Withholding on Allocations of Effectively Connected Taxable Income to Foreign Partners

Posted: 11 Mar 2006

Abstract

In this report the NYSBA tax section discusses the final, temporary, and proposed Treasury regulations issued under section 1446, relating to the withholding by partnerships of U.S. tax on allocations of effectively connected taxable income to foreign partners.

The report addresses two aspects of the final regulations: the treatment of cancellation of indebtedness (COD) income and the overlap between the section 1446 withholding rules and the FIRPTA withholding rules contained in section 1445. The report also addresses temporary and proposed regulations (section 1.1446-6T) that permit a partnership to adjust the amount of tax it withholds under section 1446 to reflect some losses or other attributes of a foreign partner.

The final regulations provide no relief from withholding in respect of COD income. The authors concur with Treasury and the IRS's decision not to provide relief in that case, because they believe that the statutory withholding requirement is clear and that the policy underlying section 1446 can be interpreted to support that decision. However, they believe that requiring partnerships to withhold on COD income under section 1446 raises complex and difficult policy issues that merit further consideration. They therefore include a detailed discussion of those issues.

The final regulations also provide that, in the case of a disposition of a U.S. real property interest (a USRPI) by a domestic partnership, which is potentially subject to the FIRPTA withholding rules under section 1445(e)(1) as well as to withholding under section 1446, the section 1446 rules prevail. The authors believe that this trumping rule reaches a result inconsistent with the statute in the case of a USRPI that is not held by the partnership in connection with a U.S. trade or business. The report therefore recommends that, in that situation, section 1445 rather than section 1446 should apply. When the USRPI is held by the partnership in connection with a U.S. trade or business, the authors believe that both section 1445 and section 1446 potentially apply and that Treasury and the IRS have authority to determine which set of rules should prevail. If consistent treatment of dispositions of real property were deemed desirable, Treasury and the IRS may wish to consider applying section 1445 in that situation also. The report does not recommend whether section 1445 or section 1446 should apply in that situation but discusses some of the relevant policy considerations.

The temporary and proposed regulations under section 1.1446-6T permit a partnership to adjust the amount of tax it withholds under section 1446 to reflect certain losses or other attributes of a foreign partner if the foreign partner meets a number of requirements and certifies to the partnership that those requirements are met. The authors support the adoption of that regulation and believe that adjusting the amount that a partnership must withhold to more closely approximate the tax that its foreign partners ultimately will owe significantly improves the section 1446 withholding regime. As currently drafted, however, those regulations provide only limited protection to a partnership that withholds in reliance on a certificate provided by a foreign partner, even if the partnership has no reason to question the validity of the certificate. Further, the conditions that must be met for a foreign partner to provide a valid certificate are extremely detailed and complex. The authors are concerned that the combination of limited protection for the partnership and complex procedural requirements and restrictions will discourage many partnerships from taking advantage of the regulations in their current form.

The report recommends that a partnership that reasonably relies on a certificate should be relieved of liability, not only for the addition to tax under section 6655, but also for the section 1446 withholding tax and interest. Whether or not Treasury and the IRS adopt that suggestion, the authors believe the procedural requirements and restrictions should be simplified. Because a partnership is not required to take into account a certificate from a foreign partner, they do not think that the many detailed procedural requirements contained in the regulations are necessary to protect partnerships. They also do not believe that simplifying the requirements would materially increase the risk of underwithholding. The report therefore recommends a number of specific simplifying changes to the procedural requirements.

Suggested Citation

Bar Association, New York State, Withholding on Allocations of Effectively Connected Taxable Income to Foreign Partners. Tax Notes, Vol. 110, No. 10, March 13, 2006, Available at SSRN: https://ssrn.com/abstract=889863

New York State Bar Association (Contact Author)

NYSBA

One Elk Street
Tax Section
Albany, NY 12207
United States
518-463-3200 (Phone)

HOME PAGE: http://www.nysba.org

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