Compliance requirements for foreign partnerships.

The recently issued proposed regulations on return requirements shift the compliance burden from a partnership to its partners for foreign partnerships not engaged in a trade or business in the U.S. When the regulations are issued in final form, the tax return filing requirement for U.S. partners in foreign partnerships will parallel those for U.S. shareholders in controlled foreign corporations (CFCs).

TEFRA 

The U.S. filing requirements for foreign partnerships have never had a definitive set of rules. In 1982, the Tax Equity and Fiscal Responsibility Act (TEFRA) amended the Code, requiring partnerships to furnish to every U.S. person, who was a partner in that partnership at any time during the tax year, a copy of the information on the partnership return to the extent required by the regulations.

1986 Regulations

Regulations proposed in 1986 provided a filing exception for a foreign partnership, without any income from sources within the U.S., that did not conduct a business in the U.S., with the exception of a partnership in which a U.S. person held an interest (directly or indirectly) in the partnership of 25% or more of any item of income, gain, loss, deduction or credit.

TRA '97

The Taxpayer Relief Act of 1997 (TRA '97) modified the filing requirements for foreign partnerships; a foreign partnership must file a partnership return for any tax year that it engages in a U.S. trade or business or has U.S.-source income. Otherwise, reporting rules similar to those applicable to CFCs apply to foreign partnerships. In that circumstance, a U.S. partner who controls a foreign partnership must file an annual information return. A U.S. partner controls a foreign partnership if the partner holds a more-than-50% interest in the partnership's capital, profits or (to the extent provided in the regulations) losses. A U.S. 10% partner of a foreign partnership controlled by U.S. 10% partners requires similar reporting. Failing to comply with the reporting requirements results in a $10,000 penalty; additional penalties of up to $50,000 apply when noncompliance continues after notification.

A U.S. person involved in an acquisition or disposition of a foreign partnership interest (or a change in that person's proportional interest) must report acquisitions, dispositions or changes involving at least a 10% interest. Failing to comply with these reporting requirements results in a $10,000 penalty; additional penalties of up to $50,000 apply when noncompliance continues after notification.

Reporting rules similar to those under present law involving transfers by U.S. persons to foreign corporations apply to foreign partnerships. These rules apply to transfers to foreign partnerships only if the U.S. person holds at least a 10% interest in the partnership or the value of the property transferred by that person for the partnership during a 12-month period exceeds $100,000. The penalty, equal to 10% of the value of the transferred property, applies to a failure to comply with these reporting requirements.

The TRA '97 provisions were generally effective for partnership tax years beginning on or after Aug. 5, 1997.

1998 Proposed Regulations

In January 1998, the IRS issued two sets of proposed regulations that would supersede the existing 1986 proposed regulations. A partnership following the existing proposed regulations, for all tax years prior to the 1998 effective date of the proposed amendments, would be treated as fully complying with the partnership filing requirements for those tax years.

A foreign partnership without any effectively connected gross income and required to file a partnership return only because it has U.S.-source gross income, would be exempt from filing if (1) no U.S. person has a direct or indirect partnership interest, (2) the gross income derived from sources within the U.S. is an amount subject to withholding, (3) Forms 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, are filed for the U.S.-source gross income and (4) the tax liability of the partners for that gross income is fully satisfied because tax has been withheld at the source.

A foreign partnership otherwise exempt from the filing requirements that wants to make a partnership-level election would be required to file a partnership return for the election year.

Thus, despite the increased reporting requirements of the TRA '97, the proposed regulations eliminated the 25%-threshold reporting requirement in the 1986 proposed regulations.

In September 1998, the Service issued Prop. Regs. Sec. 1.6038-3, implementing the compliance rules for partnership filings of foreign partnerships without any U.S.-source income or activities. Certain U.S. persons would have to provide information relating to their foreign partnership on a new form, Form 8865, Information Return of U.S. Persons With Respect To Certain Foreign Partnerships, requiring controlling partners (more than 50% ownership) of foreign partnerships to report information concerning the partnership's income and assets, certain transactions, the partners' names and other information. The form would require a partner with at least a 10% interest in a controlled foreign partnership (when there is no U.S. controlling partner) to report information only for its own partnership interest. Form 8865 would also be used to report acquisitions and dispositions of foreign partnership interests. These proposed regulations provide that U.S. indirect partners would not have to file under Sec. 6038 as long as the U.S. person to whom ownership is attributed files the information and the indirect partner includes a statement with his income tax return that identifies the U.S. person who meets the filing requirements.

The Form 8865 would be filed with the U.S. partner's income tax return (including a partnership return) for the tax year in which the partnership's annual accounting period ends. If required by the Form 8865 instructions, a duplicate Form 8865 would also be filed in Philadelphia. The proposed regulations would apply for annual accounting periods beginning after the date that these regulations are published as final in the Federal Register.

A draft of Form 8865 has been released and is available for comments on the IRS Website. As a practical matter, advisers to partners in foreign partnerships and those who had prepared their partnership returns would likely have to report as much information as before, even though the burden to report would shift to the partner. Until the regulations are finalized and the new forms are available for filing, it may be prudent to continue to file Form 1065, U.S. Partnership Income Tax Return Form, for foreign partnerships.

FROM NANCY L. BERK, CPA, NEW YORK, NY