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Firm Seeks Certainty on Tax Withholding Exemption Under PATH Act

MAR. 22, 2016

Firm Seeks Certainty on Tax Withholding Exemption Under PATH Act

DATED MAR. 22, 2016
DOCUMENT ATTRIBUTES

 

March 22, 2016

 

 

The Honorable Mark J. Mazur

 

Assistant Secretary (Tax Policy)

 

Department of the Treasury

 

1500 Pennsylvania Avenue, N.W.

 

Washington, DC 20220

 

 

The Honorable John A. Koskinen

 

Commissioner

 

Internal Revenue Service

 

1111 Constitution Avenue, N.W.

 

Washington, DC 20224

 

RE: Comments on Section 323 of the Protecting Americans from Tax Hikes Act of 2015 (the Qualified Foreign Pension Fund Exemption from FIRPTA)

 

Dear Assistant Secretary Mazur and Commissioner Koskinen:

On December 18, 2015, President Obama signed the Consolidated Appropriations Act, 2016 into law, which includes the Protecting Americans from Tax Hikes Act of 2015 (the "PATH Act"). Sections 323(a)(1) and 323(b) of the PATH Act generally provide "qualified foreign pension funds," or "QFPFs," an exemption from income and withholding tax imposed under the Foreign Investment in U.S. Real Property Tax Act of 1980 ("FIRPTA") with respect to the disposition of U.S. real property interests within the meaning of Section 897(c) of the Internal Revenue Code of 1986, as amended (the "Code"). Section 323(a)(3) of the PATH Act provides that "the Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the purposes of this subsection."

As a matter of proper statutory interpretation. legislative intent, and sound tax policy, we strongly believe and request that any regulations issued by the Secretary should confirm that:

 

(1) a QFPF that holds a U.S. real property interest indirectly through one or more tiers of wholly owned entities remains entitled to the FIRPTA exemption provided in Sections 323(a)(1) and 323(b) of the PATH Act.

(2) a QFPF that invests in U.S. real property interests along with other QFPFs via an aggregate investment vehicle that is owned solely by multiple QFPFs remains entitled to the FIRPTA exemption provided in Sections 323(a)(1) and 323(b) of the PATH Act; and

(3) a QFPF that owns an interest in a real estate investment trust (a "REIT") indirectly through a tax-transparent entity (e.g., a partnership) remains entitled to the FIRPTA exemption provided in Sections 323(a)(1) and 323(b) of the PATH Act with respect to distributions attributable to the REIT's disposition of a U.S. real property interest (a "Capital Gain Dividend").

 

Relevant Statutory Language

New Section 897(1) of the Code as added by Section 323(a) of lie PATH Act provides: "This section [897] shall not apply to any United States real property interest held directly (or indirectly through 1 or more partnerships) by, or to any distribution received from a real estate investment trust by --

 

(A) a qualified foreign pension fund, or

(B) any entity all of the interests of which are held by a qualified foreign pension fund.

 

Code Section 1443(f)(3), as amended by Section 323(b) of the PATH Act, provides that the term "foreign person," for purposes of the rules under Code 1445 for withholding of tax on dispositions of U.S. real property interests, excludes an entity under Code Section 897(1).

Indirect Investment Through Tiers of Wholly Owned Entities

Section 897(1)(B) exempts a QFPF or "any entity all of the interests of which are held by a QFPF" from FIRPTA income and withholding tax. If a QFPF were to make an investment in U.S. real property via a corporation in the QFPF's jurisdiction that is a wholly owned subsidiary of a wholly owned subsidiary of the QFPF, would such lower-tier subsidiary qualify for the pension fund FIRPTA exemption?

There appears to be no rationale or logic for excluding such a wholly owned subsidiary from the benefits accorded to a QFPF. The statutory language of Section 897(1) does not say "directly or indirectly" prior to "held by a QFPF," however, so there is an argument that the literal language of Section 323 does not exempt an entity that is indirectly but wholly owned by a QFPF. Congress did use such language in other places in the PATH Act; in fact, Congress used such language in the same paragraph in Section 323 -- providing that such section applied to any United States real property interest "held directly (or indirectly through 1 or more partnerships)." Although it does not appear that Congress intended to exclude lower-tier, wholly owned entities of QFPFs from the benefit of the FIRPTA exemption, the statutory language on its face could be interpreted to exclude lower-tier wholly owned entities.

The legislative history on this provision merely repeats the statutory language verbatim and states that the Secretary may provide such regulations as are necessary to carry out the purposes of the provision. One can surmise that the primary intent of the provision is to provide a broad FIRPTA exemption to a very narrow class of foreign investors. Congress provided a very specific definition of a QFPF, and then provided a wholesale exemption from FIRPTA for the narrow class of persons that fall within the specific definition. It would be contrary to such intent to deny a QFPF an exemption from FIRPTA for investments in U.S. real property interests merely because the QFPF structured such investments through separate but wholly owned entities. Many QFPFs ore required to make investments in such manner under their legal or investment guidelines. The Secretary should confirm that an investment in U.S. real property interests through tiers of wholly owned entities does not disqualify an otherwise eligible QFPF from the benefits of the FIRPTA exemption accorded under Section 323 of the PATH Act.

Multiple QFPF Investment Through An Aggregator Investment Vehicle

Section 323 of the PATH Act exempts a QFPF or "any entity all of the interests of which are held by a QFPF" from FIRPTA tax. This language raises an additional question of whether an entity qualifies for the FIRPTA exemption if its interests are held by multiple QFPFs, rather than by a single QFPF.

Technically, Section 323 of the PATH Act only covers an entity "all of the interests of which are held by a QFPF." It could be argued that a literal reading of this language seems to exclude an entity completely owned by multiple QFPFs. However, as with the discussion above regarding an entity that is wholly owned by a QFPF, there is no rationale or logic for excluding an entity that is completely owned by multiple QFPFs. Congress circumscribed a specific definition of a QFPF, and then provided a wholesale exemption from FIRPTA for the narrow class of persons that fall within the specific definition. It would be contrary to such intent to deny a QFPF an exemption from FIRPTA for investments in U.S. real property interests merely because the QFPF structured such investments along with other QFPFs in an aggregator investment vehicle. QFPFs from a foreign country are in some cases required to make investments in such manner with other QFPFs from the same foreign country under their legal or investment guidelines. The Secretary should confirm that an entity owned solely by multiple QFPFs remains entitled to the FIRPTA exemption provided in Section 323 of the PATH Act

REIT Capital Cain Dividends Received By A QFPF Indirectly Through A Tax-Transparent Entity

Section 323 of the PATH Act applies to "any distribution received from a real estate investment trust by -- (A) a qualified foreign pension fund, or (B) any entity all of the interests of which are held by a qualified foreign pension fund", but Section 323 does not expressly include a REIT distribution received via a partnership. The statutory provision does provide that it applies to any U.S. real property interest "held directly (or indirectly through 1 or more partnerships)," but it is not entirely clear whether these two parts of the statute work together. Accordingly, it could be argued that a Capital Gain Dividend (i.e., distribution that is attributable to a REIT's disposition of a U.S. real property interest) that a QFPF receives through a partnership is not covered under this exemption.

On the one hand, Congress did not expressly specify that REIT distributions must be received "directly" by a QFPF. However, Congress did not include a parenthetical that sanctions receipt of REIT distributions indirectly through one or more partnerships, whereas it did expressly cover REIT distributions received by an entity wholly owned by a QFPF. As a result, it could be argued that a Capital Gain Dividend received through one or more partnerships is not covered because, by definition, a partnership cannot be directly wholly owned by a QFPF.

We believe this is not the correct interpretation of the statutory provision, however, because there is no logic or rationale for drawing such an arbitrary distinction with respect to partnerships. It is hard to believe Congress intended for the stock of a REIT held through a partnership to be exempt from FIRPTA under this provision, but that any Capital Gain Dividends through the partnership would remain subject to FIRPTA. Some may point out that a similar dichotomy exists with respect to the domestically controlled REIT exception (i.e., gain on the sale of domestically controlled REIT stock is exempt from FIRPTA, whereas Capital Gain Dividends from a domestically controlled REIT are not exempt from FIRPTA). The counter-argument to this position is that the domestically controlled REIT exception is a structural exemption for foreign investors that otherwise are fully subject to tax under FIRPTA, whereas Section 323 of the PATH Act provides a complete FIRPTA exemption for QFPFs. This distinction is critical. With respect to a QFPF, the difference between the sale of REIT stock held through a partnership and a Capital Gain Dividend received through a partnership is not significant.

A reading of Section 323 of the PATH Act to accord a QFPF the exemption from FIRPTA on Capital Gain Dividends through a tax-transparent entity is strengthened by Section 322 of the PATH Act, which added a new Code Section 897(k) that provides that "stock of a real estate investment trust which is held directly (or indirectly through 1 or more partnerships) by a qualified shareholder shall not be treated as a United States real property interest, and (ii) notwithstanding subsection (h)(1), any distribution to a qualified shareholder shall not be treated as gain recognized from the sale or exchange of a United States real property interest to the extent the stock of the real estate investment trust held by such qualified shareholder is not treated as a United Stales real property interest under clause (i)." In other words, under Section 322 of the PATH Act, Capital Gain Dividends to certain "qualified shareholders" (i.e., collective investment vehicles) are not subject to FIRPTA, regardless of whether they are made through 1 or more partnerships.

Accordingly, an interpretation of Section 323 of the PATH Act that makes a distinction between the sale of REIT stock held through a partnership and a REIT Capital Gain Dividend received through a partnership seems absurd in light of Section 322 of the PATH Act. Instead, logic would dictate exempting a QFPF from FIRPTA on Capital Gain Dividends received through a partnership in accordance with the exemption granted for the underlying REIT stock. This interpretation of Section 323 of the PATH Act would be consistent with Congressional intent, sound tax policy, and Section 322 of the PATH Act. The Secretary should thus confirm that a QFPF is not denied the benefits of the exemption from FIRPTA on Capital Gain Dividends merely because those dividends flow through a partnership.

Proposed, Temporary, or Final Regulations under Code Section 897(l)

We respectfully submit our above comments. As a general matter, it is our view that any proposed, temporary, or final regulations to be issued under Section 323 of the PATH Act (Code Section 897(l)(3)) should further Congress' intent to grant qualified foreign pension funds a broad exemption from income and withholding tax under FIRPTA. Neither the best reading of the statute, Congressional intent, nor sound tax policy would justify denying a QFPF an exemption from FIRPTA merely because it makes investments In U.S. real property interests through tiers of wholly owned entities or along side other QFPFs via a holding entity that is wholly owned by QFPFs, or in a REIT through a partnership.

We thank you for your consideration of our comments on Section 323 of the PATH Act.

Please let us know if you have any questions.

Sincerely,

 

 

Richard M. Lipton

 

 

Patricia McDonald

 

 

Steven R. Schneider

 

 

Samuel P. Grilli

 

 

Diana R. Myers

 

 

Baker & McKenzie

 

Chicago, IL
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