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Canadian Fund Weighs in on Foreign Pension Fund Regs

MAY 20, 2016

Canadian Fund Weighs in on Foreign Pension Fund Regs

DATED MAY 20, 2016
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[Editor's Note: Full text, including group's letter to OECD .]

 

May 20, 2016

 

 

Internal Revenue Service

 

Courier's Desk

 

1111 Constitution Avenue NW

 

Washington, DC 20224

 

 

Attention: CC:PA:LPD:PR (REG-101329-16)

 

 

Dear Sir or Madam:

 

Re: Comment Letter Submitted Pursuant to Treasury Decision 9751 on Section 897(l)(3)

 

Canada Pension Plan Investment Board ("CPPIB") welcomes the chance to respond to the request for comments1 relating to regulations to be issued pursuant to Section 897(l)(3) of the Internal Revenue Code of 1986, as amended (the "Code").2 We appreciate the opportunity to invest in U.S. real estate and infrastructure under the exemption provided in Section 897(l), which, with the issuance of appropriate regulations, will clearly fulfill Congressional intent by bringing growth-stimulating capital into the U.S.

A. INTRODUCTION

As the largest pension fund in Canada with assets under management of approximately CAD$280 billion, we believe we are well positioned to provide input into the regulatory process in respect of Section 897(l). As a qualified foreign pension fund and an intended beneficiary of Section 897(l), we want to assist the Treasury Department and the IRS in drafting appropriate regulations under Section 897(l)(3). We are representative of a larger global constituency of pension funds that manages the retirement security of citizens from countries around the world and is a growing source of long-term investment capital.

Recently, we collaborated with some of our global pension fund peers to provide input into the Organisation for Economic Co-operation and Development's (the "OECD") work on the definition of a "recognized pension fund" for inclusion in an update to the OECD Model Tax Convention.3 While there are some differences in the language chosen by Congress and that being considered by the OECD in defining a pension fund, there are underlying principles that are applicable to both definitions in light of the wide variety of ways in which pension funds are structured around the world.

We believe that foreign pension funds around the world would benefit from additional clarity with respect to the application of Section 897(l) and that regulations should provide this clarity. Taking inspiration from our work with the OECD, our comments below reflect our understanding of the importance of striking the appropriate balance in tax legislation and regulation, and we also consider the policy intent behind the enactment of Section 897(l).

Regulations issued pursuant to Section 897(l)(3) should further the intention of Congress in enacting Section 897(l) of encouraging greater investment in U.S. real estate (including infrastructure projects that may consist, in whole or part, of U.S. real estate4) by foreign pension funds,5 and in particular Congress' intention that Section 897(l) apply to a broad range of foreign pension funds that provide pension and pension-related benefits to, among others, the general working public of a foreign country. Below we set forth a discussion of the relevant requirements of Section 897(l) and suggested principles that should be followed in drafting regulations in order to reflect application of the provision to both government-sponsored pension funds and private pension funds.

B. QUALIFIED FOREIGN PENSION FUNDS UNDER SECTION 897(l)(2)

 

1. Trust, Corporation or Other Organization or Arrangement

 

Under Section 897(l)(2), a "qualified foreign pension fund" to which Section 897(l) applies must be a "trust, corporation, or other organization or arrangement." Regulations promulgated under Section 897(l) should implement the intention of Congress to include the broad range of foreign pension funds, however they may be organized.6 This intention was made clear in the Joint Committee on Taxation's (the "JCT") General Explanation of Section 897(l) (the "Bluebook")7 which stated that "[f]oreign pension funds may be structured in a variety of ways, and may comprise one or more separate entities. The word 'arrangement' encompasses such alternative structures."

Thus, regulations should be issued reflecting the principle that any structure the various components, accounts or entities of which are there to serve the purpose of providing pension or retirement benefits is an "arrangement" under Section 897(l)(2). The regulations should recognize that foreign pension funds may be comprised of separate legal entities acting together in performing the various functions of a pension fund. For example, under the umbrella of a single pension fund, the functions of collecting contributions from employers, holding invested assets, managing fund investments and providing benefits to participants, among other functions, might each be conducted by separate entities. The regulations should make clear that, for purposes of applying the criteria to be treated as a "qualified foreign pension fund," entities arranged (whether by ownership, contract, regulation, governmental organization or another form of arrangement) to act together in performing the various functions of a pension fund may be integrated as a single "arrangement," so long as the arrangement has a unified framework with an identifiable pool of assets that can be together identified as a pension fund. Each constituent entity within such an arrangement should be entitled to the benefits of Section 897(l) insofar as it is acting as part of the arrangement.

 

2. Established Under the Law of a Foreign Country

 

Section 897(l)(2)(A) requires that a qualified foreign pension fund be "created or organized under the law of a country other than the United States." Regulations should clarify that a pension fund created or organized under the law of one or more political subdivisions of a foreign country meets this requirement, in addition to funds created or organized under the law of a federal or national government.

 

3. Established to Provide Retirement or Pension Benefits

 

Section 897(l)(2)(B) requires that a qualified foreign pension fund be "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." We suggest below principles for regulations that should be issued with respect to these requirements.
a. "One or More Employers"
Section 897(l) is intended to cover a pension fund whether or not it is established for a defined employer or set of employers. The Bluebook makes clear that "[m]ulti-employer and government-sponsored public pension funds that provide pension and pension-related benefits may satisfy [Section 897(l)(2)(B)]. For example, [qualified foreign pension funds] may be established for one or more companies or professions, or for the general working public of a foreign country" (emphasis added). Thus, regulations should be drafted so that qualification under Section 897(l)(2) is possible for pension funds that cover single employers, multiple employers, groups of employees (such as unions) and employers that are covered based on their nationality, location, industry, profession or other common features.

As reflected by the JCT's explicit statement in the Bluebook, it is clear that Congress intended Section 897(l) to apply to government-sponsored public pension funds. Nevertheless statements of commentators have evidenced some confusion on whether Section 897(l) applies to such funds.8 Thus, to resolve any outstanding doubts, the regulations should make explicit that government-sponsored pension funds established to provide pension and pension-related benefits to the general working public of a foreign country can satisfy the requirements of Section 897(l)(2)(B), including the "one or more employers" requirement.

Some government-sponsored pension funds may have features that are comparable to certain features of the U.S. social security system, in particular the retirement benefits that are provided based on mandatory contributions. A similarity to the U.S. social security system should not affect whether pension funds can qualify under Section 897(l). Government-sponsored pension funds can be distinguished from general welfare programs on the basis that such pension funds are funded by contributions, which are determined by reference to employment and made by employers or employees or both {including the self-employed). As long as a foreign pension fund is operated with an identifiable pool of assets and with the purpose of providing benefits to retired individuals (who were employed or self-employed), with contributions and benefits correlated to earnings, and otherwise meets the requirements to be treated as a qualified foreign pension fund, such fund should be entitled to the benefits of Section 897(l).

b. "Retirement or Pension Benefits"
The Bluebook recognizes that pension funds often provide pension-related benefits, such as death benefits, disability benefits and similar benefits to survivors.9 Such benefits go hand-in-hand with pension benefits in protecting employees and their families when the employee stops working, whether due to retirement, disability or death. Regulations should therefore allow a qualified foreign pension fund to provide such benefits in addition to pension benefits, and should be drafted so that the provision of such benefits is not a negative factor in determining whether a pension fund is a qualified foreign pension fund. In addition, pension funds may provide benefits that are complementary to pension benefits (for example, health benefits) ancillary to the fund's primary purpose of providing pension and pension-related benefits.

The regulations should clearly specify that pension-related benefits, including death, disability, survivor and similar benefits qualify as "retirement or pension benefits" provided to an employee, and that the incidental provision of ancillary benefits does not disqualify a pension fund from treatment as a qualified foreign pension fund. Given the variety of possible benefits that may be provided by a pension fund while remaining within the intended scope of Section 897(l), we do not believe it is feasible or advisable either to specifically define the type of benefits that may be "pension-related" or to lay down a precise numerical test for the amount of retirement or pension and pension-related versus other ancillary benefits that may be provided by a qualified foreign pension fund. Rather, the regulations should provide that a pension fund that acts to protect the financial well-being of retired workers and their families can satisfy Section 897(l)(2)(B).

c. "Current or Former Employees" (and Designees)
Because pension funds may provide benefits to self-employed persons and persons who may not be considered employees under the U.S. common law definition of employees,10 regulations should be focused on whether a pension fund covers working people and should not be concerned whether there is a separate identifiable employer for each employee. Regulations should make clear that a pension fund that provides benefits to the general working public of a foreign country may be treated as a qualified foreign pension fund. The regulations should also recognize that the self-employed are within the definition of "employee" for purposes of Section 897(l).

Further, the regulations should make clear that a qualified foreign pension fund may provide benefits to an employee or former employee's spouse, children, or other family members or dependents, even in the absence of an express designation by the employee or former employee. For example, payments similar to social security benefits paid to a surviving spouse should be permitted for a qualified foreign pension fund -- in fact, defined benefit pension plans under the U.S. Employee Retirement Income Security Act ("ERISA") generally must provide benefits to the surviving spouse of a "vested participant" unless the spouse consents to waive the benefit.11 The regulations should take into account that a foreign pension fund may define an employee's family members or dependents in a variety of ways and may be similar to ERISA plans in providing benefits to those family members or dependents without express designation by the plan participant. The regulations should provide a test that is sufficiently broad and flexible to cover multiple approaches which may differ from U.S. law in determining third parties to whom benefits may be provided -- as long as the benefit provided to the third party is intended to be in consideration for services rendered.

d. Coordination With Section 892
Many government-sponsored foreign pension funds may qualify for treatment as governmental entities under Section 892, but this qualification should not affect whether a pension fund can also qualify under Section 897(l). It is not uncommon for governments to establish pension funds that are part of the government itself. Indeed, this practice is common in the U.S. at the state and local level.12 In light of the Bluebook's explicit reference to "government-sponsored public pension funds," it is clear that Congress intended to recognize foreign pension funds that are treated as governmental entities under Section 892 as included within the scope of Section 897(l). Thus, regulations should explicitly provide that a foreign pension fund can qualify under Section 897(l) without regard to such pension fund's status as part of a foreign government or a controlled governmental entity for purposes of Section 892.

 

4. No More Than Five Percent of Assets or Income

 

Section 897(l)(2)(C) requires that a qualified foreign pension fund not have a "single participant or beneficiary with a right to more than five percent of its assets or income." Regulations should implement this provision consistent with the intent to apply only to situations where a pension fund has been established for the benefit of a very small number of individuals. The regulations should provide guidance for the manner in which such percentage is calculated, taking into account the various ways a participant's or beneficiary's entitlement to benefits may be defined. For example, to the extent a participant's or beneficiary's entitlement to retirement or pension benefits may depend on life expectancy, vesting, or cost of living adjustments, the percentage interest such participant or beneficiary has in the assets or income of a fund may be difficult to calculate. The regulations should implement the five-percent requirements to permit pension funds with sufficiently broad participation to satisfy Section 897(l)(2)(C). In particular, in cases where a pension fund is intended to cover the general working public of a foreign country, such pension fund should benefit from a presumption under which it is not necessary to satisfy any particular quantitative test.

 

5. Subject to Government Regulation and Annual Information Reporting

 

Section 897(l)(2)(D) requires that a qualified foreign pension fund be "subject to government regulation" and "provide[ ] annual information reporting about its beneficiaries to the relevant tax authorities in the country in which it is established or operates[.]" Regulations implementing this requirement should recognize the various ways in which a foreign country may regulate pension funds, and should not require any particular form of government regulation. Additionally, since government-sponsored pension funds can be treated as qualified foreign pension funds, and a government may not always regulate itself (i.e., the sponsored pension fund) in the same way that a private pension fund is regulated, regulations should provide that government regulation under Section 897(l)(2)(D) can take any form endorsed by the government and is not required to be uniform across all pension funds in a country.13

Regulations should also account for the variety of information reporting regimes that may apply to foreign pension funds. For example, pension funds may provide the information reporting contemplated by Section 897(l)(2)(D) to labor departments rather than directly to tax authorities.14 Regulations should therefore be implemented in a manner that treats as the "relevant tax authorities" the governmental recipients of pension fund information reports and should clarify that the part of the arrangement that applies the Section 897(l) exemption need not be the part that satisfies the information reporting requirement.

 

6. Tax Preference

 

Section 897(I)(2)(E) requires that, under the laws of the country under the laws of which a qualified foreign pension fund is established or operates, contributions to the fund be deductible or excluded from the gross income of the fund or taxed at a reduced rate or that taxation of the investment income of the fund be deferred or taxed at a reduced rate. Regulations should provide that pension funds that are not subject to taxation (including government-sponsored pension funds) meet the requirements of Section 897(l)(2)(E).

C. SUBSIDIARIES OF QUALIFIED FOREIGN PENSION FUNDS

 

1. Second-Tier Subsidiaries

 

Pension funds may be required by applicable foreign law or have non-tax related reasons for holding U.S. real property interests through structures that include more than one level of subsidiaries. However, there is ambiguity whether the language in Section 897(l)(1)(B) stating that "any entity all of the interests of which are held by a qualified foreign pension fund" is entitled to the benefits of Section 897(l) applies to indirect wholly owned corporate subsidiaries. There does not appear to be any policy that should affirmatively prevent Section 897(l)(1)(B) from including a second- or third-tier wholly owned corporate subsidiary of a qualified foreign pension fund.

Accordingly, regulations should allow a pension fund flexibility in structuring its holdings of U.S. real property interests by clarifying that Section 897(l)(1)(B) includes indirect wholly owned corporate subsidiaries of a qualified foreign pension fund. This look-through approach would be consistent with Section 897(c)(5), which operates on a look-through basis for determining if a parent corporation is a United States real property holding company.15

We recognize, however, that there could be potential for abuse if a qualified foreign pension fund indirectly acquires a foreign corporation and that foreign corporation is then allowed the benefits of Section 897(l) on a subsequent disposition of a U.S. real property interest or on receiving a capital gain distribution from a REIT. If IRS or the Treasury Department views the risk of abuse as material, regulations could provide that an indirect wholly owned corporate subsidiary is included in Section 897(l)(1)(B) only if such subsidiary has been indirectly (or directly) wholly owned by a qualified foreign pension fund for such subsidiary's entire existence.

 

2. Aggregate Investment Vehicles

 

In some cases, foreign pension funds may choose to invest along with other pension funds in investment vehicles owned exclusively by pension funds. However, the language "any entity all of the interests of which are held by a qualified foreign pension fund" is ambiguous whether such an investment vehicle is included. As with wholly owned second-tier corporate subsidiaries, there does not appear to be any policy that should affirmatively prevent Section 897(l)(1)(B) from including this type of investment vehicle if it is wholly owned by qualified foreign pension funds. Therefore, regulations should clarify that the language of Section 897(l)(1)(B) includes any entity all of the interests of which are held by qualified foreign pension funds.

D. CONCLUSION

We thank you for considering our comments. We believe that open discourse between you as regulators and us as the intended beneficiaries of Section 897(l) will enable you to achieve the goal of issuing appropriate regulations. To that end, we welcome your questions or feedback and would be happy to discuss our suggestions further at your convenience.

Respectfully submitted,

 

 

Kristina Fanjoy

 

Managing Director, Head of Tax

 

Canada Pension Plan Investment

 

Board

 

cc:

 

John Koskinen

 

Commissioner

 

Internal Revenue Service

 

 

Emily S. McMahon

 

Deputy Assistant Secretary (Tax Policy)

 

Office of the Tax Legislative Counsel

 

Department of the Treasury

 

 

Danielle Rolfes

 

International Tax Counsel

 

Office of the International Tax Counsel

 

Department of the Treasury

 

FOOTNOTES

 

 

1 This request was included in Treasury Decision 9751 (March 7, 2016) under the heading "Request for Comments."

2 Unless otherwise stated, all "Section" references herein are to sections of the Code.

3 Please refer to our letter, submitted in coalition with other global pension funds, to the OECD, dated April 1, 2016, in connection with the OECD's invitation to comment on its Public Discussion Draft "Treaty Residence of Pension Funds." A copy of this letter is attached and is also available through the following link at page 73 to 79: http://www.oecd.org/tax/treaties/public-comments-received-discussion-draft-treaty-residence-pension-funds.pdf.

4 In our case, we have been under-invested in U.S. infrastructure and therefore appreciate the opportunity to increase those investments as a qualified foreign pension fund exempt from Section 897.

5See Joint Comm. on Taxation, Description of Certain Revenue Provisions Contained in the President's Fiscal Year 2014 Budget Proposal (JCS-4-13), December 2013.

6 This Congressional intent for the provision to apply broadly is evidenced by the large cost estimate ($2.15 billion over ten years) that the Joint Committee on Taxation provided to Congress before Section 897(l) was enacted. Joint Comm. on Taxation, Estimated Budget Effects of the Revenue Provisions Contained in the President's Fiscal Year 2014 Budget Proposal (JCX-11-13), May 2013.

7 Joint Comm. on Taxation, General Explanation of Tax Legislation Enacted in 2015 (JCS-1-16), March 2016.

8See, e.g., Amy S. Elliot. Foreign Pension Fund FIRPTA Exemption May Need Tweaking, Tax Notes Today, Dec. 18, 2015 ("Peter J. Genz of King & Spalding said that requirement [in Section 897(l)(2)(B)] raises the question whether a foreign sovereign pension fund -- for example, one created in the context of a sovereign social security system -- might be left out of the definition").

9 For example, the California State Teachers' Retirement System provides disability and death/survivor benefits in addition to pension benefits. That qualified foreign pension funds may provide such benefits is confirmed by the Bluebook, which clearly states that "pension funds that provide pension and pension-related benefits may satisfy" this requirement.

10 For example, U.S. tax-advantaged defined benefits plans, which can be pension plans, may be established by self-employed individuals, who may make contributions both as the employee and employer.

11 29 U.S.C. 1055.

12 This practice is quite common in the U.S. -- the U.S. Census Bureau reports that all 50 state governments provide pension benefits to their employees and that many local governments do so as well. United States Census Bureau, 2014 Survey of Public Pensions: State & Local Data, https://www.census.gov/govs/retire/. As of 2013, the Census Bureau listed a total of 1,788 state and local government pension plans, https://www.census.gov/govs/retire/historical_data_2013.html. In 2009, over 27 million employees were covered by state and local government pension plans, according to a Government Accountability Office report. GAO, State and Local Government Pension Plans (GAO-12-322), March 2012.

13 For example, a government-sponsored pension fund would satisfy this requirement if that fund can point to the existence of provisions for accountability and review contained in that fund's constituting legislation.

14 Note that in the U.S., employee benefit plans file IRS Form 5500, Annual Return/Report of Employee Benefit Plan, with the Department of Labor, not the IRS.

15 We note that Section 897(l)(1) explicitly includes U.S. real property interests owned by a foreign pension fund (or its wholly owned subsidiary) indirectly through one or more partnerships; however, this does not imply that Section 897(l)(1)(B) does not contemplate indirect wholly owned subsidiaries that are not partnerships. Section 897(l)(1) makes provision for indirect ownership through partnerships for situations where the pension fund will not wholly own the underlying U.S. real property interest. It is therefore necessary in that provision to specify that U.S. real property interests held indirectly through partnerships are covered. In contrast, when discussing wholly owned subsidiaries that are not partnerships, Section 897(l)(1)(B) does not need to specify that indirect subsidiaries are covered because they could be described as wholly owned by the pension fund.

 

END OF FOOTNOTES
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