On December 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes (PATH) Act of 2015, which includes major reforms to the Foreign Investment in Real Property Tax Act of 1980, and permanently extends some provisions that have been the subject of frequent extender legislation in prior years.
FIRPTA subjects foreign persons to United States federal income tax on gain from United States real property interests (USRPI). A USRPI is an interest in real property located in the United States or the Virgin Islands including land, buildings, leaseholds, mines, wells, pipelines, and improvements/personal property associated with real property. Subject to certain exceptions, a USRPI also includes stock in a United States corporation that holds USRPIs, the value of which equals or exceeds 50 percent of the value of the corporation’s total real property holdings (foreign and U.S.) plus other assets which are used or held for use in a trade or business (such corporations are known as United States real property holding corporations or USRPHCs).
FIRPTA Withholding on USRPI
FIRPTA imposes United States federal income tax on foreign investors on gain from the disposition of a USRPI. To guarantee the collection of tax under FIRPTA, a withholding obligation is imposed on certain transferees of USRPIs. The PATH Act increases the FIRPTA withholding rate on the purchase of a USRPI from a foreign person from 10 percent to 15 percent and provides an exemption for foreign pension funds from taxation under FIRPTA when certain conditions are satisfied.
Under FIRPTA, upon the disposition of a USRPI by a foreign person, such person must report the gain or loss as if it were effectively connected with a United States trade or business (ECI) and pay tax on any net gain at rates applicable to United States persons. The FIRPTA rules also impose a withholding obligation on persons acquiring USRPIs (transferees) from foreign persons.
Effective Date: The increased rate of FIRPTA withholding is effective for dispositions occurring 60 days after December 18, 2015.
New FIRPTA Exemption for Foreign Pension Funds
The PATH Act also provides a new and complete exemption for qualified foreign pension funds (including their wholly-owned subsidiaries) from taxation under FIRPTA. Specifically, the PATH Act provides an exemption from FIRPTA for foreign pension funds meeting the following requirements: the fund is created or organized under the law of a country other than the United States; the fund is established to provide retirement or pension benefits to participants or beneficiaries that are current or former employees (or persons designated by those employees) of one or more employers in consideration for services rendered; the fund must not have a single participant or beneficiary with a right to more than five percent of its assets or income; and the fund must be subject to government regulation and provide annual information reporting about its beneficiaries to the relevant tax authorities in the country in which it operates, and under such laws either (i) contributions made to it are deductible or excluded from the gross income or taxed at a reduced rate, or (ii) taxation of any of its investment income is deferred or taxed at a reduced rate.
Effective Date: This change is effective for dispositions and distributions on or after December 19, 2015.
Domestically Controlled Real Estate Investment Trust (REIT) Criteria Clarified
Under FIRPTA, a foreign investor does not treat stock of a “domestically controlled” REIT as a USRPI. The PATH Act provides for some guidance in determining whether or not a REIT is domestically controlled. Most notably, less-than-five percent shareholders of any class of REIT stock that is regularly traded on a recognized United States securities market are generally presumed to be United States persons. Special rules apply to REIT stock owned by other REITs or RICs (regulated investment companies).
This alert mainly focuses on the significant changes to the provisions of FIRPTA withholding on USRPI and Foreign Pension Funds under the new PATH act. The other significant changes related to publicly traded REITs and RICs under this provisions of FIRPTA are not covered in this alert. To obtain more information on such topics, please contact your W&G advisor.