Firm Seeks Clarity, Predictability in Foreign Pension Fund Regs

We are writing on behalf of one of our clients, a Swedish pension fund established to secure pension obligations to several thousands of employees, to request that regulations be issued under Section 897(1)¹ to clarify certain issues pertaining to the definition of a "qualified foreign pension fund" (or "QFPF"). Our client is a member of the Swedish Pension Fund Association, a branch organization comprising 48 Swedish pension funds holding approximately SEK 190 billion of assets.

The PATH Act -- Section 897m

The Protecting Americans from Tax Hikes Act of 2015 (the "PATH Act") enacted Section 897(1) which carves out an important exception from the application of the Foreign Investment in Real Property Tax Act ("FIRPTA"). QFPFs, and entities wholly-owned by QFPFs, are generally exempt from taxation with respect to direct and indirect investments in United States real property interests and distributions from real estate investment trusts.

Section 897(1)(2) defines the term "qualified foreign pension fund" to mean "any trust, corporation, or other organization or arrangement --

Background

It has been stated that the purpose of Section 897(1) is to attract foreign pension funds to invest in U.S. real property and infrastructure projects, and to place investments by foreign and U.S. pension funds on a level playing field.² Foreign pension funds control very significant assets and are important sources of capital for investments in U.S. real property and infrastructure.

The foreign pension institutions targeted by the new rules presumably comprise a multitude of different entities and arrangements organized under the laws of many different foreign jurisdictions. It is likely that many of these institutions, while operating substantially similar to U.S. pension funds, are legally organized under the laws of foreign jurisdictions in ways that are different from U.S. pension funds. This can produce uncertainty as to their QFPF status which may discourage investment, particularly with respect to foreign pension funds that would rely on the tax-exemption in order to enter the U.S. real estate market. Many foreign pension funds tend to be managed conservatively and reject investments in asset classes that have uncertainties associated with them including uncertain tax consequences. Thus, in order to achieve the stated purpose to encourage investments by foreign pension funds, it is important that the IRS promptly adopt regulations clarifying the application of the QFPF definition to pension institutions that operate under legal, regulatory compliance frameworks that are different from the U.S. system.

General Comments

This letter is not intended to provide comprehensive comments on all aspects of Section 897(1) but we note that the broad definition of a QFPF in Section 897(1)(2) as "any trust, corporation, or other organization or arrangement" is helpful and appropriate in light of the wide variety of types of foreign pension entities and pension arrangements that may potentially be covered. In light of this we would recommend that the forthcoming regulations build on the statutory language and make it clear that the definitional criteria set forth in Section 897(1)(2)(A)-(E) be determined not just by looking at the characteristics of the specific pension entity at issue, but by also taking into consideration the overall legal framework, or "arrangement", applicable to such pension entity.

With respect to the five definitional criteria set forth in Section 897(1)(2)(A)-(E), there are items that could benefit from clarification and items that arguably should be more flexible. For example, criteria (B)-(D) contain references to "participants" and "beneficiaries" without defining those terms. By analogy to the ERISA rules, the reference to "participants" presumably refers to employees or former employees entitled to pension benefits, and the reference to "beneficiaries" presumably refers to dependents and/or designees of such employees. We believe this should be clarified.

With regard to criterion (D), the requirement that the QFPF must provide annual information reporting to the local tax authority concerning its "beneficiaries" is arguably overly narrow. While it would seem appropriate to require QFPFs to operate transparently and in compliance with local government regulations and tax reporting requirements, not all foreign pension funds are subject to annual information reporting for tax purposes with respect to payments to beneficiaries. For example, certain foreign pension funds provide annual financial reporting and/or accounting to non-tax government bodies, but do not specifically report payments to beneficiaries to tax authorities. We would suggest therefore that criterion (D) be more broadly stated to require that the foreign pension fund be subject to (and materially comply with) local tax compliance and reporting requirements.

Moreover, it would appear that the reference to "beneficiaries" in criterion (D) should be modified to "participants or beneficiaries".

Application to Swedish Pension Foundations

Our client, like many other Swedish pension funds, operates under and is subject to a specific statutory framework adopted by the Swedish Parliament in 1967 referred to as "Tryggandelagen" (loosely translated, the "Pension Security Act" or the "Act")³.

The Pension Security Act was enacted to ensure that employers set aside and properly manage assets to cover and secure future pension obligations to employees and their family members. Under the Act participating employers may establish a statutory "Pension Foundation" to which assets are contributed for the purpose of satisfying future pension obligations. The contributions are tax deductible by the employer and not subject to taxation in the hands of the Pension Foundation. In addition, the investment income of a Pension Foundation is exempt from Swedish income tax. In lieu of income tax a Pension Foundation is subject to a "yield tax" imposed on the net worth of its assets.

A Pension Foundation is governed by a Board of Directors appointed by the employer and the employees. The Directors appoint managers of the Pension Foundation. The Pension Security Act contain extensive rules and requirements relating to the management of the Pension Foundation including detailed management and investment guidelines, and rules regarding annual reporting, accounting and compliance. Pension Foundations are subject to supervision by various governmental bodies and are required to submit an annual accounting to Lansstyrelsen, a Governmental entity.

Under the Act, Pension Foundations do not assume the pension obligations of the employer. Rather, the employer remains primarily liable for the pension obligations and administer payments of pension benefits to the former employees and report those payments to the tax authorities. Under the Act, upon payment of pension benefits, the employer is entitled to and receives reimbursement from the Pension Foundation. Although the employer remains liable to the former employees, the statutory books and records of the employer do not reflect pension obligations secured by the assets of a Pension Foundation; the books and records will only reflect such obligations if and to the extent the pension obligations exceed the assets held by the Pension Foundation to cover such liabilities. In addition, in the event the employer is insolvent, in bankruptcy or is otherwise unable or unwilling to timely pay pension benefits, the Pension Foundation is required to step in and make such payments directly to the retired employees.

Accordingly, Swedish Pension Foundations established under the Pension Security Act operate in a manner that is substantively similar to many U.S. pension funds, and it would appear that a Swedish Pension Foundation would ordinarily be within the intended scope of Section 897(1). However, because a Pension Foundation is not primarily liable for the payment of the pension benefits to the retired employees, the application of the statutory definition of a QFPF to a Pension Foundation raises some issues.

Specifically, in the case of a Pension Foundation, QFPF criterion (A) and (E) are clearly satisfied and should not present any issues. Criterion (B) is satisfied assuming that, as we believe is the case, the former employees and their family members are the "participants" and "beneficiaries", and criterion (C) is satisfied provided that none of those "participants" and "beneficiaries" have the right to more than 5% of the assets or income of the fund. With respect to criterion (D), as explained above, a Pension Foundation is subject to government regulation and reporting requirements, but it does not itself provide annual tax information reporting with respect to beneficiaries. Rather, the employers, who handle the actual payment to the retired employees, provide annual information reporting regarding such payments for tax purposes. There are at least two ways that criterion (D) can be interpreted to be satisfied under the present fact pattern. First, the statutory language broadly defines a QFPF to include any "trust, corporation, other organization or arrangement". The overall statutory scheme created by the Pension Security Act would appear to constitute an "arrangement" in which case the employer's annual tax information reporting, which would be part of the overall arrangement, would satisfy the annual tax information reporting requirement. Alternatively, the annual information reporting requirement should arguably be satisfied by the legal requirement that annual accounting be reported to the supervising government body.

Conclusions and Recommendations

As a policy matter it would appear that foreign pension funds that operate in ways that are substantially similar to U.S. pension funds should generally qualify as QFPFs. With regard to Swedish Pension Foundations, it would appear that such entities are functionally similar to U.S. pension funds and should ordinarily qualify as a QFPF under a reasonable interpretation of the statutory language. However, in order to promote clarity and predictability we would recommend that regulations be issued that specifically address the points discussed herein, i.e.,:

² General Explanation of the Administration's Fiscal Year 2014 Revenue Proposals, pp. 108 and 123.

³ Technically, Lag (1967:531) om tryggande av pensionsutfastelse m.m.