In our first post regarding the proposed section 1446(f) regulations, we addressed the rules regarding which party is the withholding agent for purposes of section 1446(f). Sections 864(c)(8) and 1446(f) were adopted as part of tax reform. Section 864(c)(8) was enacted to reverse the holding of the Tax Court in Grecian Magnesite Mining v. Commissioner, which was affirmed by the U.S. Court of Appeals for the DC Circuit. In our second post, we addressed the amount required to be withheld. In this post, we discuss the general reporting requirements for the transferor, the transferee, and the partnership. Further, we provide an overview of the new “backstop withholding” rules that will end the suspension of the partnership withholding requirement under section 1446(f)(4). The IRS suspended partnership withholding under section 1446(f)(4) under Notice 2018-29.
General Reporting Requirements
Because the transferor cannot calculate its effectively connected gain or loss on the deemed sale at the partnership level without certain information from the partnership, the proposed regulations include certain information reporting rules. Generally, a foreign person (and certain domestic partnerships with direct or indirect foreign partners) that transfers an interest in a partnership covered by section 864(c)(8) must provide a statement to the partnership within 30 days of the transfer. In turn, the partnership must furnish to such transferor information necessary to comply with section 864(c)(8) if that transferor would have had a distributive share of the gain or loss from a deemed sale of the effectively connected assets.
Reporting and Depositing
A transferee required to withhold must report and pay any tax withheld by the 20th day after the date of the transfer using Form 8288 (U.S. Withholding Tax Return for Dispositions by Foreign Persons of US Real Property Interests), and Form 8288-A (Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests). The transferor’s copy of Form 8288-A is first sent to the IRS, which is stamped and validated, and a copy is mailed to the transferor.
The transferee is generally also required to provide the Form 8288-A or equivalent information to the partnership no later than 10 days after the transfer. The partnership must conduct its own review of the certification provided by the transferee, including any certifications for exception to withholding. A transferee that has relied on a certification claiming an exception or adjustment to withholding may want to ensure that the partnership has determined the certification to be correct and reliable before the due date for payment of any withheld amounts to the IRS.
A broker is required to report the withholding on Form 1042 (Annual Withholding Tax Returns for U.S. Source Income of Foreign Persons) and Form 1042-S (Foreign Person’s U.S. Source Income Subject to Withholding).
Transferor’s Tax Return
A foreign transferor must file a U.S. tax return and pay any tax due on a transfer that is subject to section 864(c)(8), regardless of whether the transferee withholds. The withholding of tax does not relieve the transferor from filing a U.S. income tax return with respect to the transfer and paying any tax due with the return. However, the tax will not be collected from the transferor to the extent it has been collected through these withholding rules.
To claim a credit for the amount withheld, the transferor must attach to its return the stamped copy of Form 8288-A or “substantial evidence” of withholding. A transferor that is a foreign partnership may claim a credit for the amount withheld against its tax liability under section 1446(a) with respect to its foreign partners.
The transferor of a PTP can claim a credit for the amount withheld by attaching a copy of the Form 1042-S to its return.
“Backstop Withholding” By the Partnership
Section 1446(f)(4) requires partnerships to withhold tax and interest on subsequent distributions to transferees that fail to withhold—in essence, the statute imposes a “backstop withholding” requirement. For purposes of this post, we use the term “backstop withholding,” which is not a term of art used in the proposed regulations, but is used here to illustrate the unique type of withholding that would be required under the statute if the actual withholding agent does not indeed withhold. Backstop withholding has been temporarily suspended under Notice 2018-29, until the regulations are finalized.
If the transferee fails to withhold, or if the partnership knows or has reason to know that the transferee’s certification (or an underlying certification from the transferor) is unreliable or incorrect, the proposed regulations would require the partnership to withhold. The partnership also would be required to withhold if the IRS notified it that the transferee provided incorrect information about the amount withheld or failed to deposit the amount withheld.
Backstop withholding must begin on the date that is the later of (i) 30 days after the transfer, or (ii) 15 days after the partnership acquires actual knowledge of the transfer. The entire amount of any distribution to the transferee must be withheld until (i) the partnership receives a certification on which it can, in fact, rely, (ii) the transferee disposes of its partnership interest (and the successor-in-interest is not related to the transferee or original transferor), or (iii) the tax liability, including applicable interest, has been satisfied.
In determining the tax liability, the partnership may not take into account any adjustments to the amount realized that might otherwise be available, such as a transferor’s certification of maximum tax liability. The purpose of this rule is to provide transferees an additional incentive to comply and to minimize the administrative burden on the partnership.
Backstop withholding must be reported on Form 8288 (U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests), and new Form 8288-C (Statement of Withholding Under IRC Section 1446(f)(4) for Withholding on Dispositions by Foreign Persons of Partnership Interests). Form 8288-C has not yet been released.
Rules When the Partnership is a Transferee
When the partnership is a transferee because of a distribution, the proposed regulations clarify that withholding under section 1446(f)(4) does not apply. However, the partnership is liable for withholding under the general rule of section 1446(f)(1) because it is treated as the transferee.
Special Rules for PTPs
PTPs are generally not required to withhold on distributions made to a transferee. However, if the PTP receives a notice from the IRS indicating that its qualified notice falsely stated that an exemption from withholding applies, or the PTP makes that determination on its own, the PTP must withhold an amount equal to the underwithholding by brokers, plus interest.
Liability for Underwithholding
The parties responsible for section 1446(f) withholding—which includes the transferee, the brokers, as well as the partnership in cases of backstop withholding—will be liable for any missed withholding tax on a transfer. Importantly, the proposed regulations specifically provide that under section 1463, if the tax is ultimately paid—either by any withholding agent or the transferor, the tax will not be recollected. The preamble also reiterates that the “tax will only be collected once.” However, in practice, the IRS may require proof from the transferee / withholding agent that the transferor has paid the tax liability. In other withholding contexts, the IRS has required the payor or withholding agent to obtain a Form 4669 (Statement of Payment Received) to establish that the underlying income and tax liability has been satisfied before the payor or withholding agent is relieved of liability for a withholding failure. Also as in other contexts, when withholding is required but is subsequently relieved by using a Form 4669, the withholding agent still faces interest, penalties, or additions to tax that would otherwise apply.
Special Rules for PTPs
In addition, an agent that acts on behalf of a transferor or transferee and knows of a false certification but fails to notify the party responsible for withholding would itself be liable for any resulting underwithholding. The liability, however, would be limited to the amount of compensation the agent received related to the transaction and any civil or criminal penalties.