FIRPTA Withholding Rules -- Final Regulations Under Section 1445

 [4830-01]

 ACTION: Final Regulations.

 SUMMARY: This document contains final Income Tax Regulations relating to the withholding that is required upon the disposition of a U.S. real property interest by publicly traded partnerships, publicly traded trusts, and real estate investment trusts. These final regulations enable publicly traded partnerships, publicly traded trusts and real estate investment trusts, by meeting certain notice requirements, to shift the responsibility for withholding on proceeds from the disposition of U.S. real property interests to a nominee where such an entity does not make a payment directly to a foreign person.

 DATES: This document is effective with respect to distributions after March 7, 1991. However, at the option of any person who would be treated by these final regulations as a withholding agent, that person may apply these regulations to any distributions occurring on an earlier date which is after December 7, 1990, as long as no other person also acts as a withholding agent with respect to the same distribution.

 FOR FURTHER INFORMATION CONTACT: John F. Dean of the Office of Associate Chief Counsel (International), within the Office of Chief Counsel, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, DC 20224 (Attention: CC:CORP:T:R (INTL-088-86) 202-377-9493, not a toll-free call).

SUPPLEMENTARY INFORMATION:

PAPERWORK REDUCTION ACT

The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the requirements of the Paperwork Reduction Act (44 U.S.C. section 3504(h)) under control number 1545-0096. The estimated annual burden per respondent/ recordkeeper varies from 3 minutes to 9 minutes, depending on individual circumstances, with an estimated average of 6 minutes.

 These estimates are an approximation of the average time expected to be necessary for a collection of information. They are based on information as is available to the Internal Revenue Service. Individual respondents/recordkeepers may require greater or less time, depending on their particular circumstances.

 Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be directed to the Internal Revenue Service, Attention: IRS Reports Clearance Officer, TR:FP, Washington, DC 20224, and to the Office of Management and Budget, Paperwork Reduction Project (RIN: 1545-AM50), Washington, DC 20503.

BACKGROUND

 On December 24, 1986, the Federal Register published proposed and temporary amendments (51 FR 46651) to the Income Tax Regulations (26 CFR Part 1) under section 1445, which was added to the Internal Revenue Code (98 Stat. 494) by section 129(a) of the Tax Reform Act of 1984. Written comments responding to this notice were received. A public hearing was not requested or held. After consideration of the comments regarding the proposed and temporary amendments, one recommendation has been adopted as an amendment in this Treasury Decision. The comments and revision are discussed below.

PUBLIC COMMENTS

 The proposed and temporary regulations establish a mechanism whereby the withholding obligation on FIRPTA distributions by publicly traded partnerships, publicly traded trusts and REITs is, under certain conditions, shifted to those who are in a position to know the foreign status of an interest holder. Section 1.1445-8T(c) provides rules governing the amount to be withheld with respect to such distributions by such entities. Due to the unique rules of section 857 governing the taxation of REITs, a distinction was drawn between them and publicly traded partnerships and trusts. Proposed and temporary regulation section 1.1445-8T(c)(2)(ii) provides that, in the case of a REIT, the amount subject to withholding under section 1445 is the amount of any distribution, determined with respect to each share or certificate of beneficial interest, which the REIT designates as a capital gain dividend (as defined in section 857(b)(3)(C)) multiplied by the number of shares or certificates of beneficial interest held by the foreign person.

 The language of the proposed and temporary regulation is largely adopted except for some clarifying changes. The final regulations clarify that, in the case of a publicly traded partnership, compliance with the withholding requirements of section 1446 satisfies the partnership's withholding requirements under section 1445-8. Also, the repeal, for taxable years beginning after 1986, of the former preferential rates of taxation for long term capital gains (subject to certain transition rules) made it necessary to adjust the withholding rules with respect to REITs, which are based on capital gain dividend designations. The new rules are reflected in section 1.1445-8(c)(2)(ii) and section 1.1445-8(h).

 The elimination of the preferential rate for net capital gains may remove an incentive for REITs to designate capital gain dividends. In this context it should be observed that, under the rules of the proposed and temporary regulations, FIRPTA withholding would be avoided if no portion of a dividend were designated as a capital gain dividend.

 A commentator suggested that this potential concern could be avoided by amending regulation section 1.1445-8T(c)(2)(ii) to require deemed capital gain dividend treatment for distributions that could be, but are not, designated as a capital gain dividend by a REIT. The suggestion has been adopted. Therefore, the largest amount of any distribution occurring March 7, 1991, that could be designated as a capital gain dividend will be deemed to have been designated by the publicly traded REIT as a capital gain dividend for purposes of section 1.1445-8, thereby making it automatically subject to withholding under this section 1.1445-8. However, the liability for withholding on a * * * distribution will shift to a nominee under the rules of section 1.1445-8(b)(3) if and only to the extent the REIT makes an actual designation of a capital gain distribution. If the REIT does not make an actual designation, it remains liable for withholding on all distributions deemed designated under this final regulation as capital gain dividends.

 If, subsequent to these regulations, a provision for preferential treatment is enacted for net capital gains, the deemed capital gain dividend provision in section 1.1445-8(c)(2)(ii) will be amended in accordance with and to reflect the enactment of such preferential treatment.

 The final regulations reserve on the issue of whether and how to impose withholding pursuant to section 1.1445-8 with respect to a dividend distributed by a REIT, which is not a capital gain dividend but is attributable to net short-term capital gain realized from the disposition of U.S. real property interests by the REIT. The Internal Revenue Service invites comments on this issue.

SPECIAL ANALYSES

 It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. Chapter 5) and the Regulatory Flexibility Act (5 U.S.C. Chapter 6) do not apply to these regulations, and, therefore, a final Regulatory Flexibility Analysis is not required.

DRAFTING INFORMATION

 The principal author of these regulations is John F. Dean of the Office of Associate Chief Counsel (International), within the Office of Chief Counsel, Internal Revenue Service. Other personnel from the Internal Revenue Service and Treasury Department participated in developing the regulations.

LIST OF SUBJECTS IN 26 CFR 1.1441-1 THROUGH 1.1464-1

 Income taxes, Aliens, Foreign corporations.

LIST OF SUBJECTS IN 26 CFR Part 602

 Reporting and recordkeeping requirements.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR Parts 1 and 602 are amended as follows:

INCOME TAX REGULATIONS 26 CFR Part 1

Paragraph 1. The authority for Part 1 is amended by removing the authorities for section 1.1445-8T and adding the following citation:

Authority: 26 U.S.C. 7805. *** Section 1.1445-8 also issued under 26 U.S.C. 1445(e)(6).

Par. 2. Section 1.1445-5(c)(3) is amended as follows:

1. By revising paragraph (c)(3)(i) to read as follows,

2. By removing paragraph (c)(3)(v), and

3. By redesignating paragraph (c)(3)(vi) as paragraph (c)(3)(v).

SECTION 1.1445-5 SPECIAL RULES CONCERNING DISTRIBUTIONS AND OTHER TRANSACTIONS BY CORPORATIONS, PARTNERSHIPS, TRUSTS, AND ESTATES.

* * * * *

(c) DISPOSITIONS OF U.S. REAL PROPERTY INTERESTS BY DOMESTIC PARTNERSHIPS, TRUSTS, AND ESTATES.

* * * * *

(3) LARGE PARTNERSHIPS OR TRUSTS -- (i) IN GENERAL. If a partnership or trust has more than 100 partners or beneficiaries, then the partnership or fiduciary of the trust may elect to withhold in accordance with the provisions of this section 1.1445-5(c)(3) in lieu of withholding in the manner required by section 1.1445-5(c)(1). However, the rules of this Section 1.1445-5(c)(3) shall not apply to any partnership or trust interests in which are regularly traded on an established securities market except as described in section 1.1445-8(c)(1). The rules of this section 1.1445-5(c)(3) shall not apply to any real estate investment trust. See section 1445-8.

* * * * *

Par. 3. Section 1.1445-8T is removed.

Par. 4. New section 1.1445-8 is added in the appropriate place to read as follows:

SECTION 1.1445-8 SPECIAL RULES REGARDING PUBLICLY TRADED PARTNERSHIPS, PUBLICLY TRADED TRUSTS AND REAL ESTATE INVESTMENT TRUSTS (REITS).

(a) Entities to which this section applies. The rules of this section apply to --

(1) Any partnership or trust, interests in which are regularly traded on an established securities market (regardless of the number of its partners or beneficiaries), and

(2) Any REIT (regardless of the form of its organization). For purposes of paragraph (a)(1) of this section, the rules of section 1445(e)(1) and this section shall not apply to a publicly traded partnership (as defined in section 7704) which is treated as a corporation under section 7704(a), or to those entities that are classified as "associations" and taxed as corporations. See section 301.7701-2.

(b) OBLIGATION TO WITHHOLD -- (1) IN GENERAL. An entity described in paragraph (a) of this section is not required to withhold under the provisions of section 1.1445-5 (c), which states the withholding requirements of domestic partnerships, trusts and estates upon the disposition of U.S. real property interests. Except as otherwise provided in this paragraph (b), an entity described in paragraph (a) of this section shall be liable to withhold tax upon the distribution of any amount attributable to the disposition of a U.S. real property interest, with respect to each holder of an interest in the entity that is a foreign person. The amount to be withheld is described in paragraph (c) of this section.

(2) PUBLICLY TRADED PARTNERSHIPS. Publicly traded partnerships which comply with the withholding procedures under section 1446 will be deemed to have satisfied their withholding obligations under this paragraph (b).

(3) SPECIAL RULE FOR CERTAIN DISTRIBUTIONS TO NOMINEES. In the case of a person that --

(i) Is a nominee (as defined in paragraph (e) of this section),

(ii) Receives a distribution attributable to the disposition of a U.S. real property interest directly from an entity described in paragraph (a) of this section or indirectly from such entity through a nominee,

(iii) Receives the distribution for payment to any foreign person, or the account of any foreign person, and

(iv) Receives a qualified notice pursuant to paragraph (f) of this section,

then the obligation to withhold in accordance with the general rules of section 1445(e)(1) and this paragraph (b) shall be imposed solely on that person to the extent of the amount specified by the qualified notice. A person obligated to withhold by reason of this paragraph (b)(3) is referred to as a withholding agent.

(4) PERSON DESIGNATED TO ACT FOR WITHHOLDING AGENT. The rules stated in section 1.1441-7(b)(1) and (2) regarding a person designated to act for a withholding agent shall apply for purposes of this section.

(5) EFFECT OF WITHHOLDING EXEMPTION GRANTED UNDER SECTION 1.1441-4(f). A letter issued by a district director under the provisions of section 1.1441-4(f), which exempts a person from withholding under section 1441 or section 1442, shall also exempt that person from withholding under this paragraph (b), if --

(i) The letter identifies another person as the withholding agent for purposes of section 1441 or 1442, and

(ii) Such other person enters into a written agreement, with the district director who issued the letter, to be the withholding agent for purposes of this paragraph (b).

The exemption granted, and the corresponding withholding obligation imposed, by this paragraph (b)(5) shall apply with respect to the first distribution made after execution of the agreement described in the preceding sentence and shall continue to apply to all distributions made during the period in which the exemption granted under section 1.1441-4(f) is in effect.

(6) PAYMENT OTHER THAN IN MONEY. The rule stated in section 1.1441-7(c) regarding payment other than in money shall apply for purposes of this section.

(c) AMOUNT TO BE WITHHELD -- (1) DISTRIBUTION FROM A PUBLICLY TRADED PARTNERSHIP OR PUBLICLY TRADED TRUST. The amount to be withheld under this section with respect to a distribution by a publicly traded partnership or publicly traded trust shall be computed in the manner described in section 1.1445-5(c)(3)(ii) and (iii), subject to the rules of this section.

(2) REITs -- (i) IN GENERAL. The amount to be withheld with respect to a distribution by a REIT, under this section shall be equal to 34 percent (28 percent in the case of a distribution occurring before January 1, 1987) of the amount described in paragraph (c)(2)(ii) of this section.

(ii) AMOUNT SUBJECT TO WITHHOLDING -- (A) IN GENERAL. Except as otherwise provided in paragraph (c)(2)(ii)(C) of this section, the amount subject to withholding is the amount of any distribution, determined with respect to each share or certificate of beneficial interest, designated by a REIT as a capital gain dividend, multiplied by the number of shares or certificates of beneficial interest owned by the foreign person. Solely for purposes of this paragraph, the largest amount of any distribution occurring after March 7, 1990 that could be designated as a capital gain dividend under section 857(b)(3)(C) shall be deemed to have been designated by a REIT as a capital gain dividend regardless of the amount actually designated.

(B) DISTRIBUTION ATTRIBUTABLE TO NET SHORT-TERM CAPITAL GAIN FROM THE DISPOSITION OF A U.S. REAL PROPERTY INTEREST. [Reserved]

(C) DESIGNATION OF PRIOR DISTRIBUTION AS CAPITAL GAIN DIVIDEND. If a REIT makes an actual designation of a prior distribution, in whole or in part, as a capital gain dividend, such prior distribution shall not be subject to withholding under this section. Rather, a REIT must characterize and treat as a capital gain dividend distribution (solely for purposes of section 1445(e)(1)) each distribution, determined with respect to each share or certificate of beneficial interest, made on the day of, or any time subsequent to, such designation as a capital gain dividend until such characterized amounts equal the amount of the prior distribution designated as a capital gain dividend. The provisions of this paragraph shall not be applicable in any taxable year in which the REIT adopts a formal or informal resolution or plan of complete liquidation.

(iii) EXAMPLE. The following example illustrates the rules of paragraph (c)(2)(ii)(C) of this section.

In the first quarter of 1988, XYZ REIT makes a dividend distribution of $2X. In the second quarter of 1988, XYZ sells real property, recognizing a long term capital gain of $15X, and makes a dividend distribution of $5X. In the third quarter of 1988, XYZ makes a distribution of $3X. In the fourth quarter of 1988, XYZ sells real property recognizing a long term capital loss of $2X. Within 30 days after the close of the taxable year, XYZ designates a capital gain dividend for the year of $13X. It subsequently makes a fourth quarter distribution of $7X. Since XYZ has made an actual designation of prior distributions during the taxable year as capital gain dividends, withholding on those prior distributions will not be required. However, the REIT must characterize, solely for purposes of section 1445(e)(1), a total amount of $13X of dividend distributions as capital gain dividends. Therefore, the fourth quarter dividend distribution of $7X must be characterized as a capital gain dividend subject to withholding under this section. In addition, XYZ will be required to characterize an additional $6X of subsequent dividend distributions as capital gain dividends.

(d) DEFINITION OF NOMINEE. For purposes of this section, the term "nominee" means a domestic person that holds an interest in an entity described in paragraph (a) of this section on behalf of another domestic or foreign person.

(e) DETERMINATION OF NON-FOREIGN STATUS BY WITHHOLDING AGENT. A withholding agent may rely on a certificate of non-foreign status pursuant to section 1.1445-2(b) or on the statements and address provided to it on Form W-9 or a form that is substantially similar to such form, to determine whether an interest holder is a domestic person. Reliance on these documents will excuse the withholding agent from liability imposed under section 1445(e)(1) in the absence of actual knowledge that the interest holder is a foreign person. A withholding agent may also employ other means to determine the status of an interest holder, but, if the agent relies on such other means and the interest holder proves, in fact, to be a foreign person, then the withholding agent is subject to any liability imposed pursuant to section 1445 and the regulations thereunder for failure to withhold.

(f) QUALIFIED NOTICE. A qualified notice for purposes of paragraph (b)(3)(iv) of this section is a notice given by a partnership, trust or REIT regarding a distribution that is attributable to the disposition of a U.S. real property interest in accordance with the notice requirements with respect to dividends described in 17 C.F.R. 240.10b-17(b)(1) or (3) issued pursuant to the Securities Exchange Act of 1934, 15 U.S.C. section 78a et seq. In the case of a REIT, a qualified notice is only a notice of a distribution, all or any portion of which the REIT actually designates, or characterizes in accordance with paragraph (c)(2)(ii)(C) of this section, as a capital gain dividend in accordance with 17 C.F.R. 240.10b-17(b)(1) or (3), with respect to each share or certificate of beneficial interest. A deemed designation under paragraph (c)(2)(ii)(A) of this section may not be the subject of a qualified notice under this paragraph (f). A person described in paragraph (b)(3) of this section shall be treated as receiving a qualified notice at the time such notice is published in accordance with 17 C.F.R. 240.10b-17(b)(1) or (3).

(g) REPORTING AND PAYING OVER WITHHELD AMOUNTS. With respect to an amount withheld under this section, a withholding agent is not required to conform to the requirements of section 1.1445-5(b)(5) but is required to report and pay over to the Internal Revenue Service any amount required to be withheld pursuant to the rules and procedures of section 1461, the regulations thereunder and section 1.6302-2. Forms 1042 and 1042S are to be used for this purpose.

(h) EARLY REFUND PROCEDURE NOT AVAILABLE. The early refund procedure set forth in section 1.1445-6(g) shall not apply to amounts withheld under the rules of this section. For adjustment of over- withheld amounts, see section 1.1461-4.

(i) LIABILITY UPON FAILURE TO WITHHOLD. For rules regarding liability upon failure to withhold under section 1445 (e) and this section, see section 1.1445-1(e).

OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT (26 CFR Part 602)

Par. 5. The authority citation for Part 602 continues to read as follows:

Authority: 26 U.S.C. 7805

Par. 6. Section 602.101(c) is amended by removing in the table "section 1.1445-8T . . . 1545-0096" and by adding in the appropriate place in the table "section 1.1445-8 . . . 1545-0096".