Withholding Rules on a Disposition of a Partnership Interest by a Foreign Person

Section 1446(f), enacted as part of the 2017 Tax Cuts and Jobs Act, requires withholding of tax on a disposition of a partnership interest that earns income that is effectively connected (effectively connected income, or “ECI”) from a trade or business conducted in the United States. Final regulations were issued on November 30, 2020, and apply to transfers that occur on or after January 29, 2021.¹

Under Section 1446(f), if any portion of the gain on the disposition of the partnership interest would be treated under section 864(c)(8) as ECI, the acquirer (the “transferee”) is required to deduct and withhold a tax equal to 10% of the amount realized on the disposition. If the transferee fails to withhold, then the partnership is required to deduct and withhold the tax from distributions to the transferee.

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Exceptions

The transferee is required to presume a transfer is subject to withholding. There are six exceptions to the requirement to withhold:

1. The transferor provides a statement certifying non-foreign status;
2. The transferor provides a statement certifying that it has no realized gain from the disposition;
3. The transferor provides a statement from the partnership certifying that less than 10 percent of the gain is ECI or that the partnership is not engaged in a U.S. trade or business;
4. The transferor provides a statement certifying that its ECI gain is less than 10 percent of the transferor’s total distributive share from the partnership for the year;
5. The transferor provides a statement certifying that a non-recognition provision applied to the transaction; or
6. The transferor provides a statement certifying that any gain is not subject to taxation under an income tax treaty between the United States and a foreign country.

Calculating The Withholding Tax

To calculate the amount of withholding tax due, the transferee must determine the amount realized on the disposition. Generally, the amount realized is either the amount of cash paid (or to be paid), the fair market value of any property transferred, the amount of any liabilities assumed from the transferor, or the amount of reduction in the transferor’s share of transferred partnership liabilities. Once this amount has been determined, 10 percent is required to be withheld.

Under the final regulations, the amount withheld can be reduced if the transferor provides a statement certifying its maximum tax liability. The maximum tax liability is the amount of the ECI gain multiplied by the applicable percentages, which is the highest tax rate under Section 1 or Section 11 that would apply to the transferor.

The following information must be included in the transferor’s certification:

• A statement that transferor is foreign person (i.e., nonresident alien, foreign corporation etc.);
• The transferor’s adjusted basis in the transferred partnership interest;
• The amount realized by the transferor;
• A statement of whether or not the transferor is still a partner in the partnership after the transfer;
• The amount of outside ordinary gain and capital gain treated as ECI;
• Computation of the transferor’s maximum tax liability;
• A statement that the transferor determined its ECI gain based on a statement provided by the partnership; and
• Representation that the transferor has provided a copy of the partnership statement to the transferee.

The partnership statement must include the partnership’s name, address, TIN, and the transferor’s deemed share of any effectively connected ordinary or capital gains.

The transferee is required to report and pay any withheld tax by the 20^th day after the date of the transfer using 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. The transferee is also required to certify to the partnership that the withholding obligation has been satisfied no later than 10 days after the transfer. The transferee should provide a copy of the Form 8288-A and other certifications provided by the transferor which the transferee relied upon.

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How Can We Help?

For assistance or questions regarding withholding on a disposition of a partnership interest by a foreign person, please contact a member of Cherry Bekaert’s International Tax practice.

Reference

¹ Treas. Reg. § 1.1446(f)-(1) through (5).