Firm Comments on Foreign Pension Fund Regs

September 3, 2019

CC:PA:LPD:PR (REG-109826-17)
Internal Revenue Service
Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Comments to Notice of Proposed Rulemaking, Fed. Reg. Vol. 84, No. 110, p. 26605, June 7, 2019, regarding proposed Treasury Regulations (the “Proposed QFPF Regulations”) under Sections 897, 1445, and 1446 of the Internal Revenue Code of 1986, as amended (the “Code”)

Ladies and Gentlemen:

We appreciate the opportunity to provide comments to the Proposed QFPF Regulations, and we thank you for your efforts in developing the Proposed QFPF Regulations to provide welcome guidance regarding the application of Code Sections 897(l), 1445 and 1446. We are writing to recommend a modification to one aspect of the Proposed QFPF Regulations, which we feel is appropriate for the reasons discussed below.

Background

We are aware of situations in which multiple “qualified foreign pension funds” within the meaning of Code Section 897(l) (each, a “QFPF”) invest in “United States real property interests” (“USRPIs”) indirectly through an entity or arrangement that is treated as a foreign partnership for U.S. federal income tax purposes and that has no partners that are not QFPFs. Under the Proposed QFPF Regulations, such a foreign partnership would not be permitted to provide a certificate of non-foreign status under Treasury Regulations Section 1.1445-2(b)(2)(i) or an IRS Form W-8EXP to certify its treatment as not foreign for purposes of Code Section 1445 under proposed Treasury Regulations Section 1.1445-2(b)(2)(v). As discussed in greater detail below, we believe that such a foreign partnership should either be treated as a “qualified controlled entity” and a “qualified holder” under the Proposed QFPF Regulations or, if not treated as a “qualified controlled entity” and a “qualified holder”, should nonetheless be excluded from the definition of “foreign person” for purposes of the certification procedures under Treasury Regulations Sections 1.1445-2(b)(2)(i) and 1.1445-2(b)(2)(v) (as those procedures are proposed to be modified by the Proposed QFPF Regulations).

Definition of “Qualified Holder” under the Proposed QFPF Regulations

As you know, the Proposed QFPF Regulations introduce the concept of a “qualified holder”.¹ A “qualified holder” is defined to mean a QFPF or a “qualified controlled entity”, unless a special limitation applies.² A “qualified controlled entity”, in turn, is defined to mean “a trust or corporation organized under the laws of a foreign country all of the interests of which are held by one or more qualified foreign pension funds directly or indirectly through one or more qualified controlled entities or partnerships.”³ Applying these two definitions, an entity or arrangement treated as a foreign partnership for U.S. federal income tax purposes that has only QFPFs as partners would not be a “qualified controlled entity”, and therefore would not be a “qualified holder”, because that entity or arrangement would be neither a trust nor a corporation.⁴

Under the proposed amendments to Treasury Regulations Sections 1.1445-2(b)(2)(i)(C)(2) and 1.1445-2(b)(2)(v), such a foreign partnership would not be permitted to provide a certification of non-foreign status under Treasury Regulations Section 1.1445-2(b)(2) or an IRS Form W-8EXP certifying non-foreign status because the foreign partnership would not be a “qualified holder”. We believe that this is an unwarranted outcome, and would result in an asymmetrical withholding certification process under Code Section 1445, as the following simple example illustrates.

Example: Three QFPFs are partners in an entity or arrangement treated as a foreign partnership for U.S. federal income tax purposes (“FP”). There are no other partners in FP. FP owns stock in a “United States real property holding corporation” (the “USRPHC”) that is not a “domestically controlled qualified investment entity”. The stock in the USRPHC is not publicly traded. FP proposes to sell the stock in the USRPHC to an unrelated buyer for cash.

If FP were able to certify its non-foreign status under either certification approach set forth in Treasury Regulations Sections 1.1445-2(b)(2)(i) or 1.1445-2(b)(v) (as proposed to be modified by the Proposed QFPF Regulations), then the buyer would be permitted to pay the purchase price without the need to withhold in reliance on such certification. However, as noted above, the Proposed QFPF Regulations, as currently drafted, would not permit FP to provide the certification of non-foreign status.

However, if FP were treated as either a trust or a corporation for U.S. federal income tax purposes (instead of being treated as a foreign partnership), then FP would be a “qualified holder” and could provide a certification of non-foreign status. Moreover, if each of the three QFPF beneficial owners of FP were to hold their share of the underlying USRPHC stock directly (rather than through FP), each QFPF would be treated as a “qualified holder” and could provide a certification of non-foreign status.

The preceding example illustrates an asymmetry in the Code Section 1445 withholding certification process that we believe is not warranted and creates unnecessary uncertainty for QFPFs that pool their capital and hold investments through foreign partnerships that have only QFPFs as partners. In all three cases illustrated in the example (i.e., a sale of USRPHC stock by foreign partnership wholly-owned by QFPFs, a sale of USRPHC stock by a foreign corporation or foreign trust wholly-owned by QFPFs, and direct sale of USRPHC stock by QFPFs), the substantive U.S. federal income tax outcome is the same — any gain is exempt from taxation under Code Section 897(a) by reason of Code Section 897(l). The preamble to the Proposed QFPF Regulations expressly acknowledges that a QFPF's distributive share of gain derived through a foreign partnership is subject to the exemption provided by Code Section 897(l).⁵ Accordingly, we believe that the withholding certification process under Code Section 1445 should be the same as well.

Recommendation

For the reasons set forth above, we recommend that a foreign partnership with only QFPFs as partners should either be treated as a “qualified controlled entity” and a “qualified holder” under the Proposed QFPF Regulations or, if not treated as a “qualified controlled entity” and a “qualified holder”, should nonetheless be excluded from the definition of “foreign person” for purposes of the certification procedures under Treasury Regulations Sections 1.1445-2(b)(2)(i) and 1.1445-2(b)(2)(v) (as those procedures are proposed to be modified by the Proposed QFPF Regulations) so that such a foreign partnership is permitted to provide a certificate of non-foreign status under Treasury Regulations Section 1.1445-2(b)(2)(i) or an IRS Form W-8EXP certifying its non-foreign status under proposed Treasury Regulations Section 1.1445-2(b)(2)(v).

We appreciate your efforts in addressing our comments, as well as other comments to the Proposed QFPF Regulations that you may receive. We would welcome the opportunity to discuss our comments at your convenience, should you find that such a discussion would be helpful. Thank you for your consideration, and please feel free to contact the undersigned with any questions.

Very truly yours,

Daniel A. Nelson
Morgan, Lewis & Bockius LLP
Boston, MA