Tax Alert - IRS Proposed Regulations Apply U.S. Tax Exemption From U.S. Real Property Gains to Qualified Foreign Pension Funds

June 20, 2019

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Foreign pension funds who invest in U.S. real property received good news from the Internal Revenue Service (IRS) when favorable proposed regulations to implement an exemption of U.S. federal income tax on dispositions of an interest in U.S. real property were released on June 6, 2019. If finalized, qualified foreign pension funds (QFPF) will have greater clarity on the ability to invest in U.S. real property, including infrastructure projects, without attracting U.S. federal income tax.

Background

The Foreign Investment in Real Property Tax Act (FIRPTA) subjects non-U.S. investors in U.S. real property to U.S. federal income tax on U.S. real property gains.  There are reporting requirements and tax withholding that are part of this FIRPTA regime. The Protecting Americans from Tax Hikes Act of 2015, signed by President Obama on December 18, 2015, provides an exemption from the U.S. federal income tax, withholding, and related reporting for any U.S. real property interest (USRPI) held directly or indirectly through one or more partnerships by a QFPF or any other entity, all of the interests of which are held by such QFPF.

The Proposed Regulations

The Proposed Regulations make the U.S. federal income tax exemption in Code Section 897(l) available to ‘Qualified Holders’ which are defined as QFPFs or Qualified Controlled Entities (QCE). A QCE includes any non-U.S. trust or non-U.S. corporation, all of the interests of which are held by one or more QFPFs, directly or indirectly, through one or more QCEs or partnerships.  This will allow for pension funds to invest in partnership structures that invest in U.S. real property to be exempt from U.S. federal income tax.

Highlights from the new proposed regulations include:

  1. Determination of Qualified Controlled Entities – A QCE is defined by the proposed regulations as a trust or corporation organized under the laws of a foreign country in which all of the interests (other than an interest held solely as a creditor) are held directly by one or more QFPFs or indirectly through one or more QCEs or partnerships. The proposed regulations provide that an entity with interests owned by multiple QFPFs will now be treated as a QCE. 
  2. Determination of QFPFs - The proposed regulations have expanded the definition of QFPFs. Under the proposed regulations, multi-employer pension funds and government-sponsored public pension funds are also considered QFPFs. Additionally, retirement or pension funds organized by trade unions or professional associations may now be treated as a QFPF.
  3. Withholding Tax and Certification Rules - The proposed regulations state that the IRS will revise Form W-8EXP, which is typically used by foreign governments and international organizations to claim exemption from withholding tax, so that it can also be used by QFPFs for the Section 897(l) exemption.
  4. Anti-Avoidance Rule - To prevent the inappropriate avoidance of U.S. tax, the proposed regulations provide that a Qualified Holder does not include any entity or governmental unit that at any time during the ’testing period’ was not a QFPF, a part of QFPF, or a QCE. 

Effective Date

The proposed regulations are to apply to distributions and dispositions of USRPI occurring on or after the date Treasury adopts these rules as final regulations. A QFPF may rely on the proposed regulations with respect to any disposition of a USRPI occurring on or after December 18, 2015, as long as the plan “consistently and accurately” complies with the proposed regulations.  The proposed regulations anti-avoidance rule will apply to dispositions of USRPIs and distributions occurring on or after June 7, 2019.

Other Considerations

In addition, taxpayers may also need to consider the U.S. state and local income tax implications, as some states conform to the federal QFPF exemption.

If you think that you may be affected by the proposed regulations, BDO is ready to help. Contact one of our U.S. tax professionals today. 

Dan Lundenberg
Partner, U.S. Corporate Tax Practice Leader

John McCrudden
Partner, U.S. Corporate Tax

Gilbert Lederhos
Partner, U.S. Corporate Tax

Brent Hoshizaki
Partner, U.S. Corporate Tax


The information in this publication is current as of June 20, 2019.

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.