Our previous post, The Code Fails to Define a “U.S. Trade or Business,” even though You’re Still on the Hook for Paying Taxes on It, we discussed the broad terminology behind what classifies as a U.S. trade or business. In particular, we discussed how there is no bright line definition for the term and how it instead requires an analysis of the nonresident alien’s facts and circumstances. Recently, however, one question has come to the forefront of this discussion: is a nonresident alien’s sale of a partnership interest in a partnership conducting a U.S. trade or business itself a U.S. trade or business? Under the new Tax Cuts and Jobs Act of 2017, the answer is yes. Be sure to remember here, that a nonresident alien is either an individual or entity who has not fulfilled one of the U.S. residency tests discussed in our blog titled U.S. Residents are Taxable, U.S. Persons: So, What is a “U.S. Resident”?
Section 864(c)(8) of the Code specifically deals with the “Gain or Loss of Foreign Persons from Sale or Exchange of Certain Partnership Interests.” In particular, it states that “if a nonresident alien individual or foreign corporation owns, directly or indirectly, an interest in a partnership which is engaged in any trade or business within the United States, gain or loss on the sale or exchange of all (or any portion of) such interest shall be treated as effectively connected with the conduct of such trade or business to the extent such gain or loss does not exceed the amount determined under subparagraph (B).”
To summarize this section, if a nonresident alien sells either part or whole of their interest in a partnership engaged in a U.S. trade or business, then the gain or loss will be treated as taxable ECI. However, the amount of ECI realized from this sale is limited to “an amount determined under subparagraph (B).”
Under 864(c)(8)(b), ECI is limited to the portion of the partner’s distributive share of the gain or loss which would have been considered ECI if the partnership had sold all of its assets at their fair market value on the date of sale. If no loss or gain on this hypothetical sale of all of the partnership’s assets would be ECI, then no amount will be considered as ECI, and the nonresident alien will not be taxed on the sale.
If you need help delineating whether these sections may be applicable to your or your client’s proposed sale of partnership interest, then please contact us at AsenaAdvisors.com. Please note, that this blog provides an overarching discussion of the relevant sections, and that other sections may be applicable to you or your client’s scenario; for example, if the partnership holds an interest in U.S. real property, then a further analysis must be conducted to determine the amount and nature of your or your client’s U.S. tax obligation.