The IRS' Chief Counsel's Office released a memorandum (AM 2023-003) and advised on the application of the regularly traded exception in two different situations where a non-resident alien individual's gain on the disposition of a domestic corporation's stock could be treated as effectively connected income under section 897.
In its memorandum, the IRS asserted that the regularly traded exception should be assessed at the partnership level when a partnership owns stock of a US real property holding corporation (USRPHC). This means that if a partnership exceeds the 5% stock ownership threshold with respect to a corporation, stock of which is regularly traded on an established securities market, a foreign partner of the partnership is subject to US tax under section 897(a) on its allocable share of any gain from a sale of such stock by the partnership.
Accordingly, a foreign partner could be subject to US tax on the disposal of a publicly traded USRPHC even if the foreign partner does not indirectly own more than 5% of the stock sold by its partnership vehicle.
Section 897 pertains to the taxation of foreign persons on the disposition of US real property interests. It generally provides that when a foreign person sells or disposes of a US real property interest (USRPI), the gain from the transaction is generally subject to US taxation as effectively connected income. The term "USRPI" refers to any interest, whether direct or indirect, in real property located in the United States or in any domestic corporation that primarily holds USRPIs.
However, there is an exception known as the "regularly traded exception" provided under section 897(c). This exception applies when the USRPI interest is regularly traded on an established securities market and the foreign person holds no more than a 5% interest in the class of stock that represents the USRPI.