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Aftermath of YA Global: A Call for Procedural Clarity for Section 1446 Withholding Tax

The New York State Bar Association Tax Section (the “NYSBA”) has asked the government to provide guidance on the procedure for filing a protective return in respect of withholding tax in response to YA Global Investments, LP v. Commissioner, which we discussed here.

In YA Global, the Tax Court held that YA Global Investments, LP (“YA Global”) was engaged in a U.S. trade or business and thus should have been withholding on allocations of income effectively connected with such business to foreign partners.  The Tax Court rejected YA Global’s argument that its filing of IRS Form 1065, “U.S. Return of Partnership Income,” had commenced the statute of limitations because the return omitted the crucial fact that YA Global was engaged in a U.S. trade or business.  Therefore, reporting zero withholding tax liability on Form 1065 failed to start the statute of limitations. The Tax Court explained that YA Global should instead have filed IRS Form 8804, “Annual Return for Partnership Withholding Tax (Section 1446),” describing its activities and evidencing its belief that it did not have income effectively connected with a U.S. trade or business.

The NYSBA’s report highlights a procedural issue with the YA Global decision.  Despite the Court’s instruction, Form 8804 does not include a formal procedure to file on a protective basis nor a way to distinguish between a protective and a routine filing.  Filings for foreign corporations do not share this issue because IRS Form 1120-F, “U.S. Income Tax Return of a Foreign Corporation,” allows foreign corporations to check a box and include a statement to explain that it is filing a protective return.  By contrast, a foreign partnership has no comparable way of clearly marking its Form 8804 as a protective return.  The NYSBA requests that Treasury and the IRS clarify how taxpayers who believe they do not have effectively connected income can file Form 8804 on a protective basis or otherwise commence the three-year statute of limitations on their withholding tax liabilities.

The NYSBA suggests two potential solutions:

First, the IRS could update Form 1065 to allow taxpayers to check a box and include a statement in lieu of filing Form 8804.  The NYSBA believes that using Form 1065 rather than Form 8804 as a protective return would be more helpful to the IRS’s review of a foreign partnership’s international tax liabilities.  Attaching a simple statement in lieu of filing a separate Form 8804 would also alleviate the administrative burden to the IRS.

Alternatively, the IRS could update Form 8804 to allow taxpayers to clearly indicate that it is a protective return by checking a box and attaching a statement, similar to Form 1120-F.

Treasury and the IRS should heed the NYSBA’s request to create an efficient and reliable path for partnerships to start the statute of limitations for Section 1446 withholding tax.  If not, a retroactive decision that a foreign partnership was engaged in a U.S. trade or business and thus should have been withholding on allocations to its foreign partners could have significant, far-reaching consequences.

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Linda Z. Swartz
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Adam Blakemore
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Jon Brose
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Andrew Carlon
T. +1 212 504 6378

Mark P. Howe
T. +1 202 862 2236

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