FIRPTA treats any gain or loss realized on the disposition of a USRPI by a foreign person as “effectively connected with the conduct of a US trade or business” (ECI.) ECI is a class of income that is subject to US income taxation on a “net” basis. Withholding laws relating to FIRPTA also provide for a withholding tax applicable to dispositions of a USRPI. For a disposition of a USRPI by a foreign person, these laws impose a requirement on the transferee to deduct and withhold a tax equal to ten percent of the gross amount realized on the disposition. (Certain exceptions may apply.)
Investment by Qualified Foreign Pension Funds
Under the PATH Act, a new exception has been enacted with respect to foreign pension funds and retirement plans. Neither FIRPTA, nor the related withholding tax provisions, will apply to a USRPI held directly, or indirectly through one or more partnerships, or to any distribution received from a REIT, by a “qualified foreign pension fund,” or any entity that is wholly owned by a “qualified foreign pension fund.”
A “qualified foreign pension fund” includes a trust, corporation, or other organization or arrangement:
- That is created or organized under the laws of a foreign country;
- That is established to provide retirement or pension benefits to participants or beneficiaries that are current or former employees (or their designees) for services rendered;
- That does not have a single participant or beneficiary with rights to more than five percent of assets or income;
- That is subject to foreign government regulation, and reports annually information about its beneficiaries to the tax authorities in the country in which it is established or operates;
- And, under the laws of the country in which it is established or operates,
- Either contributions to such organization or arrangement are deductible or excluded from the gross income of the entity, or taxed at a reduced rate, or
- Any investment income of the organization or arrangement is subject to deferred taxation, or taxed at a reduced rate.
While the goal of this new exception appears to be to attract additional foreign investment in the United States, the requirements above will limit the number of foreign pension funds that are eligible. In addition, although the PATH Act exempts these pension funds from FIRPTA withholding, the Act doesn’t provide for a means to inform the “withholding agent” that it does not have a withholding obligation.
Increase in withholding tax
As noted above, a disposition of a USRPI is subject to a withholding tax equal to ten percent of the amount realized (subject to certain exceptions.) The withholding tax obligation is imposed on the transferee of the USRPI. The PATH Act increases this withholding tax to fifteen percent. The increase doesn’t apply to the sale of a personal residence for a price of not more than $1 million. The increased withholding tax applies to the disposition of a USRPI 60 days or more after the date of enactment (December 18, 2015.)
If you have questions about FIRPTA, or any other cross-border tax or transfer pricing matters, please contact the author of this article, Fuad Saba.
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