How will amounts withheld under Section 1446(f) be reported?
Non-U.S. residents can expect a reporting experience like the current Form 1042-S regime they receive on U.S. source income subject to withholding.
Specifically, a broker is generally required to report on Form 1042-S a payment of an amount realized from the transfer of a PTP interest. When reporting to a non-U.S. partnership, the Form 1042-S should be issued directly to the partnership (as a recipient for reporting purposes) rather than to the partners.
The Final Regulations also clarify that aggregate reporting should be used with respect to amounts realized by a transferor on transfers of PTP interests, as opposed to reporting on a transfer by transfer basis. Instructions to Form 1042-S will amended to reflect these requirements.
Do non-U.S. partners need to file a U.S. tax return?
Yes; the new regulatory packages, including sections 864(c)(8) and 1446(f) reinforces that the IRS expects all non-U.S. partners to file U.S. income tax returns to report their effectively connected income regardless of whether all tax has been satisfied through withholding.
As a practical matter, it is expected that section 1446(f) withholding will exceed the non-U.S. partner’s final substantive liability for the tax year, so the tax return filing will be the mechanism for obtaining any refund due the investor.
How will the regulations impact financial institutions acting as intermediaries on behalf of their customers that are partners in partnerships?
These regulations create significant disadvantages for investors holding USTB partnership interests through non-qualified intermediary accounts. Specifically, the regulations do not allow a withholding agent to rely on underlying partner information passed up by a nonqualified intermediary (an “NQI”) to determine the amount of withholding under section 1446(f). As a result, 10% withholding will be required on the full amount realized when paid to an NQI on behalf of their customer.
Consider the example where a USTB partnership interest is transferred in an NQI account that has passed up a Form W-8 from the non-U.S. resident partner that is exempt from section 1446(f) withholding under an applicable treaty. In that instance, the full 10% withholding would still be required as the regulations do not allow the withholding agent to consider the partner’s documentation.
While the IRS acknowledges the resulting overwithholding, they support a remedy only insofar as the NQI provides reporting to their customer for the purpose of seeking a credit for the amount withheld.
Qualified intermediaries (QIs) can expect a very different experience with significantly more flexibility. A QI is permitted to assume (or not assume) primary withholding responsibility under section 1446(f) on a sale of a PTP interest regardless of whether they assume other withholding responsibilities on FDAP income. Additionally, a QI may assume primary withholding responsibility under section 1446(f) for sales of PTP interests but not a distribution, and vice versa.
For QIs that do not assume primary withholding responsibility under section 1446(f), the Final Regulations allow a withholding agent to rely on a QIs allocation of an amount realized based on aggregate information about the account holders of the QI (i.e., withholding rate pools) transferring PTP interests to determine withholding. A broker may also rely on specific payee information provided by a QI with respect to a non-U.S. seller (rather than pooled information).
What should you be doing now for the Section 1446(f) regulations?
We recommend that clients consider the following:
- Review their holdings to check if they have any clients holding U.S. partnership securities.
- If so, are they held in segregated or omnibus accounts? If omnibus accounts, consider moving to segregated to ensure correct withholding, reporting and K1 distribution.
- Are they held through an NQI or QI designated account? If NQI, consider implications of holding through an NQI rather than a QI account.
- Consider how potential matching of client trades occur. Do you undertake internal transfers before trading? If so, how will you make certain a full record is kept ensuring correct withholding and reporting?
- Will you restrict holding of these assets going forward? If so, consider how this will be implemented.
- Have you communicated with your clients to ensure they fully understand the implications of holding U.S. securities under the new regime, including potentially requiring a U.S. TIN and the need to submit a U.S. tax return?
In the interim, please contact your local BBH Global Tax Services representative if you would like to discuss these recommendations further.
What is BBH doing now in light of these new regulations?
BBH has a project on-going to assess the impact to the Firm and we remain committed to sharing our insights and views on Section 1446(f) and related U.S. tax regulations. We expect to publish additional communications on any changes to service levels and product offerings for our customers on their PTP holdings, including changes to account types and documentation requirements.