ABA Tax Section Critiques Proposed Regs on Foreign Government Exemptions

ABA Tax Section Critiques Proposed Regs on Foreign Government Exemptions

American Bar Association Section of Taxation

The American Bar Association Section of Taxation has submitted comments on proposed regulations (<a href="/lr/resolve//7fhxn">REG-100442-22</a>) on the treatment of specified entities, including qualified foreign pension funds, for purposes of the exemption from taxation afforded to foreign governments and to address the determination whether a qualified investment entity is domestically controlled. The tax section explains that gain or loss of a nonresident alien individual or foreign corporation from the disposition of an interest in a domestically controlled qualified investment entity (QIE) is not subject to tax under <a href="/research/federal/usc26/897#cq97-0000002" resolve="/lr/resolve//cq97#cq97-0000002">section 897(a)</a>. A QIE is considered domestically controlled if, at all times during the testing period, less than 50 percent of the value of the stock was held directly or indirectly by foreign persons. Although the tax code does not define the term “directly or indirectly” for purposes of <a href="/research/federal/usc26/897" resolve="/lr/resolve//cq97">section 897</a>, existing regulations provide that the actual owners of stock are taken into account to make this determination. However, instead of taking into account actual owners of stock in determining whether a QIE is domestically controlled, the proposed regs apply a look-through approach to QIE interests actually owned by specified entities. For example, section members note that foreign owners of some foreign-owned domestic corporations are considered to directly or indirectly own stock of a QIE in making the domestically controlled determination (the corporate look-through rule). The tax section has expressed concerns with the corporate look-through rule, recommending that the IRS eliminate it and instead reaffirm the conclusions of a 2009 private letter ruling (<a href="/lr/resolve//1k9yn">LTR 200923001</a>) regarding domestic control. In that ruling, a real estate investment trust could be considered a domestically controlled QIE if the majority of its common shares were held by domestic subchapter C corporations. Alternatively, section members suggest amending the corporate look-through rule in one or more of five ways. Moreover, if the rule is not withdrawn, members recommend several actions to take, including the provision of transition relief, regarding the publication date of the final regs, which would serve as the effective date. The tax section points out that the <a href="/research/federal/usc26/892" resolve="/lr/resolve//cp87">section 892</a> exemption for some income received by a foreign government does not apply to income received directly or indirectly from commercial activities, such as income (A) derived from the conduct of any commercial activity (whether within or outside the United States), (B) received by a controlled commercial entity (CCE) or received (directly or indirectly) from a CCE, or (C) derived from the disposition of any interest in a CCE. For purposes of qualifying as a CCE, a U.S. real property holding corporation (USRPHC) is treated as engaged in commercial activity (the deeming rule). The proposed regs reiterate the deeming rule while also providing two exceptions. The tax section cautions, however, that even with the exceptions, when a foreign government invests in U.S. real estate through a controlled entity that owns interests in lower-tier USRPHCs, the deeming rule will cause any income (including income from sources other than the USRPHCs) derived from the controlled entity to lose its exemption under <a href="/research/federal/usc26/892" resolve="/lr/resolve//cp87">section 892</a> (unless the controlled entity is itself a USRPHC solely as a result of owning interests in other USRPHCs not controlled by the foreign government). Section members therefore propose withdrawing the deeming rule, or else amending it. Members also suggest that gain arising from the disposition of a partnership interest be exempt under <a href="/research/federal/usc26/892" resolve="/lr/resolve//cp87">section 892</a> to the extent that it is attributable to assets that, if sold directly by the foreign government, would be exempt.

The American Bar Association Section of Taxation has submitted comments on proposed regulations (REG-100442-22) on the treatment of specified entities, including qualified foreign pension funds, for purposes of the exemption from taxation afforded to foreign governments and to address the determination whether a qualified investment entity is domestically controlled.

The American Bar Association Section of Taxation has submitted comments on proposed regulations (REG-100442-22) on the treatment of specified entities, including qualified foreign pension funds, for purposes of the exemption from taxation afforded to foreign governments and to address the determination whether a qualified investment entity is domestically controlled. The tax section explains that gain or loss of a nonresident alien individual or foreign corporation from the disposition of an interest in a domestically controlled qualified investment entity (QIE) is not subject to tax under section 897(a). A QIE is considered domestically controlled if, at all times during the testing period, less than 50 percent of the value of the stock was held directly or indirectly by foreign persons. Although the tax code does not define the term “directly or indirectly” for purposes of section 897, existing regulations provide that the actual owners of stock are taken into account to make this determination. However, instead of taking into account actual owners of stock in determining whether a QIE is domestically controlled, the proposed regs apply a look-through approach to QIE interests actually owned by specified entities. For example, section members note that foreign owners of some foreign-owned domestic corporations are considered to directly or indirectly own stock of a QIE in making the domestically controlled determination (the corporate look-through rule). The tax section has expressed concerns with the corporate look-through rule, recommending that the IRS eliminate it and instead reaffirm the conclusions of a 2009 private letter ruling (LTR 200923001) regarding domestic control. In that ruling, a real estate investment trust could be considered a domestically controlled QIE if the majority of its common shares were held by domestic subchapter C corporations. Alternatively, section members suggest amending the corporate look-through rule in one or more of five ways. Moreover, if the rule is not withdrawn, members recommend several actions to take, including the provision of transition relief, regarding the publication date of the final regs, which would serve as the effective date. The tax section points out that the section 892 exemption for some income received by a foreign government does not apply to income received directly or indirectly from commercial activities, such as income (A) derived from the conduct of any commercial activity (whether within or outside the United States), (B) received by a controlled commercial entity (CCE) or received (directly or indirectly) from a CCE, or (C) derived from the disposition of any interest in a CCE. For purposes of qualifying as a CCE, a U.S. real property holding corporation (USRPHC) is treated as engaged in commercial activity (the deeming rule). The proposed regs reiterate the deeming rule while also providing two exceptions. The tax section cautions, however, that even with the exceptions, when a foreign government invests in U.S. real estate through a controlled entity that owns interests in lower-tier USRPHCs, the deeming rule will cause any income (including income from sources other than the USRPHCs) derived from the controlled entity to lose its exemption under section 892 (unless the controlled entity is itself a USRPHC solely as a result of owning interests in other USRPHCs not controlled by the foreign government). Section members therefore propose withdrawing the deeming rule, or else amending it. Members also suggest that gain arising from the disposition of a partnership interest be exempt under section 892 to the extent that it is attributable to assets that, if sold directly by the foreign government, would be exempt.

Sec. 892 Income of foreign governments and of international organizations

Sec. 897 Disposition of investment in United States real property

United States

Benefits and pensions

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ABA Tax Section Critiques Proposed Regs on Foreign Government Exemptions