To file or not to file, that is the question for foreign partnerships.

• Author: Garre, Karen T.

The use of hybrid entities (i.e., an entity treated as a branch or partnership for U.S. tax purposes and a corporation under governing foreign law) in international joint venturing has gained widespread appeal. The new "check-the-box" regulations simplify the process by allowing eligible foreign entities to elect partnership status.

At the same time, the issues of whether and when foreign partnerships are required to file U.S. partnership returns and the consequences of failing to file remain far from clear. For example, is a foreign partnership with no direct U.S. partners that has no U.S. trade or business and no U.S.-source income required to file a U.S. partnership return? If not, how does such a partnership make partnership-level elections? The IRS has announced, as part of its 1997 business plan, that it intends to issue regulations under Sec. 6031. In the meantime, the lack of clear guidance has left practitioners in a quandary in advising clients whether foreign partnerships must file U.S. returns.

Sec. 6031 requires "every partnership" to file a US. partnership return. However, Regs. Sec. 1.6031-1(d)(1) exempts foreign partnerships that do not carry on a U.S. trade or business and have no U.S.-source income from the filing requirement, even if the foreign partnership has U.S. partners. The Service, however, may require U.S. partners to provide all necessary information to substantiate their distributive shares of partnership income and loss. Moreover, Regs. Sec. 1.6031-1 explicitly provides that if the foreign partnership has U.S. partners, any partnership-level election (including a Sec. 754 election) must be made by filing a U.S. partnership return.

Language enacted as part of the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) addresses the return filing issue. TEFRA Section 404 (which did not amend Sec. 6031) provides that "[e]xcept as hereafter provided in regulations ... nothing in section 6031 ... shall be treated as excluding any partnershp from the filing requirements of such section for any taxable year if the income tax liability ... of any United States person is determined in whole or in part by taking into account (directly or indirectly) partnership items of such partnership...." (Emphasis added.) Congress was concerned that, for foreign partnerships with U.S. partners, partnership return filing requirements generally did not apply under prior law and partnership records kept outside the U.S. often could not...