International Tax Bulletin (January 2016)
PATH Act Changes to FIRPTA
By Brian Wainwright, a tax partner in the Palo Alto office of Pillsbury Winthrop Shaw Pittman LLP and Robert S. Logan, a special counsel in the firm's Washington, D.C. office.
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The Protecting Americans from Tax Hikes Act of 2015 (the "PATH Act," Division Q of the Consolidated Appropriations Act, 2016, P.L. 114-113, enacted December 18, 2015) made some important changes to the U.S. federal income tax treatment of U.S. real estate investments by non-U.S. persons under the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA").
Increased WithholdingThe withholding rate applicable to dispositions by non-U.S. persons of United States real property interests ("USRPIs") has been increased from 10 percent to 15 percent of gross proceeds, except for sales of residences intended for personal use by the acquirer if the purchase price does not exceed $1 million.
Foreign Pension ExemptionFIRPTA and its related withholding tax no longer apply after December 18, 2015 to dispositions of USRPIs held directly (or indirectly through one or more partnerships) by, or to distributions received from a real estate investment trust ("REIT") by, a qualified foreign pension fund or by a non-U.S. entity wholly owned by a qualified foreign pension fund. A qualified foreign pension fund is any trust, corporation or other organization or arrangement (i) which is created or organized under the law of a country other than the United States, (ii) which is established to provide retirement or pension benefits to participants or beneficiaries that are current or former employees (or persons designated by such employees) of one or more employers in consideration for services rendered, (iii) which does not have a single participant or beneficiary with a right to more than five percent of its assets or income, (iv) which is subject to government regulation and provides annual information reporting about its beneficiaries to the relevant tax authorities in the country in which it is established or operates, and (v) with respect to which, under the laws of the country in which it is established or operates, (A) contributions to such organization or arrangement that would otherwise be subject to tax under such laws are deductible or excluded from the gross income of such entity or taxed at a reduced rate, or (B) taxation of any investment income of such organization or arrangement is deferred or such income is taxed at a reduced rate.
Qualified Investment EntitiesSpecial FIRPTA rules apply to "qualified investment entities." A qualified investment entity includes any REIT and certain regulated investment companies ("RICs") that are or are deemed to be United States real property holding corporations ("USRPHCs"). A USRPHC is, in general, a corporation that holds USRPIs with a value of 50 percent or more of its total business assets and worldwide real property. The PATH Act modifies these rules in the following important respects:
Qualified ShareholdersFIRPTA will not apply to dispositions of REIT stock (including REIT stock held indirectly through one or more partnerships) by, or distributions from a REIT attributable to the REIT's disposition of USRPIs to, a "qualified shareholder" of the REIT. While certain holders of publicly traded REIT stock or stock in REITs that are "domestically controlled" (i.e., less than 50 percent ownership by foreign persons during a specified period) receive beneficial treatment under FIRPTA, the new rule for qualified shareholders applies even if the REIT is not publicly traded or domestically controlled. A qualified shareholder is a foreign person that (i) is eligible for the benefits of a comprehensive income tax treaty which includes exchange of information provisions and whose principal class of interests is listed and regularly traded on a recognized stock exchange, or is a partnership created or organized under foreign law as a limited partnership in a jurisdiction that has a tax information exchange agreement with the U.S. and has a class of limited partnership units traded on the NYSE or NASDAQ representing greater than 50 percent of the value of all partnership units, (ii) is a "qualified collective investment vehicle," and (iii) maintains records on the identity of direct owners of more than five percent of the class of the foreign person's interests or units.
A "qualified collective investment vehicle" is a foreign entity that (i) is eligible for a reduced rate of withholding under an income tax treaty even if it holds more than 10 percent of the stock of the REIT, (ii) is publicly traded, treated as a partnership under the Code, is a withholding foreign partnership, and would be treated as a USRPHC if it were a domestic corporation, or (iii) is designated as such by the Treasury Department and is either fiscally transparent or is required to include dividends in income but is entitled to a deduction for distributions.
The qualified investor exception is not applicable to the extent that an "applicable investor" (other than a qualified shareholder) holds an interest in the qualified shareholder (except for an interest solely as a creditor) and such applicable investor directly, indirectly, or constructively (through certain attribution rules) holds 10 percent or more of the REIT. In such a case, generally the qualified shareholder's interests in, and distributions from, the REIT remain subject to FIRPTA to the extent of the applicable shareholder's proportionate ownership of the qualified shareholder.
A special rule also applies to REIT distributions to a qualified shareholder that would be treated as a sale or exchange of stock under Internal Revenue Code sections 301(c)(3), 302, or 331 that treats the portion attributable to an applicable investor as FIRPTA gain and portions attributable to other investors as income subject to dividend withholding (subject to treaty reductions).
Presumptions Regarding Domestic ControlFinally, the PATH Act introduces new rules and presumptions regarding whether a qualified investment entity is domestically controlled.
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