Foreign Partnerships

Tax Treatment of a Foreign Partnership

A business entity organized outside the 50 states and the District of Columbia is a foreign entity. Under the default classification rules, a foreign entity with two or more owners is a partnership if at least one of the owners has unlimited liability with respect to the affairs of the entity. Under the internal revenue laws, any foreign or domestic partnership is a fiscally transparent entity that is not subject to tax. Instead, any item of income, gain, loss, and deduction flows through to the partners and is recognized by them on their income tax return. Our tax services to foreign partnerships could be summarized broadly in two separate groups

Foreign Partnerships with US Income or Activities

Controlled Foreign Partnership and Tax Obligations of the American Partners

Foreign Partnerships with US Income or Business

A foreign partnership that is engaged in a US trade or business activity is required to file an annual an information return on Form 1065 "US Return of Partnership Income." Foreign partnerships that have US investment or other passive income may also need to file an information return. Because of the fiscal transparency, the partnership return reports a pro-rata share of US source income allocable to each partner. Then the partners may also need to file a return or a claim for a refund of over-collected withholding taxes.

As an anti-treaty shopping measure, a mandatory tax withholding applies to foreign partnerships. The tax is due on passive or investment income and income effectively connected with a US trade or business. A foreign partnership will avoid tax withholding at source if it enters into a withholding agreement with the IRS to act as a withholding agent for its direct non-resident partners. We ensure foreign partnerships with US income or operations are compliant with the hefty tax withholding and reporting requirement, with a stress on

  • Preparation of Form 1065 "US Return of Partnership Income"
  • Preparation of federal and state income tax returns for all foreign partners
  • Assistance with and implementation of withholding agreements
  • Tax treaty interpretations and reduced withholding under a treaty provision
  • Assistance with Form W-8IMY, W-8BEN, and W-8ECI
  • US source income rules, rates of tax withholding and "check-the-box" election
  • Income tax planning, consultancy, and advisory services

Controlled Foreign Partnerships and Taxation of the US Partners

Further, a control of a foreign partnership by a US person triggers comprehensive reporting of the partnership's affairs and an inclusion of income in compliance with the internal revenue laws. A US person is considered in control of a foreign partnership if at any time during the year the US person owns more than 50% of the capital or is entitled to more than 50% of the profits, losses or deductions of the partnership.

A reporting on transactional basis is also required in certain formations, dissolutions, and reorganizations of a foreign partnership with more than 10% US ownership interest. The reporting is made on Form 8865 which closely mimics the information returns required for domestic US partnerships. Consequently, a pro-rata share of the income, gains, losses, and deductions of the foreign partnership is included in the income of the US partner and is taxed accordingly.

The current taxation on partnership distributions could be shielded from US tax through the creation of a hybrid entity. A hybrid is a form of business entity that is treated as a corporation in one jurisdiction and as a fiscally transparent entity in another. If an election under the "check-the-box" rules is made, a controlled foreign partnership will be treated as a Controlled Foreign Corporation for federal tax purposes. Assuming no Subpart F income inclusion applies, the reverse hybrid allows a single layer of taxation under the foreign country's local legislation and a simultaneous deferral of US tax until a dividend distribution is made.

Because of the difference in treatment, a hybrid entity provides many tax advantages and tax planning opportunities. We offer a full range of services to accommodate the onerous provisions applicable to US partners in foreign partnerships, including

  • Preparation of Form 8865 "Return of US Person With Respect to Certain Foreign Partnerships"
  • Preparation of federal and state income tax returns for the US partner
  • Assistance with tax treaty-based return positions, US transfer pricing regulations and interpretation of income tax conventions
  • Claims of Foreign Tax Credit and Deemed Paid Foreign Tax Credit
  • Assistance with "check-the-box" elections
  • Income tax planning, consultancy, and advisory services

Should you wish to register for our partnership tax services, you may do so at any time. Did not find what you were looking for? Ask your questions and get a free quote with more information about how we can assist you further. You may also contact us directly.