interest is not effected through one or more brokers, then the transferee is required to withhold in accordance with the rules that apply to transfers of non-PTP interests.
All Section references are to the Code.
For a discussion of Notice 2018-29, click here
For these purposes, a “transfer” includes a distribution from a partnership.
In a welcome but not directly related change, the Proposed Regulations would also modify the FIRPTA withholding provisions of Section 1445 (applicable to transfers by foreign persons of U.S. real property interests) by providing that a certification of nonforeign status for such purposes includes a valid IRS Form W-9.