Our July 24, 2017 Tax Alert, Tax Court Rejects IRS Guidance on Foreign Partner Redemption Gain; Creates Refund Possibilities, discussed the United States Tax Court’s holding in Grecian Magnesite Mining, Industrial & Shipping Co., SA (“Grecian Magnesite”).
The Tax Cuts and Jobs Act has effectively overturned the Court’s holding by stating that the gain or loss incurred by a foreign partner on the disposition of a partnership interest is treated as effectively connected with a U.S. trade or business to the extent that the sale of the partnership assets would have generated effectively connected income(“ECI”).
In Grecian Magnesite, the Tax Court rejected the IRS’s long-standing view promulgated in Revenue Ruling 91-32, holding that a foreign partner’s gain or loss from the disposition of its interest in a partnership engaged in a U.S. trade or business is not ECI (except for certain gains related to U.S. real property interests), and therefore such foreign partner’s gain or loss on the disposition of a U.S. partnership interest is generally not subject to U.S. tax.
On December 22, 2017, President Donald Trump signed into law a tax reform bill that effectively repeals the result in the Grecian Magnesite decision, and codified Rev. Rul. 91-32 into law, by revising Internal Revenue Code Section 864(c) to include a provision stating that a foreign partner’s disposition of a partnership interest is subject to U.S. taxation as ECI to the extent the foreign partner would have had ECI had the partnership sold all of its assets at fair market value on the date of disposition. This revision is applicable to dispositions of partnership interests occurring on or after November 27, 2017.
Additionally, the tax reform bill added Internal Revenue Code (IRC) Section 1446(f) which requires that, beginning in 2018, the buyer of a foreign person’s partnership interest withhold 10% of the amount realized by the seller if any portion of the seller’s gain on disposition would be ECI under the newly revised Section 864(c).
If the buyer does not withhold the correct amount of tax, the partnership shall be responsible for deducting and withholding, from distributions to the buyer, the amount that the buyer failed to withhold from the seller. Since the amount realized includes the seller’s share of the partnership’s liabilities, it is possible that the withholding could be greater than the amount of cash received by the seller.
An exemption from withholding exists if a nonresident alien or a foreign corporation certifies that it is not a non-U.S. person. Further, the IRS, in Notice 2018-08, has suspended this withholding requirement on the transfer of publicly traded partnership (“PTP”) interests (as defined under IRC Section 7704(b)). The IRS intends to offer additional guidance on the withholding, deposit, and reporting of tax on the disposition of PTP interests in the future.
Although the tax reform bill eliminates the tax-free treatment provided for in Grecian Magnesite with respect to a foreign partner’s disposition of a domestic partnership interest, there may still be possible refund opportunities for foreign partners that disposed of a partnership interest with ECI prior to November 27, 2017.
The IRS filed a Notice of Appeal, in Grecian Magnesite, with the U.S. Tax Court on December 15, 2017 and, depending on the result of the appeal, may continue to apply Rev. Rul. 91-32 for transactions prior to December 22, 2017.
Internal Revenue Code Section 1446(f) creates added complexity for buyers of partnership interests from foreign persons. In addition to requiring the withholding of tax, buyers must obtain additional information and documentation from a foreign seller, which can increase both the time and expense of purchasing the partnership interest. Partnerships also potentially face increased exposure and responsibility should the purchasing partner not properly withhold the correct amount of tax from the foreign partner. Partnerships should consider amending their partnership or operating agreements to provide clarity with respect to dispositions of partnership interests, withholding, and documentation requirements.
Please contact your Mazars USA professional for additional information.
 See Grecian Magnesite Mining, Industrial & Shipping Co., SA v. Commissioner, 149 T.C. No. 3 (July 13, 2017).