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Digital Economy: Supreme Court Overturns Physical Presence Requirement for State Sales Tax

In a landmark decision changing course on decades of precedent, the United States Supreme Court decided on June 21, 2018 South Dakota v. Wayfair, Inc., et al. Justice Kennedy, writing for the Court’s 5-4 majority, expressly overruled the physical presence rule established over fifty years ago in Bellas Hess[1] and affirmed over twenty-five years ago in Quill,[2] which prohibited states from collecting sales tax from online vendors lacking an in-state physical presence. While the Court stopped short of formally declaring the South Dakota tax statute constitutional, instead remanding the case to the South Dakota Supreme Court to resolve any other potential arguments under the Court’s “dormant Commerce Clause”[3] jurisprudence and under other existing case law,[4] the case strongly supports the view that the physical presence rule in Quill inadequately addressed the realities of the digital economy and its effects on interstate competition and state tax revenues.

Even under Quill, many states had passed a variety of measures aimed at recouping tax revenue from the expanding digital economy. These measures intended to capture sales and use tax revenue that had been lost from declining sales at brick-and-mortar retailers—where the right of a state to impose sales tax (regardless of the residence of the purchaser) is in no doubt. Wayfair is widely expected to be taken as a go-ahead for other states to adopt laws based on South Dakota’s model statute (likely with an eye to the details noted in the Court’s opinion). As a result, many internet-trade companies, especially smaller retailers, may face significant burdens in complying with the differing tax regimes of thousands of state and local jurisdictions.

The Majority Opinion’s Reasoning

The Court’s majority opinion declared that Quill was “unsound and incorrect.”[5] The physical presence rule was 1) not a necessary interpretation of the Complete Auto substantial nexus requirement; 2) created rather than resolved market distortions; and 3) imposed an “arbitrary, formalistic distinction” of the type rejected by the Court’s modern dormant Commerce Clause precedents. In addition, the Court noted that the physical presence rule was “an extraordinary imposition by the Judiciary on States’ authority to collect taxes and perform critical public functions.”

Throughout its opinion, the Court explained how the expansion of e-commerce had changed economic realities. Quill was decided prior to the Internet revolution, which exacerbated its shortcomings. As a result, the Court said, Quill “increased the revenue shortfall faced by States seeking to collect their sales and use taxes” and “put both local businesses and many interstate businesses with physical presence at a competitive disadvantage.”

The Future of Taxation of Interstate E-Commerce

As noted, though the Wayfair decision overturned Quill’s physical presence standard, it left open the possibility of challenging state taxes on other grounds under existing general dormant Commerce Clause jurisprudence. As a result, the statute, upon remand (and any similar tax statutes passed by other states) generally will be subject to the four-pronged test from Complete Auto[6]. According to Complete Auto, state taxes are valid under the Court’s dormant Commerce Clause jurisprudence so long as they 1) apply to an activity with a substantial nexus with the taxing state; 2) are fairly apportioned; 3) do not discriminate against interstate commerce; and 4) are fairly related to the services the state provides.

Applying the first element to South Dakota’s statute, the Court stated that the nexus was “clearly sufficient” because the sellers’ significant quantity of business could not have occurred unless they had availed themselves of “the substantial privilege of carrying on business in South Dakota.”

The Court suggested, without deciding, that several limitations in South Dakota’s statute would satisfy the second and third elements of the Complete Auto test. First, the law protected small retailers by setting a threshold requiring tax collection only from online vendors who conducted more than 200 separate in-state transactions or had annual in-state sales exceeding $100,000. Second, the obligation to collect tax did not apply retroactively. Third, South Dakota is one of more than 20 states that has adopted the Streamlined Sales and Use Tax Agreement, which reduces the administrative costs of compliance for retailers.

While states are widely expected to model legislation on the South Dakota statute, it remains to be seen just what modifications they will make, especially given the wide disparities between existing state tax regimes. States may attempt to lower the economic thresholds, even though they already provide scant protection in large states, such as California. Nor did the Court provide a clear answer on whether a retroactive statute would be unconstitutional. Finally, as acknowledged in the majority opinion, Congress may choose to resolve these remaining issues by taking action.

Please contact any of the authors listed here or any other Proskauer tax attorney with whom you normally consult to discuss the implications of Wayfair in your particular circumstances.

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The substantial assistance of summer law clerk Scott Tan in preparing this post is gratefully acknowledged by the authors.

 

[1] National Bellas Hess, Inc. v. Department of Revenue of Ill., 386 U.S. 753 (1967).

[2] Quill Corp. v. North Dakota, 504 U.S. 298 (1992).

[3] U.S. Const. Article 1, Section 8, Clause 3.

[4] Specifically, the opinion remanded for consideration of the other prongs of the four-pronged test of Complete Auto Transit, Inc. v Brady, 430 U.S. 274 (1977). The first prong, requiring a substantial nexus, was the prong at issue in Quill and Wayfair.

[5] As noted, the Opinion of the Court was written by Justice Kennedy and joined by Justices Thomas, Ginsburg, Alito and Gorsuch. Importantly, Chief Justice Roberts’s dissent (joined by Justices Breyer, Kagan and Sotomayor) takes little to no issue with the majority view that Bellas Hass and Quill were likely wrongly decided, but disagrees with the decision of the majority to overrule those decisions and would instead have put the issue squarely on Congress, where a number of bills to reach this result have been proposed over the years with no success.

[6] Complete Auto Transit, Inc. v Brady 430 U.S. 274 (1977).

Division of Corporate Finance Releases Updated C&DIs

On May 11, 2018, the Securities and Exchange Commission’s Division of Corporate Finance (the “Division”) released new Compliance and Disclosure Interpretations (“C&DIs”) comprising the Division’s new interpretations of the proxy rules and Schedules 14A and 14C. The new C&DIs replace interpretations previously published in the Division’s Proxy Rules and Schedule 14A Manual of Publicly Available Telephone Interpretations  and the Division’s March 1999 Supplement to the Manual of Publicly Available Telephone Interpretations (“Telephone Interpretations”).

Of interest for equity compensation matters is C&DI 161.03, which clarifies disclosure obligations in the New Plan Benefits Table that is required in a proxy statement pursuant to Item 10(a)(2) of Schedule 14A when shareholders are being asked to approve the adoption or material amendment of an equity plan. Previously, telephone interpretation guidance provided that when the New Plan Benefits Table is required in a proxy statement, even if an amount of “0” will be entered in the table, all of the individuals and groups for which award or benefit information is required should be listed in the table. New C&DI 161.03 updates this guidance in providing an alternative method of satisfying the Item 10(a)(2) requirement for individuals and groups for which award and benefit information to be reported is “0” through a narrative disclosure accompanying the New Plan Benefits Table, rather than in the New Plan Benefits Table itself. While such individuals and groups must still be reported, this C&DI provides some flexibility in the manner of reporting.

The Division noted that some of the new C&DIs reflect “substantive” changes to the previously available Telephone Interpretations, some reflect “technical revisions,” and the remaining reflect only non-substantive changes. The following table includes each of the new C&DIs identified by the Division as containing substantive or technical changes, together with the previously available Telephone Interpretation guidance that has now been superseded.

Substantive Changes

Prior Telephone Interpretation New C&DI
Cumulative voting rights disclosure

Rule 14a-4

The authority to cumulate votes among directors, in the discretion of the proxy, need not be printed in bold-face type on the proxy card itself pursuant to Rule 14a-4(b)(1). There should, however, be appropriate disclosure of cumulative voting in the proxy statement.

 

Cumulative voting rights disclosure

Question 124.01

Question: Rule 14a-4(b)(1) states that a proxy may confer discretionary authority with respect to matters as to which a choice has not been specified by the security holder, so long as the form of proxy states in bold-faced type how the proxy holder will vote where no choice is specified. If action is to be taken with respect to the election of directors and the persons solicited have cumulative voting rights, can a soliciting party cumulate votes among director nominees by simply indicating this in bold-faced type on the proxy card?

Answer: Yes, as long as state law grants the proxy holder the authority to exercise discretion to cumulate votes and does not require separate security holder approval with respect to cumulative voting. [May 11, 2018]

Preliminary proxy materials for shareholder submissions

7S. Rule 14a-4(c)(1), (c)(2)

(a) If a company receives timely and complete notice of a matter submitted by a shareholder in accordance with Rule 14a-4(c)(2)(i), the company does not have discretionary voting authority on the matter. Thus, if the company wants to vote its proxies on the matter at the annual meeting, it must include the matter on its proxy card and provide in its proxy statement the necessary disclosure, including, inter alia, information on how and why the company intends to vote on the matter. In this circumstance, the company may not rely on the discussion in Section IV(D) of Release No. 34-40018 (May 21, 1998) on filing proxy statements in preliminary form. The benefits of that interpretive position are available only when a company properly may exercise discretionary voting authority on a non Rule 14a-8 matter… Here, because the company has received timely and complete notice, thereby precluding it from exercising discretionary authority, the company cannot file a plain-vanilla proxy statement under Rule 14a-6.

(b) If the notice is timely but deficient (i.e., does not comply with the requirements listed in 14a-4(c)(2)(i) by, for example, failing to indicate that the proponent intends to deliver a proxy statement and form of proxy to holders of at least that percentage of the company’s voting shares necessary to approve the matter), the company would not be required to put the matter on its proxy card. However, the company’s ability to exercise discretionary authority is conditioned on including in its proxy statement advice on the nature of the matter and how the company intends to exercise its discretion to vote on that matter. The company’s ability to file a plain-vanilla proxy statement pursuant to Rule 14a-6 will depend upon, among other factors, the extent of its comments on, or discussion in, its proxy material of any solicitation in opposition in connection with the meeting. [Superseded]

Preliminary proxy materials for shareholder submissions

Question 124.07

Question: The Division has permitted registrants to avoid filing proxy materials in preliminary form despite receipt of adequate advance notification of a non-Rule 14a-8 matter as long as the registrant disclosed in its proxy statement the nature of the matter and how the registrant intends to exercise discretionary authority if the matter was actually represented for a vote at the meeting. See Section IV.D of Release No. 34-40018 (May 21, 1998). Can a registrant rely on this position if it cannot properly exercise discretionary authority on the matter in accordance with Rule 14a-4(c)(2)?

Answer: No. [May 11, 2018]

Preliminary proxy statements for corporate name changes

Rule 14a-6(a)

The caller raised the question whether a preliminary proxy statement need be filed in connection with a proposed corporate name change to be submitted for shareholder approval at the issuer’s annual meeting, along with a shareholder proposal and the election of directors. While the latter two items fall within one of five Rule 14a-6(a) exclusions from the preliminary proxy filing requirement, a change in the issuer’s name to delete the surname of a long-dead founder that bore no relation to a change in the present membership of the board of directors would not appear to qualify for exclusion under the literal reading of the rule.

As set forth in Exchange Act Rel. No. 25217 (Dec. 21, 1987), the underlying purpose of these exclusions is “to relieve registrants and the Commission of unnecessary administrative burdens and processing costs associated with the filing the processing of proxy material that is currently subject to selective review in preliminary form.” Consistent with this purpose and the reason for the name change proposal, the Division staff advised the requestor that a preliminary proxy filing relating to the planned name change was not required.

Preliminary proxy statements for corporate name changes

Question 126.02

Question: Is a registrant required to file a preliminary proxy statement in connection with a proposed corporate name change to be submitted for security holder approval at the annual meeting?

Answer: No. As set forth in Release No. 34-25217 (Dec. 21, 1987), the underlying purpose of the exclusions from the preliminary proxy filing requirement is “to relieve registrants and the Commission of unnecessary administrative burdens and preparation and processing costs associated with the filing and processing of proxy material that is currently subject to selective review procedures, but ordinarily is not selected for review in preliminary form.” Consistent with this purpose, a change in the registrant’s name, by itself, does not require the filing of a preliminary proxy statement. [May 11, 2018]

Information required pursuant to Note A of Schedule 14A

9S. Schedule 14A, Note A

Note A to Schedule 14A requires that information called for by Items 11, 13 and 14 be provided when security holders are asked to authorize the issuance of additional securities to be used to acquire another specified company when there will be no separate opportunity to vote on the acquisition. This would be the case even when the securities will be sold in a public offering for cash to finance the transaction. [Superseded]

Information required pursuant to Note A of Schedule 14A

Question 151.01

Question: A registrant solicits its security holders to approve the authorization of additional common stock for issuance in a public offering. While the registrant could use the cash proceeds from the public offering as consideration for a recently announced acquisition of another company, it has alternative means for fully financing the acquisition (such as available credit under an executed credit agreement in the full amount of the acquisition consideration) and may choose to use those alternative financing means instead. Would the proposal to authorize additional common stock “involve” the acquisition for purposes of Note A of Schedule 14A?

Answer: No. Raising proceeds through a sale of common stock is not an integral part of the acquisition transaction because at the time the acquisition consideration is payable, the registrant has other means of fully financing the acquisition. The proposal would therefore not involve the acquisition and Note A would not apply. By contrast, if the cash proceeds from the public offering are expected to be used to pay any material portion of the consideration for the acquisition, then Note A would apply. [May 11, 2018]

New Plan Benefits Table

Schedule 14A, Item 10(a)(2)

If the New Plan Benefits Table is required, all of the individuals and groups for which award or benefit information is required should be listed (including those for which the amount to be reported is “0”).

New Plan Benefits Table

Question 161.03

Question: If a registrant is required to disclose the New Plan Benefits Table called for under Item 10(a)(2) of Schedule 14A, should it list in the table all of the individuals and groups for which award and benefit information is required, even if the amount to be reported is “0”?

Answer: Yes. Alternatively, the registrant can choose to identify any individual or group for which the award and benefit information to be reported is “0” through narrative disclosure that accompanies the New Plan Benefits Table. [May 11, 2018]

Elimination of preemptive rights

** Schedule 14A **

A proxy statement requesting shareholder approval of the elimination of preemptive rights involves the modification of a security for purposes of Item 12 of Schedule 14A (and may be tantamount to creation of a new security, depending on the facts and circumstances, thereby raising an issue regarding Securities Act registration absent an exemption). Thus, the financial statement requirements of Item 13 would apply.

Elimination of preemptive rights

Question 163.01

Question: Does a proxy statement seeking security holder approval for the elimination of preemptive rights from a security involve a modification of that security for purposes of Item 12 of Schedule 14A?

Answer: Yes. Accordingly, financial and other information would be required in the proxy statement to the extent required by Item13 of Schedule 14A. [May 11, 2018]

Technical Revisions

Prior Telephone Interpretation New C&DI
Proxy card circulation in connection with Form S-4

** Rule 14a-6; Form S-4 **

A registrant can use its S-4 proxy statement/prospectus as a red herring. Since 1992, registrants have been able to solicit immediately upon filing of a preliminary proxy statement (absent invocation of confidential treatment under Rule 14a-6(e)(2)) rather than waiting 10 days pursuant to Rule 14a-6(a), so long as the proxy card (whether in preliminary or definitive form) is not circulated. Because a vote on the transaction described would amount to an investment decision with respect to the securities being registered, no proxy card could be sent until after the registration statement became effective and the final prospectus was furnished.

Proxy card circulation in connection with Form S-4

Question 126.04

Question: Can a registrant that filed a Form S-4 send proxy cards to its security holders upon the filing of a preliminary proxy statement/prospectus?

Answer: No, as Exchange Act Rule 14a-4(f) prohibits the delivery of proxy cards unless the security holders concurrently or previously received a definitive proxy statement filed with the Commission. Further, because a vote on the transaction described also would amount to a sale of the securities being registered, no proxy card can be sent until after the Form S-4 is declared effective and the final prospectus has been furnished to security holders. [May 11, 2018]

Filing of additional communications

** Rule 14a-6; Form S-4 **

An issuer filed a registration statement on Form S-4 that contained its proxy material. After the effective date of the registration statement, the issuer decided to mail an additional letter to shareholders in connection with the transaction. This letter is filed as additional soliciting material pursuant to Rule 14a-6 upon first use.

Filing of additional communications

Question 126.05

Question: A registrant files a registration statement on Form S-4 that contains its proxy statement disclosure pursuant to Instruction E.1 of Form S-4. After the effective date of the registration statement, the registrant sends an additional communication to security holders relating to the transaction. Does this communication need to be filed as other soliciting material pursuant to Rule 14a-6(b) no later than the date it is first sent or given to security holders?

Answer: Yes. Given the communication was sent after the furnishing of the definitive proxy statement, it should not be filed under Rule 14a-12. [May 11, 2018]

Disclosure requirements in connection with director elections

Schedule 14A

An issuer recently solicited proxies for the election of 15 directors. In about three months, the issuer hopes to acquire another company, and will hold a special meeting to elect one of the officers of the newly acquired company as a sixteenth director. The issuer asked whether the proxy material for the special meeting would have to include the information required by Items 6 and 7 of Schedule 14A for the 15 recently elected directors. The issuer was informed that Schedule 14A would require that information to be included in the proxy statement.

Disclosure requirements in connection with director elections

Question 158.01

Question: A registrant will hold a special meeting to elect one new person to its board of directors. The incumbent directors were elected at the annual security holder meeting three months ago and will not be up for re-election. Do the proxy materials for the special meeting have to include the information required by Items 7 and 8 of Schedule 14A for the incumbent directors?

Answer: Yes. [May 11, 2018]

Director disclosure in connection with merger

Schedule 14A, Note A

B is to be merged into A in a Rule 145 transaction. B’s shareholders will be voting to approve the transaction and will become shareholders of A. A’s shareholders are not voting on the proposed transaction. Three of B’s directors will become directors of A. Pursuant to Note A to Schedule 14A the Form S-4 should contain the information required by Items 6 and 7 of Schedule 14A as to the A directors.

Director disclosure in connection with merger

Question 158.03

Question: B is to be merged into A in a Rule 145 transaction. B’s security holders will be voting to approve the proposed transaction and will become security holders of A. A’s security holders are not voting on the proposed transaction. Three of B’s directors will become directors of A. Is it necessary to include the information required by Items 7 and 8 of Schedule 14A as to the directors of A in A’s Form S-4, which includes B’s proxy statement?

Answer: Yes. Pursuant to Note A to Schedule 14A, the Form S-4 should contain the information required by Items 7 and 8 of Schedule 14A as to the A directors. [May 11, 2018]

UK Tax Round Up: May 2018

Welcome to the May edition of the Proskauer UK Tax Round Up. This month we saw Advocate Generals’ opinions in two European Court VAT cases with UK implications and welcome European Commission State Aid approval for EMI option schemes which had expired.

Please view this month’s issue of the UK Tax Round Up.

UK Tax Round Up: June 2018

Welcome to the June edition of the Proskauer UK Tax Round Up. The last month has been relatively quiet in terms of new announcements and developments. We expect more activity over the next few weeks as the draft Finance (No.3) Bill will be published on 6 July 2018.

Please view this month’s issue of the UK Tax Round Up.

UK Tax Round Up: April 2018

Welcome to the April edition of the Proskauer UK Tax Round Up. This month saw changes to the taxation of termination payments and the UK’s adoption of the OECD Multilateral Instrument into its double tax treaties coming a step closer.

Please view this month’s issue of the UK Tax Round Up.

Tax Reform – I.R.S. Updates Withholding Tax Guidance on Sales of Partnership Interests

On April 2, 2018, the Internal Revenue Service (“IRS”) released Notice 2018-29[1] (the “Notice”), announcing the intention of the IRS and the Department of the Treasury to issue regulations regarding the withholding requirements under Section 1446(f),[2] which was promulgated pursuant to recently enacted U.S. tax legislation, commonly referred to as the “Tax Cuts and Jobs Act”.[3] The Notice also provided interim guidance that taxpayers may rely on until further guidance is issued.

The Notice does not affect the suspension of withholding pursuant to Section 1446(f) for publicly traded partnerships under Notice 2018-08, issued in December of 2017, nor does the guidance related to Section 1446(f) affect a transferor’s tax liability under Section 864(c)(8).

General Rules

For dispositions of partnership interests occurring after December 31, 2017, Section 1446(f) generally requires the transferee to withhold and remit 10 percent of the “amount realized” by the transferor, if any portion of the gain (if any) realized by the transferor would be treated as effectively connected with the conduct of a trade or business in the United States under Section 864(c)(8). The “amount realized” generally includes proceeds (whether cash or other property) as well as any liabilities deemed assumed by the transferee for tax purposes. Though Section 1446(f) generally requires a transferee to effect the withholding, Section 1446(f)(4) imposes a secondary obligation on the transferred partnership: in the event the transferee fails to withhold and remit the appropriate amount, the partnership is required to withhold and remit the amount of the shortfall (together with interest) from its subsequent distributions to the transferee.

Reporting and Paying Over Withheld Amounts

In the Notice, the IRS has indicated that the procedural regime that exists under the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”) and Section 1445 generally will also apply to Section 1446(f). Generally, this will mean reporting and paying over any withheld amounts within 20 days of the relevant transfer. The IRS has asserted that withholding agents will not be subject to interest and penalties on account of late payment if any withholding that, per the Notice, is due prior to May 31, 2018, is paid in full on or prior to May 31, 2018.

The IRS is not currently issuing new forms for Section 1446, and taxpayers are generally instructed to continue to use the forms required under Section 1445 (with “Section 1446(f)(1) withholding” noted on the relevant form).

Where withholding is required under both Section 1445 and Section 1446(f), the transferee need only withhold pursuant to Section 1445 (unless the transferor has obtained a withholding certificate pursuant to Treasury Regulations Section 1.1445-11T(d)(1), in which case the transferee must withhold the greater of the amount required to be withheld pursuant to Section 1445 and the amount required to be withheld pursuant to Section 1446(f)).

Suspension of Secondary Partnership Withholding Obligation

Until further guidance is provided, the IRS has suspended the secondary withholding obligation imposed on partnerships in the event a transferee fails to appropriately withhold in accordance with Section 1446(f).

Exceptions to Withholding Requirements

Pursuant to the statutory exception provided in Section 1446(f)(2), the IRS has provided that withholding will not be required where a transferor certifies its non-foreign status in an affidavit, signed under penalties of perjury, containing the transferor’s U.S. taxpayer identification number (if applicable). Generally, a correct and complete Form W-9 will satisfy these requirements. Until the IRS issues further guidance, such certifications should not be remitted to the IRS. As with FIRPTA, where a transferee has actual knowledge, or receives notice from its agent or the transferor’s agent, that a certification is false, the certification may not be relied upon.

In addition to the statutory exception, the Notice provides that withholding is generally not required where (i) a transferor certifies that no gain will be realized in the disposition, (ii) a transferor certifies, no more than 30 days prior to the date of transfer, that, for the “immediately prior taxable year”[4] and the two taxable years that precede it, it has been a partner in the partnership for the entirety of each such taxable year and its share of effectively connected taxable income (as determined under Treasury Regulations Section 1.1446-2) for each such taxable year was less than 25% of its total distributive share for such year,[5] or (iii) the transferred partnership certifies, no more than 30 days prior to the date of transfer, that the amount of gain that would be treated as effectively connected with the conduct of a trade or business within the United States if the partnership were to sell all of its assets as of the date of the certification would be less than 25% of the total gain.[6] As with the certification of non-foreign status, these certificates must be signed under penalties of perjury, and the certifications provided by the transferor must also contain the transferor’s U.S. taxpayer identification number (if applicable).

Lastly, the IRS has provided that no withholding is required in nonrecognition transactions where the transferor provides the transferee a notice that satisfies the requirements of Treasury Regulations Section 1.1445-2(d)(2) (which also requires that the relevant statement be made under penalties of perjury), treating references therein to “1445(a)” and “U.S. real property interest” as references to “1446(f)” and “partnership interest”, respectively (though until further guidance is issued, transferees should not remit such notices to the IRS). The IRS specifically noted that future regulations regarding the treatment of nonrecognition transactions under Section 864(c)(8) may impact this.

Determining Partnership Liabilities included in Amount Realized

For purposes of determining the amount of liabilities included in a transferor’s amount realized, the IRS has generally provided for certificates that may be issued (under penalties of perjury) in certain circumstances by certain transferors or transferred partnerships. These certificates will generally allow a transferee to rely on the amount of partnership liabilities reported as apportioned to the transferor on the most-recent Schedule K-1 (Form 1065) of the transferred partnership, and will need to state that the certifier has no actual knowledge of events that would alter such amount by 25 percent or more.

No Withholding in Excess of Proceeds Paid

The Notice generally provides that in no event shall a transferee be required to withhold an amount in excess of the amount realized less the liabilities deemed assumed by the transferee in the transfer. This means there is no “dry withholding” requirement – as a transferee’s obligation to withhold is capped by the cash or other property paid in the transaction.

Application to Distributions

In clarifying that Section 1446(f) also applied to certain partnership distributions, the IRS has provided that a partnership may rely on either its own books and records or a certification from the distributee partner when determining whether the distribution exceeds the partner’s basis in its partnership interest, and thus whether the distribution will be, at least in part, treated as a transfer subject to Section 1446(f).

Application to Tiered Partnerships

A look-through rule will be used to determine the amount of effectively connected taxable income realized pursuant to Section 864(c)(8) by a transferor that disposes of an ‘upper-tier’ partnership that also owns ‘lower-tier’ partnerships. The IRS has indicated that future regulations will require lower-tier partnerships to furnish information to upper-tier partnerships in order to effectuate this look-through rule and related withholding obligations.

Request for Comments

The IRS has also requested comments on the rules to be issued under Section 1446(f). Of specific interest, the IRS has asked for comments regarding (i) rules for determining the amount realized, including when the required withholding exceeds the proceeds of a sale and (ii) procedures that reduce the amount to be withheld, including in connection with “identifiable historically compliant taxpayers”.

Former summer associate Christine Sherman provided invaluable assistance in preparation of this update

[1] “Guidance Regarding the Implementation of New Section 1446(f) for Partnership Interests That Are Not Publicly Traded.”

[2] Unless otherwise noted, all references to ‘Sections’ herein are references to sections of the Internal Revenue Code of 1986, as amended.

[3] Public Law No: 115-97, enacted December 22, 2017. The legislation does not have a short title; the official title is “H.R.1 – An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018.”

[4] A transferor’s “immediately prior taxable year” is the most recent taxable year of the transferor that includes the partnership taxable year that ends with or within the transferor’s taxable year and for which both a Form 8805, Foreign Partner’s Information Statement of Section 1446 Withholding Tax, and a Schedule K-1 (Form 1065) were due (including extensions) or filed (if earlier) by the time of the transfer. This appears to mean that, for a transferor that files on a calendar-year basis and transfers as of, say, January 1, 2018, the “immediately prior taxable year” would actually be 2016 – but further guidance from the IRS will be necessary to confirm that.

[5] Transferees may not rely on such certificates prior to the transferor’s receipt of the relevant Schedule K-1s (Forms 1065) and Forms 8805.

[6] For the 25% tests described in (ii) and (iii), the IRS is considering lowering the withholding threshold. This would have the impact of subjecting more transfers to withholding.

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