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Attorneys Request Modification of Guidance on Distributions Between Foreign Governments, REITs

OCT. 8, 2013

Attorneys Request Modification of Guidance on Distributions Between Foreign Governments, REITs

DATED OCT. 8, 2013
DOCUMENT ATTRIBUTES
  • Authors
    Berger, Gregory W.
    Hart, John C.
    Mason, Andrew S.
    Rayis, John D.
  • Institutional Authors
    Brownstein Hyatt Farber Schreck LLP
    Simpson Thacher & Bartlett LLP
    Sullivan & Cromwell LLP
    Skadden, Arps, Slate, Meagher & Flom LLP
  • Cross-Reference
    Notice 2007-55 2007 TNT 115-12: Internal Revenue Bulletin.
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2013-25039
  • Tax Analysts Electronic Citation
    2013 TNT 210-18

 

October 8, 2013

 

 

Mr. Mark J. Mazur

 

Assistant Secretary for Tax Policy

 

U.S. Department of the Treasury

 

1500 Pennsylvania Avenue, NW

 

Washington, DC 20220

 

RE: Requested Modification to Notice 2007-55 with respect to Foreign Pension Funds

 

Dear Mr. Mazur,

Thank you for meeting with us on July 29, 2013 to discuss Notice 2007-55 (referred to herein as the "Notice") as it applies to foreign pension funds. In light of the President's fiscal year 2014 budget proposal to exempt certain foreign pension funds from the application of FIRPTA,1 we strongly advocated the withdrawal of the Notice in accordance with such proposal. At the meeting, we agreed at your request to provide a written summary of why we think the Treasury Department can and should withdraw section 2 of the Notice (captioned "Liquidating Distributions") as it applies to foreign pension funds, as a matter of law and tax policy. We are not asking that section 1 of the Notice (captioned "Distributions During the Life of the REIT") be withdrawn. As described below, however, we believe that Treasury has the authority, without legislative change, to modify section 2 of the Notice to implement the President's budget proposal and should take action to do so.

As we discussed, the Notice announced that the IRS intended to treat real estate investment trust ("REIT") redemptions and liquidating distributions as subject to the FIRPTA tax rules, a position viewed by many as contrary to well-established U.S. tax law treating such distributions as sales of stock. Needless to say, the IRS' position has caused considerable consternation in the foreign investor community and has severely constrained continued foreign investment in U.S. real estate, at a time when the real estate industry is in need of additional capital.

The Notice creates distinctions in tax treatment between U.S. and non-U.S. pension fund investors in economically parallel positions. U.S. pension funds and tax-exempt entities are generally exempt from U.S. federal income tax on gains realized on the disposition of stock in U.S. real property companies (such as REITs), as well as on the receipt of REIT distributions attributable to gains from sales or disposition of U.S. real property. When a REIT redeems shares held by a U.S. pension fund, or makes a liquidating distribution to a U.S. pension fund, the U.S. pension fund is not subject to U.S. tax. Subjecting foreign pension funds, including those qualifying for treatment under section 892 of the Code, to U.S. FIRPTA tax on such gains imposes a U.S. tax burden on foreign pension funds that is not borne by their U.S. counterparts. This dichotomy of tax treatment both discourages foreign investment in the U.S. and furthers no apparent policy goal.

As we noted at our meeting, the legislative discussion surrounding FIRPTA demonstrates that, in enacting FIRPTA, Congress sought to address disparities in taxation between U.S. and non-U.S. persons investing in U.S. real property. A 1980 Senate Finance Committee Report expressly stated: "The Committee believes that it is essential to establish equity of tax treatment in U.S. real property between foreign and domestic investors. The Committee does not intend by the provisions of Title IX to impose a penalty on foreign investors or to discourage foreign investors from investing in the United States."2

Fairness was a primary goal in enacting FIRPTA. As the legislative history to FIRPTA makes clear, Congress sought to level the playing field between U.S. and non-U.S. investors in real estate. Subject to specific statutory exceptions, Congress intended to apply the same tax treatment to similarly situated investors regardless of their country of residence. At the same time, however, Congress did not intend to discourage foreign investment in U.S. real estate by making such investment overly costly and logistically challenging.

The FIRPTA rules as modified by the Notice subject foreign pension funds to substantially heavier U.S. tax burdens and more burdensome compliance requirements than their U.S. counterparts. This result runs counter to FIRPTA's stated purpose. Congress expressly stated that it did not intend for FIRPTA to penalize foreign investors or discourage them from investing in U.S. real estate; however, the Notice creates a system with punitive consequences that disproportionately taxes foreign pension funds.

This inequitable treatment was explicitly noted by the President in the Administration's fiscal year 2014 budget proposal to exempt foreign pension funds from the application of FIRPTA. The General Explanation of the Administration's Fiscal Year 2014 Revenue Proposals notes that "[g]ain of a U.S. pension fund from the disposition of a U.S. real property interest generally is exempt from U.S. tax, but gain of a similar pension fund created or organized outside the United States from the disposition of that same property would be subject to U.S. tax under FIRPTA."

The need for fairness in this area is also underscored by the recent introduction in the House of H.R. 2870, the "Real Estate Investment and Jobs Act of 2013," which if enacted would reverse Notice 2007-55 generally, not simply in its application to foreign pension funds. A similar bill, S. 1181, was introduced in the Senate in June 2013 and currently has 30 bipartisan Senate co-sponsors. These bills demonstrate a continued commitment on the part of Congress to restore prior interpretations and afford foreign investors additional certainty as to the tax result of an investment in a U.S. REIT. The provision in H.R. 2870 and S. 1181 addressing REIT liquidating distributions mirrors the provision in bills introduced with strong bipartisan support in the House and Senate during the last Congressional session. These continued bipartisan efforts demonstrate the strong commitment in Congress to rectifying the position taken in the Notice. As you know, we are strongly in favor of the amendments contained in H.R. 2870 and S. 1181 and believe such changes are necessary. In the meantime, however, Treasury can increase foreign investment without legislative action by following the President's recommendation and modifying the Notice as it applies to foreign pension funds.

It is our understanding that the withdrawal of the Notice has been under consideration at Treasury for some time. Contemporaneous media reports stated that, in response to questions from Senator Cantwell, Treasury Secretary Lew suggested at his Senate Finance Committee confirmation hearing this past February that he supported withdrawal of the Notice, and stated that work on such rules was in progress and he expected to see the project to completion.

With the Notice outstanding, foreign investors face potential U.S. tax burdens that make such investors hesitant to invest more equity in the U.S. real estate sector. As stated in a 2008 letter from the Canada Pension Plan Investment Board to the Treasury International Tax Counsel's office regarding the investment decisions foreign investors may make in light of the Notice, "the Notice will result in less foreign investment in U.S. real estate funds structured as REITs." This result undermines current efforts to attract investment in the commercial real estate market. Furthermore, adopting the position set forth in the Notice in regulations would make permanent a FIRPTA regime under which U.S. real estate would be far less attractive to foreign investors than in the past.

Notices are generally issued to provide interim guidance on an expedited basis until temporary regulations can be published or final regulations adopted. Since section 897 does not have any express delegation of regulatory authority to the Secretary, the regulations described in the Notice would be issued under Treasury's general authority under section 7805(a). A notice is a public announcement issued by the IRS that has application to tax law interpretation.3 Consequently, modifying the Notice in a manner that is consistent with the legislative history and the President's budget proposal would not run afoul of the statutory rules in section 897 and would be fully within the scope of Treasury's authority.

We believe that Treasury does not need to wait for legislation to withdraw section 2 of the Notice as it applies to foreign pension funds. Modifying the Notice in this manner would be entirely consistent with congressional intent in enacting FIRPTA to create tax parity between U.S. and foreign investors. Such action would be consistent with the budget proposal by the White House, and would be a simple and appropriate step that Treasury can take to rectify the discriminatory application of FIRPTA to foreign pension funds, while ameliorating the impact of the Notice.

As noted by a recent CBRE report, the proposed changes by the President's budget proposal could increase foreign investment in a number of major U.S. cities, particularly those with historically lower rates of return on investments.4 The report noted that such changes could also increase clarity and transparency for investors doing business in the U.S. by replacing the varying sets of tax regulations, exemptions and withholding requirements currently in place for foreign and domestic investors with a single, clearly defined tax scheme, which would also minimize market distortions.

The time for a response from Treasury is now. We strongly urge you to implement the President's initiative to modify section 2 of the Notice to exempt certain foreign pension funds from the application of FIRPTA, thereby reducing barriers to foreign investment in U.S. real estate and encouraging a much-needed influx of capital into the U.S. commercial real estate market.

We appreciate your consideration of this request.

Sincerely,

 

 

Gregory W. Berger

 

Brownstein Hyatt Farber

 

Schreck, LLP

 

 

John C. Hart

 

Simpson Thacher & Bartlett LLP

 

 

Andrew S. Mason

 

Sullivan & Cromwell LLP

 

 

John D. Rayis

 

Skadden, Arps, Slate, Meagher &

 

Flom LLP

 

FOOTNOTES

 

 

1 "FIRPTA" refers to the Foreign Investment in Real Property Tax Act of 1980, which was included as part of the Omnibus Reconciliation Act of 1980 (P.L. 96-499).

2See S. Rep. No. 504, 96th Cong., 1st Sess. 6 (1979), at 511. H.R. Rep. No. 96-1167 2d Sess., at 530 (1980).

3 I.R.M. § 4.10.7.2.4.1 (Jan. 1, 2006).

4See Jeffrey Kottmeier and James Costello, "Foreign Investment in Real Property Act (FIRPTA): Proposed Changes Could Reallocate Foreign Investment in U.S.", CBRE U.S. ViewPoint (August 2013).

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Authors
    Berger, Gregory W.
    Hart, John C.
    Mason, Andrew S.
    Rayis, John D.
  • Institutional Authors
    Brownstein Hyatt Farber Schreck LLP
    Simpson Thacher & Bartlett LLP
    Sullivan & Cromwell LLP
    Skadden, Arps, Slate, Meagher & Flom LLP
  • Cross-Reference
    Notice 2007-55 2007 TNT 115-12: Internal Revenue Bulletin.
  • Code Sections
  • Subject Area/Tax Topics
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2013-25039
  • Tax Analysts Electronic Citation
    2013 TNT 210-18
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