Omnibus appropriations legislation enacted March 23 includes extensive changes to the Foreign Investment in Real Property Tax Act (FIRPTA). The changes, contained in the tax technical corrections section of the bill, are designed to ensure the reforms adopted in 2015 operate as Congress intended and encourage job growth and new investment in U.S. real estate.
The Protecting Americans from Tax Hikes (PATH) Act of 2015 ushered in the first major changes to the FIRPTA since its enactment in 1980. For several years, Republican and Democratic Members of Congress had come together to introduce bipartisan legislation aimed at rolling back the FIRPTA statute. See Real Estate Jobs and Investment Act of 2011 (H.R. 2989, S. 1616); Real Estate Jobs and Investment Act of 2013 (H.R. 2870, S. 1181), Real Estate Jobs and Investment Act of 2014 (H.R. 5487); Real Estate Jobs and Investment Act of 2015 (H.R. 2128, S. 915). FIRPTA discourages foreign investment in U.S. real estate by treating gains from U.S. Real Property Interests (USRPIs) as income effectively connected with a U.S. trade or business (in contrast to foreign investment in other asset classes, which does not trigger U.S. tax liability).
In 2015, Congress increased the ownership stake that a foreign investor can take in a publicly traded U.S. real estate investment trust (REIT) without triggering FIRPTA. The ownership percentage was increased from 5% to 10%. Second, Congress exempted foreign pension funds from FIRPTA altogether. See Deloitte summary of the PATH Act changes to FIRPTA. The exemption for foreign pension funds creates greater tax parity between tax-exempt U.S. pension funds and the foreign counterparts. Globally, pension funds are a large and growing source of capital for real estate development. According to data firm Preqin, 87% of public and 73% of private pension funds actively invest in real estate. Pension funds tend to be patient, long-term investors.
After its enactment, some observers concluded that the drafting of the foreign pension fund definition unintentionally excluded governmental pension plans or arrangements where participation was broad and the beneficiary and benefit provider did not have a direct employer-employee relationship (e.g., Social Security-type arrangements). They also expressed concern that the definition unintentionally excluded plans established to provide pensions for the self-employed, and arrangements where a separate legal entity pools retirement assets from multiple employers or multiple pension plans, or plans that were not subject to annual information reporting. For detailed commentary on the questions and concerns raised regarding the PATH Act foreign pension fund definition, see: Baker McKenzie, KPMG, and PwC.
In most countries, government-based pension systems are the dominant provider of retirement benefits, with no similar private, defined benefit system in place. Failure to cover broad-based, governmental plans threatened to dramatically limit the applicability of the FIRPTA foreign pension fund exemption, thus undermining Congress’ intention to: (a) spur jobs and investment in U.S. real estate and (b) reduce disparities in the U.S. taxation of foreign and domestic pension plans.
Similarly, some governments, particularly in Europe, have pension programs that are generally obligatory by law (for professionals working as employees or self-employed) in a particular area. So the pensioners are a mixture of employees and self-employed individuals. The professionals are obliged to make regular payments to the plans in return they receive the claim to get a pension benefits. While U.S. pensions provisions often explicitly treat self-employed persons as employees for purposes of the provisions, the lack of specific language in FIRPTA foreign pension fund exemption created uncertainty with respect to plans that cover self-employed persons.
In addition, it was unclear under the PATH Act whether REIT dividends allocated through a partnership to a foreign pension fund would be covered by the foreign pension exemption.
The FIRPTA technical corrections in the omnibus appropriations bill were first introduced in the Tax Technical Corrections Act of 2016 (H.R. 6439). They are the product of significant stakeholder input, and were available to the public for comments for roughly 15 months.
Specifically, the new FIRPTA provisions:
- Clarify that a government-established fund to provide public retirement or pension benefits (i.e., a Social Security-type arrangement) may qualify for the foreign pension fund exemption;
- Clarify that a fund established by one or more employers to provide retirement or pension benefits to participants or beneficiaries (including self-employed individuals), such as a multiple-employer plan, may qualify for the foreign pension fund exemption;
- Modify the requirement that the foreign pension fund provide annual information reporting about its beneficiaries to the relevant tax authorities by clarifying that it is sufficient if the information is available to the relevant authorities;
- Modify the requirement that the income of the foreign pension fund be taxed at a reduced rate to clarify that it covers situations where the income is excluded from tax altogether;
- Clarify that FIRPTA does not apply to any USRPI held directly (or indirectly through one or more partnerships) by a qualified foreign pension fund or an entity all the interests of which are held by a qualified foreign pension fund; and
- Clarify that FIRPTA does not apply to to any distribution received from a REIT by a qualified foreign pension fund, or an entity all the interests of which are held by a qualified foreign pension fund.
The technical corrections in the omnibus spending bill remove the lingering uncertainty and ensure that a wide variety of foreign pension arrangements can invest in United States Real Property Interests without a risk of FIRPTA liability.