New rules introduced as part of the 2017 tax reform reconciliation act (the Act), signed into law on December 22, 2017 by President Trump, may require partnerships and transferees of partnership interests to withhold in connection with sales or exchanges by foreign persons of interests in partnerships with ECI-generating property. As described in this article, uncertainties around reporting procedures for withholding and around the technical application of the new rules mean that partnerships should exercise caution when a foreign person intends to sell or exchange partnership interests.
Under the Act, Section 864(c)(8) treats gain from the sale of an interest in a partnership that is engaged in the conduct of a US trade or business as gain effectively connected with the conduct of that business (effectively connected income, or ECI). Section 864(c)(8) subjects foreign partners selling or exchanging (or otherwise disposing of) partnership interests to U.S. federal income tax at ordinary graduated rates, plus potential branch profits tax. The Act also included new Section 1446(f), which imposes withholding requirements on persons acquiring from foreign persons interests in partnerships that hold property that generates ECI. Section 864(c)(8) applies to dispositions of partnership interests occurring after November 27, 2017. The new withholding requirement generally applies to dispositions after December 31, 2017.
PwC has submitted comments to Treasury suggesting suspension of the Section 1446(f) withholding requirement to all partnerships. In the interim, partnerships should exercise caution when allowing partners to transfer interests in partnerships or when distributing cash. Because partnerships are subject to backstop withholding under Section 1446(f), all partnerships should consider requiring transferor partners to provide documentation proving that they are not foreign persons, and if the transferor is a foreign person, demonstrating appropriate withholding.
Principal, M&A Tax, PwC US