We discussed the Tax Reform Act and Grecian Magnesite v
Commissioner in the May edition of International Tax
Review. The 2017 Tax Act added new Section 864(c)(8),
providing that if a non-resident alien individual or foreign
corporation owns, directly or indirectly, an interest in a
partnership that is engaged in a trade or business within the
US, gain or loss on the sale or exchange of all (or any portion
of) such interest will be treated as income that is effectively
connected with the conduct of a US trade or business (ECI).
This is the end result that the IRS unsuccessfully advocated in
Grecian, but the result the IRS wanted is now
Determining the amount of taxable ECI gain or loss will
present interesting issues under these new rules and likely
will give rise to some surprises. The statute says the amount
of gain or loss that is ECI is: (i) The portion of the
partner's distributive share of the amount of gain or loss that
would have been ECI, if the partnership had sold all of its
assets at their fair market value as of the date of the sale or
exchange of such interest; or (ii) Zero, if no gain or loss on
such deemed sale would have been ECI.
First, the source of the hypothetical gain must be
determined. Under section 865(i)(5), the section 865 source
rules are applied at the partner level. In this case the
partner will be a foreign person.
Under section 865(d), the gain on the deemed sale of
intangibles likely initially will be foreign source income
(although there is a special rule for goodwill that looks to
where the goodwill was 'generated').
Section 865(e)(2) can cause the gain, initially treated as
foreign source in the case of non-goodwill intangibles, to be
characterised as US source income if it is 'attributable' to a
US office of the foreign person under the principles of section
864(c)(5). See section 865(e)(3).
This was an issue addressed in Grecian Magnesite
Mining, although in the context of the sale of a
partnership interest, whereas under section 864(c)(8) it would
need to be addressed in the context of the hypothetical sale by
the partnership of all of its assets. In Grecian, the
Tax Court expressed skepticism over attributing the partner's
gain to a US office, although Grecian is on
Section 865(h) also provides a treaty election to
characterise the gain on the sale of an intangible (including
goodwill) that otherwise would be US source income as foreign
source income if a treaty would apply to treat it as foreign
source income. Perhaps any such treaty should override the Code
without the need for the election if the treaty post-dates the
enactment of section 865 (1986).
To the extent the gain on the hypothetical sale of the
partnership's assets constitutes foreign source income, it
would generally not constitute ECI. See section 864(c)(4). The
flush language in section 864(c)(4)(B) (regarding gain
equivalent to a royalty), however, should be considered,
although if applicable, section 865(e)(2) would also need to be
If the hypothetical gain is US source income from the sale
of a capital asset, section 864(c)(2) provides rules to
determine whether the gain is ECI. Other US source gain likely
is ECI under section 864(c)(3).
Real property is subject to the Real Property Tax Act
(FIRPTA), section 864(c)(8)(C).
As noted above, the gain on the sale of the partner's
partnership interest is ECI to the extent it does not exceed
the partner's distributive share of the deemed-sale ECI amount.
Applying the rules discussed above, the hypothetical
deemed-sale gain might be much smaller than initially
Under recent IRS Notice 2108-29, If the partnership's
calculations applying these rules showed that the partnership's
effectively connected gain under section 864(c)(8) would be
less than 25% of the total gain from the deemed sale of all of
its assets, then the transferee is relieved of its withholding
obligation under section 1446(f).
Jim Fuller (firstname.lastname@example.org)
and David Forst (email@example.com)
Fenwick & West