Withholding on Partnership Interest Sale or Exchange By a Foreign Person

Newly enacted Internal Revenue Code sections 864(c)(8) and 1446(f) impose a 10% withholding tax on amount realized by foreigners from a sale or exchange of interest in a partnership with an effectively connected income of U.S. trade or business effective for a transaction entered into after November 27, 2017.

Section 1446(f) provides that a purchaser of a partnership interest is generally required to withhold 10% of the amount realized on the disposition if any portion of the foreign seller’s gain is effectively connected income of U.S. trade or business, as defined under section 864(c)(8).  Withholding is exempted if:

• The purchaser receives a non-foreign affidavit from the seller;
• The purchaser receives an affidavit that no gain is attributable to a U.S. trade or business;
• The IRS provides for reduced withholding through issuance of a withholding certificate; or
• The partnership is publicly traded.

If the purchaser does not withhold when required, the partnership is required to withhold from distributions to the purchaser an amount equal to the under-withholding plus interest, thereby putting an ultimate responsibility to the partnership.

How the changes to sections 864 and 1446 will affect foreign sellers of residents of countries with income tax treaty with U.S. is unclear.  Generally, U.S. tax treaties exclude gain on sale of partnership interest by a foreign person from U.S. taxation if that person has does not have a permanent establishment in the U.S.  However, in general, newly enacted domestic tax laws override older tax treaty provisions.  Hence, it is unclear whether a non-U.S. person can successfully claim exemption from the new withholding requirement under section 1446(f).

Below is a link to an article covering interplay of newly enacted section 1446(f) with income tax treaties.
- http://www.klgates.com/disposition-of-a-partnership-interest-now-subject-to-tax-withholding-01-18-2018/

Below are the links to the inquiries made by American Bar Association and NY State Bar Association for clarification on interplay between the 1446(f) withholding requirement and existing income tax treaties.
- https://www.americanbar.org/content/dam/aba/administrative/taxation/policy/031918comments.authcheckdam.pdf
- https://www.nysba.org/Sections/Tax/Tax_Section_Reports/Tax_Section_Reports_2018/1387_Letter.html