- November 14, 2020
- Salvatore Russo
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Final Regulations on Foreign Person’s Transfer of Partnership Interest
The IRS has issued final regulations that address the gain or loss of certain foreign persons on the sale or exchange of an interest in a partnership that is engaged in a trade or business in the United States. The regulations provide guidance on determining the amount of gain or loss treated as effectively connected income under Code Sec. 864(c)(8), as well coordination rules. The final regulations retain the basic approach and structure of the proposed regulations ( REG-113604-18) with certain revisions. Proposed regulations ( REG-105476-18) on information reporting and withholding on dispositions of these interests will be finalized at a later date.
Deemed Sale Gain or Loss
If a nonresident alien
or foreign corporation disposes of an interest in a partnership that is
engaged in any trade or business in the United States, the gain or loss
is treated as effectively connected gain or loss under Code Sec.
864(c)(8). The amount of gain or loss is limited to the portion of the
foreign transferor’s distributive share of gain or loss that would have
been effectively connected had the partnership sold all of its assets at
fair market value (the deemed sale limitation).
The foreign transferor must first determine its gain or loss on the transfer of the partnership interest (outside gain or outside loss). Once the outside gain or loss is determined, the following steps are taken to derive the limitation based on the deemed sale, against which the outside gain or loss is compared:
Step 1: Determine the amount of gain or loss from each partnership
asset as if the partnership conducted a deemed sale of all of its assets
on the date of transfer (these amounts are referred to as deemed sale
gain or deemed sale loss);
Step 2: Determine the amount of the deemed
sale gain or loss that would be treated as effectively connected gain
or loss with respect to each asset (these amounts are referred to as
deemed sale EC gain or deemed sale EC loss); and
Step 3: Determine
the foreign transferor’s distributive share of deemed sale effectively
connected gain or deemed sale effectively connected loss.
Sourcing Rules
The final regulations address the
sourcing rules that are often material in determining whether gain or
loss is effectively connected with the conduct of a trade or business
within the United States (Step 2). Because the sales are deemed sales,
the regulations provide simplifying factual assumptions that generally
treat deemed gain and loss as U.S. source where there is a partnership
office in the United States (U.S. office attribution rule). The final
regulations clarify that the general rules apply to personal property
held by the partnership on the date of the deemed sale. The regulations
also clarify that the U.S. office attribution rule does not apply unless
the partnership maintains an office or other U.S. fixed place of
business in the United States.
The final regulations provide additional sourcing rules for determining the foreign source portion of deemed sale gain and loss attributable to inventory, intangibles, and depreciable personal property specifically included in the deemed sale. The sourcing rules are needed because gain or loss from actual sales of each of these assets would be subject to specific sourcing rules under the Code, but sourcing deemed sale gain or loss under those rules would generally require facts that are not determinable in a deemed sale.
Under a 10-year rule, assets that have no nexus to the United States are removed from the deemed effectively connected gain or loss determination. The 10-year period is adjusted for partnerships not in existence for the period. The testing period is also adjusted to include periods during which the asset was held.
Treaties and Coordination Rules
The final
regulations also address treaty coordination rules and provide that (1)
treaty provisions are taken into account in computing the Step 3 amount,
above; and (2) treaty benefits are available only if the transferor
meets limitation of benefits (LOB) requirements. The final regulation
also provide additional rules to coordinate the regulations with treaty
provisions governing the disposition of U.S. real property interests.
The Step 3 amount does not include amounts that are excluded from the foreign transferor’s gross income or otherwise exempt from U.S. federal income tax by reason of an applicable provision of the Code, or amounts excepted under Code Sec. 897.
The final regulations clarify the interaction between the Code Sec. 897 coordination rule (i.e., application of Code Sec. 864(c)(8) over Code Sec. 897(g)) and the nonrecognition rules. Any transfer of an interest in a partnership as part of a nonrecognition transaction will not be subject to Code Sec. 864(c)(8) to the extent that the gain or loss on the transfer is not recognized. Rather, if the partnership owns one or more U.S. real property interests, Code Sec. 897(g) and its regulations will apply with respect to the unrecognized gain or loss.
Applicability Dates
The regulations generally
apply to transfers occurring on or after December 26, 2018, which is the
date on which the proposed regulations were filed with the Federal
Register. Additionally, the final regulations apply to amounts taken
into account on or after December 26, 2018, pursuant to an installment
sale (as defined in Code Sec. 453(b)) occurring on or after November 27,
2017, and before December 26, 2018.