Partnerships Doing Business in U.S. Must Withhold Tax When Foreign Partner Leaves
When Congress moved the U.S. to a modified territorial tax system, it also put in place compliance measures designed to make sure that income generated within U.S. borders does not escape taxation. Section 1446(f) is one of those provisions. It requires withholding on dispositions of partnership interests by foreign persons where the partnership has U.S. business activities. The IRS has proposed regulations that require withholding of tax on non-U.S. partners that recognize gain or loss from the sale or exchange of an interest in these partnerships.
10% Withholding
Specifically, the rules require the transferee to deduct and withhold a tax equal to 10% of the amount realized on the disposition of a partnership interest if the gain would be treated as effectively connected with the conduct of a U.S. trade or business. Also, the foreign transferor must notify the partnership within 30 days of the transfer by providing a statement that includes information the partnership needs to calculate possible gain and loss.
No withholding is required, however, if the transferor furnishes an affidavit to the transferee giving the transferor’s U.S. taxpayer identification number and stating that the transferor is not a foreign person. The regulations also allow the transferor or transferee to request that a reduced amount be withheld, instead of the 10%. If a transferee fails to withhold the required amount, then the partnership must deduct and withhold from the transferee’s distributions an amount equal to the amount the transferee failed to withhold, plus interest.
The new rules have a retroactive element which requires partnerships to withhold on partnership interests previously transferred by a non-U.S. partner if the correct tax was not withheld at the time of the transfer.
Publicly Traded Partnerships
Publicly traded partnerships (PTPs) also are affected by the new regulations. Banks, brokers, and custodians now will have to withhold on transfers by foreign persons of their interests in PTPs. Previously, the withholding requirement on PTPs had been suspended. The regulations reactivate it. The regulations also make changes to the rules that apply to notice requirements and to those acting as nominees and withholding agents for PTPs.
The regulations are only proposed at this point, and the IRS is requesting comments by mid-July 2019. The regulations could be finalized after that time and could incorporate suggestions made by those who submit comments.