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In Notice 2023-8, the IRS provides additional guidance on the final regulations under IRC Section 1446(f) for withholding on dispositions of interests in publicly traded partnerships (PTPs). The Notice addresses (1) withholding requirements for non-US PTPs, (2) reliance on late documentation and (3) when the short-sale exception applies. The Notice does not delay the effective date of withholding, which remains January 1, 2023.

The IRS said it intends to issue proposed regulations that would amend the final regulations to implement the guidance in the Notice.

Background

If IRC Section 864(c)(8) treats gain on a sale of an interest in a partnership as effectively connected with the conduct of a US trade or a business, IRC Section 1446(f) requires the transferee to withhold 10% of the amount realized, unless a relevant exception applies. For a transfer of a PTP interest, the regulations require the broker receiving the distribution on behalf of the transferor to withhold on the amount realized on the transfer unless:

• The broker can rely on a certification from the transferor claiming an exception or reduction to withholding or a representation by the PTP via qualified notice that the 10% exception under Treas. Reg. Section 1.1446(f)-4(b)(3)(ii) applies

or

• The payment is made to a qualified intermediary (QI) or entity that is treated as a US person for tax purposes and assumes primary withholding responsibility under IRC Section 1446(f)(1)

In Notice 2021-51, 2021-36 I.R.B. 361, the IRS deferred the applicability date of these provisions one year, to transfers occurring on or after January 1, 2023 (see Tax Alert 2021-1565). Subsequently, the revised, final Qualified Intermediary (QI) agreement in Revenue Procedure 2022-43, 2022-52 I.R.B. 570, effective as of January 1, 2023, required QIs to withhold under IRC Section 1446(f) upon the transfer of a PTP interest (see Tax Alert 2023-0011).

The notice applies to PTP sales and distributions made on or after January 1, 2023. Brokers (including QIs) may rely on the Notice until the proposed regulations are issued.

Non-US securities

The IRC Section 1446(f) regulations generally require withholding on the sale of all PTP interests, unless the PTP represents on a qualified notice that an exception applies. The qualified notice must state, as of the "PTP designated date," that either (1) the PTP represents that effectively connected gain on a hypothetical sale of PTP assets is either less than 10% of total gain, or none, or (2) the partnership was not engaged in a trade or business within the US. The PTP must have posted the qualified notice online during the 92 days before the transfer date.

Given the broad withholding implications of IRC Section 1446(f), non-US based entities are especially challenged by this provision, as they may not have analyzed the US tax classification of PTPs or issued qualified notices. Additionally, brokers struggle to maintain a worldwide list of all PTPs, particularly those that are traded on non-US securities markets.

The Notice partially addresses this challenge by allowing a broker to presume that a foreign-traded entity is not a PTP unless the broker has actual knowledge otherwise. If the broker knows a foreign-traded entity is a PTP, however, the broker must withhold under IRC Section 1446(f) on the disposition of a PTP interest unless the PTP issues a qualified notice that a withholding exception applies.

EY observes: A broker will need to determine when it "knows" a foreign-traded entity is a PTP and may try relying on vendor lists. Further, a foreign-traded entity that is a PTP is likely structured to meet a withholding exception. These entities will need to duplicate qualified notices every 92 days, as a longer period or "evergreen" qualified notices are not option.

Late-provided tax documentation

The IRC Section 1446 regulations do not currently address broker use of late-provided tax documentation to refund IRC Section 1446 withholding tax. The regulations also do not contain cross references to the Chapters 3 and 4 withholding provisions, which contain procedures for late-provided tax documentation.

The proposed changes in Notice 2023-8 will permit brokers to rely on late-provided tax documentation (referenced as "certifications" in the Notice) for purposes of IRC Section 1446(a) and 1446(f) withholding tax adjustments. This change applies to tax documentation provided by investors selling PTP interests and/or receiving PTP distributions.

The changes are similar to the limitations and requirements in the Chapters 3 and 4 regulations, and provide the following:

EY observes: Notice 2023-8 bases its timing requirements on when the "payment" is made. In contrast, the IRC Section 1446(f) regulations require a withholding determination based on the seller's status on trade date even though the withholding is applied on the settlement date (i.e., when gross proceeds are paid). The Notice does not address this distinction. In addition, the existing Chapters 3 and 4 regulations require documentary evidence (to establish foreign status) when tax documentation is provided more than a year after payment, regardless of whether a treaty claim is made. The Notice limits the documentary-evidence requirement to when treaty benefits are claimed. These differences in terminology and requirements are potentially an oversight in the Notice that may be clarified in the proposed regulations.

The Notice includes an example of a foreign partnership trying to claim the IRC Section 1446(f) modified amount realized (MAR). A broker may rely on late tax documentation if both the partnership's Form W-8IMY and the partners' underlying tax documentation satisfy the requirements discussed previously.

EY observes: The Notice does not specifically address late withholding statements or late partner allocations. It is not uncommon for foreign partnerships to provide updated withholding statements (or revised allocations) after a payment is made, and on a recurring basis. As drafted, it appears that overwithholding adjustments may be possible if the Form W-8IMY and/or the accompanying tax documentation satisfy these requirements, and only allocations to validly documented partners change.

Notice 2023-8 states that "the allowance for late certifications would apply to any certification used to claim an exception or reduction to withholding on the transfer of a PTP interest under [Treas. Reg. Section] 1.1446(f)-4."

EY Observes: Treas. Reg. Section 1.1446(f)-4 considers Form W-9 a "certification." The Notice appears to extend the late tax certification allowance (including affidavits) to Forms W-9. In addition, the example of the foreign partnership MAR calculation applies the late tax certification methodology "to establish a claim of non-foreign status" (i.e., a Form W-9) of an underlying partner. The Notice states, however, that "it is appropriate to allow brokers to rely on late certifications for purposes of withholding under [IRC S]ection 1446(f) in order to reduce overwithholding and claims for refund and to better coordinate with the documentation rules under [IRC S]ections 1441 and 1471." The late tax documentation rules do not permit refunds of backup withholding if a late Form W-9 is provided. This is a key consideration that needs to be clarified in the proposed regulations or through additional IRS guidance as it would significantly impact a broker's presumption rules for undocumented account holders.

Short sales

The IRC Section 1446(f) regulations do not address whether a short sale of a PTP interest is subject to the same 10% withholding as any other sale. In a short sale, an investor borrows securities (in this case, PTP interests), immediately sells them (which the IRS refers to as a "sale to market") and eventually replaces the borrowed securities with identical securities purchased on the open market or from other holdings of the borrower. The investor profits if the securities delivered to close the short sale cost less than the proceeds of the sale to market.

EY observes: In a typical case, the short seller momentarily possesses the PTP interest just before the sale to market, but arguably never intends to share in the partnership's joint profits. As a result, the short seller may not become a "partner" subject to the substantive tax under IRC Section 864(c)(8), which is the point of the withholding tax in IRC Section 1446(f). Additionally, gain on the closing of the short sale is typically triggered under the constructive sale rules of IRC Section 1259, not by the delivery of the PTP interest back to the party from whom the taxpayer borrowed it. See Revenue Ruling 2002-44, 2002-2 C.B. 84 (gain on closing of appreciated short stock position realized when closing trade is entered into, not when stock delivered). This gives the taxpayer another argument that the gain is not realized upon disposition of the PTP interest.

Notice 2023-8 states that the IRS and Treasury intend to amend the regulations to provide an exception to withholding in most cases for a short seller's sale to market and its delivery of identical PTP interests to close the short sale.

The government seems to be concerned, however, about situations where the investor holds the same PTP interests that it is selling short, such that the short sale amounts to a constructive sale under IRC Section 1259 or the delivery to close the short completes an actual sale of the pre-existing PTP position. The short sale exception will not apply if, on the date the sale to market is entered on the books of the broker, either (1) the investor holds substantially identical property (within the meaning of IRC Section 1233) in an account with the broker, or (2) the broker has actual knowledge that the taxpayer holds substantially identical property in an account with another broker, regardless of whether the pre-existing PTP position is actually delivered to close the short sale.

EY observes: It may be difficult to put into operation a check for "substantially identical" property held by the same investor at the same broker, potentially in other accounts. The IRS's approach contrasts with the wash sale regulations under IRC Section 6045, which generally limit the broker's responsibilities to the same account and the same CUSIP, even though the substantive rule for wash sales under IRC Section 1091 applies to "substantially identical" securities. The IRS seems to accept that brokers may not be able to make certain wash-sale adjustments. It remains to be seen whether a similar practical accommodation will be made for the short-sale exception in the IRC Section 1446(f) regulations.

When the short-sale exception does not apply, a broker's liability becomes fixed on the date the sale to market is booked, but the broker is not required to satisfy the withholding liability until payment is made, i.e., the sale to market settles and the cash becomes available. The deposit deadline would follow the standard deposit rules for Chapter 3 withholding under Treas. Reg. Section 1.6302-2.

EY observes: The Notice does not address a taxpayer's liability under IRC Section 864(c)(8). It is possible that a taxpayer could be liable for tax under that provision even if no withholding is required. This may affect taxpayers who acquire a PTP interest after the short position has been opened and do not immediately use that PTP interest to close out the short position.

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Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor