Earlier, the United States Department of the Treasury and the Internal Revenue Service (IRS) proposed revisions to the tax treatment of publicly traded partnerships (PTPs) held by foreign individuals.
Gain or loss on the sale of an investment in a partnership engaged in the US by a non-US partner could be taxed as business income under this regulation, which takes effect on 1 January 2023.
With this in mind, let’s take a look at the implications and whether you should sell your investments today.
What are Publicly traded partnerships (PTPs)?
Before we continue, we need to understand what is a publicly traded partnership (PTP).
On the surface, PTPs trade like stocks on major US and global markets and are frequently indistinguishable from equities and ETFs, which is why you may be holding them without realizing it. However, there are differences between them, and if you are holding on to PTPs, you need to note specific tax implications.
A PTP is a commercial entity held by two or more co-owners whose shares are listed on a securities market. Just think of them like an ETF but with a different tax structure.
This vehicle is very popular in the real estate and energy industries because it combines the tax advantages of a limited partnership with the liquidity of a publicly traded instrument.
Nevertheless, to avoid the statutory corporate income tax, the entity must obtain 90% of its income from qualifying sources outlined in the Internal Revenue Code, such as income derived from exploration, development, mining or production, processing, refining, and transportation of minerals and natural resources, which is why most of such entities are from these industries.
Check out this list* from TD Ameritrade to see if you own any PTP securities.
*Note: This is not an exhaustive list, and you should review your portfolio on an individual basis.
Advantages of investing in PTPs
You may be wondering why would people invest in PTPs.
With the tax benefits that organizations can gain from listing under PTPs, whereby cash distributions of the company are taxed just once at the unit holder level and not separately at the corporate level, investors are offered more quarterly income from these favorable tax treatments.
Apart from that, another advantage of investing in PTPs securities is that they are significantly more liquid than ordinary partnerships because they are publicly listed.
ETF vs PTP tax structure
That said, PTPs are more challenging to comprehend. ETFs and PTPs have different tax structures, and hence the withholding tax is applied differently.
As a foreign investor in ETFs, you’ve probably heard of the dividend withholding tax, which is imposed on foreign investors at a flat rate of 30% on US dividend income. (This rate can be reduced by treaty, such as an Ireland-domiciled ETFs with a dividend tax rate of 15%.)
PTP investors, on the other hand, are often taxed on a “flow-through” basis on their percentage of US source revenue.
In principle, income generated by the entity proportionate to the shareholder will be taxed at progressive rates of up to 37% for individuals and 21% for corporations. This is what we now have, but with the new regulation, there will be an additional tax.
How it’ll impact you as a foreign investor, and why should you consider selling?
In addition to the prevailing tax on PTPs, foreign investors would face an extra 10% withholding tax on any gains realized on sales after 1 January 2023, up from 0% currently.
The additional 10% withholding tax could easily wipe out your entire yield when you sell
This differs from the current tax in that it depends on the foreign investor selling the security for profit instead of the income flowing through the partnership.
With this, the most apparent impact would be if you continued to hold such securities and only liquidate them after 1 January 2023. Doing so, you would then be required to pay an extra 10% tax on the gross proceeds of the sale of your PTP units.
Liquidity may drop as brokers discontinue selling PTPs
Aside from that, numerous brokers, including UOB Kay Hian, LIM & TAN Securities, and Syfetrade, have already announced or even discontinued selling such vehicles on their platforms. That is, even if you want to buy it, you won’t be able to. (You can still sell.)
This leads us to the final potential impact: with brokers no longer selling PTPs, there may be less liquidity in such vehicles, making it more difficult for investors to exit in the future, thus leading to a higher price impact.
Conclusion
Overall, the flow-through treatment of US partnership interests under the PTPs might be advantageous for US-based investors since the structure prevents company earnings from being subject to two levels of taxation (corporate level plus shareholder level).
However, as a non-US investor, this structure not only poses a challenge for individuals who have not previously filed a US return and calculated their own US tax liabilities but with the new legislation kicking in, there are fewer incentives for you to invest in such vehicles.
If you realize you are holding such securities, now is the time to reconsider whether it is worthwhile to keep them. If not, you should act quickly and sell it by the deadline set by your broker, if any, to avoid the withholding tax and reporting obligations. However, if you want to keep it, you should understand more about the tax implications of your PTP investment.
