IRS Issues Proposed Regulations Clarifying FIRPTA Exemption for Qualified Foreign Pension Funds
On June 6, 2019 the US Internal Revenue Service (the IRS) and US Department of the Treasury issued proposed regulations (Proposed Regulations) that provide guidance with respect to (1) the scope of the exception for a "qualified foreign pension fund" (QFPF) from US federal tax imposed under Section 897(a) of the US Internal Revenue Code on gain or loss from the disposition of, and distributions with respect to, "United States real property interests" (USRPIs), (2) the parameters for qualifying as a QFPF, and (3) documentation permitted to certify that no US federal withholding tax is required on the disposition of a USRPI.
Section 897(a)(1) provides that gain or loss of a nonresident alien individual or a non-US corporation from the disposition of a USRPI is subject to tax as if the nonresident alien individual or non-US corporation were engaged in a US trade or business during the taxable year and such gain or loss were effectively connected with that US trade or business.
A USRPI generally includes an interest in real property located in the United States or the Virgin Islands, and any interest (other than solely as a creditor) in any US corporation unless the taxpayer establishes that such US corporation was at no time a "United States real property holding corporation"; during the five-year period ending on the date of the disposition of the interest. Section 897(h)(1) generally provides that any distribution by a real estate investment trust or certain regulated investment companies to a nonresident alien individual or non-US corporation is, to the extent attributable to gain from the sale or exchange of USRPIs, treated as gain recognized by such nonresident alien individual or non-US corporation from the sale or exchange of a USRPI.
Section 897(l) provides that a QFPF is not treated as a nonresident alien individual or a non-US corporation for purposes of Section 897. As such, a QFPF is not subject to US federal tax on the gain or loss from the disposition of, and distributions with respect to, USRPIs.
A QFPF is any trust, corporation or other organization or arrangement that:
- is created or organized under the law of a country other than the United States;
- is established to provide retirement or pension benefits to participants or beneficiaries that are current or former employees;
- does not have a single participant or beneficiary with a right to more than five percent of its assets or income;
- is subject to government regulation and provides, or otherwise makes available, annual information reporting about its beneficiaries to the relevant tax authorities in the country in which it is established or operates; and
- with respect to which, under the laws of the country in which it is established or operates, either (a) contributions to it that would otherwise be subject to tax are deductible or excluded from the gross income of such entity or taxed at a reduced rate, or (b) taxation of any of its investment income is deferred or such income is taxed at a reduced rate.
Qualified Controlled Entities and Anti-Abuse Rules
In addition to an entity that qualifies as a QFPF in its own right, the Proposed Regulations provide that a trust or corporation organized under the laws of a non-US jurisdiction, all of the interests (other than an interest solely as a creditor) of which are held by one or more QFPFs directly or indirectly through one or more qualified controlled entities or partnerships (QCEs) also is treated as a QFPF under Section 897(l).
As such, multiple QFPFs may directly or indirectly own a QCE and such QCE will be treated as a QFPF for purposes of Section 897(l), subject to certain anti-abuse rules discussed below. Furthermore, because the Proposed Regulations' definition of a QCE provides that Section 897(l) applies to gain or loss earned indirectly through one or more partnerships, the Proposed Regulations treat only corporations and trusts, but not partnerships, as QCEs. The Proposed Regulations also permit QCEs to be owned by other QCEs, effectively permitting tiered QFPF holding structures.
To combat possible abuse of the QFPF exemption, the Proposed Regulations provide that a QFPF or QCE does not include any entity or governmental unit that, at any time during a specific "testing period," was not a QFPF, a part of a QFPF, or a QCE. For example, the Proposed Regulations explain that if FC1, a non-US corporation that is neither a QFPF or a QCE, owns 100% of FC2, a non-US corporation, that owns USRPIs, FC1 could sell all of the stock of FC2 to a QFPF without incurring any US tax liability. Absent an anti-abuse rule, this transaction would result in FC2 becoming a QCE, thereby allowing the avoidance of US federal tax on the immediate disposition of the USRPIs by FC2. The "testing period" is the shortest of (1) the period beginning on December 18, 2015 and ending on the date of a disposition described in Section 897(a) or a distribution described in Section 897(h), (2) the 10-year period ending on the date of the disposition or the distribution, or (3) the period during which the entity (or its predecessor) was in existence. However, this anti-abuse rule does not apply to an entity or governmental unit that did not own USRPIs as of the date it became a QFPF, a part of a QFPF or a QCE.
QFPF Qualification Requirements
The Proposed Regulations also provide the following additional guidance regarding the QFPF qualification requirements:
- The Proposed Regulations clarify that a QFPF may be organized under the law of a state, a province or a political subdivision of any country other than the United States.
- The Proposed Regulations clarify that (i) multi-employer pension funds, (ii) government-sponsored public pension funds that provide pension and pension-related benefits and (iii) pension funds organized by trade unions, professional associations and other similar groups may be treated as QFPFs.
- The Proposed Regulations provide that up to 15% of an otherwise eligible pension fund's benefits may consist of so-called "ancillary benefits." "Ancillary benefits" are defined as benefits payable upon the diagnosis of a terminal illness, death benefits, disability benefits, medical benefits, unemployment benefits and similar benefits.
- The Proposed Regulations provide that, for purposes of the five percent limitation, an individual is attributed ownership of assets and income to which certain family members and related entities have a right.
- The Proposed Regulations provide that, when a government administers a pension or retirement plan itself, such government does not need to provide annual information to itself.
- The Proposed Regulations provide that a QFPF may provide the required annual information to one or more governmental units in which the eligible fund is created or organized, instead of to the relevant tax authorities.
- The Proposed Regulations clarify that, if a country has no income tax, then the otherwise eligible pension fund that is established and operates in such country automatically satisfies the requirement that contributions to such fund are tax-deductible or that the fund's investment income is taxed at a reduced rate.
- The Proposed Regulations provide that, in order to satisfy the requirement that contributions to a fund are tax-deductible or that the fund's investment income is taxed at a reduced rate, at least 85%of the contributions to the fund must be deductible or excluded from the gross income or taxed at a reduced rate, or tax on at least 85% of the investment income of the fund must be deferred or taxed at a reduced rate.
Section 1445 generally requires a transferee to withhold 15% of the amount realized on any disposition of a USRPI by a non-US person. However, no withholding is required if the transferor furnishes to the transferee a so-called "certificate of non-foreign status." A QFPF may provide a certificate of non-foreign status in order to certify its exemption from withholding under Section 1445.
A partnership generally must withhold US federal tax under Section 1446 on effectively connected taxable income (ECTI) allocable to a non-US partner. The Proposed Regulations provide that any gain from the disposition of a USRPI will not be treated as ECTI subject to Section 1446 withholding to the extent allocable to a QFPF. A QFPF may provide a certificate of non-foreign status in order to certify its exemption from withholding under Section 1446.
The IRS intends to revise Form W-8EXP to permit QFPFs to certify their status under Section 897(l). Once Form W-8EXP has been revised, a QFPF may use either a revised Form W-8EXP or a certificate of non-foreign status to certify its exemption from withholding under both Section 1445 and Section 1446.
The Proposed Regulations generally apply to dispositions of USRPIs and distributions described in Section 897(h) occurring on or after the date on which the Proposed Regulations are finalized. However, the QCE rules and anti-abuse rule discussed above, among other provisions, apply to dispositions of USRPIs and distributions described in Section 897(h) occurring on or after June 6, 2019. A taxpayer may rely on the Proposed Regulations with respect to transactions occurring on or after December 18, 2015, and prior to finalization of the Proposed Regulations, if the taxpayer consistently and accurately complies with the rules in the Proposed Regulations. Taxpayers should consider whether to amend prior year tax returns in order to consistently and accurately comply with the rules in the Proposed Regulations.
© Arnold & Porter Kaye Scholer LLP 2019 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.