Canada: IRS Issues New Regulations For Withholding On Effectively Connected Income Allocable To Foreign Partners

On May 13, 2005, the Treasury Department issued final and temporary regulations (T.D. 9200) and proposed regulations (REG-108524-00) as guidance on the withholding tax obligation – under section 1446 – of partnerships that are engaged in a U.S. trade or business and have one or more foreign partners.

A foreign person that conducts a trade or business in the United States generally is subject to U.S. tax on the income that is effectively connected with that trade or business. Similar rules apply to income earned by a foreign person through a partnership that is engaged in a U.S. trade or business.

A partnership that is engaged in a U.S. trade or business is required to withhold and pay over tax to the extent that its net income that is effectively connected with its U.S. trade or business is allocable to a foreign partner. The amount of the tax due generally is computed by applying the foreign partner’s highest marginal income tax rate to the amount of the partnership's effectively connected income that is allocable to its foreign partners.

The regulations are generally favorable and have incorporated some of the recommendations of practitioners. One area where relief was not provided is in the context of cancellation of indebtedness.

The following is a summary of significant aspects of the newly issued regulations:

Lower Tax Rates For Capital Gains

The prior revenue procedures did not address income subject to special rates of tax, such as the 15% maximum tax rate for long-term capital gains for non-corporate taxpayers. The final regulations favorably provide that partnerships may consider the type of gain or other special items of income allocable to a foreign partner during the taxable year when computing its section 1446 obligation. For example, a partnership can give a foreign partner other than a corporation the benefit of preferential capital gains tax rates. Certain certification will be required to obtain the reduced rate.


Since the quarterly payments are necessarily based on estimates, it is quite possible that, viewed at the end of the year, too much tax will have been withheld. The prior revenue procedures allowed a partnership to obtain a refund of the section 1446 tax. The 2003 proposed regulations would have dropped this rule, so that only the partners could obtain refunds. The final regulations return to the approach of the prior revenue procedures, permitting refunds at the partnership level.


Because a partnership is only required to perform section 1446 withholding with respect to its foreign partners, a partnership has to determine whether a partner is foreign. The prior guidance included a process to certify status but the process was not integrated with the nonresident alien withholding rules for interest and dividends under Code sections 1441 and 1442. The documentation requirements under the final regulations are generally consistent with the nonresident alien withholding rules for interest and dividends. For example, U.S. individuals and corporations may certify their status on Form W-9, and foreign individuals and corporations may certify their status on Form W-8BEN. However, there are two significant differences. First, a partner that is a domestic grantor trust with a foreign beneficiary will be treated as a foreign partner for purposes of section 1446. Second, a foreign simple trust will be treated as an entity for purposes of section 1446, whereas it is treated as a flow-through entity for purposes of sections 1441 and 1442. These rules will require domestic grantor trusts and foreign simple trusts to be doubledocumented, using one kind of documentation for section 1446 and another kind for sections 1441 and 1442.

Partner-level Attributes

When a foreign partner has losses and deductions (that are effectively connected with a U.S. trade or business) outside of the partnership, withholding at the maximum rate on his share of the partnership’s taxable income frequently will result in the overstatement of his liability. Such an overstatement of liability can be particularly burdensome if the partnership income in question is non-cash income, such as cancellation-of-indebtedness income or income from a deed in lieu of foreclosure – the partnership may not have any cash to make section 1446 payments. There was no relief provided in such circumstances in the prior revenue procedures, and the IRS noted the issue in the proposed regulations. Under the new temporary regulations, certain foreign partners will be able to certify that they have losses, loss carry-forwards, etc., outside of the partnership that will reduce their tax liability on their share of the partnership’s income, which will enable the partnership to reduce withholding accordingly. The partnership will be liable if such certification proves to be wrong, however, and so this alternative may not be used often, except in related-party situations or where an adequate indemnity is provided. More general relief from withholding in the case of cancellation-of-indebtedness income, deeds in lieu of foreclosure, and other distress situations has not been provided in the new regulations.

Foreign Partnerships Owning Interests in U.S. Partnerships

If a foreign partnership is a partner in a U.S. partnership, prior revenue procedures required withholding on the foreign partnership’s entire share of ECTI from the U.S. partnership, even if some of the partners in the foreign partnership were U.S. persons who would have been exempt if they had been direct partners in the U.S. partnership. This situation is alleviated in the final regulations: the foreign partnership can now pass through documentation from its partners to the lower-tier U.S. partnership, so that the U.S. partnership will only withhold on income allocable to the foreign partners of the upper-tier foreign partnership.

Tiered U.S. Partnerships

Ordinarily, if one U.S. partnership is a partner in a second U.S. partnership, the upper-tier partnership is responsible for any section 1446 obligations. Under the final regulations, if both partnerships agree, the upper-tier U.S. partnership can pass along documentation about its partners to the lower-tier U.S. partnership, which will take over any necessary section 1446 withholding with respect any foreign partners of the upper-tier U.S. partnership. There was no comparable prior procedure.

1445/1446 Overlap

If a U.S. partnership with foreign partners sells real estate, in principle withholding could be required under section 1446 as well as the section 1445 (FIRPTA) rules. The final regulations reconfirm that any necessary withholding will be done under the section 1446 rules, not the section 1445 rules. Thus, it will not be possible to obtain a special certificate under the section 1445 procedures to reduce or eliminate withholding under section 1446.

Effective Dates

The final regulations are effective for partnership tax years beginning after May 18, 2005. However, a partnership may elect to apply the provisions of the final regulations to partnership tax years beginning after December 31, 2004.

The final regulations render the prior revenue procedures, i.e., Rev. Proc. 89-31 (1989-1 C.B. 895) and Rev. Proc. 92-66 (1992-2 C.B. 428) obsolete for partnership tax years beginning after May 18, 2005, or for partnership tax years beginning after December 31, 2004, if the partnership makes an election under Treas. Reg. section 1.1446-7.

The temporary regulations are effective for partnership tax years beginning after May 18, 2005. However, a partnership may elect to apply the temporary regulations to partnership tax years beginning after December 31, 2004, provided the partnership also elects to apply the final regulations under Reg. sections 1.1446-1 through 1.1446-5 to partnership tax years beginning after December 31, 2004.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.