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IRS Clarifies Foreign Partner Withholding Rules

The newly issued proposed regs supercede all interim guidance.

The Internal Revenue Service recently issued guidance that could impact foreign persons with U.S. investments and persons buying partnership interests from foreign sellers. (A “foreign person” is an individual or corporation who isn’t considered a “resident” of the United States for U.S. federal income tax purposes pursuant to Internal Revenue Code Section 7701.) The Tax Cuts and Jobs Act of 2017 introduced two provisions targeting sales and other dispositions by foreign partners of interests in partnerships that are engaged in a U.S. trade or business:

  • Internal Revenue Code Section 864(c)(8) treats gains or losses from the sale or other disposition of such partnership interests by a foreign partner as “effectively connected” gains or losses to the extent a sale of the underlying assets would give rise to “effectively connected” gain or loss (meaning that the gains may be taxable to the foreign partner in the United States).
  • IRC Section 1446(f), introduced in tandem with Section 864(c)(8), imposes a federal tax withholding obligation on the transferees (and in some cases on the partnership itself).

The IRS published interim guidance last year in Notices 2018-08 and 2018-29. This guidance has now been superseded by proposed regulations (proposed regs) issued in May 2019. Once finalized, the proposed regs will apply to transfers of partnership interests that occur 60 days after publication of the regulations in the Federal Register. Here are several key issues that practitioners will want to consider in advising non-U.S. clients making partnership investments in the United States, partnerships that accept foreign investors and clients acquiring interests in partnerships from foreign persons.

Background on Withholding Rules

Sections 864(c)(8) and 1446(f) were added to the IRC to repeal key portions of the U.S. Tax Court’s 2017 decision in Grecian Magnesite Mining, Industrial & Shipping Co., S.A. v. Commissioner, 149 T.C. No. 3 (July 13, 2017).  Prior to the addition of Sections 864(c)(8) and 1446(f), foreign taxpayers often took the position that gains from the sales of interests in U.S. and foreign partnerships that didn’t own U.S. real property should be treated as capital gains (like gains from the sale of stock of most corporations); thus, they shouldn’t be subject to U.S. income tax, even if the partnership held U.S.-situs property or was engaged in a U.S. trade or business. The IRS took a contrary position in Revenue Procedure 91-32, arguing that such gains should be treated as income that is effectively connected with a U.S. trade or business (effectively connected income or ECI), which is taxable in the U.S. to foreign taxpayers, if the partnership itself was engaged in a U.S. trade or business and a sale of its underlying assets would generate ECI. Until the Grecian Magnesite decision came down, this remained an area of contention between taxpayers and the IRS.

As a result of the addition of Section 864(c)(8), if a foreign partner recognizes gains on the sale or exchange of an interest in a partnership that’s engaged in a U.S. trade or business, the portion of such gain attributable to U.S. trade or business assets is treated as ECI. Thus, any such gain is now generally subject to U.S. federal income tax at normal graduated tax rates.

To assist in the collection of this tax, Section 1446(f) requires the transferee of a partnership interest to deduct and withhold a tax equal to 10% of the amount realized by the foreign transferor if any portion of the gain is treated as ECI under Section 864(c)(8). The tax withheld is then credited against the foreign transferor’s ultimate U.S. federal income tax liability, as reconciled on a U.S. federal income tax return. Practitioners who have dealt with foreign investments in U.S. real property will note the similarity in scope and function of Section 1446(f), which was patterned after the withholding regime imposed under Section 1445 on dispositions of U.S. real property under the Foreign Investment in Real Property Tax Act (FIRPTA).

Mechanics of New Withholding Rules

The proposed regs generally require transferees to withhold 10% of the amount realized on any transfer of a partnership interest unless a withholding exception applies. For a withholding exception to apply, one of the following must occur:

  1. The transferor must certify that any of the following are true:
    1. the transferor isn’t a foreign person;
    2. the transferor won’t realize any gain on the transfer (including ordinary income pursuant to the “hot assets” rules of IRC Section 751);
    3. the transferor was, at all times during the three preceding taxable years ending with the most recent year for which a Schedule K-1 was issued, a partner in the partnership, the ECI of the partnership allocated to the partner (and to certain “related persons”) during each such year was less than $1 million and less than 10% of the partner’s total distributive share of net income from the partnership, and the transferor’s share of such ECI was properly reported to the IRS (and tax paid thereon) during each such year;
    4. a nonrecognition provision of the IRC applies such that the transferor isn’t required to recognize any gain or loss on the transfer; or
    5. the transferor isn’t subject to tax on any gain realized from the transfer pursuant to an income tax treaty.
  1. Alternatively, the partnership certifies that, if it sold all of its assets for their fair market value, either:
    1. less than 10% of the net gain would be ECI; or
    2. No gain would be ECI.

For purposes of determining the amount of withholding required by the transferee, the transferor’s amount realized includes, in addition to cash and any other property received in the sale or exchange, the amount of any liabilities assumed by the transferee or to which the partnership interest is subject, as well as any reduction in the transferor’s share of partnership liabilities. In instances in which the amount required to be withheld exceeds the amount realized without regard to a reduction in partnership liabilities, or when a reduction in liabilities can’t be determined, the amount to be withheld is the full amount realized without regard to any reduction in partnership liabilities. When the transferor is a foreign partnership with both foreign and U.S. partners, the proposed regs provide that the amount realized may be reduced on the basis of a Form W-8IMY provided by the transferor establishing the percentage of gain that would be allocated to U.S. rather than foreign partners.

Similar to an existing exception to the withholding rules under FIRPTA, the proposed regs also provide for the amount of withholding to be reduced in cases in which the maximum tax liability from the transfer is less than the amount required to be withheld under Section 1446(f).

The proposed regs require that amounts withheld by the transferee be reported and paid to the IRS by the 20th day after the date of the transfer. In addition, transferees are required to certify to the partnership that they’ve satisfied their withholding obligation no later than 10 days after the date of transfer. If the transferee doesn’t remit the appropriate amounts to the IRS, then the partnership itself may have secondary withholding obligations.

Notice 2018-08 temporarily suspended withholding on transfers of publicly traded partnership interests. The proposed regs end that suspension and provide special rules for transfers of interests in publicly traded partnerships.

The proposed regs require a foreign partner who disposes of an interest in a partnership that’s engaged in a U.S. trade or business to notify the partnership within 30 days of the disposition. Thereafter, the partnership is required to provide the disposing partner with certain information that will assist the partner in determining his Section 864(c)(8) gain or loss realized from the disposition.


Practitioners need to be aware that if a partnership is engaged in a U.S. trade or business and an interest in the partnership is sold or exchanged by a foreign partner, Section 1446(f) may require the transferee to withhold a portion of the transferor’s amount realized. This has implications for foreign investors, the partnerships themselves and for persons acquiring interests in partnerships engaged in a U.S. trade or business.

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