U.S. PARTNERSHIP MUST WITHHOLD TAX ON UNDISTRIBUTED AMOUNTS ON A FOREIGN PARTNER'S DISTRIBUTIVE SHARE OF FDAP INCOME.

Rev. Rul. 89-33

ISSUE

May a domestic partnership choose not to withhold tax on undistributed amounts of a foreign partner's distributive share of fixed or determinable annual or periodical income that is not effectively connected with a trade or business within the United States?

FACTS

A, a nonresident alien, is a member of P, a domestic partnership. P earns fixed or determinable annual or periodical income during the taxable year that is not effectively connected with a trade or business within the United States. At the end of the taxable year, P computes the distributive shares of individual partners on the basis of the partnership income. P does not make a distribution to its partners. A is not entitled to the benefits of an income tax treaty.

LAW AND ANALYSIS

Section 1441(a) of the Internal Revenue Code of 1986 provides that any person having the control, receipt, custody, disposal or payment of an item of fixed or determinable annual or periodical income of any nonresident alien individual must (except as otherwise provided in regulations) withhold a tax equal to 30 percent of the gross amount of the income. Section 1441(b) of the Code defines the types of income subject to withholding. In addition, that section provides that in the case of a nonresident alien individual who is a member of a domestic partnership, the items of income subject to withholding includes fixed or determinable income included in the nonresident alien's distributive share of partnership income. Thus, items of fixed or determinable annual or periodical income included in a nonresident alien partner's distributive share are subject to withholding unless an exception is provided by regulations.

Section 1.1441-3(f) of the Income Tax Regulations provides rules that apply to domestic partnerships and domestic fiduciaries of trusts. That section contains this sentence: "If a partnership or a fiduciary withholds under this section on a distributive partnership share or distributable net income of a trust or estate before the income is actually distributed to a partner or beneficiary, then withholding is not required when such income is subsequently distributed." This statement is intended merely to illustrate how section 1441 of the Code operates in the described circumstances and to prevent the imposition of additional withholding at the time of distribution to the partner. The statement does not make withholding on a nonresident alien individual's distributive share of the partnership's fixed or determinable annual or periodical income optional. Mandatory withholding is explicitly required by the first sentence of section 1.441-3(f): "Domestic partnerships are REQUIRED to withhold the tax at source . . . [on items of fixed or determinable annual or periodical income] that are included in the distributive share (INCLUDING AMOUNT THAT ARE NOT ACTUALLY DISTRIBUTED) of a member of such partnership who is a nonresident alien . . . (emphasis added)."

HOLDING

A domestic partnership is required to withhold tax on undistributed amounts of a foreign partner's distributive share of fixed or determinable annual or periodical income.

This ruling is not intended to address issues arising under section 1446 of the Code (regarding withholding on effectively connected income).

DRAFTING INFORMATION

The principal author of this revenue ruling is Emerson Yearwood of the Office of the Associate Chief Counsel (International), Internal Revenue Service. For further information regarding this revenue ruling contact Mr. Yearwood on (202) 566-3490 (not a toll- free call).