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Coordination With FIRPTA on Sale of Partnership Interests Under Proposed Section 1446(f) Regulations

Treasury and the IRS published proposed regulations, 84 Fed. Reg. 21,198 (May 13, 2019) (the “Proposed Regulations”) for withholding of tax on gain from sales or exchanges of certain partnership interests held by foreign individuals or corporations under section 1446(f) (“Section 1446(f)”) of the Internal Revenue Code of 1986, as amended (“Code”). The Proposed Regulations raise compliance issues in coordinating the new Section 1446(f) withholding requirements with parallel withholding provisions under the Foreign Investment in Real Property Tax Act of 1980, 94 Stat. 2682 sec. 1122 (“FIRPTA”).

Background. Congress enacted Section 1446(f) as part of the 2017 tax reform legislation commonly known as the Tax Cuts and Jobs Act of 2017 (“TCJA”), Pub. L. 115-97, 131 Stat. 2139 sec. 13501(b). Generally, Section 1446(f) requires withholding at the rate of 10 percent of the amount realized on a transfer of an interest in a partnership if any portion of the gain were deemed effectively connected with the conduct of a trade or business within the United States. Effectively connected gain is determined under the new Section 864(c)(8), Pub. L. 115-97, 131 Stat. 2138 sec. 13501(a).

Section 1446(f) Withholding. Section 1446(f) applies to a sale or exchange of a partnership interest held directly or indirectly by a nonresident alien individual or a foreign corporation. The tax must be withheld generally by a transferee of the partnership interest. In some instances, the partnership, the interest in which is transferred, and in the case of a publicly traded partnership, a broker effecting the transaction must withhold the tax under Section 1446(f).

FIRPTA. A partnership interest may constitute a United States Real Property Interest (“USRPI”) within the meaning of Section 897(c), which in part codifies FIRPTA. Under Section 897(a), gain or loss from the disposition of an USRPI generally is treated as effectively connected with the conduct of a trade or business in the United States. An amount treated as effectively connected gain under Section 897 is subject to withholding under Section 1445, generally at the rate of 15 percent, or 21 percent for distributions by foreign corporations of certain appreciated USRPIs, on or after February 17, 2016.


FIRPTA Withholding. Section 1445(e)(5) in part requires withholding by a transferee of a partnership interest of a tax at the rate of 15 percent of the amount realized on the disposition, to the extent provided in regulations. Temporary Treasury regulation section 1.1445-11T(d)(1) imposes withholding on dispositions of partnership interests by foreign partners, in which 50 percent or more of the gross assets value consists of USRPIs, and 90 percent or more of the gross assets value consists of USRPIs and cash or cash equivalents.

Coordination of Withholding Rules under Sections 1445(e) and 1446(f). Proposed Treasury regulation section 1.864(c)(8)-1(d), 83 Fed. Reg. 66,647, 66,653 (Dec. 27, 2018) clarifies that Section 864(c)(8) does not turn off income recognition under FIRPTA. Conversely, under Section 864(c)(8)(C), any effectively connected gain or loss under Section 897 reduces amounts taken into account under Section 864(c)(8).


Under the Proposed Regulations, for a transferee to which Section 1445(e)(5), Temp. Treas. reg. section 1.1445-11T(d)(1) and Section 1446(f)(1) apply only FIRPTA withholding is required. However, under the temporary regulation, a taxpayer (generally, the seller of the partnership interest) may apply for a FIRPTA withholding certificate for reduced withholding under Section 1445 Treasury regulations. In this scenario, a transferee of the partnership interest must withhold a tax in the amount that is the greater of the amounts required to be withheld under either Sections 1445(e) or 1446(f)(1).


Determining Withholding Tax Liability. Under the Proposed Regulations, a foreign transferor must notify a non-publicly-traded partnership, in which the interest is transferred, of the transfer. In turn, the specified partnership must furnish a notice to the notifying transferor setting forth, among other information, the amount of deemed sale effectively connected gain or loss on the transfer of the partnership interest. Certain exceptions to withholding under Section 1446(f) may apply. Under one of the exceptions, based on the partnership statement, the transferor may provide to the transferee a certification of maximum tax liability to limit withholding to amounts determined by the partnership.


A foreign partner may sell an interest in a non-publicly-traded partnership that holds real property located in the United States, cash and some intangible assets. A portion of the purchase price may be treated as effectively connected gain under either Sections 1445 or 1446(f). In that case, the partnership would determine amounts treated as effectively connected gain under each Code section, multiply the respective amounts by the applicable withholding tax rate, either 10 percent under Section 1446(f) or 15 percent under Section 1445(e) and determine the greater amount of tax. The transferee, upon receipt of a certification from the seller, would withhold the tax.


Which Statute Yields Higher Withholding Tax Liability? Even though the withholding tax rate was higher under FIRPTA, the amount of the withholding tax actually may be higher under Section 1446(f). As illustrated in an example below, the result may depend in part on the percentage of the purchase price that would be attributable to USRPIs under Section 897(g) and the Treasury regulations. 

Effectively connected gain or loss is calculated under Section 864(c)(8)(B) based on a deemed sale of the all partnership assets at their fair market value on the date of the actual sale of the partnership interest. The applicable gain or loss would be the portion of the actual purchase price that would be the selling partner’s hypothetical distributive share of effectively connected gain or loss realized on the deemed sale.


If the USRPIs and cash or equivalents constitute less than 90 percent of the gross assets of the partnership, Section 1445(e) withholding is not triggered, and the transferee withholds at the lower tax rate under Section 1446(f). However, if the USRPIs and cash or equivalent comprise 90 percent of the partnership assets, then the tax rate under Section 1445(e) would apply.

Example. For example, the purchase price of the partnership interest is $1,000x, USRPIs comprise 50 percent of the gross assets value of the partnership, and USRPIs and cash together equal 90 percent of that value. All income and loss items of the partnership are allocated pro-rata to each partner. The Section 1445 withholding tax on the portion of the partnership interest attributable USRPIs would be $500x multiplied by 15 percent, or $75x.


If a deemed sale of all partnership assets resulted only in effectively connected gain or loss, the withholding tax on the sale of the partnership interest under Section 1446(f) would be $100x. However, keeping intangibles outside the United States would reduce effectively connected gain on a hypothetical sale and accordingly, actual Section 1446(f) withholding tax liability. Conversely, if a higher percentage of assets were USRPIs, the withholding tax liability under FIRPTA would be higher.

Practical Considerations. Thus, the percentage of partnership assets treated as USRPIs under FIRPTA, the asset mix and the allocation provisions in the partnership agreement each would affect the applicable withholding tax rate under Section 1446(f). Partners and partnerships must be aware how each of these factors would affect the withholding tax liability of the foreign partners on disposition of the interests under both Sections 1445 and 1446(f).