Recent Changes to the Foreign Investment in Real Property Tax Act (FIRPTA) – Part II

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FIRPTA treats any gain or loss realized on the disposition of a United States Real Property Interest (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 fifteen percent (previously ten percent) of the gross amount realized on the disposition. (Certain exceptions may apply.)

In part I of our article, published in our January 2016 Newsletter, we covered the changes to FIRPTA with respect to investments by “Qualified Foreign Pension Funds” under the PATH Tax Act of 2015.

“Domestically Controlled REIT” Exception

The Act has added clarity for publicly traded REITs and their shareholders who depend on the exception for domestically controlled REITs. Under the pre-PATH Act law, gains on the sale of shares in a domestically controlled REIT (meaning a REIT that is held by US persons to the extent of 50% or more of its stock) were not subject to FIRPTA. However, publicly traded REITs have encountered challenges in applying this exception, because they have sometimes been unable to determine the domestic or foreign status of shareholders holding less than a 5% percent interest. The Act allows a U.S. publicly traded REIT to presume that all less-than-5% shareholders are U.S. persons unless the REIT has actual knowledge to the contrary.

FIRPTA “Cleansing Rule”

The Act makes it clear that the FIRPTA “cleansing rule” exception does not apply to REITs or RICs. Under the law prior to the PATH Act, FIRPTA did not apply to the gain recognized on the disposition of shares of a US Real Property Holding Corporation, if (a) all of the United States real property interests held by such U.S. corporation at any time during the relevant testing period were disposed of in transactions in which the full amount of the gain (if any) was recognized, and (b) as of the date of the disposition of such shares, such U.S. corporation did not hold any United States real property interests. The rationale behind the cleansing rule was that the gain on the U.S. real property, having been taxed once already, should not be taxed again by way of taxing the stock sale. That rationale, however, does not apply to REITs. Accordingly, the Act provides that the FIRPTA cleansing rule does not apply to U.S. corporations (or any of their predecessors) that have been REITs during the relevant testing period.

Dividends Received Deduction

Dividends from REITs and RICs are no longer treated as dividends from domestic corporations for purposes of determining whether certain dividends from a foreign corporation, which are attributable to dividends from an 80 percent-owned domestic corporation, are eligible for the Section 245 dividends received deduction.

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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