Broker Withholding on Sales of Interests in Publicly Traded Partnerships (PTPs) and Guidance Under Notice 2023-8
- Jun 20, 2023
Two Internal Revenue Code (“IRC”) sections enacted in the Tax Cuts and Jobs Act (“TCJA”) of 2017 impact withholding by brokers on transfers of interests in publicly traded partnerships (“PTP”).
- IRC Sec. 864(c)(8) provides rules determining what amount of gain or loss on the sale of a partnership interest by a nonresident creates income effectively connected with a U.S. trade or business; and
- IRC Sec. 1446(f) provides withholding rules regarding the transfer of a partnership subject to IRC Sec. 864(c)(8).
On November 30, 2020, final regulations (Final Regulations) were published regarding withholding taxes under IRC Sec. 1446(f). The Final Regulations were to apply to transfers that occur on or after January 1, 2022. Notice 2021-51 deferred the applicability of the regulations applicable to PTPs to transfers that occur on or after January 1, 2023.
Withholding on the Transfer of a Non-PTP Interest
In general, the transferee of a non-PTP interest is required to withhold an amount equal to 10% of the transferor’s amount realized unless an exception applies. 10% withholding also applies to a PTP interest.
Withholding on the Transfer of a PTP Interest
A transferee of a PTP interest itself generally is not required to withhold under IRC Sec. 1446(f) where the transfer is affected through one or more brokers. Instead, the Final Regulations provide that, unless an exception applies, the broker effecting such a transfer is required to withhold under IRC Sec. 1446(f) if it makes a payment to another broker that it is required to treat as a foreign person or to a foreign transferor that is its customer. Specifically, a broker paying the purchase price for a PTP interest to another broker generally must withhold under IRC Sec. 1446(f) unless it obtains documentation establishing that the payee broker is either a qualified intermediary (“QI”) that assumes primary withholding responsibility for the payment or is a U.S. branch of a foreign person agreeing to be treated as a U.S. person with respect to the payment.
Exceptions. Proposed regulations (Proposed Regulations) provides five exceptions to a broker’s withholding obligation under IRC Sec. 1446(f) with respect to PTP interests:
- Reliance on the transferor’s certification of non-foreign status, including reliance on a Form W-9;
- Reliance on a qualified notice from the PTP stating that, had the PTP sold all of its assets at fair market value, either the amount of effectively connected gain would be less than 10% of the total gain, or no gain would have been effectively connected (the “10 Percent Exception”);
- With respect to a distribution from a PTP, reliance on a PTP’s designation in a qualified notice that such distribution does not exceed the net income of the PTP since the record date of the PTP’s last distribution (the “Distribution Exception”);
- Where the transfer is subject to backup withholding under IRC Sec. 3406; and
- Reliance on the transferor’s certification that the transferor is not subject to tax on any gain from the transfer pursuant to an applicable income tax treaty.
The Final Regulations made the following key changes to these exceptions:
- Clarified and expanded certain aspects of the 10-Percent Exception;
- Retained the 92-day rule: Under the Proposed Regulations, a broker could rely on a qualified notice posted by a PTP stating that the 10-Percent Exception applies as long as the notice was posted within the 92-day period ending on the date of the transfer. Treasury considered a request to extend the reliance period to 183 days after posting, but ultimately retained the 92-day rule on the basis that PTPs generally are able to determine the value of their assets quarterly, and because limiting reliance to the 92-day period “ensure[s] that the broker is using the most recent information available;”
- Expanded the 10-Percent Exception to apply to a PTP that certifies in a qualified notice that it has not been considered to be engaged in a U.S. trade or business during its current taxable year;
- Removed the Distribution Exception altogether, in light of the new procedure in the Final Regulations for determining the amount realized for IRC Sec. 1446(f) purposes on a distribution from a PTP (discussed below); and
- Added a new exception in the case of a transferor that certifies on a Form W-8ECI that it is a dealer in securities (as defined in IRC Sec. 475(c)(1)) and that any gain from its transfer of a PTP interest is effectively connected gain without regard to IRC Sec. 864(c)(8).
Determination of Withholding Amount. Under the Proposed Regulations, a broker generally determined the amount realized based on the gross proceeds paid on the transfer, subject to modification of the amount realized in the case of foreign partnership transferors with U.S. partners. The Final Regulations adopt the rule in the Proposed Regulations that allows the amount subject to withholding on a transfer by a foreign partnership to be reduced to the extent the amount realized is allocable to U.S. partners. The foreign partnership transferor must provide a Form W-8IMY accompanied by (i) a withholding statement setting forth the percentage of gain from the transfer allocable to each direct or indirect partner and (ii) certifications of non-foreign status for each U.S. partner. The Final Regulations also allow the amount withheld to be reduced because one or more foreign partners in the transferor partnership is eligible for treaty benefits.
The IRC Sec. 1446(f) regulations generally require withholding on the sale of all PTP interests, unless the PTP represents that an exception applies.
A number of trade groups raised concerns regarding the difficulty of brokers determining whether entities organized outside the U.S. are classified as PTPs for U.S. tax purposes. Notice 2023-8 states that the Treasury and the IRS have determined that the burden on brokers to make the determination likely outweighs any tax collected on the transfer of the foreign PTP.
Notice 2023-8 provides that the Treasury Department and the IRS intend to issue proposed regulations that would amend the Final Regulations to provide withholding relief to brokers on the sale of an interest in an entity that is organized outside of the United States and that trades solely on a foreign established securities market or foreign secondary market (foreign-traded entity). This proposed amendment would allow a broker that effects a sale of an interest in a foreign-traded entity to presume that the entity is not a PTP for U.S. tax purposes unless the broker has actual knowledge otherwise. However, the Treasury and the IRS have determined that it is inappropriate to allow a broker that knows that a foreign-traded entity is a PTP for U.S. tax purposes to presume that the PTP does not have effectively connected income, and therefore does not intend to include such a presumption in the proposed regulations. Thus, in such a case, a broker would be required to withhold under IRC Sec. 1446(f) on the sale of an interest in the PTP unless the PTP has indicated on a qualified notice that the 10-Percent Exception applies, or the broker receives a certification from the transferor claiming another exception or reduction to withholding.
The Notice also states that the Treasury Department and the IRS intend to issue proposed regulations that would amend the final regulations to allow brokers to rely on late certifications from a transferor of a PTP interest that claims an exception or reduction to withholding when certain requirements are met. The same allowance would be provided for late certifications received by nominees treated as withholding agents under Treas. Reg. 1446-4 on PTP interests, subject to certain limitations.
The Treasury Department and the IRS have received requests for clarity on the application of IRC Sec. 1446(f) to transactions described by requestors as short sales of PTP interests (PTP shorts). In a PTP short, a taxpayer obtains a PTP interest from a third party (original PTP interest owner), subject to an obligation to deliver an identical PTP interest to the original PTP interest owner in the future. The taxpayer immediately sells the PTP interest to an unrelated market participant for cash (sale to market). To satisfy its obligation to deliver an identical PTP interest to the original PTP interest owner, the taxpayer may buy a replacement PTP interest and deliver it to the original PTP interest owner. As an economic matter, the taxpayer will profit from the transaction if the value of the PTP interest has declined during the term of the PTP short. Alternatively, the taxpayer may instead deliver a PTP interest that it holds at that time to the original PTP interest owner. In the latter case, the taxpayer may have owned the PTP interest when it enters into the PTP short, or it may have acquired the PTP interest during the term of the PTP short. Taxpayers typically carry out these transactions through a broker, who has the legal relationship with both the taxpayer and the original PTP interest owner.
Applicability Date and Taxpayer Reliance
The proposed regulations would apply to transfers or distributions made on or after January 1, 2023. Before the promulgation of the proposed regulations, a broker required to withhold under IRC Sec. 1446(a) or 1446(f) may rely on the provisions of the Notice regarding the proposed regulations.
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Harold Adrion is a Consultant specializing in international tax. He has advised U.S. and foreign-based multinational publicly and privately held enterprises and individuals on domestic and international tax issues for more than 30 years.
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