Final regulations on disposition of interests in a partnership engaged in a U.S. trade and withholding under Section 1446(f)

The Internal Revenue Service (“IRS”) released final regulations (TD 9919) providing guidance on section 864(c)(8), enacted as part of the 2017 Tax Cuts & Jobs Act (“TCJA”). That provision overturned the Tax Court’s decision in Grecian Magnesite Mining, 149 T.C. No. 3 (2017), and treated the sale by a foreign person of an interest in a partnership engaged in a US trade or business as effectively connected income (or loss) to the extent of the portion of the partner’s distributive share of the amount of gain which would have been effectively connected income if the partnership had sold all of its assets at their fair market value as of the date of the sale or exchange of the interest.

In general, the final regulations largely adopt the proposed regulations that were issued with certain modifications. The final regulations provide additional guidance to taxpayers for how to calculate the amount of effectively connected gain or loss on such a disposition and apply to transfers taking place or after December 27, 2018, the date of the proposed regulations, and to amounts taken into account on or after that date as part of an installment sale occurring on or after November 27, 2017, and before December 27, 2018.

The IRS has also issued final regulations (T.D. 9926) addressing the withholding requirements of section 1446(f) and information reporting requirements for dispositions by foreign persons of interests in a partnership engaged in a US trade or business.

The deemed asset sale

The 2018 proposed regulations provided for a 3-step process for calculating the effectively connected gain or loss from the deemed sale of the partnership assets under section 864(c)(8). In general, this amount is determined through a three-step process.

  • Step 1: calculate the amount of gain or loss from each partnership asset as if the partnership had conducted a deemed sale of all of its assets on the date of transfer.
  • Step 2: determine the amount of the deemed sale gain or loss that would be treated as effectively connected gain or loss for each asset.
  • Step 3: determine the foreign transferor’s distributive share of the deemed sale effectively connected gain or loss amounts determined in step two.

The challenge with applying this multi-step process to a deemed asset sale is that the sourcing analysis required to determine when the disposition of an asset gives rise to effectively connected gain or loss often is not workable in the case of a deemed sale. To address this disconnect, the regulations provide for rules that serve as a proxy for performing this analysis. Under the regulations’ methodology, the deemed sale gain and loss is generally treated as US source with certain specified exceptions.

In the final regulations, the IRS responded to comments that the proposed rules were overbroad in treating deemed sale gain or loss as US source by narrowing the general rule for certain categories of assets, namely inventory, intangibles, and depreciable personal property. Under the revised methodology, available facts can be relied on as a proxy to provide the analysis that would ordinarily be performed under the sourcing rules.

The regulations include a rule for sourcing deemed sales of inventory based on historical data showing how inventory sales were sourced by the partnership over a specified period and a look-back rule for determining the foreign source portion of deemed sale gain or loss from intangibles.

The final regulations also contain additional guidance for how the deemed sale rule interacts with US tax treaties, clarifying that the US office attribution rule does not apply unless the partnership maintains an office or other fixed place of business in the United States and that the regulations will take into account an applicable treaty when computing the amount of a foreign transferor’s distributive share of deemed sale effectively connected gain and loss.

Mazars’ Insight
Because the amount calculated as effectively connected gain or loss on the sale of a partnership interest by a foreign partner might differ under the final regulations, taxpayers should review calculations of gain or loss for any such transactions occurring after December 26, 2018.

Please contact your Mazars USA LLP professional for additional information.

This alert was produced in conjunction with Ivins, Phillips & Barker, Chtd.

Published on January 27, 2021

The information provided here is for general guidance only, and does not constitute the provision of tax advice, accounting services, investment advice, legal advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisers.