Last week, the IRS released proposed regulations under section 1446(f) which require tax withholding and reporting on the sale by a non-U.S. partner of interests in partnerships that have U.S. trade or business assets. The section 1446(f) provision was added into the Internal Revenue Code by the Tax Cuts and Jobs Act of 2017 and had been effective for sales on or after January 1, 2018. However, brokers and those in public markets have for the most part been as yet unaffected by the rules as the IRS had in a prior notice suspended the application of the withholding rules to sales of publicly traded partnerships (PTPs). That respite may soon be ending.

The new proposed regulations, when finalized, would allow section 1446(f) to apply to sales of PTPs by non-U.S. partners. The temporary suspension would then be lifted.

Moreover, while the transferee of a partnership interest generally is responsible for withholding under section 1446(f) provisions applicable to non-publicly traded partnerships, the same will not be true for PTPs (since the transferee/purchaser generally doesn’t know who the transferor is). “From a broker’s perspective,” Nelson Suit, Tax Counsel at Scivantage Inc. notes, “the key take-away is that the responsibility for withholding on sales of PTPs by a non-U.S. partner now shifts to the broker. If these rules become finalized, the broker will need to identify PTP sales and non-U.S. sellers, determine whether an exception may apply based on one of a number of possible certifications, and conduct proper withholding and reporting.”

The new rules will require a re-assessment of current information reporting and withholding systems, even those that have been vetted for traditional withholding on income paid to nonresident accounts. Section 1446(f) would require a 10% withholding on proceeds from the sale of PTPs by a non-U.S. holder. “This will be something new,” said Mr. Suit, “We have generally not been required to withhold on gross proceeds paid to non-U.S. persons on publicly traded securities. So procedures will need to be built to identify such trades and implement in essence a sort of gross proceeds withholding, and it’s not a simple regime at that. A number of exceptions could apply which may require some thought as to information flow from both PTPs and sellers.”

There are some unexpected quirks too. For example, brokers under the proposed rules may reduce the amount subject to withholding under section 1446(f) to a foreign partnership if the foreign partnership can substantiate and account for the percentage of its partners that are U.S. persons. But Form 1042-S tax reporting is made to the partnership and not the partners, which is contrary to the current process for other U.S. source income payments paid to foreign partnerships.

While these regulations remain proposed, brokers may wish to begin the process of thinking through the provisions and their potential impact on their customer onboarding, tax withholding and reporting systems. Where are the potential gaps in the process? How might those gaps be bridged if the rules become finalized as proposed? Are there comments the broker may wish to provide to the IRS that might argue for a modification of the proposed rules?

Brokers will be key players in this new withholding framework.