How the Tax Reform Created a 10% Tax For Foreign Partners Who Sell Their U.S. Partnership Holdings
December 22, 2017 marks the day of a lot of tax reform in the United States. It signed into law the Tax Cuts and Jobs Act (TCJA) and created a 10% tax that is to be collected and withheld by the person in the United States who is purchasing a foreign persons exchange, sale or other disposition of partnership interest to the extent that the foreign person would have ECI (effectively connected income) if the partnership had sold all of it’s assets. According to thetaxadviser.com, this new tax requirement was a direct result of a tax court decision from 2017 that made a ruling that said that the gain on a sale of a partnership interest was not considered ECI.
There is more to know though about these changes because these changes to ECI and the withholding tax requirements that were established by the TCJA is creating serious questions and uncertainty about how to comply with the withholding requirement and how to calculate the tax. The Department of the Treasury and the IRS have already released some noticed since the enactment to try to address issues relating to withholdings on dispositions of non-PTP and PTP (publically traded partnerships) interests but still even with some notices, it’s clear there are still a lot of questions.
Before the new TCJA was put into effect there was Rev. Rul. 91-32 that guided taxpayers when it came to how to calculate ECI upon the sale or exchange of a partnership interest and that rule historically treated the partnership as an aggregation of it’s assets. The position stated that upon the sale of a partnership interest, a foreign partner if they are deemed to pwn a proportionate share should be subjected to tax of the share of the gain relating to any asset that generate ECI, as if the assets had been sold directly. The gain of the sale of a U.S. partnership that conducts business in the United States for the foreign person would be treated as ECI to the extent that the foreign persons share is made up of ECI property for any unrealized gain. This has always caused some issues and questions that hopefully the TCJA will help clear up. Prior to TCJA it was uncertain whether or not the gain on a sale of a partnership interest by a foreign person is ECI based on the partnership’s engagement of a U.S. business or trade. There is another opposing viewpoint of Sec. 741 that says a partnership is treated as an entity on it’s own instead of each partner being treated as a co-owner of the assets of the partnership.
Some other things worth noting:
- July 13, 2017 saw the court ruling of Grecian Magnesite Mining where the tax court rejected Rev. Rul. 91-32 and went against the IRS’s long-standing position of treating a sale of a partnership interest as ECI.
- The tax court agreed with the Grecian that the gain from a sale of a partnership interest is a sale of an indivisible capital asset and is not ECI.
- Both the IRS and Grecian could agree that the gain on the portion of the sale of its partnership interest that related to the U.S. partnerships investments in United States real property was indeed ECI.
- The IRS has since appealed the Grecian ruling.
- The TCJA reversed the application of the Grecian ruling for future transfers of partnership interests.
- If the gain would have been treated as ECI if the partnership has sold all of its assets at fair market value then the gain or loss to a foreign corporation or individual from the exchange, sale or other disposition of a partnership interest is ECI.
- This goes into effect for all transactions on or after November 27, 2017.
- The purchaser has to withhold a 10% tax if they are purchasing from a foreigner unless they can certify that the transferor is not a foreign person.
- The partnership must deduct and withhold from distributions to transferee partner an amount that would satisfy the withholding amount plus interest if the transferee fails to withhold the money upon the transfer.
- This applies to private partnerships and PTP’s.
- The new provisions fails to lay out how to know whether or not a seller is foreign for a PTP since most of those sales are done through an exchange and that information is generally not known.
- New guidance also fails to lay out how a PTP should comply with their obligation to withhold tax when the buyer of the PTP units does not withhold the necessary amount like they are supposed to.
- IRS and Treasury granted a temporary suspension of the 10% withholding obligation on December 29, 2017 until they can issue further guidance on these confusing regulations.
- TCJA doesn’t require brokers to try and facilitate this withholding on their clients behalf, so everyone is unsure on how to proceed with this withholding issue.
- Any sales prior to TCJA still are upheld with the rulings from the Grecian decision.
- If you can obtain a certification of non-foreign status then you are exempt from the withholding requirement as the transferee.
- Transferee can usually rely on a W-9 form previously received with all required information to try and prove non-foreign status.
- A transferee can be exempt from the withholding requirement if they can get a certification of no realized gain certificate.
- You can be exempt from the withholding requirement if you can get a certification of less than 25% ECI in three prior tax years or less than 25% effectively connected gain certificate.
- No withholding is required if they transferee receives a notice from the transferor that the transfer is a non-recognition transaction.
It is extremely clear that the two notices that have already been given and the temporary relief of the new 10% withholding rules for PTP’s have helped some and given some clarification, but not nearly enough. There is much more clarification and guidance that is needed on these issues and we are going to have to wait for the power that be to help us navigate these new regulations correctly. Everyone is confused, and for good reason. We need new guidance pronto.
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