US IRS suspends application of new Section 1446(f) withholding requirement on dispositions of publicly traded partnership interests

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1 12 January 2018 Global Tax Alert US IRS suspends application of new Section 1446(f) withholding requirement on dispositions of publicly traded partnership interests EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: In Notice (the Notice), the United States (US) Internal Revenue Service (IRS) has suspended application of new Section 1446(f) to dispositions of certain publicly traded partnership (PTP) interests until further guidance is issued. Background P.L (the Act) commonly known by its pre-enactment title, the Tax Cuts and Jobs Act was enacted on 22 December Among other changes to the Internal Revenue Code, the Act created new Section 864(c)(8), which treats the portion of gain (or loss) from the sale or exchange of an interest in a partnership that is engaged in a US trade or business as effectively connected income (ECI) to the extent the gain (or loss) from the sale or exchange of the underlying assets held by the partnership would be treated as ECI allocable to such partner. This provision effectively overrules Grecian Magnesite Mining, Industrial & Shipping Co. v. Commissioner, 149 T.C. No. 3 (2017), and reinstates the IRS s position under Revenue Ruling 91-32, C.B New Section 864(c)(8) applies to sales, exchanges and dispositions on or after 27 November Foreign sellers of partnership interests must file US income tax returns to pay the new tax.

2 2 Global Tax Alert The Act also added new Section 1446(f), which requires the purchaser of a partnership interest to withhold 10% of the amount realized on the sale or exchange of the partnership interest, unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation. The buyer of the partnership interest must withhold 10% of the amount realized on the disposition (i.e., the sale price, not the amount of gain) unless the selling partner provides an affidavit that it is not a foreign person or the IRS agrees in advance to a reduced amount that will not jeopardize the collection of tax, presumably upon a showing that the tax on the gain would be less than 10% of the sale price. In the event that the buyer/new partner fails to withhold the full amount, the partnership must withhold on distributions to the new partner in an amount equal to the underwithholding, plus interest. New Section 1446(f) applies to sales or exchanges of partnership interests for sales, exchanges and dispositions after 31 December Withholding suspended until future guidance issued In the Notice, the IRS stated that it has received comments from stakeholders expressing concerns that applying new Section 1446(f) without guidance would present significant practical problems. For instance, stakeholders may not be able to determine whether the transferor partner is foreign or domestic, or whether any portion of a transferor partner s gain would be treated as ECI under new Section 864(c)(8). In response to the concerns expressed, the IRS issued the Notice, which suspends withholding on sales of PTP interests until regulations or other guidance under Section 1446(f) is issued. The suspension applies to dispositions of interests in PTPs only; it does not extend to publicly traded interests. Further, the substantive tax imposed by Section 864(c)(8) still applies to foreign persons disposing of interests in partnerships. Several of the challenges highlighted in the Notice include: The need for brokers to develop (or enhance) withholding systems for when a PTP interest is sold by a foreign partner through that broker, and withholding is performed on behalf of the transferee Inability to determine whether the partner is foreign or US, and what portion of the gain would be treated as effectively connected under Section 864(c)(8) because PTP interests are typically held in street name and transferred through a clearing house Difficulty in determining whether withholding is required because a sale may be aggregated with other sales and purchases of partnership interests by multiple customers at the same broker In future regulations or other guidance, the IRS plans to address how to withhold, deposit and report the tax withheld under Section 1446(f) with respect to a disposition of an interest in a publicly traded partnership. The IRS stated that such future guidance will be prospective and will include transition rules to allow sufficient time to prepare systems and processes for compliance. Request for comments The IRS specifically requests comments on various issues to be addressed in the future guidance under Section 1446(f), including: (1) the application to interests in publicly traded partnerships, including the role of brokers in collecting the tax; (2) rules for determining the amount realized, taking into account Section 752(d); and (3) procedures for requesting a reduced amount required to be withheld. The IRS also requests comments on whether a temporary suspension of Section 1446(f) for partnership interests that are not PTP interests is needed, and what additional guidance may be needed to assist taxpayers in applying new Sections 864(c)(8) and 1446(f). Implications The withholding tax under new Section 1446(f) is separate and distinct from the substantive tax. Foreign partners must still file a US tax return, even if subjected to the withholding tax by a broker. Partnerships will need to be aware of the interplay between the withholding tax and the substantive tax, including the mechanics of the partnership providing withholding tax details to the foreign partner, which will then be used for purposes of completing their tax return (and the determination of whether any additional tax is owed). The 10% withholding tax applies to non-ptp interests effective 1 January This requires identifying non-ptp interests, and ensuring the appropriate withholding tax is applied. Partners in non-publicly traded master limited partnerships and other partnerships will therefore not benefit from the delay. However, the Notice specifically requests comments on whether withholding on the disposition of non-ptp interests also should be temporarily suspended (it would appear that withholding on such dispositions is expected

3 Global Tax Alert 3 under the statutory requirement, but procedurally this may not be possible without the issuance of further guidance), and what additional guidance or forms are needed to help taxpayers properly apply new Sections 864(c)(8) and 1446(f). Taxpayers and stakeholders should give serious consideration to providing comments to the Government on these matters since withholding on dispositions of non-ptp interests has its own challenges (e.g., how to deposit amounts withheld) that might be similar (or different but equally problematic) to the concerns identified in the Notice for dispositions of PTP interests. The temporary suspension also does not apply to Section 864(c)(8). Therefore, the substantive tax continues to apply to sales of partnership interests on or after 27 November Foreign partners must file US tax returns to pay the appropriate amount of tax. The effect of the substantive tax is to treat the gain as effectively connected income. Accordingly, the substantive tax rate is determined by Section 1 (non-corporate partners) or Section 11 (corporate partners) and may be greater than or less than 10% of the amount realized. Foreign investors with longstanding positions in PTPs may be surprised to learn that they owe US tax on the sale of their PTP interests, even if no tax is withheld, and that this may cause them to have an economic loss, depending on the creditability of the US tax in their home countries.

4 4 Global Tax Alert For additional information with respect to this Alert, please contact the following: Ernst & Young LLP, International Tax Services, Washington, DC Lilo Hester Julia Tonkovich International Tax Services Global ITS, Alex Postma, Amsterdam ITS Director, Americas, Jeffrey Michalak, Detroit ITS Markets Leader, Americas, Stephen O Neil, New York Ernst & Young LLP, National Director of ITS Technical Services, Jose Murillo, Washington ITS Regional Contacts, Ernst & Young LLP (US) Central Colleen Warner, Chicago Northeast Johnny Lindroos, McLean, VA Southeast Scott Shell, Charlotte, NC Southwest Amy Ritchie, Houston West Sadler Nelson, San Jose, CA Financial Services Chris J Housman, New York Canada Ernst & Young LLP (Canada) Albert Anelli, Montreal

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