I recently completed two trades on a sale of AllianceBernstein (AB) shares in both my non-registered and registered accounts, resulting in a 10-per-cent U.S. withholding tax on the entire gross proceeds of the sale, even though my gains on the stock were basically breakeven. My brokerage account system allowed me to invest the entire proceeds and not withhold the tax, resulting in overdrafts in both accounts. I have a W-8BEN form for U.S. non-residents, which I filed with the bank. Did the broker perform this withholding correctly? Is there a way to claim these proceeds back?
AllianceBernstein trades on the New York Stock Exchange under the ticker AB-N, which may make it seem on the surface like any other publicly traded stock. It isn’t.
The company’s tax information page explains the issue. When you buy AB, you are purchasing limited partnership interests in a holding company, AllianceBernstein Holding, which is structured as a publicly traded partnership or PTP. This company owns an interest of about 39.5 per cent in AllianceBernstein L.P., a private limited partnership.
Buying units of a PTP also gives you a slice of its income, which is meant to be recorded on a U.S. individual income tax return as if you earned the income directly.
“If you’re a partner of a partnership that carries on business in the U.S., or has what’s called ‘effectively connected income,’ then you’d pay tax on that,” said Ian Caines, a partner at Davies Ward Phillips & Vineberg LLP in Toronto.
This is pretty straightforward for U.S. investors. The story for non-U.S. investors has become more complicated since the enactment of the U.S. Tax Cuts and Jobs Act in December, 2017, which imposes withholding requirements on any taxable income derived from a PTP’s business in the United States.
If you’re a non-U.S. individual investor, your effectively connected income is withheld at the highest individual tax rate of 37 per cent. The law also imposes a withholding requirement of 10 per cent of the proceeds of the sale of an interest in a partnership.
As you have learned, painfully, this withholding applies whether or not you’ve recorded a capital gain.
“Awareness is really the key here,” said Paula Owen, managing director at Andersen in Calgary and a cross-border tax expert. She told me that while the withholding requirements came into effect at the beginning of 2018, it was not until January, 2022, that they began to be consistently enforced. She said she has seen an uptick in inquiries related to PTP withholdings over the past 18 months.
The good news is that the 37-per-cent withholding on PTP income, and the 10-per-cent withholding on the proceeds of the sale are “a backup withholding, not a final tax obligation,” Mr. Caines said. By filing a U.S. tax return, which you are required to do already as a PTP unit holder, you can recover any excess tax.
If you owe U.S. tax and haven’t been filing a U.S. return you could face penalties, Ms. Owen said, though the withholding should have you covered.
Unfortunately, the IRS isn’t making it easy for non-U.S. investors to file returns. To do so, you need to register for a U.S. Individual Taxpayer Identification Number, or ITIN. Ms. Owen said recent rule changes imposing stricter documentation requirements have made it more difficult for Canadians to obtain one.
Submitting an application for an ITIN “isn’t a very smooth process,” but the best approach is to file an IRS Form W-7 (“Application for IRS Individual Taxpayer Identification Number”) along with a U.S. tax return, she said. An exemption allowing you to apply for the number without filing a tax return is “going to get more complicated going forward.”
The IRS’s W-8BEN form is used to indicate that you’re not a U.S. tax resident, but isn’t relevant in your situation.
For most Canadian investors, the W-8BEN is used to take advantage of the Canada-U.S. tax treaty to reduce the dividend withholding tax to 15 per cent from the usual 30 and eliminate tax on interest. Ms. Owen said there isn’t a treaty article that would reduce the withholding on income derived from your sale of PTP units.
It all adds up to a big headache for Canadian investors. As Ms. Owen delicately put it, “there’s definitely other investments that don’t cause compliance fees and other hassles.”
As for your brokerage’s handling of the sale, both Ms. Owen and Mr. Caines expressed surprise that you were credited with the gross proceeds, not the net amount after withholding. Based on IRS regulations (specifically, Section 1446(f): PTP Interests), the broker is supposed to do the withholding, Mr. Caines said.
E-mail your questions to agalbraith@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.