Tuesday 11 September 2018

Guidance on Withholding on US Partnership Interest's Sale*

The Treasury department and the IRS issued Notice 2018-29 on April 2, 2018 (following closely the publication of "US Partnership Interest Sale Triggers 10 Percent Withholding," Canadian Tax Highlights, February 2018). The notice makes three exceptions to the withholding requirement. 

The recent Tax Cuts and Jobs Act (US tax reform) added Code sections 864(c)(8) and 1446(f). The former deems the gain or loss from the exchange or disposition of a private US partnership interest to be effectively connected with a US trade or business if the sale of all partnership assets at FMV would be deemed effectively connected income (ECI); the latter imposes a 10 percent withholding on the amount realized on the gain of a private partnership interest if such gain is deemed ECI under section 864(c)(8). Withholding is not required if the transferor is not a non-US person under section 1446(f)(2). If a transferee fails to withhold as section 1446(f) requires, the partnership must deduct and withhold that amount as tax (plus interest) from distributions to the transferee. 

Before the publication of notice 2018-29, it was not entirely clear whether sections 864(c)(8) and 1446(f) were intended to override existing US tax treaties if ECI income was not taxable in the United States because it was not derived from a US PE. Section 6.05 appears to indicate that those provisions were not intended to override treaties: section 6.05 refers to regulation section 1.1445-2(d)(2) and says that a transferor and a transferee may rely thereon to exempt them from withholding. That regulation provides that a transferee is not required to withhold if there is no gain or loss pursuant to a US treaty. In reading regulation 1.1445-2(d)(2), section 6.05 instructs the reader to substitute section 1445(a) for section 1446(f) and also to substitute "partnership interest" for "US real property interest." Section 6.05 further provides that the treaty statement received from the transferor is not to be mailed into the IRS offices. 

The notice includes two other exceptions to withholding, which are relevant in the event the transferee chooses to not rely on a treaty exception. These two exceptions are set out clearly, unlike the language that sets out the treaty exception. The first of these exceptions clarifies that section 1446(f) applies only if there is a gain on disposition: section 6 says that under planned regulations a transferee may generally rely on a certification received by it and issued by the transferor—signed under penalties of perjury and including a US ITIN—that says that the transfer of its partnership interest does not result in realized gain. However, the transferee is not relieved from withholding if it has knowledge that the certification is false. 

Section 6.03 provides further withholding relief if in three prior taxable years the transferor had less than 25 percent ECI attributable to the partnership interest being transferred. Treasury and the IRS confirm their intention to issue regulations providing that section 1446(f)(1) does not require withholding on a partnership interest's transfer if the transferee receives a certification issued by the transferor—signed under penalties of perjury and including a US ITIN—no earlier than 30 days before the transfer, to the effect that the transferor was a partner in the partnership throughout each of its immediately prior taxable year and its two preceding taxable years, and that its allocable share of effectively connected taxable income for each such taxable year was less than 25 percent of the transferor's total distributive share of partnership income for that year. According to the notice, the transferor's immediately prior taxable year is its most recent taxable year that includes or ends with the partnership's taxable year-end and for which forms 8805 ("Foreign Partner's Information Statement of Section 1446 Withholding Tax") and 1065 ("U.S. Return of Partnership Income," schedule K-1) were due (including extensions) or filed by the time of the transfer. The notice cautions that a transferee may not rely on a certification that was provided before the transferor receives those forms, nor can it rely on a certification—and is not relieved from withholding—if it has actual knowledge that the certification is false. 

Withholding is also not required (notice section 6.04) if the transferee receives—no earlier than 30 days before the transfer—from the partnership a certification to the effect that if the partnership had sold all its assets at FMV, the gain effectively connected with the conduct of a trade or business within the United States would be less than 25 percent of the total gain on the deemed sale of all its assets. For a Canadian transferee, this option is more viable than that of section 6.03, because a US partnership with a December year-end usually seeks extensions to file returns until September: it is difficult for the Canadian transferee to access before mid-June forms 8805 and 1065 for the partnership's most recent taxable year. 

Sunita Doobay
TaxChambers LLP, Toronto

*First published in the May edition of the Canadian Tax Highlights, a Canadian Tax Foundation newsletter.