IRS proposes regulations on partnership sales by foreign persons

Tax Hot Topics newsletterThe IRS has released proposed regulations (REG-104352-18) on the changes under Section 864(c)(8) for the treatment of certain foreign persons that recognize gain or loss from the sale or exchange of an interest in a partnership that is engaged in a U.S. trade or business, and partnerships that directly or indirectly have foreign persons as partners.

A foreign partner in a partnership that is engaged in the conduct of a trade or business within the U.S. is itself considered to be so engaged, but the rules surrounding sales of partnership interests have shifted several times under IRS guidance, case law, and now tax reform.

In 1991, the IRS ruled (Rev. Rul. 91-32) that gain or loss realized by a foreign partner upon the disposition of its interest in a partnership that is engaged in a trade or business through a fixed place of business in the U.S. is U.S.-source, effectively connected gain or loss. However, it would be U.S. source effectively connected gain or loss only to the extent that the partner's distributive share of unrealized gain or loss of the partnership would be attributable to property of the partnership that produces effectively connected income.

In 2017, the Tax Court in Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner decisively rejected Rev. Rul. 91-32, holding that certain gain recognized by a nonresident partner on the redemption of its interest in a U.S. partnership was not taxable because it was not U.S.-source income, and was also not effectively connected with a U.S. trade or business.

The Tax Cuts and Jobs Act (TCJA) generally overturned the result of Grecian Magnesite with the enactment Section 864(c)(8), which more closely follows the IRS’s original ruling. Section 864(c)(8) now provides that gain or loss of a nonresident alien individual or foreign corporation from the sale, exchange, or other disposition of a partnership interest is treated as effectively connected with the conduct of a U.S. trade or business to the extent that the transferor would have had effectively connected gain or loss if the partnership had sold all of its assets at fair market value as of the date of the sale or exchange.

The proposed regulations provide guidance in a number of key areas:

  • Computation of effectively connected gain or loss on the transfer of a partnership interest
  • Rules that coordinate Section 864(c)(8) with the FIRPTA rules of Section 897(g)
  • Application to tiered partnerships, including when a foreign partner transfers an interest in an upper-tier partnership owning one or more lower-tier partnerships conducting activities of a U.S. trade or business
  • Applicability of treaty relief
  • Anti-abuse provision referred to as an “anti-stuffing” rule, designed to prevent inappropriate reductions in amounts characterized as effectively connected income

In general, the guidance is largely consistent with Rev. Rul. 91-32 and is effective for any sale, exchange, or disposition occurring on or after Nov. 27, 2017.

The IRS has also released two related notices (Notice 2018-29 and Notice 2018-08) that address withholding requirements associated with certain transfers of non-publicly traded partnerships (see our Tax Flash for more details), and also temporarily suspended certain withholding obligations related to dispositions of publicly traded partnerships (see our previous overage for more information). The IRS is expected to issue proposed regulations under Section 1446(f) covering the aforementioned withholding requirements in a separate package.

Grant Thornton Insight: Transferees that acquire a partnership interest on or after Nov. 27, 2017, that is not expected to fall under Section 864(c)(8) (such as if the transferor is not foreign) should obtain the required certification from the transferor as described in Notice 2018-29. If the required affidavit is not received, the IRS could presume that the transferor is foreign and that the transferee is subject to withholding requirements under Section 1446(f).
David Sites
Partner, Washington National Tax Office
T +1 202 861 4104

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