In October 2020, the US Internal Revenue Service (IRS) published the final regulations under section 1446(f) of the US Internal Revenue Code (IRC) (hereinafter “final regulations”). The final regulations set out the detailed withholding and reporting requirements in relation to a non-US person selling an interest in a partnership that is engaged in a US trade or business.

In this blog, we summarise how the final regulations and the planned changes to the Qualified Intermediary (QI) agreement affect non-US banks that hold publicly traded partnership (PTP) interests in custody for their clients. We also outline why acting as a Nonqualified Intermediary (NQI) with respect to PTP interests, which is a common practice amongst various Swiss and Liechtenstein banks, may no longer be a feasible approach as of 1 January 2022.

Legislative history

Sections 864(c)(8) and 1446(f) were added to the IRC in 2017 as part of the Tax Cuts and Jobs Act. Section 864(c)(8) provides rules for determining the amount of gain or loss that is treated as effectively connected with a US trade or business when a non-US person sells an interest in a partnership that is engaged in a US trade or business. Section 1446(f) provides withholding and reporting rules applicable to the transfer of partnership interests described in section 864(c)(8).

The IRS issued notices in 2017 and 2018 suspending the application of the rules for PTP interests and provided guidance for withholding on transfers of non-PTP interests.

In May 2019, the IRS issued proposed regulations under IRC section 1446(f). The final regulations retain the basic approach and structure of the proposed regulations, but include several modifications and clarifications.

The provisions of the final regulations generally have an applicability date of 29 January 2021, i.e. 60 days after publication in the Federal Register. However, certain provisions, including those pertaining to PTPs, go into effect for transfers taking place on or after 1 January 2022.

High-level summary of the rules for PTPs

As of 1 January 2022, a broker must generally withhold, and remit to the IRS, a tax equal to 10% of the gross proceeds from the sale of a PTP interest that is paid to a transferor (i.e. seller) that is a non-US customer or to a non-US broker. In addition, 1446(f) withholding is required on PTP distributions attributable to an amount in excess of cumulative net income on a qualified notice.

However, a broker is not required to withhold in the following situations (non-exhaustive):

• The amount realised is paid to a QI that:

- Assumes primary withholding responsibility for the payment, or

- Does not assume primary withholding responsibility for the payment but provides the broker with information indicating that the transferor is exempt from withholding (see below),

• The broker receives the amount realised from another broker that has withheld the full amount required,
• The broker receives a certification that the transferor is a US person (e.g. on IRS Form W-9),
• The broker receives a certification that the transferor is exempt from US withholding taxes on relevant gains under an income tax treaty (NB: the IRS announced that it will revise the instructions to Forms W-8BEN and W-8BEN-E to clarify how a treaty claim for a section 1446(f) payment must be documented),
• The broker relies on a qualified notice from the PTP indicating that no withholding is required (e.g. because PTP is not engaged in a US trade or business).

Irrespective of whether withholding is applied, a broker making relevant payments must report these on Forms 1042 and 1042-S.

Implications on QIs

A QI crediting the gross proceeds from the sale of PTP interests (and in-scope distributions) to its account holders qualifies as a broker for purposes of section 1446(f). The IRS announced that it will incorporate respective withholding and reporting obligations into the QI agreement. However, as the current QI agreement is valid until 31 December 2022 while the PTP rules become effective on 1 January 2022, the requirements for the year 2022 will be set forth in a rider (i.e. addendum) to the QI agreement. In this context, the IRS announced in the preamble to the final regulations that compliance with section 1446(f) will neither be included in the QI periodic reviews performed for the calendar year 2022 nor the QI periodic certifications for the certification period ending on 31 December 2022.

Based on the final regulations, the preamble as well as verbal comments made by IRS representatives at conferences, we understand that QIs will have three options to comply with their section 1446(f) obligations. We set out these three options below together with the corresponding documentation, withholding, and reporting practicalities.

1. QI assumes primary withholding responsibility: The preamble to the final regulations indicate that the IRS will grant QIs “appropriate flexibility to make appropriate arrangements to assume, or not assume, certain withholding responsibilities”. In particular, QIs will be allowed to assume primary withholding responsibility under section 1446(f) on a payment-by-payment basis. In addition, QIs may assume (or not assume) primary withholding responsibility under section 1446(f) regardless of whether they assume primary chapter 3 and 4 withholding responsibility, except that a QI that assumes primary withholding responsibilities on any portion of a PTP distribution will be required to assume primary withholding responsibilities for the entire distribution.

- Documentation: QI providers FORM W-8IMY to upstream custodian (no documentation regarding customers required to be provided to upstream custodian).

- Withholding: QI deducts withholding tax and makes deposits with the IRS.

- Reporting: QI reports the 1446(f) payment on Forms 1042 and 1042-S. For purposes of Form 1042-S, QI is permitted to report on a pooled basis to the extent allowed  for other payments under the QI agreement (even though some clients may nevertheless request separate reporting and a recipient copy).

2. QI does not assume primary withholding responsibility and provides withholding rate pool information upstream

- Documentation: QI provides upstream custodian with Form W-8IMY and a withholding statement allocating the payment to withholding rate pools of foreign transferors subject to 10% withholding, foreign transferors qualifying for an exception from withholding and/or US transferors included in a chapter 4 withholding rate pool of US payees.

- Withholding: Upstream custodian deducts withholding tax and makes deposits with the IRS.

- Reporting: QI reports the 1446(f) payment on Forms 1042 and 1042-S. For purposes of Form 1042-S, QI is permitted to report on a pooled basis to the extent allowed for other payments under the QI agreement (even though some clients may nevertheless request separate reporting and a recipient copy).

 3. QI does not assume primary withholding responsibility and provides recipient-specific information upstream

- Documentation: QI provides upstream custodian with Form W-8IMY, a withholding statement and documentation for each transferor (e.g. Form W-8BEN, W-8BEN-E or W-9).

- Withholding: Upstream custodian deducts withholding tax and makes deposits with the IRS.

- Reporting: QI has no reporting obligations with respect to the 1446(f) payments, although they are within the scope of the QI agreement. Instead, the upstream custodian treats the partner (i.e. the QI’s account holder) as the recipient for purposes of Form 1042-S reporting.

Notably, the IRS intends to incorporate the nominee reporting requirements (see Treas. Reg. §1.6031(c)-1T) into the QI agreement. Under these rules, the QI would additionally be required to provide certain information, including details about the partners (i.e. the QI’s account holders) to the partnership, which enables both the partnership to correctly report on Schedule K-1 (Form 1065) and the non-US partners to satisfy their own US income tax filing requirements. Until further details are published in the QI agreement, it is open to be confirmed whether providing recipient-specific information upstream would alleviate this burden.

Implications on NQIs

While various Swiss and Liechtenstein banks currently act in an NQI capacity with respect to PTP interests, this may no longer be a feasible approach as of 1 January 2022 because:

• An NQI receiving the gross proceeds from the sale of PTP interests (and in-scope distributions) is generally subject to 10% withholding, even if it discloses partner information to the upstream custodian,
• The upstream custodian reports the payment on Form 1042-S as paid to an unknown account holder, with the NQI reported as an intermediary for the amount (rather than as the recipient), which could potentially expose the bank acting as NQI to unwanted IRS scrutiny, and
• The NQI will be required to issue recipient-specific Forms 1042-S to the account holders to enable them to claim a credit for the amount withheld, which is generally not required in the QI scenario where the correct withholding is applied at source.
  Finally, it is worth noting that acting as an NQI, at least from a US perspective, does not provide relief from nominee reporting.

Deloitte's view: 

Non-US banks holding PTP interests in custody for their clients should familiarise themselves with the new rules and determine the best approach to comply with the section 1446(f) obligations.

The actual implementation work will vary depending on the approach taken. Obviously, the efforts will be higher for banks intending to act as primary QIs for 1446(f) payments. This is mainly due to the need to expand withholding systems and processes to cover gross proceeds from PTP interests (while current US withholding tax is mostly limited to income). However, even banks that plan to be non-primary QIs should consider the impact on the account set-up with the upstream custodian, documentation processes (from account holders and towards upstream custodian), the QI reporting and compliance, as well as the potential nominee reporting obligation. Finally, some banks may even decide after having performed a cost benefit analysis to exit the PTP business and cease to offer such investments to clients.

With less than 12 months until go-live (and no clear indication when the rider to the QI agreement will be published), non-US banks should take the first steps now to ensure 1446(f) compliance.

If you would like to discuss this topic further, please reach out to our key contacts below

Key contacts

Brandi Caruso - Partner, Financial Services Tax & Legal

Brandi heads Deloitte’s Financial Services Tax team in Switzerland and Liechtenstein. She has extensive expertise in advising the Swiss financial services industry on the implementation of U.S. and international transparency regimes (including QI, FATCA, Section 871(m), CRS, MDR and DAC6). Brandi leads the Financial Services Tax team efforts related to innovative technology solutions. Brandi is a U.S. Certified Public Accountant and has 20 years of experience with Deloitte and has worked in London and San Diego.

Email

Karim Schubiger – Director, Financial Services Tax 

Karim leads the Tax Transparency team in the Suisse Romande and Ticino markets within the Financial Services Tax & Legal practice, responsible for services related to QI, FATCA, CRS, 871(m) and DAC6. He is a technical advisor and subject matter expert to financial institutions in the banking, trust, and insurance sectors. Prior to joining Deloitte, Karim worked for eight years in support teams of Swiss banks, in particular in areas such as operations, project and change management as well as operational taxes.

Email

Robin King - Senior Manager, Financial Services Tax

Robin is a Senior Manager working in Financial Services Tax. He is currently advising leading Swiss universal and private banks, acting as subject matter expert in the area of QI, FATCA , CRS and DAC6. Robin is the author of several articles on CRS. Prior to joining Deloitte, he worked as a cross-border tax compliance expert at a Swiss private bank.

Email

Elena Bonsembiante - Manager Financial Services Tax

Elena is a QI, FATCA and CRS specialist and an Italian certified public accountant. She is leading as Manager several QI, FATCA and CRS projects for middle sized banks in the French and Italian speaking areas. Prior to joining Deloitte Switzerland, she worked for Deloitte Italy and other Italian Tax Firms. 

Email