IRS Provides Welcome Clarification on Application of IRC Sec. 864(c)(8) Regarding Sales of Interests in Partnerships Engaged in a U.S. Trade or Business

On September 21, 2020, the IRS released final regulations (“Final Regulations”) on the application of IRC Sec. 864(c)(8).  IRC Sec. 864(c)(8) effectively overturned the Tax Court holding in Grecian Magnesite Mining Industrial & Shipping Co. v. Commissioner, 149 T.C. 63 (2017), aff’d 926 F. 3d 819 (D.C. Cir. 2019).

Contrary to what many practitioners believed to be the correct interpretation of the law, the IRS had maintained that when a nonresident alien individual or foreign corporation (“foreign transferor”) sells an interest in a partnership which has a U.S. trade or business, a proportionate part of the partner’s gain was subject to U.S. tax. The IRS issued Rev. Rul. 91-32 which expressed its view. The Grecian case held that Rev. Rul. 91-32 was not a valid interpretation of U.S. law.  Congress as part of the Tax Cuts and Jobs Act enacted IRC Secs. 864(c)(8) and 1446(f), which treat gain or loss on the sale of a foreign partner’s interest in a partnership that has a U.S. trade or business as a deemed gain or loss on the sale of partnership assets attributable to that U.S. trade or business.

Proposed regulations (“Proposed Regulations”) were issued on December 20, 2018. The Final Regulations largely adopt the Proposed Regulations with some beneficial clarifications.

Summary of Changes in Final Regulations

The Final Regulations provide rules that source gain or loss from specific assets (inventory, intangible and depreciable personal property) in a more reasonable manner.

The Final Regulations clarify that IRC Sec. 864(c)(8) limits the amount of gain or loss effectively connected with a U. S. trade or business to the portion of the foreign transferor’s distributive share of gain or loss that would have been effectively connected if the partnership had sold all of its assets at fair market value.

• The Final Regulations coordinate the application of the provision with tax treaties and with the taxation of U.S. real property interests (i.e., FIRPTA provisions).

Although the Final Regulations provide many helpful clarifications, there are still significant issues that will need to be dealt with.  Examples of such issues are the application of tiered partnerships when a foreign transferor disposes of its interest – there are significant issues with obtaining the necessary information to determine gain -- as well as enforcement issues and legal issues regarding partnership agreements applying IRC Sec. 864(b)(8).