Originally published by Thompson & Knight LLP.
Posted by Kathleen Gerber, John Cohn, and Todd Lowther
On December 18, 2015, President Barack Obama signed the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act”) into law. The PATH Act made significant changes to the Foreign Investment in Real Property Tax Act (“FIRPTA”), including an increase in the rate of withholding on dispositions of U.S. real property interests subject to FIRPTA. The PATH Act also made an important change relevant to foreign pension funds, as further discussed below.
While non-U.S. investors generally are not subject to U.S. income tax on capital gains that are not effectively connected to a U.S. trade or business, FIRPTA subjects non-U.S. investors to U.S. income tax on gains realized from the disposition of any “U.S. real property interest.” Section 897(a) of the Internal Revenue Code of 1986, as amended (the “Code”), treats all such gains as if they were effectively connected to the conduct of a U.S. trade or business and subject to U.S. income tax and withholding. A U.S. real property interest includes any interest in U.S. real property, whether owned directly or indirectly through a partnership, as well as shares of stock in a “U.S. real property holding corporation.” A U.S. real property holding corporation generally is any U.S. corporation with U.S. real property interests that have a fair market value equal to or greater than the fair market value of all of the corporation’s real property interests (U.S. or foreign) and all other assets which are used or held for use in the corporation’s trade or business.
Currently, the withholding rate for dispositions subject to FIRPTA is 10% of the amount realized. The PATH Act increased the FIRPTA withholding rate to 15% of the amount realized for most dispositions occurring after February 16, 2016. Persons anticipating an acquisition of a U.S. real property interest (including interests in partnerships and corporations with material U.S. real property interests) from a foreign seller after February 16, 2016 should review the purchase agreement and other related documents to determine if amendments are needed to reflect the increased withholding rate and communicate with the foreign seller accordingly.
The PATH Act also amended FIRPTA to include an important exception for foreign pension funds in new Section 897(l), pursuant to which FIRPTA no longer applies to any U.S. real property interest held directly or indirectly through one or more partnerships by, or to any distribution received from a real estate investment trust (“REIT”) by, (1) a “qualified foreign pension fund” or (2) an entity all of the interests of which are held by a qualified foreign pension fund. A qualified foreign pension fund is defined for these purposes as any trust, corporation, or other organization or arrangement (1) which is created or organized under the law of a country other than the United States, (2) 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, (3) which does not have a single participant or beneficiary with a right to more than 5% of its assets or income, (4) 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 (5) with respect to which, under the laws of the country in which it is established or operates (i) contributions to such entity which would otherwise be subject to tax are deductible or excluded from the gross income of such entity or taxed at a reduced rate, or (ii) taxation of any investment income of such entity is deferred or such income is taxed at a reduced rate.
Since U.S. pension funds generally are exempt from U.S. tax on capital gains, the PATH Act eliminates the prior disparate treatment between domestic and foreign pension funds upon dispositions of interests in U.S. real property. The PATH Act does not affect the taxation of other periodic income that may be realized in connection with investments in U.S. real estate, including rents or interest. Further, a foreign pension fund will continue to be taxed on gains realized upon a disposition of U.S. real property to the extent that the property was otherwise held in connection with a U.S. trade or business.
A conforming amendment was made to Section 1445 of the Code to exempt from withholding any disposition by a foreign pension fund that is otherwise exempt from FIRPTA under the new Section 897(l) of the Code. The PATH Act also made other amendments to FIRPTA relevant to interests in regulated investment companies (“RICs”) and REITs. The changes to FIRPTA enacted by the PATH Act (other than the increased withholding rate discussed above) apply to all dispositions and distributions occurring after December 18, 2015.
If you have any questions regarding the PATH Act changes or related matters, please contact one of us or another tax lawyer at Thompson and Knight.
Curated by Texas Bar Today. Follow us on Twitter @texasbartoday.
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