Group Seeks Relief Under Proposed Partnership Withholding Regs

July 12, 2019

Internal Revenue Service
CC:PA:LPD:PR (REG-105476-18)
Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: REG-105476-18 — Comments on the Proposed Regulations Concerning the Withholding of Tax under Section 1446(f) with Respect to Interests in Partnerships Engaged in the Conduct of a U.S. Trade or Business

Dear Sir or Madam:

The Master Limited Partnership Association (“MLPA”) is pleased to submit comments on the proposed regulations promulgated on May 13, 2019 (the “Proposed Regulations”) related to the withholding of tax under Section 1446(f) and information reporting with respect to certain dispositions of interests in partnerships engaged in the conduct of a trade or business within the United States.¹

The MLPA is the nation's only trade association representing MLPs.² For more than three decades, the association has represented the interests of MLPs in Washington, D.C. and the states. MLPs are an integral way our nation's private sector finances the infrastructure needed to fully utilize newly discovered domestic energy resources — leading to greater energy independence for the United States — and to ensure that a wide variety of energy products make their way efficiently and safely from the production fields to American homes, businesses and communities.

We appreciate the continued efforts of the IRS and Treasury to provide taxpayers with guidance on the implementation of Section 1446(f) and are pleased to offer recommendations to facilitate proper administration of the rules with respect to MLP interests.

Background

MLPs have been part of the American energy infrastructure industry since 1981. As of December 31, 2018, there were more than 80 energy MLPs representing a market capitalization of $300 billion.³

MLPs are publicly traded partnerships within the meaning of Section 7704 that are not subject to entity-level taxation, because 90 percent or more of their income is natural resource or passive-type income within the meaning of Section 7704(c). Common interests in MLPs, generally referred to as “units,” are traded on an established security exchange, such as the NYSE or NASDAQ.⁴

As part of the Tax Cuts and Jobs Act of 2017 (“TCJA”), Congress enacted Section 1446(f), which requires the transferee of a partnership interest to withhold tax if any portion of the transferor's gain (if any) would be treated under Section 864(c)(8) as effectively connected to the conduct of a U.S. trade or business. In such instances, the transferee is required to deduct and withhold a tax equal to 10 percent of the transferor's amount realized.⁵ If the transferee fails to withhold the appropriate amount, the partnership is required to deduct and withhold from distributions to the transferee partner the amount that should have been withheld on the payment to the transferor by the transferee.⁶

Due to the administrative complexity involved in applying Section 1446(f) to sales of MLP units, which are publicly traded securities, the IRS and Treasury temporarily suspended the requirement to withhold on sales of MLP units.⁷ The IRS has proposed lifting the suspension of the rules with respect to publicly traded partnerships 60 days after the Proposed Regulations are published as final regulations.

In the Proposed Regulations, the IRS and Treasury addressed the issues associated with the sale or exchange of MLP units effected through one or more brokers. In general, if a transfer of MLP units is effected through one or more brokers, the Proposed Regulations relieve a transferee of MLP units of its obligation to withhold; instead, the withholding obligation is imposed on the transferor's broker.⁸ The MLP is generally relieved of the backstop withholding obligation that otherwise applies to partnerships if a transferee fails to withhold.⁹ In addition, the definition of “amount realized” is modified in the case of a sale of a publicly traded partnership interest to mean the transferor's gross proceeds (i.e., without regard to the transferor's allocation of partnership liabilities). Thus, the transferor's broker generally can calculate the withholding obligation without knowing the transferor's allocation of the partnership's liabilities.

MLPA commends the IRS and Treasury for their practical approach to making the withholding rules administrable for sales or exchanges of publicly traded partnership interests. As discussed in detail below, the Proposed Regulations also provide rules addressing the application of Section 1446(f) to partnership distributions. This letter discusses one clarification that we believe is necessary to coordinate the withholding rules applicable to MLPs under Sections 1446(a) and (f).

Summary of Recommendation

Final regulations should provide an exception to withholding under Section 1446(f) for any distribution by an MLP to the extent the distribution is subject to withholding under Section 1446(a).

Discussion of Recommendation

Section 731(a) provides that to the extent a distribution of money exceeds a partner's adjusted basis in its partnership interest, the partner recognizes gain that is “considered as gain or loss from the sale or exchange of the partnership interest of the distributee partner.” Although this language could be understood simply to determine the character of the gain recognized by the distributee under section 731(a), the Proposed Regulations apply Section 1446(f) to distributions to a partner in excess of its basis as if the partnership were the transferee with respect to some portion of the distributee's partnership interest.

In the case of distributions by a non-MLP partnership, the Proposed Regulations provide that for purposes of establishing an exemption from withholding under Section 1446(f), a partnership may rely on its books and records or on a certification by the distributee partner to determine the partner's basis in its interest and whether gain is recognized by the partner as a result of the distribution.¹⁰ The Proposed Regulations do not, however, offer a similar exception for distributions by an MLP. The preamble to the Proposed Regulations notes that it would be administratively difficult for a broker to timely obtain the necessary information in order to make a determination as to whether withholding under Section 1446(f) would be applicable.

The Proposed Regulations provide an exception to withholding (i.e., the qualified current income exception) with respect to an MLP distribution only if the MLP provides a qualified notice indicating that the entire distribution does not exceed the net income earned by the MLP since the record date of the partnership's last distribution.¹¹ In our view, MLPs are very unlikely to use this exception. If an MLP published a qualified notice claiming in error that a distribution was exempt from withholding under the qualified current income exception, Prop. Reg. 1.1446(f)-3(b)(2)(ii) would transfer the burden of withholding on the distribution from the broker to the MLP. Rather than risk incurring a withholding liability, most MLPs will avoid claiming the application of the exception. Thus, in the absence of additional relief, even distributions of current income (which should not cause any unitholder to recognize gain under section 731(a)) are likely to be subject to double withholding.

If the exception does not apply, a broker would be expected to withhold under Section 1446(f) on the MLP's distributions to a foreign distributee partner whose units are held through an account with the broker.¹² The amount withheld would be equal to 10 percent of the cash distributed to the partner and 10 percent of the fair market value of any property distributed.¹³

Section 1446(f) is not the only withholding provision applicable to MLP distributions. Section 1446(a) generally requires partnerships to withhold on the effectively connected taxable income allocable to a foreign partner under Section 704 whether or not such income is distributed. In the case of an MLP, Treas. Reg. § 1.1446-4 provides that withholding is required only on the distribution of an MLP's effectively connected income to a foreign partner. MLPs generally provide a qualified notice with respect to each distribution attributable to effectively connected taxable income, and brokers, as the withholding agents, are required to withhold an amount equal to the applicable percentage of the distribution, as determined under Treas. Reg. § 1.1446-4(b)(2).¹⁴

The Proposed Regulations have provisions that coordinate the application of Section 1446(f) with other withholding regimes.¹⁵ One example, specific to Section 1446(a), is that of an upper-tier partnership that recognizes gain from the transfer of an interest in a lower-tier partnership that is engaged in the conduct of a U.S. trade or business. The gain recognized by the upper-tier partnership is included in the effectively connected taxable income of the upper-tier partnership and is subject to withholding under Section 1446(a). In this case, the Prop. Reg. § 1.1446-3(c)(4) provides that the upper-tier partnership that is subject to withholding under Section 1446(f)(1) (in its capacity as the transferor of the lower-tier partnership interest) may claim a credit for the amount withheld under Section 1446(f) against its Section 1446(a) withholding tax liability. This coordinating rule does not, however, address Section 1446(f) withholding on MLP distributions that are also subject to withholding by brokers under Treas. Reg. § 1.1446-4. As a result, brokers could be subject to two withholding requirements on an MLP distribution, i.e., under Section 1446(a) and Section 1446(f), with respect to a single MLP distribution. In order to coordinate the Section 1446(f) withholding regime set forth in the Proposed Regulations with the Section 1446(a) withholding applicable to MLP distributions, final regulations should clarify that no withholding is required under Section 1446(f) on MLP distributions to the extent such distributions are subject to withholding under Section 1446(a) and Treas. Reg. § 1.1446-4.

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If you have any questions, please do not hesitate to contact our external advisors on this letter: Robert Baldwin and Michael Hauswirth.

Sincerely,

Master Limited Partnership Association
Washington, DC