On April 2, 2018, the U.S. Treasury Department and the Internal Revenue Service (IRS) issued Notice 2018-29, "Guidance Regarding the Implementation of New Section 1446(f) for Partnership Interests That Are Not Publicly Traded" (the Notice), addressing Sections 1446(f) and 864(c)(8) of the Internal Revenue Code of 1986 (the Code).1This is the second notice addressing these provisions, which were added as part of legislation commonly referred to as the Tax Cuts and Jobs Act (the Act). Section 864(c)(8) provides that gain or loss from the transfer of a partnership interest by a non-U.S. person is treated as income effectively connected with a U.S. trade or business (ECI) to the extent of the transferring partner's distributive share of effectively connected gain or loss had the partnership sold all its assets for fair market value. Section 1446(f) requires withholding of 10 percent of the amount realized by a non-U.S. person on a disposition of a partnership interest, if gain from such disposition would be treated as ECI under Section 864(c)(8).
The Treasury Department and the IRS previously released Notice 2018-8, which suspended the Section 1446(f) withholding obligation for transfers of publicly traded partnership interests pending issuance of regulations. Notice 2018-29 addresses transfers of interests in partnerships that are not publicly traded. The Notice provides certain interim rules for complying with the Section 1446(f) withholding regime, as well as certain exceptions from withholding.
Certification That Transferor Is a U.S. Person or That No Gain Will Be Realized
The Notice states that the Treasury Department and the IRS intend to issue regulations, as contemplated by Section 1446(f)(2), providing for the issuance of a certificate to inform the transferee of a partnership interest that withholding is not required where the transferor is not a foreign person. This is similar to the regime currently in effect under Section 1445 and the "Foreign Investment in Real Property Tax Act" (FIRPTA). Under the FIRPTA regime, the transferee of a U.S. real property interest is not required to withhold if it receives an affidavit from the transferor stating, among other things, the transferor's U.S. taxpayer identification number and that the transferor is not a foreign person. Pursuant to the Notice, this type of certification of non-foreign status also may be made for purposes of avoiding any withholding under Section 1446(f), and can take the form of an IRS Form W-9 or a statement similar to the FIRPTA certificate described in Treas. Reg. Section 1.1445-2(b). The transferee can also establish that no withholding is required under Section 1446(f) by obtaining a certification from the transferor that the transferor will not realize gain on the transfer of the partnership interest.
Certification of Less Than 25 Percent ECI
The Notice also provides an exception to Section 1446(f) withholding for transfers of partnership interests if: (i) the transferor provides a certification to the transferee that (A) the transferor was a partner in the partnership for the entirety of the prior three taxable years and (B) less than 25 percent of the transferor's distributive share of partnership income for those three taxable years was ECI; or (ii) the partnership provides a certification that less than 25 percent of the partnership's gain from the hypothetical sale of its assets for fair market value would constitute ECI. The Notice states that the Treasury Department and the IRS intend to provide future guidance that will lower these 25 percent thresholds.
Suspension of Withholding Obligation for Nonrecognition Transactions
The Treasury Department and the IRS intend to issue regulations providing that transfers of partnership interests in nonrecognition transactions generally will be exempt from Section 1446(f) withholding provided the transferee obtains a certificate, similar to that contemplated by the FIRPTA regime, stating that the transferor is not required to recognize gain or loss in the transaction by reason of the nonrecognition provisions of the Code or applicable treaties. The Notice states that the Treasury Department and the IRS are studying the appropriate treatment of nonrecognition transactions under Section 864(c)(8). Pending further guidance, the Notice suspends the application of Section 1446(f) with respect to transfers of partnership interests in nonrecognition transactions.
Calculation of Amount Realized
If Section 1446(f) withholding applies to a transfer, the transferee must withhold 10 percent of the "amount realized" by the transferor in the transaction, which includes both the proceeds paid to the transferor and any reduction in the transferor's share of partnership liabilities or liabilities to which the transferred partnership interest is subject. The Notice provides that, for purposes of determining the amount of any liability of the partnership included in the amount realized, the transferee may rely on a certificate as to the amount from either: (i) the partnership; or (ii) the transferor (provided that the transferor and related persons owned less than a 50 percent interest in capital, profits, deductions, and losses in the partnership in the 12 months before the transfer) based on its most recent Form K-1.
In certain situations, 10 percent of the amount realized may exceed the amount of proceeds payable by the transferee. In other situations, the transferee may not be able to determine the amount of liability relief to include in the amount realized. In these situations, the Notice provides that, subject to certain limited exceptions, a transferee may withhold the entire amount of proceeds payable to the transferor in satisfaction of its Section 1446(f) withholding obligation.
Partnership Distributions
A partnership distribution to a non-U.S. partner in excess of the distributee's basis in its partnership interest is treated as gain from the sale or exchange of a partnership interest, and therefore Section 1446(f) could apply to such a distribution. The Notice provides that a partnership making a distribution to which Section 1446(f) withholding applies may rely on its books and records or request a certificate from the distributee partner to determine the extent to which such distribution exceeds the partner's basis and the amount to be withheld.
Suspension of Partnership Obligation if Transferee Fails to Withhold
Section 1446(f)(4) provides that if a transferee fails to withhold under Section 1446, the partnership whose interest is transferred is required to withhold the amount that should have been withheld (plus interest) from subsequent distributions to the transferee. The Treasury Department and the IRS intend to issue implementing regulations; however, the Notice suspends application of Section 1446(f)(4) until such guidance is issued.
For further information or to discuss any of the provisions described above, please contact Greg Broome (gbroome@wsgr.com, 415-947-2139); Myra Sutanto Shen (msutantoshen@wsgr.com, 650-565-3815); Jonathan Zhu (jzhu@wsgr.com, 650-849-3388); or any member of the tax practice at Wilson Sonsini.
