Foreign Partnership Definition | International Business Tax Lawyers

Defining a partnership as “foreign” or “domestic” can be highly important for US tax purposes. In this article, I will explain the foreign partnership definition and explain its significance.

Foreign Partnership Definition: Importance

There may be important US international tax law consequences that stem from whether a partnership is classified as “foreign” or “domestic”. These consequences may encompass not only income tax compliance, but also the type of information returns that may have to be filed. Even tax withholding requirements may be affected by this classification.

Let me give you a few examples of where foreign partnership directly appears in the IRC (Internal Revenue Code) in order for you to appreciate the significance of the foreign partnership definition. The term foreign partnership appears in such diverse provisions as IRC §6046A (filing of information returns by U.S. persons with regard to acquisition, disposition, or substantial change of interest in foreign partnership – this is the famous IRS Form 8865), §3401(d)(2) (wage withholding), §168(h)(5) (tax-exempt entity leasing rules) and even tax withholding rules for disposition of US real property under §1445.

The main reason for this significance of the foreign partnership definition lies in §7701(a)(30), which states that a foreign partnership is not a “US Person”, a highly important term of art in US international tax law. The implications of being a “foreign person” rather than a “US person” can be huge, extending as far as affecting anti-deferral tax regimes.

Foreign Partnership Definition: Formal Partnership

Let’s delve now into the foreign partnership definition. Our starting point is §7701(a)(5); it states that a partnership is considered to be foreign as long as it is “not domestic”. §7701(a)(4) defines domestic partnership as those which were “created or organized in the United States, or under the law of the United States or of any State.”

Under §7701(a)(9), the term “United States” includes only the states and the District of Columbia. In other words, if a partnership is formally organized in any place other than the fifty states of the United States and the District of Columbia, it is a foreign partnership.

What about partnerships created or organized in US possessions? The IRS and the courts have consistently stated that they are foreign (though there are more examples of these rulings with respect to corporations rather than partnerships).

What if a partnership is chartered both in the United States and another country? Without delving too deeply into legal analysis, pursuant to Treas. Reg. §301.7701-5(a), such a partnership would be classified as a domestic entity

Foreign Partnership Definition: Common Law/Private Agreement Partnerships

The above definition only works well in cases where a partnership is formally created or organized under the laws of a country. However, it is also possible for the IRS to classify a contractual relationship as a partnership for tax purposes. In these cases, the determination of whether a partnership is a foreign or domestic for US international tax purposes is a lot more difficult.

At this point, there is no absolute clarity provided by the IRS on this issue. However, there are two main approaches for determining whether a deemed partnership is domestic or foreign that may be acceptable to the IRS: (1) the contract’s governing law; and (2) primary location of the business of the deemed partnership. Let’s review these approaches.

Foreign Partnership Definition for Deemed Partnerships: Governing Law Approach

The governing law approach to classification of partnerships as foreign or domestic states that a partnership should be classified as foreign or domestic depending on the governing law which controls the agreement that gave rise to the deemed partnership.

The IRS often likes this approach, because it pretty much mimics the foreign partnership definition for formal partnerships described above. In other words, while in a formal partnership we look at the place of organization, the governing law approach for deemed partnerships basically looks at the jurisdiction which controls the legal enforcement of the partnership agreement. Both approaches are based on the premise that the foreign partnership definition should depend on whether the partners’ rights and duties are defined under domestic or foreign law.

Foreign Partnership Definition for Deemed Partnerships: Business Location Approach

The primary location of business approach, on the other hand, seeks to classify a deemed partnership not based on where the partners’ rights and duties are defined, but based on where the business of the partnership is actually conducted. The advantage of this approach is that it is closer to business reality and does not artificially classify a partnership based on which law governs it.

There are, however, problems with this approach which make the IRS like it a lot less. First of all, it is very difficult to apply this approach to a partnership with extensive business operations within and outside of the United States. Second, the classification of the same partnership may often switch depending on the shift in the volume of its US operations versus foreign operations.

Contact Sherayzen Law Office for Help With Foreign Partnership Definition

If you are unclear about the classification of your partnership for US tax purposes or you wish to change the existing classification for US tax planning purposes, contact the US international tax law firm of Sherayzen Law Office for professional help. We Can Help You!

Foreign Partnership Tax Attorneys: Filing Form 8865 Schedule O (Part I)

Foreign Partnership Tax Attorneys should point out to their clients that Form 8865 should be used by US taxpayers to report the information required under IRC section 6038 (reporting regarding controlled foreign partnerships), section 6038B (reporting of transfers made to foreign partnerships), and/or section 6046A (reporting of acquisitions, dispositions, and changes in foreign partnership interests).

This article will explain the basics of Part I (“Transfers Reportable Under Section 6038B”) for Schedule O– “Transfer of Property to a Foreign Partnership”, an additional form submitted with Form 8865 that must be completed by certain categories of taxpayers. This article is not intended to convey tax or legal advice. US-International partnership taxation can involve many complex tax and legal issues, so you are advised to seek an experienced attorney in these matters. Sherayzen Law Office, Ltd. can assist you in all of your tax and legal needs, and help you avoid making costly mistakes.

Foreign Partnership Tax Attorneys: Who Must File Schedule O?

Schedule O is typically required to be filed by Category 3 filers under the Form 8865 instructions. In general, Category 3 filers are US persons who contributed property during their tax year to a foreign partnership in exchange for a partnership interest in the partnership (a section 721 transfer), if such persons either owned (directly or constructively) at least a 10% interest in the foreign partnership immediately after the contribution, or if value of the property contributed, when added to the value of any other property contributed to the partnership by such persons (including related persons), during the 12-month period ending on the date of the contribution is greater than $100,000.

Note, this is a general summary of Category 3 filers, and does not include all possibilities. It is very important to consult a foreign partnership tax attorney for help. Please see the instructions or contact Sherayzen Law Office for further details.

Foreign Partnership Tax Attorneys: Schedule O, Part I (“Transfers Reportable Under Section 6038B”)

Part I of Schedule O is used to report the contribution of property to a foreign partnership. In column (a), taxpayers must fill out the date of the property transfer (and if the transfer consisted of multiple transactions over a number of dates, the date the transfer was completed, would be entered). In Column (b), taxpayers list the number of items of property contributed, and in column (c), the fair market value of the property transferred, as of the date of the transfer, must be specified. Column (d) needs to be completed to detail the contributed property’s adjusted basis as of the date of transfer.

If appreciated property was contributed by a taxpayer, column (e) must be filled out, and the method (traditional, traditional with curative allocations, or remedial) used by the foreign partnership to make section 704(c) allocations with respect to each item of property must be specified (see Regulations section 1.704-3(b), (c), and (d) for more information). Also note that the instructions require that if appreciated property or intangible property is contributed, taxpayers must, “[P]rovide the information required in columns (a) through (g) separately with respect to each item of property transferred (except to the extent you are allowed to aggregate the property under Regulations sections 1.704-3(e)(2), (3), and (4)).” If gain was recognized by the taxpayer on the contribution of property, then column (f) must be completed. In Column (g), taxpayers need to state their percentage interest in the foreign partnership immediately after the property transfer (see the instructions for further information about specific types of percentage interest).

Finally, taxpayers may need to provide supplemental information, if required. Further, if property was contributed to a foreign partnership as part of a broader transaction, information about the transaction should be described.

Contact Sherayzen Law Office for Help With Foreign Partnership Compliance

If you have an ownership interest in a foreign partnership, please contact Sherayzen Law Office for help. Our experienced foreign partnership tax law firm will thoroughly review the facts and circumstances of your case, properly prepare all of the required tax compliance documents and offer further planning with respect to U.S. taxes.