IRS Releases Proposed Regulations on Partnership Interests

On December 20, 2018, the Internal Revenue Service (the “IRS”) and the Treasury Department released proposed regulations (the “Proposed Regulations”) under Section 864(c)(8), a provision providing for U.S. federal taxation of a foreign partner’s gain on the sale or exchange of certain partnership interests.

Background

Before the 2017 Tax Cuts and Jobs Act (TCJA), it was unclear whether foreign persons were taxable on gain from the sale or exchange of an interest in a partnership that was engaged in a U.S. trade or business (USTB). Generally, foreign persons are subject to U.S. taxation on income that is effectively connected (ECI) with a USTB, including income derived through a partnership. Section 875 of the Code provides that a foreign partner is considered to be engaged in the USTB of a partnership of which he is a member. Foreign persons who qualify for treaty benefits under a double tax treaty are generally only taxable on ECI to the extent it is attributable to a permanent establishment (PE) in the U.S. In both instances, it was unclear whether the sale of a partnership interest with a USTB or PE would be taxable to a foreign partner who was not otherwise engaged in business in the U.S.

In 1991, the IRS issued Revenue Ruling 91-32, holding that a foreign partner is subject to U.S. federal taxation on the sale or exchange of a partnership interest to the extent the gain was attributable to assets used in a USTB. In such a case, the partner was deemed to have ECI from the sale or exchange of the partnership interest in an amount equal to the partner’s share of ECI that would have been recognized by the partnership if it had sold all of its assets.