Close
Close

IRS releases guidance on withholding on transfers of non-publicly traded partnership interests

RFP
The IRS provided guidance on April 2 (Notice 2018-29) on the withholding requirements associated with certain transfers of non-publicly traded partnership interests enacted by the Tax Cuts and Jobs Act. The notice includes rules and procedures relating to qualifications for exemptions from withholding or reductions in the amount of withholding under Section 1446(f). The notice also includes interim guidance designed to allow for the effective and orderly implementation of the statute.

The new guidance follows Notice 2018-08 (Grant Thornton coverage), which temporarily suspended certain withholding obligations enacted under new Section 1446(f). The suspension under Notice 2018-08 applies only to dispositions of interests in publicly traded partnerships and does not extend to non-publicly traded partnership interests. Notice 2018-08 continues to apply to publicly traded partnerships, as the rules in Notice 2018-29 do not apply to the transfer of a publicly traded partnership.

Background In general, new Section 864(c)(8) treats a foreign taxpayer's gain or loss on the sale or exchange of a partnership interest as effectively connected with the conduct of a trade or business in the United States to the extent that gain or loss would be treated as effectively connected with the conduct of a trade or business in the United States if the partnership sold all of its assets. New Section 1446(f)(1) provides that if any portion of the gain on any disposition of an interest in a partnership is treated under Section 864(c)(8) as effectively connected with the conduct of a trade or business within the United States, then the transferee must deduct and withhold a tax equal to 10% of the amount realized on the disposition.

Application of Section 1445 principles The IRS said that until further guidance has been issued under Section 1446(f), transferees of non-publicly traded partnerships subject to withholding generally must use the rules in Section 1445 and the regulations thereunder for purposes of reporting and paying over the tax (except as otherwise provided in the notice). Section 1445 is otherwise applicable to dispositions of U.S. real property interests (as defined in Section 897(c)).

Consistent with the general requirement to apply the Section 1445 rules, Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests, and Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests should be used to report and pay the withholding tax under Section 1446(f)(1). The forms should include the statement “Section 1446(f)(1) withholding” at the top, and should be completed and filed in accordance with other procedures as provided in the notice.

Additionally, many of the other Section 1445 rules will apply to the Section 1446(f) withholding. For example, the requirement to report and pay withholding within 20 days of a transfer applies to the dispositions of non-publicly traded partnerships, and the transferee is liable for the tax as well as for the penalties and interest.

The notice indicates that a grace period will be included in the regulations when issued. The grace period will provide an exception to interest and penalties for forms and payments due before May 31, 2018, if the appropriate forms are filed and amounts are paid on or before that date.

The regulations will also include a coordination rule. Under this coordination rule, a transferee that is otherwise subject to both Section 1445 and 1446 withholding is only subject to the payment and reporting requirements under Section 1445. The coordination rule is subject to an exception when the transferee must withhold a greater amount under Section 1446. In such a case, the transferee may comply with the requirements under either Section 1445 or 1446, but must withhold the greater amount required under either section.

Exceptions to Section 1446(f) withholding Generally, unless the transferee receives a required affidavit or otherwise satisfies one of the exceptions, the transferee must presume that the transferor is foreign, and thus subject to withholding under Section 1446(f)(1). As a result, even when the sale of a partnership interest is between two U.S. parties, it would nevertheless be subject to withholding but for an exception.

The notice lays out a number of exceptions that would eliminate the need to deduct and withhold taxes under Section 1446(f)(1) with respect to certain dispositions of interests in partnerships. These exceptions may apply when:

  • The transferee receives a certification of non-foreign status
  • The transferee receives a certification of no realized gain
  • The transferee receives a certification that the transferor had less than 25% effectively connected taxable income in three prior taxable years
  • The transferee receives a certification from the partnership that less than 25% of the gain under Section 864(c)(8) was effectively connected gain
  • The exchange qualifies as a non-recognition transaction (e.g., Sections 332, 351, 355, 356, 361)

The notice lays out a number of procedural requirements related to the above exceptions that must be followed in order to avoid withholding. Additionally, if the transferee has actual knowledge that a certification listed above is false, it may not be relied upon.

Partnership liabilities included in amount realized Section 1446(f)(1) applies to the amount realized on the disposition of a partnership interest, which includes a reduction in the transferor’s share of partnership liabilities. The notice provides two alternatives that a transferee may rely upon for determining the amount of partnership liabilities that are included in the amount realized.

The first alternative is to obtain a certification from the transferor partner. Under this rule, a transferor that is not a controlling partner may provide a certification to the transferee providing the transferor’s share of partnership liabilities reported on the most recent Schedule K-1 for a partnership taxable year that closed no more than 10 months before the date of the transfer. The certification must also provide that the transferor does not have actual knowledge of events occurring after the issuance of the Schedule K-1 that would cause the share of partnership liabilities at the time of the transfer to be significantly different than the amount shown on the Schedule K-1.

The second alternative is to obtain a certification from the partnership providing the amount of the transferor’s share of partnership liabilities. Under this rule, the partnership may issue a certification no earlier than 30 days before the transfer. It must provide the amount of the transferor’s share of the partnership liabilities (which may be the amount reported on the most recently prepared Schedule K-1) and that the partnership does not have an actual knowledge of events occurring after its determination that would cause it to be significantly different than the amount shown on the certification provided to the transferee.

For purposes of these two alternatives, a difference in the amount of the transferor’s share of partnership liabilities of 25% or less is not a significant difference. Also, a transferor partner is a controlling partner if the transferor (and related persons) owned a 50% or greater interest in capital, profits, deductions or losses in the 12 months preceding the transfer.

Withholding limitation for partnership liabilities The notice provides a withholding limitation relating to the transferor’s share of partnership liabilities in cases where the amount required to be withheld under Section 1446(f) exceeds the amount of cash or property transferred, or in cases where the transferor is unable to provide any information to the transferee about its share of partnership liabilities. In such cases, the notice generally limits the amount of withholding to the total amount of cash and property that is transferred. A transferee may rely on this rule only if the transferee (1) is not the partnership in which the transferor is a partner, and (2) is not a related person to the transferor. A transferee that applies this limitation must report certain information on Form 8288.

Withholding required for certain partnership distributions Another area addressed by the notice involves distributions by a partnership to a partner. Under Section 731(a), a partner recognizes gain to the extent that money (including marketable securities) distributed by the partnership exceeds the basis in the partnership interest (outside basis) immediately before the distribution. Any gain recognized under Section 731(a) is considered gain from the sale or exchange of the partnership interest of the distributee partner and thus requires withholding under Section 1446(f). However, because a partnership may not know the distributee partner’s outside basis, it may not know whether a distribution will cause the distributee partner to recognize gain. In response, the notice provides that if a partnership makes a distribution, the partnership may rely on its books and records or a certification received from the distributee partner to determine whether the distribution exceeds the partner’s outside basis, provided that the partnership does not know or have reason to know these are incorrect and the partnership retains a record of the documentation relied upon.

Withholding by partnerships Section 1446(f)(4) provides that, if a transferee fails to withhold any amount required to be withheld under Section 1441(f)(1), the partnership is required to deduct and withhold from distributions to the transferee the amount the transferee failed to withhold (plus interest). The IRS intends to issue regulations addressing the partnership’s withholding requirements under Section 1446(f)(4). However, the notice provides that such regulations and the requirement that partnerships must withhold under Section 1446(f)(4) will not apply until regulations or other guidance has been issued.

Application to tiered partnerships The IRS intends to issue regulations clarifying that if a transferor transfers an interest in an upper-tier partnership) that directly or indirectly owns an interest in alower-tier partnership), and the lower-tier partnership would have effectively connected gain upon the deemed sale or exchange of the lower-tier partnership interest, a portion of the gain recognized by the transferor of the upper-tier partnership is characterized as effectively connected gain. The regulations will require lower-tier partnerships to furnish certain information to its partners.

Next steps The notice provides much needed guidance and procedures related to withholding under Section 1446(f)(4). Previously, withholding agents were in the dark on when and how to withhold and remit to the IRS. In addition, the notice provides that the purchasing partner is liable for any amounts under-withheld (including penalties and interest), despite the selling partner being subject to tax on the transaction. As a result, taxpayers planning to purchase an interest in a partnership should carefully review the notice and its impact on any planned partnership transactions. Additionally, taxpayers who have previously purchased interests in certain partnerships on or after Nov. 27, 2017, should also review the notice to ensure that proper procedures are followed within the grace period ending May 31, 2018.

For more information contact: David Sites
Partner, International Tax
Washington National Tax Office, Grant Thornton LLP
T +1 202 861 4104

David Zaiken
Managing Director, International Tax
Washington National Tax Office, Grant Thornton LLP
T +1 202 521 1543

Cory Perry
Senior Manager, International Tax
Washington National Tax Office, Grant Thornton LLP
T +1 202 521 1509

Grace Kim
Principal, Partnership Tax
Washington National Tax Office, Grant Thornton LLP
T +1 202 521 1509

Jose Carrasco
Senior Manager, Partnership Tax
Washington National Tax Office, Grant Thornton LLP
T +1 202 521 1552

Tax professional standards statement
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein.
Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.