PwC Discusses Effect of Partnership Withholding Regs on PTPs

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:

We respectfully submit this letter on behalf of a client in response to the request for comments in REG-105476-18, issued by the Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) on May 13, 2019 (the “Proposed Regulations”). The Proposed Regulations relate 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

Summary of Recommendation

Final regulations should clarify that the 10-percent exception set forth in in Prop. Reg. §1.1446(f)-4(b)(3) should apply to a publicly traded partnership (“PTP”) that owns U.S. real property interests (within the meaning of section 897(c)) (“USRPIs”) if such PTP is not engaged in the conduct of a trade or business within the United States without regard to section 897.

Discussion of Recommendation

New sections 864(c)(8) and 1446(f) were added by section 13501 of “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” P.L. 115-97 (the “Act”), which was enacted on December 22, 2017. Section 864(c)(8)(A) provides generally, that if a nonresident alien individual or foreign corporation owns, directly or indirectly, an interest in a partnership that is engaged in any trade or business within the United States, gain on the sale or exchange of all (or any portion of) such interest is treated as effectively connected with the conduct of such trade or business to the extent such gain does not exceed the portion of the partner's distributive share of the amount of gain which would have been effectively connected with the conduct of a trade or business within the United States if the partnership had sold all of its assets at their fair market value as of the date of the sale or exchange.

In order to coordinate new rules under section 864(c)(8) and rules applicable to USRPIs under section 897, the effectively connected gain (or loss) amount determined under section 864(c)(8)(A) is reduced under section 864(c)(8)(C) by any gain (or loss) with respect to any USRPIs of the partnership. USRPI gain is intended to be governed by the rules of section 897.

Prop. Reg. § 1.864(c)(8)-1(d) clarifies that the amount treated as income effectively connected with a U.S. trade or business (“ECI”) under section 864(c)(8) is only reduced by the amount treated as ECI by reason of section 897 if section 864(c)(8) does not otherwise apply.² In such cases, section 897 is effectively the controlling provision, and section 864(c)(8)(C) serves to turn off 864(c)(8) and eliminate the double withholding that could result from the application of both section 1445 and section 1446(f). (Conversely, in cases in which section 864(c)(8) applies without regard to USRPIs owned by the partnership, the proposed regulations under section 864(c)(8) effectively make it the controlling provision.)

Section 1446(f) generally provides a withholding mechanism to collect the tax imposed on a foreign person under section 864(c)(8). Specifically, section 1446(f) provides that if any portion of the gain on the disposition of a partnership interest would be ECI under section 864(c)(8), then the transferee is required to deduct and withhold 10 percent of the amount realized by the transferor, unless the transferee obtains an affidavit that certifies that no withholding is required (i.e. non-foreign affidavit, among others). Additionally, in the event a transferee fails to obtain an affidavit that eliminates the requirement to withhold and fails to withhold, section 1446(f) requires the partnership to withhold from distributions to the transferee an amount equal to the tax (i.e., 10 percent of the amount realized by the transferor) and interest that should have been withheld.

In the case of a PTP, the Proposed Regulations generally shift the withholding required under section 1446(f)(1) from the transferee to the transferor's broker. The Proposed Regulations provide a number of exceptions to the broker's obligation to withhold. Of particular relevance to this discussion is the exception provided in Prop. Reg. § 1.1446(f)-4(b)(3) (the “10-percent exception”). Under this exception, a broker is not required to withhold on the transfer of a PTP interest if the PTP posts a qualified notice that provides that less than 10 percent of the total gain that the PTP would recognize if it sold all of its assets in a hypothetical sale on the “PTP designated date” would be effectively connected with the conduct of a trade or business in the United States. The Proposed Regulations provide that the terms of the hypothetical sale are those set forth in Prop. Reg. § 1.864(c)(8)-1(c).³

Under Prop. Reg. § 1.864(c)(8)-1(c), gain taxable under section 897 is included in the determination of ECI. As discussed above, however, Prop. Reg. § 1.864(c)(8)-1(d) provides that 897(g) governs in those cases where section 864(c)(8) is not otherwise applicable. In such cases, i.e., where the partnership would not recognize ECI in a hypothetical sale except in connection with its USPRIs, section 864(c)(8)(C) turns off section 864(c)(8) by eliminating any gain attributable to USRPIs.

For purposes of qualifying for the 10-percent exception, the Proposed Regulations do not indicate clearly that a PTP that holds USRPIs but is not otherwise engaged in a U.S. trade or business is entitled to reduce the ECI amount determined under Prop. Reg. § 1.864(c)(8)-1(c) pursuant to section 864(c)(8)(C). In the absence of a clarification of this point in final regulations, such PTPs will be unable to provide a qualified notice claiming application of the 10-percent exception, which may then force brokers to withhold under both section 1446(f) and section 1445.

We recommend that final regulations under section 1446(f) clarify that for purposes of the 10-percent exception, the gain determined “in the manner described in Prop. Reg. § 1.864(c)(8)-1(c)” should take into account adjustments under section 864(c)(8)(C) and Prop. Reg. § 1.864(c)(8)-1(d). Thus, a PTP that owns USPRIs but is not otherwise engaged in a trade or business in the United States would be entitled to reduce the amount determined under § 1.864(c)(8)-1(c) by the full amount of any gain attributable to the USRPIs and, therefore, qualify for the 10-percent exception.

We also recommend including an example similar to that set forth below to illustrate the application of the clarified language.

* * *

Conclusion

In the absence of clarification in the final regulations, PTPs that are not otherwise engaged in a U.S. trade or business would not be entitled to reduce the amount determined under Prop. Reg. § 1.864(c)(8)-1(c) by the full amount of any gain attributable to the USRPIs and qualify for the 10-percent exception.

If you have questions regarding this comment, please contact Patrick Courtney, Candace Ewell, or Michael Hauswirth.

Yours sincerely,

PricewaterhouseCoopers LLP
New York, NY