Foreign Investor Initial Tax Considerations

Transcription

1 ABA Section of Taxation 2011 Fall Meeting Real Estate Committee REAL ESTATE FUNDS: To Block or Not To Block? October 21, 2011 Panel Members: Kimberly S. Blanchard Weil Gotshal & Manges LLP Michael Hirschfeld Dechert LLP Moderator: Eliot L. Kaplan Squire, Sanders & Dempsey (US) LLP Investor Initial Tax Considerations Considerations with Blocker: Debt versus Equity FIRPTA ECI Commercial Activity for Privacy US Blocker versus Blocker Investor driven to drink by the Blocker tax structures 1 1

2 Options Individual 15% tax or 35% tax Privacy Concerns Estate Tax but - only one level of tax! real estate Consider type of Disregarded Entity 2 Additional Investor Initial Tax Considerations (cont d) Individual Corp. real estate No Estate Tax Branch Profits Tax Privacy Concerns Sale of Stock - Tax Free BUT! Tax-Free Refinancing Distributions 3 2

3 Additional Investor Initial Tax Considerations (cont d) Individual U.S. Corp. real estate No Branch Profits Tax Dividend Withholding Tax Estate Tax Privacy Concerns Sale of Stock Taxable Taxable Refinancing Distributions 4 Additional Investor Initial Tax Considerations (cont d) Individual Corp. U.S. Corp. Real Estate Best Option? No Branch Profits Tax No Estate Tax No Disclosure Sale of Stock Taxable Refinancing Distributions 5 3

4 Multiple Properties INDIVIDUAL Corp. US Corp. US 1 US 2 US 3 6 Multiple Properties (cont d) INDIVIDUAL Corp. US 1 US 2 US 3 7 4

5 Simple Above-the- Blocker Structure Simple form for only one investment where exit is not by selling stock GP US Blocker USRPI 8 Structure for Eligible Investments Other GP No need for a blocker above if investment is in s or C corporations below or other assets that can be held directly by foreign investors (such as debt); if DC, foreign investor can sell stock free of FIRPTA tax; if any corporation, 892 investor can sell stock free of FIRPTA tax if not 50% owned. USRPI USRPI USRPI 9 5

6 Simple Below-the- Blocker Structure Other GP In practice this would usually be done through an AIV or parallel fund so no ECI taint from main fund participation. Blocker Carry Splitter Other Investments Non- Eligible Investment 10 Additional Investor Considerations Separate Blocker for each Real Estate Investment (Branch Tax) Above-the- Blocker versus Below-the Blocker Reason for Splitter (carry) Section 875 Considerations 11 6

7 Use of AIV with Above-the- Blocker Other GP Blocker Main AIV USRPI 12 Structuring Notes The use of buckets to track different types of investments is common. Most foreign investors can invest in debt unblocked, but if debt is converted to equity the investment may need to be dropped into a blocker structure. Note that many treaty-country investors will not want the fund or any entity between the investor and the US source income to be an entity treated as opaque at home due to 894 regulations; LLCs are often prohibited. 13 7

8 Self-Help Blocker-Splitter Structure Where Holds and ECI Splitter US Blocker ECI This is used less commonly where the sponsor cannot separate good from bad investments ECI 14 Series Blocker and Splitter Structure GP Series Series LLC LLC Series (each LLC taxed as (each taxed as (each corporations) corporations) taxed as corporations) Carry Splitter Non- Eligible Investment 15 8

9 Series Blocker and Splitter Structure As stated above, most real estate funds set up a separate corporation to make each real estate investment, enabling each corporation to sell its assets and distribute proceeds free of FIRPTA tax to foreign investors. A series LLC or similar cell structure can be used in the same way. 16 Other Investor Tax Considerations Reason for Leverage at Blocker; Interest- Stripping Rules; Portfolio Interest; Tax Treaties Section 1446 Withholding Section 894 Concerns Governments, Section 892, T(b), Domestically-Controlled S, Notice , 897(h)(1) Return Filing Requirements 17 9

10 Tax-Exempt Income of US tax-exempt investors generally is not subject to US federal income tax, except for unrelated business taxable income (UBTI), which is subject to tax at regular corporate rates. UBTI is gross income derived from any unrelated trade or business regularly carried on by the tax-exempt, less any deductions associated with such trade or business. 18 Tax-Exempt (cont d) Certain passive income items, including dividends, interest and capital gain, are excluded from UBTI. However, if investment property yielding dividends, interest or other excludable income is leveraged, it may result in such income becoming unrelated debt financed income which is a separate category of UBTI. To the extent a tax-exempt investor s level of UBTI is higher than 20% of all its revenues, a tax-exempt investor may start worrying about its exemption

11 Tax-Exempt (cont d) UBTI arises due to a tax-exempt investor s share of income from Real Estate if the Real Estate s is a pass-through (e.g., partnership, LLC) and engaged in non-exempt business or if it is leveraged 20 Tax-Exempt (cont d) Taxable Blocker Tax Exempt Potential solution to UBTI is to use blocker corporation to shelter UBTI otherwise allocable to the Tax Exempt Entity holding interests in the Real Estate

12 Tax-Exempt (cont d) Structure contemplates investment of tax-exempt investors capital into a C corporation, which then contributes to the Real Estate. This structure protects the tax-exempt investor from potential UBTI resulting from: Real Estate investments in passthrough entities, whose unrelated business status would otherwise pass through to tax-exempt. Debt leverage imposed at the Real Estate level. Consider whether Blocker should be US or Corporation. 22 Tax-Exempt (cont d) Similar to Investor Below-the- block structures, Tax-Exempt also utilize this structure. Other Blocker RE Investment RE Investment RE Investment Similar to Investor structures, a carry splitter is often used

13 Tax-Exempt Tax-Exempt are sometimes placed in a Parallel- Structure Taxable General Partner Tax Exempt Real Estate Real Estate 24 13