On May 7, 2019, the IRS and Treasury Department issued proposed regulations under sections 864(c)(8) and 1446(f) of the tax code. Under section 864(c)(8), foreign partners are taxed on certain gains realized from a sale or redemption of an interest in a partnership that is engaged in a U.S. trade or business. This tax is enforced through the withholding provisions of section 1446(f), which generally require a purchaser of such an interest to withhold from the gross sale proceeds at a rate of 10%. The proposed regulations would replace two notices issued in 2018, which provided interim guidance.

Cadwalader tax partners Jason Schwartz and Gary Silverstein, in conjunction with Structured Finance Industry Group, Inc., submitted a letter to the IRS on section 1446(f) and the notices. The following are a few highlights of the proposed regulations:

• Notification and Reporting. The proposed regulations would require a foreigner that transfers a partnership interest to notify the partnership of the transfer within 30 days of the date of the transfer. The partnership would then have to furnish the information necessary for the transferor to compute its section 864(c)(8) tax liability by the due date (with extensions) of the Schedule K-1 for the tax year in which the transfer occurred.
• Smaller Safe Harbor.  The proposed regulations provide that a transferee of a partnership interest is not required to withhold tax on a foreign transferor if the partnership certifies that the amount of effectively connected gain on a hypothetical sale of its assets would be less than 10% of the partnership's total net gain. Notice 2018-29 used a 25% threshold.
• Reduction of Withholding.  The proposed regulations helpfully allow (1) a partnership's "amount realized," for purposes of calculating the required withholding amount, to be reduced by amounts allocable to U.S. partners and (2) the withholding amount to be reduced where the maximum tax liability under section 864(c)(8) is lower than the withholding otherwise required (e.g., where a nonrecognition provision or income tax treaty reduces the tax).
• Publicly Traded Partnerships.  Under the proposed regulations, if a transfer of a publicly traded partnership interest is effected through one or more brokers, withholding responsibility generally is imposed on the broker who either (1) pays the amount realized on the transfer to another broker that is a foreign person and that has not assumed primary withholding responsibility with respect to the payment or (2) is effecting the transfer on behalf of the transferor as the broker's customer.  To avoid withholding by multiple brokers, the proposed regulations generally provide that a broker is not required to withhold if it knows that the withholding obligation has been satisfied by another broker.
• Tax on Transferee.  A partnership is generally required to withhold on distributions to a transferee that fails to properly withhold under section 1446(f). However, under the proposed regulations, amounts withheld by the partnership do not relieve the transferor from its obligation to pay tax under section 864(c)(8) and are not credited against the transferor’s tax liability. Absent further guidance, it is unclear how a transferee might acquire the information needed to apply for a refund of amounts withheld by the partnership that the transferor subsequently pays in satisfaction of its tax liability. In the meantime, consideration should be given to whether the partnership’s operating agreement and the relevant transfer agreement between the transferor and transferee adequately address this scenario.

The provisions of the proposed regulations relating to section 1446(f) generally would apply to transfers that occur at least 60 days after the proposed regulations are finalized.  Until then, taxpayers may apply the rules of the notices or, for transfers of non-publicly traded partnership interests, may instead choose to apply the rules of the proposed regulations in their entirety to all transfers as if they were final regulations.