Investments in US Real Property by Non-US Investors: Basic FIRPTA Rules

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1 Investments in US Real Property by Non-US Investors: Basic FIRPTA Rules Kelly M. Kogan, Chadbourne & Park LLP, with PLC Tax This Note describes the basic aspects of the FIRPTA rules, including the types of property that qualify as US real property interests, the types of transactions subject to the FIRPTA rules and the withholding obligations applicable to dispositions of US real property interests by foreign persons. This is just one example of the many online resources Practical Law Company offers. To access this resource and others, visit practicallaw.com. Under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), gain or loss from the disposition of a US real property interest (USRPI) by a foreign person is treated as effectively connected with the conduct of a US trade or business and is subject to US tax if the foreign person is a: Foreign individual not resident in the US for tax purposes (nonresident alien individual). Foreign corporation. If a disposition of a USRPI is subject to FIRPTA, the foreign person must: Report the gain or loss as being effectively connected with a US trade or business (ECI) on a US federal income tax return filed for the year of the disposition. Pay tax on any net gain at the regular rates applicable to US persons. Foreign corporations that sell or otherwise dispose of a USRPI may also be subject to the 30% branch profits tax (IRC 884). To ensure the collection of tax under FIRPTA, the FIRPTA rules also impose a withholding obligation on certain transferees of USRPIs, and certain entities that distribute, or dispose of, USRPIs (see FIRPTA Withholding Rules). This Note describes the basic aspects of the FIRPTA rules, including the types of property that qualify as a USRPI and the types of transactions that are subject to the FIRPTA rules. It also discusses the withholding obligations applicable to dispositions of a USRPI. In addition, it describes the consequences of failing to comply with the FIRPTA rules and discusses how to remedy those failures. WHAT IS A US REAL PROPERTY INTEREST? A USRPI is an interest, other than solely as a creditor, in: Real property located in the US or the Virgin Islands. Subject to certain exceptions, a US corporation unless a foreign person establishes that the US corporation was not a US real property holding corporation (USRPHC) at any time during the shorter of: the period during which the foreign person held the interest in the US corporation; or the five-year period ending on the date of the disposition. (Treas. Reg (c)(1).) An interest in real property other than solely as a creditor includes: Fee ownership. Co-ownership. A leasehold interest. A time sharing interest. A life estate, remainder or reversionary interest in the real property. Any direct or indirect right to share in the appreciation in value, or in the gross or net proceeds or profits generated by, the real property. An option to acquire an interest in real property even if the option is not currently exercisable. (Treas. Reg (d)(2)(i), (2)(ii)(B).) An interest in an entity other than solely as a creditor includes: Stock of a corporation. A partnership interest. An interest in a trust or estate as a beneficiary or an ownership interest in a grantor trust. An interest that is a direct or indirect right to share in the appreciation in value of any of the interests described above. Learn more about Practical Law Company practicallaw.com

2 Investments in US Real Property by Non-US Investors: Basic FIRPTA Rules A USRPI also includes an interest in a partnership to the extent that the gain on a disposition of the interest in the partnership is attributable to a USRPI held by the partnership (Treas. Reg T(a)). A USRPI does not include: An interest solely as a creditor in real property located in the US or the Virgin Islands or in a US corporation. This generally includes straight debt investments (even though the creditor has a right to repossess or foreclose on the property under a mortgage, security agreement, financing statement or other collateral instrument) if the: debt is not convertible into an equity interest in the US real property or US corporation; interest on the debt is not linked to the performance of the underlying US real property or US corporation; and debt does not have an equity kicker or other terms that would allow the debtholder to participate in profits from the USRPI. (Treas. Reg (c)(2)(i) and (ii)(c), (d)(3)(i), (ii)(b) and (ii)(c).) Interests in a real estate investment trust (REIT) if less than 50% of the fair market value of the REIT s outstanding stock was held directly or indirectly by foreign persons during the five-year period ending on the date of disposition (domesticallycontrolled REIT) (Treas. Reg (c)(2)(i)). For more information on REITS, see Practice Note, REITs: Overview ( An interest in a US corporation that has disposed of all of its USRPI in taxable transactions and has not subsequently acquired any USRPI (commonly referred to as the purge exception) (Treas. Reg (c)(2)(ii) and (f)(2).) An interest in a US corporation if the US corporation has at least one class of stock regularly traded on an established securities market and the foreign person s interest is in either: the regularly traded class of stock but only if the foreign person did not own more than 5% of the total fair market value of that class of stock at any time during the five-year period ending on the date of the disposition of that interest (Treas. Reg (c)(2)(iii)(A)); or a non-regularly traded class of stock of the US corporation but only if on the date the foreign person acquired the interest its fair market value did not exceed 5% of the fair market value of the regularly traded class of the US corporation s stock with the lowest fair market value on that date. For purposes of this rule, if the foreign person later acquires an additional interest in the same class of non-regularly traded stock, then all interests in that class of stock are aggregated and valued as of the date of the later acquisition to determine if the foreign person s interests in the non-regularly traded class exceed the 5% limitation (Treas. Reg (c)(2)(iii)(B), Temp. Treas. Reg T(b)). Definition of Real Property Real property includes: Land and unsevered natural products of the land (see Land and Unsevered Natural Products of the Land). Improvements (see Improvements). Certain types of personal property associated with the use of real property (see Personal Property Associated with Use of Real Property). (Treas. Reg (b)(1).) Land and Unsevered Natural Products of the Land In addition to land, real property includes unsevered natural products of the land. Therefore, real property includes: Growing crops and timber. Mines. Wells. Other natural deposits. Once growing crops and timber have been severed from the land, however, they cease to be real property for FIRPTA purposes. Similarly, natural deposits such as minerals and ore that have been extracted from the land no longer fall within the definition of real property. The storage of severed crops or timber or extracted natural products in or on land does not cause them to be characterized as real property (Treas. Reg (b)(2)). Improvements An improvement is: A building. Any other inherently permanent structure that is affixed to real property and will ordinarily remain affixed for an indefinite period of time, including: swimming pools; paved parking areas; special foundations for heavy equipment; wharves and docks; bridges; fences; certain advertising displays and outdoor lighting facilities; railroad tracks and signals; telephone poles; certain telephone and television cables; broadcasting towers; oil derricks; oil and gas pipelines; oil and gas storage tanks; grain storage bins; or silos. 2

3 The structural components of either a building or inherently permanent structure. Structural components of a building or an inherently permanent structure are items that relate to the operation or maintenance of the building or inherently permanent structure. These can include: Walls. Partitions. Floors. Ceilings. Windows and doors. Wiring, plumbing and central heating and conditioning systems. Lighting fixtures. Pipes and ducts. Elevators and escalators. Sprinkler systems. Fire escapes. (Treas. Reg (b)(3).) Personal Property Associated with Use of Real Property Personal property that falls within the following categories is considered to be associated with the use of real property and therefore is a USRPI: Personal property used in mining, farming and forestry (for example, mining equipment, farm machinery, draft animals and equipment used to grow and cut timber, but not including property used to process or transport severed minerals, crops or timber) (Treas. Reg (b)(4)(A)). Personal property predominantly used to construct or improve real property (for example, equipment used to alter the natural contours of land, to clear and prepare raw land for construction, or to construct improvements) (Treas. Reg (b)(4)(B)). Property predominantly used in the operation of a lodging facility (for example, beds and other furniture, refrigerators, ranges and other equipment, as well as property used in the common areas of a lodging facility, such as lobby furniture and laundry equipment) (Treas. Reg (b)(4)(C)). Property predominantly used in the rental of furnished office and other work space (for example, furniture and equipment included in the rental of furnished office space) (Treas. Reg (b)(4)(D)). Interests in US Corporations Subject to certain exceptions, a USRPI includes an interest (other than an interest solely as a creditor) in any US corporation unless the foreign person disposing of the interest timely establishes that the US corporation was not a USRPHC at any time during the shorter of the following two look-back periods: The period during which the seller held the interest in the US corporation. The five-year period ending on the date of disposition of the interest in the US corporation. (IRC 897(c)(1)(ii) and Treas. Reg (c)(1).) In other words, with certain limited exceptions, any interest in any US corporation is presumed to be a USRPI unless the transferor rebuts this presumption in the manner and in accordance with the timelines discussed below (see Rebutting the Presumption of USRPI Status for Stock in a US Corporation). This presumption rule is the reason why FIRPTA is such a trap for the unwary. Many foreign persons that own stock in a US corporation that owns little or no USRPI will transfer that stock assuming that FIRPTA does not apply to the transfer. However, the FIRPTA rules make clear that any gain in the stock will be triggered by the transfer and must be recognized as ECI that is taxable to the foreign transferor unless certain steps are taken before the transaction to rebut this presumption. REBUTTING THE PRESUMPTION OF USRPI STATUS FOR STOCK IN A US CORPORATION To rebut the presumption that stock of a US corporation is a USRPI, a foreign transferor must ensure that the US corporation: Confirms that it was not a USRPHC at any time during the relevant look-back period (see Confirm No USRPHC Status During Relevant Look-back Period). Timely notifies the foreign transferor that it was not a USRPHC at any time during the relevant look-back period by providing it with a Statement of Non-USRPI Status (see Timely Compliance with Notification Requirements). Within 30 days of providing the foreign transferor with a Statement of Non-USRPI Status, the US corporation must forward a copy of the statement to the IRS (see Timely Compliance with Notification Requirements). To avoid US tax liability and a requirement to file a US federal income tax return under the FIRPTA rules, the foreign transferor must receive the notification described in the second step above by the date its US federal income tax return for the year of the transfer would otherwise be due (Treas. Reg (g)(1)(ii)). However, in many instances the transferor (or the US corporation at the request of the transferor) must provide the transferee with a copy of that notification by the date of the transfer so that the transferee is not required to withhold and remit a portion of the sale proceeds to the IRS (see FIRPTA Withholding Rules). For this reason, the US corporation s determination of its non-usrphc status during the relevant look-back period and its notification to the foreign transferor of its determination must be completed by the date of the transfer. It is common in transactions involving a foreign seller s sale of stock in a US corporation to include a closing condition requiring the seller to obtain a Statement of Non-USRPI Status from the US corporation and to provide a copy of the statement to the buyer no later than the date of the sale. Also, because the US corporation is 3

4 Investments in US Real Property by Non-US Investors: Basic FIRPTA Rules often providing the Statement of Non-USRPI Status based on data generated before the transfer date, the parties to the transaction will generally agree that the US corporation may not acquire or dispose of any assets that could cause it to become a USRPHC during the period between the date the data is generated and the transfer date. It is not necessary to rebut the presumption that stock of a US corporation being transferred by a foreign transferor is a USRPI if the US corporation is a: Domestically controlled REIT. A corporation with a class of stock that is regularly traded on an established securities market and either: the stock being transferred is the regularly traded class of stock and the foreign transferor did not own more than 5% of that class of stock at any time during the relevant lookback period; or the stock being transferred is not part of a regularly traded class of stock and on the date the foreign person acquired any stock of that class the combined fair market value of the stock acquired and the stock of the same class already held did not exceed 5% of the fair market value of the class of regularly traded stock of the US corporation having the lowest fair market value on the acquisition date. (Treas. Reg (c)(2)(iii)(A) and (B) and (m), (g) (3), and Temp. Treas. Reg T(b) and (d).) Confirm No USRPHC Status During Relevant Look-back Period The first step in rebutting the presumption that stock of a US corporation is a USRPI is to request the US corporation to determine whether it was a USRPHC at any time during the relevant look-back period. The relevant look back period is the shorter of: The period during which the transferor held the interest in the US corporation. The five year period that ends on the date that the foreign person disposes of the stock. A US corporation is a USRPHC on a particular date if, on that date, the value of its USRPIs equals or exceeds 50% of the sum of the values of its USRPIs, its interests in real property located outside of the United States (if any) and any other of its assets used or held for use in its trade or business. Calculating this fraction, which is commonly referred to as the FIRPTA Fraction, requires the US corporation to: Identify the items of property included in the FIRPTA Fraction (see Identifying Property Included in FIRPTA Faction). Determine the value of the items of property included in the FIRPTA Fraction (see Valuing Assets). Determine when the FIRPTA Fraction must be calculated during the relevant look-back period (see When to Calculate the FIRPTA Fraction). Identifying Property Included in FIRPTA Fraction To calculate the FIRPTA Fraction, a US corporation must first identify the items of property whose values will be included in the fraction (whether in the numerator or the denominator). Note that not all property that a US corporation owns is included in the FIRPTA Fraction. The numerator amount is the aggregate values of all of the US corporation s USRPIs. The denominator amount is not the value of the US corporation as a whole, but consists solely of the aggregate values of the US corporation s: USRPIs. Real property located outside the US. Assets used or held for use in its trade or business. An asset is considered to be used or held for use in a trade or business of the US corporation if it meets all of the following: The asset is not a USRPI. The asset falls within one of the following categories: stock in trade of an entity, inventory or property held by the entity primarily for sale to customers in the ordinary course of its trade or business; depreciable property used or held for use in the trade or business; livestock (including poultry) used or held for use in a trade or business for draft, breeding, dairy or sporting purposes. goodwill and going concern value, patents, inventions, formulas, copyrights, literary, musical, or artistic franchises, license, customers lists and similar intangible property; or cash, stock, securities, receivables of all kinds, options or contracts to acquire any of the above, and options or contracts to acquire commodities. The asset is used or held for use in the US corporation s trade or business, meaning that it is: held for the principal purpose of promoting the present conduct of the trade or business; acquired or held in the ordinary course of the trade or business; or otherwise held in a direct relationship to the trade or business. (Treas. Reg (f)(1) and (2).) An asset qualifies as an asset held in a direct relationship to the trade or business only if the asset is needed to meet the present needs (not anticipated future needs) of the trade or business. Therefore, assets that are typically not included in the denominator of the FIRPTA Fraction include: Excess cash. Prepaid items. Deferred tax assets. 4

5 Assets excluded from the denominator also include machinery and other property that is not currently being used in the US corporation s trade or business because, for example, the property has been retired or has been purchased but not yet placed in service. Instead of establishing the extent to which liquid assets (including cash, stock, securities, accounts receivable, and options) are used in a trade or business, the FIRPTA rules include a presumption that the value of a US company s liquid assets in an amount up to 5% of the fair market value of the US company s other trade or business assets are used in its trade or business. This presumption does not apply, however, to any liquid asset that is acquired or held in order to prevent the corporation from qualifying as a USRPHC (Treas. Reg (f)(3)(i)). Look-through Rule for Interests in Partnerships and Stock of Subsidiaries In calculating its FIRPTA Fraction, a corporation that is a partner in a partnership ignores its interest in the partnership and instead includes its proportionate share of the values of the relevant assets of the partnership on the date it calculates its FIRPTA Fraction (Treas. Reg (e)(2) and (e)(2)). Similarly, a corporation that holds a controlling interest (directly or indirectly) in a lower-tier corporation (whether US or foreign) ignores its interest in the lower-tier corporation and includes the values of its pro rata share of the relevant assets held by the lower-tier corporation on the date it calculates its FIRPTA Fraction (Treas. Reg (e)(2) and (e)(3)). A controlling interest is 50% or more of the fair market value of all classes of stock of the lower-tier corporation (Treas. Reg (e)(3)). In contrast, a corporation that owns a non-controlling interest in a lower-tier corporation (whether US or foreign) on a date that it computes a FIRPTA Fraction must treat the non-controlling interest in the lower-tier corporation as a USRPI unless it can establish that the interest was not a USRPI on that date (Treas. Reg (d)(1) and (e)(1)). This can be established by having the lower-tier corporation itself meet the requirements for rebutting the presumption of USRPI status (for example, by confirming that it was not a USRPHC at any time during the relevant look-back period and timely complying with the relevant notification requirements) (Treas. Reg (g)(2)(ii)). Alternatively, the upper-tier corporation can make an independent determination that the lower-tier corporation was not a USRPHC at any time during the relevant look-back period based on the best evidence available. This evidence can be drawn from annual reports, financial statements, records of the lower-tier corporation or from any other source that demonstrates to a reasonable certainty that the interest in the lower-tier corporation is not a USRPI (Treas. Reg (g)(2)(iv)). If an upper-tier corporation independently determines that an interest in a lower-tier corporation is not a USRPI, it must make a submission to the IRS briefly summarizing the facts upon which the corporation s determination is based and the sources of the information relied upon. The FIRPTA rules do not specify a particular form that must be used to make this submission, but they do indicate that the submission must be attached to or incorporated in a Notice of Non-USRPI Status sent to the IRS by the upper-tier corporation (Treas. Reg (h)(5)(iv)). Valuing Assets The second issue that must be addressed in order to calculate the FIRPTA Fraction is to determine the value of the relevant assets. In general, the value of an asset included in the FIRPTA Fraction is its fair market value on the determination date. Alternatively, the FIRPTA rules allow a US corporation to use the values of the relevant assets as shown on its financial accounting books and records (Treas. Reg (b)(2)). However, if the US corporation uses the book value of its assets in its FIRPTA Fraction, the threshold for not being treated as a USRPHC falls to 25% or less. In other words, a US corporation is treated as qualifying as a USRPHC if the book value of its USRPIs exceeds 25% of all of: The sum of the book value of its USRPIs. Its interests in real property located outside the US. Its assets used or held for use in its trade or business. If that occurs, the US corporation can redo the FIRPTA Fraction using the fair market values of the relevant assets on that date to be able to take advantage of the higher 50% threshold that is applicable when fair market values are used. When to Calculate the FIRPTA Fraction The third issue in calculating the FIRPTA Fraction is to determine how often the FIRPTA Fraction must be calculated during the relevant look-back period. In general, a US corporation does not need to calculate a FIRPTA Fraction during the first 120 days after the later of its date of incorporation or the date on which it first issues shares (Treas. Reg (c)(1)(iv)). Once that 120-day start-up period has expired, the FIRPTA rules generally require that the FIRPTA Fraction be calculated on the following dates: The last day of the US corporation s taxable year. The date on which the US corporation (or any partnership or corporation whose assets the US corporation is treated as owning) acquires any USRPI. The date on which the US corporation (or any partnership or corporation whose assets the US corporation is treated as owning) disposes of any interest in real property located outside of the US or certain of its assets used or held for use in its trade or business. (Treas. Reg (c)(1).) Under these rules, a US corporation must analyze its acquisitions and dispositions (and the acquisitions and dispositions of assets held by any partnership or corporation whose assets the US corporation is treated as owning) during the entire look-back period to determine on what days the US corporation must compute a FIRPTA Fraction. For some US corporations, this rule could require a nearly daily computation during the relevant look-back period. 5

6 Investments in US Real Property by Non-US Investors: Basic FIRPTA Rules To mitigate the hardship of the general rule, the FIRPTA rules allow a corporation to choose to compute a FIRPTA Fraction at the end of each calendar month during the relevant look-back period rather than on the dates described above. If the corporation chooses this option, however, it must also compute a FIRPTA Fraction for any date on which, pursuant to a single transaction, it either acquires a USRPI or disposes of foreign real property or trade or business assets if the total fair market value of the assets acquired or disposed of exceeds 5% of the sum of the fair market values of the assets included in the FIRPTA Fraction before the acquisition or disposition (Treas. Reg (c)(3)). Timely Compliance with Notification Requirements If, after the request of a foreign transferor, a US corporation determines that it was not a USRPHC at any time during the relevant look-back period, the US corporation must timely notify both the transferor and the IRS of its determination. If the US corporation fails to timely provide these notifications, the foreign transferor will not have rebutted the presumption that the stock of the US corporation is a USRPI. It must therefore recognize the gain in the transferred stock as ECI. However, discretionary relief for late notifications can be requested from the IRS under Revenue Procedure (see Requesting Relief under Revenue Procedure ). A US corporation timely notifies the foreign transferor and the IRS of its determination that its stock is not a USRPI by both: Providing the transferor with a Statement of Non-USRPI Status no later than the date that the transferor would be required to file a US federal income tax return reporting any built-in gain in the transferred stock as ECI (Treas. Reg (g)(1)(ii)(A) and (h)(1)). Ensuring that the Statement of Non-USRPI Status is valid by sending a notification of its determination that its stock is not a USRPI to the IRS no later than 30 days after the US corporation provides the transferor with a Statement of Non- USRPI Status. This notice is sometimes referred to as the Notice of Non-USRPI Status (Treas. Reg (h)(2)). If the US corporation timely provides the Statement of Non-USRPI Status to the transferor and the Notice of Non-USRPI Status to the IRS, the transferor is not required to report any gain in the transferred stock as ECI, and is not required to file a US tax return (assuming it does not have ECI from other sources). If the US corporation does not timely provide the statement to the transferor or the Notice of Non-USRPI Status to the IRS, the transferor must file a tax return reporting any built-in gain in the transferred USRPI as ECI and pay any tax due, subject to the discretionary relief provisions of Revenue Procedure (see Requesting Relief under Revenue Procedure ). Notwithstanding the deadlines described above, a foreign transferor often requests that the US corporation provide both it and the transferee with the Statement of Non-USRPI Status on the date of the transfer so that the transferee will not have to withhold and remit a portion of the sales proceeds to the IRS (see FIRPTA Withholding Rules). The statement of non-usrpi status can even be provided before the transfer (although in that instance the transferee usually requires representations that the US corporation providing the statement of non-usrpi status will not acquire or dispose of any assets that could cause it to become a USRPHC during the period between the date the statement is provided and the date of the transfer). A statement of non-usrpi status cannot be provided, however, more than 30 days before the transfer of the USRPI (Treas. Reg (c)(3)(i)). FIRPTA DISPOSITIONS CAN INCLUDE NONRECOGNITION TRANSFERS, EXCHANGES AND DISTRIBUTIONS The FIRPTA rules apply to any disposition of a USRPI by a foreign person. A disposition is defined broadly and includes not only sales of a USRPI but also certain transfers, exchanges and distributions that are not taxable under other US federal income tax rules. Nonrecognition Transfers and Exchanges The FIRPTA rules can require the recognition of gain for US federal income tax purposes on many transfers and exchanges of a USRPI that would otherwise qualify for nonrecognition treatment under other US federal income tax rules, including: Transfers of a USRPI by a foreign person to a corporation qualifying for nonrecognition treatment under IRC Section 351 (see Transfers and Exchanges with US Transferees and Transfers and Exchanges with Foreign Corporate Transferees). For a discussion of IRC Section 351, see Practice Note, Taxation of Corporations: Formation Transactions ( us.practicallaw.com/ ). Deemed transfers or exchanges of a USRPI by a foreign corporation in connection with a tax-free reorganization qualifying for nonrecognition treatment under IRC Section 361(a) or 354 (see Transfers and Exchanges with US Transferees and Transfers and Exchanges with Foreign Corporate Transferees). For a discussion of tax-free reorganizations, see Practice Note, Tax-Free Reorganizations: Acquisitive Reorganizations ( us.practicallaw.com/ ). The FIRPTA rules override the nonrecognition treatment otherwise allowed by these rules and treat the disposition as a taxable transfer or exchange unless the disposition also meets the additional requirements for nonrecognition treatment under the FIRPTA rules (see Claiming Nonrecognition Treatment under the FIRPTA Rules). Nonrecognition Distributions The FIRPTA rules can also require the recognition of gain for US federal income tax purposes, or in certain cases payment of a toll charge, on distributions of a USRPI that would otherwise qualify for nonrecognition treatment under other US federal income tax rules, including: Liquidating distributions of a USRPI by a foreign corporation to a shareholder that meets the stock ownership requirements of IRC Section 332(b) with respect to stock in the foreign corporation (see Distributions Qualifying for Nonrecognition Treatment). 6

7 Deemed distributions of stock of a US corporation by a foreign corporation in connection with a tax-free reorganization qualifying for nonrecognition treatment under IRC Section 361(c) (see Distributions Qualifying for Nonrecognition Treatment). The FIRPTA rules override any nonrecognition treatment otherwise allowed by these rules and treat the distribution as a taxable distribution unless the disposition also meets the additional requirements for nonrecognition treatment under the FIRPTA rules (see Claiming Nonrecognition Treatment under the FIRPTA Rules). The FIRPTA rules do not override IRC Section 332(a) and do not require a foreign corporation that meets the stock ownership requirements of IRC Section 332(b) with respect to stock in a US corporation that is a USRPI to recognize gain under IRC Sections 367(a) or 897(e)(1) as a result of the liquidation of the US corporation into the foreign corporation (Temp. Treas. Reg T(b)(3)(iv)(A)). FIRPTA Does Not Override Nonrecognition Treatment of Built-in Losses The FIRPTA rules override the nonrecognition treatment of otherwise non-taxable transfers, exchanges and distributions of USRPI by foreign persons only if there is built-in gain in the transferred, exchanged or distributed USRPI. The FIRPTA rules do not override nonrecognition treatment of a disposition of USRPI to the extent the result would be the recognition of a loss. (Temp. Treas. Reg T(c)(1), T(a)(1).) Special Rules for IRC Section 355 Spin-offs The FIRPTA rules also require the recognition of gain (but not loss) in the following spin-offs: A foreign corporation s distribution of stock of a US corporation in a transaction otherwise qualifying for nonrecognition treatment under IRC Section 355, unless the distributing foreign corporation rebuts the presumption that the distributed stock of the US corporation is a USRPI. The amount of gain that must be recognized by a distributing foreign corporation that fails to rebut this presumption is the lesser of: the fair market value of the distributed stock over its adjusted basis in the hands of the distributing foreign corporation; or the amount by which the aggregate basis of the distributed stock in the hands of the distributee(s) exceeds the aggregate adjusted basis of the distributed stock in the hands of the distributing corporation. (Temp. Treas. Reg T(c)(3).) A US corporation s distribution of stock in a foreign corporation or stock in a US corporation that is not a USRPHC when the distribution occurs to a foreign shareholder under IRC Section 355(a). In both cases, the foreign shareholder is treated as having exchanged a proportionate part of the stock in the distributing US corporation (which is presumed to be a USRPI) for stock that is not treated as a USRPI (Temp. Treas. Reg T(a)(4)). In other words, the foreign person is treated as flunking the USRPI for USRPI requirement (discussed below) and would have to recognize any built-in gain in the stock of the distributing US corporation that the foreign shareholder is deemed to have exchanged as ECI, unless the foreign shareholder rebuts the presumption that the stock of the distributing US corporation is a USRPI. For more information on spin-offs, see Practice Note, Spin-offs: Overview ( CLAIMING NONRECOGNITION TREATMENT UNDER THE FIRPTA RULES For a foreign person that disposes of a USRPI to claim nonrecognition treatment on the disposition, the disposition must meet both: The requirements for claiming nonrecognition treatment under the non-firpta rules. The requirements for claiming nonrecognition treatment under the FIRPTA rules. The FIRPTA-related requirements differ depending on whether the disposition is either a: Transfer or exchange of a USRPI (see Transfers and Exchanges with US Transferees and Transfers and Exchanges with Foreign Corporate Transferees). Distribution of a USRPI (see Distributions Qualifying for Nonrecognition Treatment). Transfers and Exchanges with US Transferees A foreign person that transfers (or is deemed to transfer) a USRPI to a US transferee in a transaction otherwise qualifying for nonrecognition treatment under other US federal income tax rules (for example, under IRC Section 351 as part of a tax-free transfer of property to a corporation or under IRC Section 361(a) or 354 as part of a tax-free reorganization) can generally claim nonrecognition treatment under the FIRPTA rules only if the following requirements are met: The foreign transferor receives (or is deemed to receive) in exchange for the transferred USRPI other property that, immediately following the exchange, would be subject to US taxation on its disposition (Temp. Treas. Reg T(a) (1)). This generally applies only if the other property is also a USRPI. This is commonly referred to as the USRPI for USRPI requirement. If the property received by the foreign transferor in the exchange is stock of a US corporation, the US corporation must be a USRPHC immediately after the exchange (Temp. Treas. Reg T(a)(1)). (In other words, the rule that stock of a US corporation is presumed to be USRPI does not apply for purposes of the USRPI for USRPI requirement.) This requirement does not apply, however, to foreign shareholders that are deemed to exchange stock of a US corporation under IRC Section 354 7

8 Investments in US Real Property by Non-US Investors: Basic FIRPTA Rules in recapitalizations, reincorporations, and corporate migration transactions that qualify as tax-free reorganizations under IRC Section 368(a)(1)(E) or (F) and meet certain other requirements (Temp. Treas. Reg T(a)(1), as amended by Notice 99-43). Instead, the stock deemed received in the exchange will be treated for FIRPTA purposes as the same interest in the US corporation that was deemed exchanged. The transferor meets one of the following filing requirements: the transferor files a US federal income tax return for the taxable year of the transfer and attaches certain specified information describing the transaction to the return; or alternatively, if the transfer qualifies for nonrecognition treatment in its entirety and the transferor does not have any ECI from other sources during the taxable year in which the transfer occurs, then the transferor is not required to file a US federal income tax return reporting the transfer if the transferee timely submits a Notice of Nonrecognition Transfer required by FIRPTA s withholding rules to the IRS (see FIRPTA Withholding Rules). (Temp. Treas. Reg T(a)(1) and Temp. Treas. Reg T(d)(1)(iii), as amended by Notice ) Transfers and Exchanges with Foreign Corporate Transferees A foreign person that transfers (or is deemed to transfer) a USRPI to a foreign corporation in a transaction otherwise qualifying for nonrecognition treatment under other US federal income tax rules (for example, under IRC Section 351 as part of a tax-free transfer of property to a corporation or under IRC Section 361(a) or 354 as part of a tax-free reorganization) can claim nonrecognition treatment under the FIRPTA rules only if the following requirements are met: The USRPI is transferred (or deemed transferred) by a foreign corporation to a foreign transferee corporation in a transfer of property: under IRC Section 361(a) or (b) in a transaction qualifying as a reorganization under IRC Section 368(a)(1)(D) or 368(a)(1)(F); under IRC Section 361(a) or (b) in certain non-public foreign-to-foreign mergers that qualify as reorganizations under either IRC Section 368(a)(1)(A) (including so-called triangular mergers that qualify under IRC Section 368(a) (2)(D) or 368(a)(2)(E)) or IRC Section 368(a)(1)(C), if certain ownership requirements are met after the merger. This exception is intended to apply in the case of internal restructurings if other exceptions are not available; under IRC Section 361(a) or (b) in certain non-public foreign-to-foreign mergers that qualify as reorganizations under either IRC Section 368(a)(1)(A) (including triangular mergers that qualify under IRC Section 368(a)(2)(D) or 368(a)(2)(E)) or IRC Section 368(a)(1)(C), if during the five year period ending on the date of the reorganization the transferor foreign corporation would not have been a USRPHC if the corporation had been a US corporation; under IRC Section 361(a) or (b) in certain public foreign-toforeign mergers that qualify as reorganizations under either IRC Section 368(a)(1)(A) (including triangular mergers that qualify under IRS Section 368(a)(2)(D) or 368(a)(2)(E)) or IRC Section 368(a)(1)(C) if additional requirements are met; or qualifying under IRC Section 351, or an exchange of stock under IRC Section 354(a) in a reorganization under IRC 368(a)(1)(B), if the USRPI transferred or exchanged is stock of a USRPHC, the transferor(s) satisfy certain ownership requirements after the transfer, and other requirements are met. The foreign corporate transferee that receives the USRPI from the foreign transferor would be subject to US taxation on its later disposition of the USRPI. The transferor meets one of the following filing requirements: the transferor files a US federal income tax return for the taxable year of the transfer and attaches certain specified information describing the transaction to the return; or if the transfer qualifies in its entirety for nonrecognition treatment and the transferor does not have any ECI from other sources during the taxable year in which the transfer occurs, the transferee timely submits a Notice of Nonrecognition Transfer required by FIRPTA s withholding rules to the IRS (see FIRPTA Withholding Rules). (Temp. Treas. Reg T(b)(1), as amended by Notice , and Temp. Treas. Reg T(d)(1)(iii), as amended by Notice ) For transfers of property under IRC Section 361(a) or (b) to qualify for nonrecognition treatment under the FIRPTA rules, there must also be a tax-free exchange of the transferor corporation stock for the stock of the transferee corporation (or its parent) under IRC Section 354(a) as part of the same reorganization. For a discussion of tax-free reorganizations, see Practice Note, Tax-Free Reorganizations: Acquisitive Reorganizations ( us.practicallaw.com/ ). Distributions Qualifying for Nonrecognition Treatment Except for distributions subject to a toll charge requirement (see Toll Charge Requirement Applies to Certain Distributions), a foreign corporation that distributes a USRPI in a transaction otherwise qualifying for nonrecognition treatment under other US federal income tax rules (for example, under IRC Section 337 as part of a tax-free liquidating distribution) can claim nonrecognition treatment under the FIRPTA rules only if the following requirements are met: At the time of the receipt of the distributed USRPI, the distributee would be subject to US income tax on a later disposition of the distributed USRPI. The basis of the distributed USRPI in the hands of the distributee is no greater than the adjusted basis of the property before the distribution, increased by the amount of gain (if any) recognized by the distributing corporation on the distribution. 8

9 The foreign distributor files a US federal income tax return for the taxable year of the distribution and attaches certain specified information describing the distribution to the return. (Treas. Reg T(c)(2).) Toll Charge Requirement Applies to Certain Distributions Special rules for claiming nonrecognition treatment apply to distributions of a USRPI under IRC Section 337 or 361(c) as part of: A liquidation of a foreign corporation into a US corporation meeting the stock ownership requirements of IRC Section 332(b). Certain inbound statutory mergers and consolidations described in IRC Section 368(a)(1)(A) (including triangular mergers that qualify under IRC Section 368(a)(2)(D) and (E)) and inbound reorganizations described in IRC Section 368(a) (1)(C), 368(a)(1)(D) or 368(a)(1)(F) in which: a foreign corporation is deemed to transfer property to a US corporation under IRC Section 361(a) or (b) in return for stock of the US corporate transferee; the US corporate transferee in the IRC Section 361(a) or (b) transfer is a USRPHC immediately after the deemed transfer; and the foreign corporation is deemed to distribute the stock of the US corporation to its shareholders. A distribution of a USRPI by a foreign corporation to its shareholders occurring as part of these transactions qualifies for nonrecognition treatment under the FIRPTA rules only if the following requirements are met: The foreign distributing corporation pays a toll charge equal to the amount of any taxes and interest that IRC Section 897 would have imposed on all persons who disposed of an interest in the distributing foreign corporation (or a corporation from which the assets were acquired in a transaction described in IRC Section 381) during the relevant look-back period if the distributing foreign corporation (or the predecessor corporation) had been a US corporation on the date of each such disposition. At the time of the distribution, the distributee of the USRPI would be subject to US taxation on a later disposition of the stock of the distributed US corporation. The foreign distributing corporation files a US federal income tax return for the taxable year of the transfer and attaches certain specified information describing the transaction to the return. (Temp. Treas. Reg T(c)(2)(i) and (ii) and (c)(4)(ii) and (iii), as amended by Notices and ).) If the requirements for nonrecognition treatment are met for an inbound statutory merger, consolidation or reorganization, the nonrecognition treatment only applies to the deemed distribution of stock of the US corporation to the foreign corporation s shareholders. If the foreign corporation itself owns a USRPI that it transfers to the US corporation as part of the transaction, it must meet the nonrecognition rules for transfers to US transferees to avoid taxation under FIRPTA for that part of the transaction (see Transfers and Exchanges with US Transferees). FIRPTA WITHHOLDING RULES To ensure the collection of tax on a foreign person s disposition of a USRPI, the FIRPTA rules impose a withholding obligation on: US and foreign transferees of a USRPI from a foreign person (including foreign partnerships) (IRC 1445(a); Treas. Reg (a)). In certain cases, a foreign corporation that distributes a USRPI to another person (IRC 1445(e)(2); Treas. Reg (d)). A US corporation that is or was a USRPHC during the relevant look-back period and distributes property to a foreign shareholder other than in a distribution with respect to its stock that qualifies as a dividend (IRC 1445(e)(3); Treas. Reg (e)). A US partnership that disposes of a USRPI and has one or more foreign partners to which gain from the disposition is allocable (unless the US partnership withholds under the general withholding rules in IRC Section 1446 applicable to effectively connected taxable income allocable to foreign partners) (IRC 1445(e)(1); Treas. Reg (c)(1)(ii); Treas. Reg (c)(2)). The transferee of a foreign partner s interest in a partnership if both: 50% or more of the value of the partnership s gross assets held directly or indirectly are USRPIs. 90% or more of the value of the partnership s gross assets held directly or indirectly are USRPIs, plus cash and cash equivalents. (Temp. Treas. Reg T(d).) Distributions to a foreign beneficiary from a US trust or estate to the extent attributable to dispositions of USRPIs by the US trust or estate (Treas. Reg (c)(1)(iii)). Distributions to nonresident alien individuals and foreign corporations from a real estate investment trust, or a regulated investment company that qualifies as a USRPHC, if any portion of the distribution is treated under IRC Section 897(h)(1) as gain from the sale or exchange of a USRPI (IRC 1445(e)(6); Treas. Reg ). The exercise of an option to acquire a USRPI, if the option grantor is a foreign person (Treas. Reg (b)(3)(iv)). Depending on the circumstances, the withholding rules can require the withholding of an amount that is greater or less than the substantive tax liability of a foreign person from its disposition of a USRPI under the FIRPTA rules. To the extent the amount withheld under the FIRPTA withholding rules exceeds the foreign person s substantive tax liability from the disposition, the foreign person can request a refund of the excess amount on a tax return filed for the year of the transfer. 9

10 Investments in US Real Property by Non-US Investors: Basic FIRPTA Rules In addition, substantive tax liability under FIRPTA only applies to nonresident alien individuals and foreign corporations that dispose of a USRPI (IRC 897(a)(1)). In contrast, the FIRPTA withholding tax applies not only to dispositions of USRPIs by those foreign persons but also to dispositions of USRPIs by foreign partnerships, trusts and estates (IRC 1445(f)(3)). The FIRPTA withholding obligation does not apply to: A transfer of a USRPI by a person that is not a foreign person. In that instance, the transferee may request a statement from the transferor certifying that the transferor is not a foreign person, although the transferee can instead rely on other means to establish that the transferor is not a foreign person (Treas. Reg (b)). A disposition that qualifies for nonrecognition treatment under both general tax rules and the FIRPTA rules if certain filing and notification requirements are timely met (Treas. Reg (d)(2) and (b)(2)). A disposition of stock of a US corporation that has established that it was not a USRPHC at any time during the relevant lookback period if other notification requirements are timely met (Treas. Reg (c)(3)). A disposition of stock in a US corporation that has at least one class of stock regularly traded on an established securities market and either: the stock disposed of is part of a class of stock of the US corporation that is regularly traded on an established securities market; or the stock disposed of is part of a class of stock of the US corporation that is not regularly traded on an established securities market, the disposition is by a single transferor (or related transferors), and at the time the foreign person acquired any interest in the class of non-regularly traded stock the combined fair market value of all shares of that class of stock held by the foreign person did not exceed 5% of the fair market value of the class of regularly traded stock of the US corporation having the lowest fair market value on the acquisition date. (IRC Section 1445(b)(6) and Treas. Reg (c)(2).) An option grantor s realization of income on the grant or lapse of an option to acquire a US real property interest (Treas. Reg (b)(3)(i), (ii)). In addition, the amount required to be withheld can be reduced if, before the transfer: A foreign person can establish that its final tax liability with respect to the disposition of a USRPI will be less than the amount required to be withheld under the FIRPTA rules. The person obligated to withhold under the FIRPTA rules receives a withholding certificate from the IRS that allows the person to withhold only the amount of the foreign person s US federal income tax liability from the disposition of the USRPI (IRC Section 1445(c)(1) and Treas. Reg and ) (see FIRPTA Withholding Certificates). Transfers of USRPI by Foreign Persons In general, a transferee (whether US or foreign) of a USRPI (including a partnership interest treated entirely as a USRPI for withholding purposes) must deduct and withhold a tax equal to 10% of the amount realized by the transferor if the transferor is a foreign person (including a foreign partnership, trust or estate) (IRC Sections 1445(a) and (f)(3) and 7701(a)(30)). The amount realized by the transferor is the sum of the: Cash paid or to be paid. Fair market value of other property transferred, or to be transferred. Outstanding amount of any liability assumed by the transferee or to which the USRPI is subject immediately before and after the transfer. (Treas. Reg (g)(5).) The amount required to be withheld by the transferee is therefore independent of the transferor s tax liability on any gain in the transferred USRPI. Except as discussed below, this amount must be withheld even if the transferor recognizes a loss on a sale of USRPI or is eligible for nonrecognition treatment on a transfer of USRPI under the FIRPTA rules. A transferee required to withhold FIRPTA withholding tax must report (on IRS Forms 8288 and 8288-A) and remit the tax to the IRS by the 20th day after the date of the transfer. The IRS stamps Form 8288-A to show receipt and then mails a stamped copy to the transferor. The transferor must attach the stamped copy of the Form 8288-A to its US federal income tax return for the year of the transfer to claim a credit for the withheld amount against its income tax liability from the transfer (Treas. Reg (c)(1) and (f)(2)). A transferee is not required to withhold on a foreign person s transfer of a USRPI if: The transfer qualifies for nonrecognition treatment in its entirety (under both general tax rules and the FIRPTA rules) and: the transferor provides the transferee with a Notice of Nonrecognition Transfer, which contains the information specified in Treasury Regulation Section (d)(2)(iii), on or before the date of the transfer; and by the 20th day after the date of the transfer, the transferee provides a copy of the transferor s Notice of Nonrecognition Transfer to the IRS along with a cover letter setting out the name, identifying number, and office address of the transferee (Treas. Reg (d)(2)(i)). The foreign person transfers stock of a US corporation that has established that it was not a USRPHC at any time during the relevant look-back period and the following requirements are met on or up to 30 days before the date of the transfer: the US corporation provides a Statement of Non-USRPI Status to the transferor and a Notice of Non-USRPI status to the IRS within the following 30 days. A foreign transferor 10

11 that receives a Statement of Non-USRPI Status can rely on that statement to eliminate its substantive tax liability unless the US corporation later notifies the transferor that it became a USRPHC after the date of the statement but before the date of the transfer (Treas. Reg (g)(1)(ii)(B)) (see Timely Compliance with Notification Requirements); and the transferor provides a copy of the statement to the transferee (Treas. Reg (c)(3)). Either the transferor or the transferee obtains a withholding certificate from the IRS before the transfer (Treas. Reg (d)((7) and ) (see FIRPTA Withholding Certificates). Distributions of USRPI by Foreign Corporations If a foreign corporation distributes a USRPI to its shareholders, the foreign corporate distributor, and not the distributee, must withhold and remit the FIRPTA withholding tax to the IRS. The amount of the FIRPTA withholding tax is 35% of the amount of gain recognized by the foreign corporation (and not 10% of the amount realized by the distributee) on the distribution. The distributing foreign corporation must report (on IRS Forms 8288 and 8288-A) and remit the tax to the IRS by the 20th day after the date of the distribution. The IRS stamps Form 8288-A to show receipt and then mails a stamped copy to the distributing foreign corporation. The foreign distributing corporation must attach the stamped copy of the Form 8288-A to its US federal income tax return for the year of the distribution in order to claim a credit for the withheld amount against its income tax liability from the distribution (Treas. Reg (b)(5) and (d)). A distributing foreign corporation is not required to withhold an amount under the FIRPTA rules if: The distribution qualifies in its entirety for nonrecognition treatment (under both general tax rules and the FIRPTA rules) and the distributing foreign corporation submits a Notice of Nonrecognition Transfer to the IRS, which contains the information described in Treasury Regulation Section (b)(2)(ii), by the 20th day after the date of the distribution (Treas. Reg (b)(2) and (d)(1)). The USRPI distributed by the foreign corporation is an interest in a US corporation, the US corporation has established that it was not a USRPHC at any time during the relevant look-back period, and the US corporation provides: a Statement of Non-USRPI Status to the distributing foreign corporation on or before the date of the distribution; and a Notice of Non-USRPI Status to the IRS within 30 days of providing the distributing foreign corporation with a Statement of Non-USRPI Status (Treas. Reg (b) (4) and (d)(2)(i)). The distributing foreign corporation obtains a withholding certificate from the IRS before the distribution (Treas. Reg (d)(2)(ii) and ) (see FIRPTA Withholding Certificates). Distributions of Property by US Corporations to Foreign Shareholders If a US corporation that is or was a USRPHC during the relevant look-back period distributes property to a foreign shareholder, the US corporation must withhold 10% of the amount of the distribution that is: A redemption of stock treated as an exchange under IRC Section 302(a). An exchange under IRC Section 331 or 332 as a result of a liquidation of the US corporation. A distribution that qualifies as a return of capital under IRC Section 301(c)(2). A distribution that qualifies as a sale or exchange of property under IRC Section 301(c)(3). For a discussion of when a corporate distribution is treated as a return of capital or a sale or exchange of property, see Practice Note, Taxation of Corporations: US Holders Generally Prefer to Own Equity ( Generally, a 30% withholding tax under IRC Section 1441 or 1442 applies to a distribution to a foreign shareholder by a US corporation (regardless of whether it is a current or former USRPHC) if the distribution is treated as a dividend, unless the 30% withholding tax is reduced or eliminated under a relevant income tax treaty. A current or former USRPHC, having withholding obligations under the FIRPTA rules of IRC Section 1445 and the general withholding rules of IRC Sections 1441 and 1442, can satisfy both by either: Withholding on the full amount of the distribution under IRC Section 1441 or 1442, whether or not any portion of the distribution represents a return of basis or capital gain. If a reduced tax rate under an income tax treaty applies to the distribution, then the applicable rate of withholding on the distribution cannot be less than 10% (Treas. Reg (c)(4)(i)(A) and (e)(2)). Withholding under both IRC Section 1441 or 1442 and IRC Section In this case, the US corporation must make a reasonable estimate of the portion of the distribution that is a dividend and then must withhold under IRC Section 1441 or 1442 on the portion that is estimated to be a dividend and withhold on the remainder of the distribution under IRC Section 1445 (Treas. Reg (c)(4)(i)(B) and (e)(2)). If a US corporation makes a distribution of property to a foreign shareholder that is subject to FIRPTA withholding, it must report (on IRS Forms 8288 and 8288-A) and remit the amount of tax withheld under the FIRPTA rules to the IRS by the 20th day after the date of the distribution. The IRS stamps Form 8288-A to show receipt and then mails a stamped copy to the foreign shareholder. The foreign shareholder must attach the stamped copy of the Form 8288-A to its US federal income tax return for the year of the distribution in order to claim a credit for the withheld amount against its income tax liability (if any) from the distribution (Treas. Reg (b)(5) and (e)). 11

12 Investments in US Real Property by Non-US Investors: Basic FIRPTA Rules A distributing US corporation is not required to withhold an amount under the FIRPTA rules if either: The distribution qualifies in its entirety for nonrecognition treatment (under both general tax rules and the FIRPTA rules) and the distributing US corporation submits a Notice of Nonrecognition Transfer to the IRS, which contains the information described in Treasury Regulation Section (b)(2)(ii), by the 20th day after the date of the distribution (Treas. Reg (b)(2) and (e)(3)(ii)). The distributing US corporation obtains a withholding certificate from the IRS before the distribution (Treas. Reg (e)(3)(iv) and ) (see FIRPTA Withholding Certificates). Dispositions of a USRPI by Foreign and Domestic Partnerships A foreign partnership is treated as a foreign person for purposes of the FIRPTA withholding rules. Therefore, a transferee of a USRPI from a foreign partnership must deduct and withhold a tax equal to 10% of the amount realized by the transferring foreign partnership (IRC Sections 1445(a), 1445(f)(3) and 7701(a) (30)) (see Transfers of USRPI by Foreign Persons). The foreign partnership may also be required to withhold an amount under IRC Section 1446 to the extent any gain recognized by the foreign partnership is effectively connected taxable income allocable to a foreign partner of the foreign partnership. In that case, the foreign partnership may be able to credit the amount withheld under the FIRPTA rules against its IRC Section 1446 tax liability (Treas. Reg (c)(2)(ii)). If a US partnership transfers a USRPI and any partner of the US partnership is a foreign person, then the US partnership must withhold a tax equal to 35% of the foreign partner s distributive share of the gain realized by the US partnership on the transfer of the USRPI (Treas. Reg (c)(1)(ii)). In addition, if any amount recognized by the US partnership is effectively connected taxable income allocable to a foreign partner of the US partnership, the US partnership may also be required to withhold under IRC Section In that case, if the US partnership complies with the withholding tax requirements under IRC Section 1446, it is deemed to have complied with the withholding tax requirements under IRC Section 1445 (Treas. Reg (c)(2)(i)). This is commonly referred to as the Section 1446 trumping rule. Distributions of a USRPI by foreign and US partnerships to a partner are not subject to FIRPTA withholding (Temp. Treas. Reg T(c)). Transfers of Partnership Interests by Foreign Persons A transferee of an interest in a US or foreign partnership from a foreign transferor must withhold 10% of the amount realized by the transferor only if both the following requirements are met: 50% or more of the value of the partnership s gross assets consist of USRPI. 90% or more of the value of the partnership s gross assets consist of USRPI plus cash or cash equivalents. For purposes of this rule, cash equivalents means any asset readily convertible into cash (whether or not denominated in US dollars), including: bank accounts; certificates of deposit; money market accounts; commercial paper; US and foreign treasury obligations and bonds; corporate obligations and bonds; precious metals or commodities; and publicly traded instruments. (IRC Section 1445(a) and Temp. Treas. Reg T(d)(1).) A transferee of an interest in a US or foreign partnership does not need to withhold an amount under the FIRPTA withholding rule if: The transferee receives a statement, issued by the partnership and signed by a general partner under penalties of perjury no earlier than 30 days before the transfer, certifying that the partnership does not meet one or both of the gross asset requirements described above (Temp. Treas. Reg T(d)(2)(i)). However, the transferee may not rely on the statement if the transferee knows, or has reason to know, that the statement is false. The transferee determines by other means that the partnership does not meet one or both of the gross asset requirements described above (Temp. Treas. Reg T(d)(1)). A transferee s obligation to withhold on the transfer of a partnership interest by a foreign person does not affect the substantive tax liability of the transferor (or its foreign partners if the transferor is itself a partnership) under FIRPTA. For substantive tax purposes, an interest in a US or foreign partnership interest is treated as a USRPI only to the extent that the gain on the disposition is attributable to a USRPI held by the partnership (Temp. Treas. Reg T(a)). A transfer of a partnership interest can therefore be subject to partial substantive taxation under FIRPTA and either full FIRPTA withholding or no FIRPTA withholding depending on the values of USRPIs and cash and cash equivalents owned by the partnership. If a transfer of a partnership interest is subject to full withholding, the person with substantive tax liability from the transfer can claim a refund for any excess amount by filing an income tax return for the year of the transfer and showing the extent to which its gain on the transfer of the partnership interest is not attributable to USRPIs (Temp. Treas. Reg T(d)(1)). Alternatively, the person can request a withholding certificate to reduce the amount withheld to an amount equal to its substantive tax liability (Temp. Treas. Reg and Temp. Treas. Reg T(d) (1)) (see FIRPTA Withholding Certificates). 12

13 FIRPTA Withholding Certificates The amount that must be withheld by a withholding agent on a disposition of a USRPI can be reduced or eliminated by the withholding agent s receipt of a withholding certificate from the IRS. Withholding certificates are generally requested where the foreign person having the substantive tax liability from the disposition both: Recognizes minimal gain on the disposition (or even recognizes a loss). Does not want to wait until it files a US federal income tax return for the year of the disposition to request a refund of all or a portion of the amount of tax withheld. To request a withholding certificate, a Form 8288-B, together with related attachments, must be submitted to the IRS before the date of the disposition (Treas. Reg and ). The purpose of these submissions is to show the IRS that the amount otherwise required to be withheld under the FIRPTA withholding rules will exceed a foreign person s tax liability from the disposition. The IRS generally acts on a withholding certificate request within 90 days after receiving a complete application (Treas. Reg (a) and (a)(1)). If the applicant for a withholding certificate is not the withholding agent, the person must notify the withholding agent in writing before the transfer that the certificate has been requested (Treas. Reg (c)(2)(i)(B)). If the disposition of a USRPI occurs before the IRS issues the withholding certificate, the person required to withhold under the FIRPTA rules must withhold the full amount required to be withheld under the FIRPTA regulations, but can place the withheld amount in an escrow account instead of remitting it to the IRS pending the IRS issuance of the withholding certificate. Once the IRS issues the withholding certificate, the escrow agent sends the amount specified in the withholding certificate (if any) to the IRS by the 20th day following the IRS issuance of the withholding certificate and forwards the remaining amount to the transferor (Treas. Reg (c)(2)(i)(A) and (b)(5)(i)). CONSEQUENCES OF FAILING TO COMPLY WITH THE FIRPTA FILING REQUIREMENTS A failure by a transferor, transferee or distributor of a USRPI to comply with the FIRPTA filing and notification requirements (including meeting the relevant filing and notification deadlines) can result in US federal income tax return filing obligations and the imposition of substantive or withholding tax liability, plus related interest and penalties, in transactions that would otherwise qualify for an exception to the FIRPTA rules. The specific consequences depend on the person s obligations in the transaction and the FIRPTA filings that were missed. However, it may be possible to obtain relief for late filings and notifications under Revenue Procedure (see Requesting Relief under Revenue Procedure ). Consequences for a Foreign Transferor of a USRPI A foreign person that transfers a USRPI (including transfers otherwise eligible for nonrecognition treatment under general tax rules) must report any gain from the transfer as ECI on a US federal income tax return filed for the year of the transfer and pay any tax due unless either: The USRPI transferred is stock of a US corporation, and the US corporation provides: a Statement of Non-USRPI Status to the foreign transferor no later than the due date of the foreign transferor s US federal income tax return for the year of the transfer; and a Notice of Non-USRPI Status to the IRS within 30 days of providing the foreign transferor with the Statement of Non- USRPI Status (Temp. Treas. Reg (g)(1)(ii)(A)). The transfer qualifies in its entirety for nonrecognition treatment under general US federal income tax rules and the FIRPTA rules and either: the foreign transferor files a US federal income tax return for the year of the transfer and attaches the information specified in Treasury Regulation Section T(d)(1)(iii) to the return; or the transfer qualifies in its entirety for nonrecognition treatment, the foreign transferor has no ECI from other sources and the transferee timely submits a Notice of Nonrecognition Transfer to the IRS (Temp. Treas. Reg T(a)(1) as amended by Notice 89-57). A transferor s failure to comply with these obligations will result in the imposition of substantive tax liability plus related interest and penalties. Consequences for a Transferee of a USRPI A US or foreign transferee of a USRPI from a foreign transferor must withhold and remit 10% of the gross amount realized by the transferor to the IRS no later than 20 days after the date of the transfer unless either: The USRPI transferred is stock of a US corporation, and the US corporation provides: a Statement of Non-USRPI Status to the foreign transferor, and the foreign transferor provides the transferee with a copy of the Statement of Non-USRPI Status, no later than the date of the transfer; and a Notice of Non-USRPI Status to the IRS within 30 days of providing the Statement of Non-USRPI Status to the foreign transferor (Treas. Reg (g)(1)(ii)(A)). The transferee obtains a Notice of Nonrecognition Transfer from the transferor by the date of the transfer, and within 20 days of the date of the transfer the transferee files a copy of the Notice of Nonrecognition Transfer with the IRS (Treas. Reg (d)(2)). A transferee s failure to comply with these obligations will result in the imposition of withholding tax liability plus related interest and penalties. 13

14 Investments in US Real Property by Non-US Investors: Basic FIRPTA Rules Consequences for a Foreign Distributor of a USRPI A foreign distributor of a USRPI must withhold and remit 35% of the amount of gain recognized by the foreign distributor to the IRS no later than 20 days after the date of the distribution unless either: The USRPI distributed is stock of a US corporation, and the US corporation provides: a Statement of Non-USRPI Status to the foreign distributor no later than the date of the distribution; and a Notice of Non-USRPI Status to the IRS within 30 days of providing the foreign distributor with the Statement of Non- USRPI Status (Treas. Reg (b)(4)(iii)). The USRPI is distributed in a transaction qualifying for nonrecognition treatment under both general tax rules and the FIRPTA rules, and the distributor files a Notice of Nonrecognition Transfer with the IRS within 20 days of the date of the distribution (Treas. Reg (b)(2)). A foreign distributor s failure to comply with these obligations will result in the imposition of a withholding tax liability plus related interest and penalties. In addition, if the distributor fails to meet one of the requirements described above by the due date of a US federal income tax return for the year of the distribution, the distributor will also incur a substantive tax liability plus related interest and penalties. The IRS can only collect one liability (either for withholding tax liability or substantive tax liability), but it can assert separate interest and penalties for failing to comply with the two requirements (Treas. Reg (e) and (d)(1)). REMEDYING FAILURES TO COMPLY WITH THE FIRPTA RULES The FIRPTA rules provide for the elimination of some or all of the substantive and/or withholding tax liability, interest and penalties arising from a failure to comply with the relevant filing and withholding obligations. There are three methods for doing this: Paying the tax due. Establishing that no substantive tax was due on the disposition. Requesting relief under Notice Paying the Tax Due The first method for eliminating FIRPTA-related tax liability is for the transferor or distributor to pay the substantive FIRPTA tax when it files a US federal income tax return for the year of the disposition. This will be treated as a payment of the withholding tax liability imposed on the transferee or the distributor (Treas. Reg (e)(3)(i)). It does not eliminate any interest and penalties related to the FIRPTA withholding tax liability that accrued before the payment of the substantive FIRPTA tax liability (Treas. Reg (e)(3) (ii)). This method is primarily relevant for related party transactions (such as internal restructurings). tax liability when it files an income tax return for the year of the disposition (Treas. Reg (f)(1)). The transferee or distributor s payment of its withholding tax liability will not eliminate any interest and penalties related to the substantive and withholding tax liabilities that accrued before the payment of the withholding tax liability. Establishing that no Substantive Tax was Due The second method for eliminating FIRPTA-related tax liability is to have the party with the substantive FIRPTA tax liability (for example, a foreign seller of stock in a US corporation) file a US federal income tax return and establish that no substantive tax was due on the transaction because either: There was no gain on the transferred USRPI. The distributed USRPI was stock of a US corporation and the person filing the return attaches a valid and timely Statement of Non-USRPI Status from the transferred US corporation. The person filing the return provides the necessary information to establish that the transaction qualified for nonrecognition treatment under both general and FIRPTA tax rules. Once this occurs, any withholding tax otherwise due is treated as having been paid (Treas. Reg (e)(3)(i)). This method does not eliminate any interest or penalties that accrued with respect to the withholding tax liability before the time that it was deemed paid. This method is primarily relevant for related party transactions (such as internal restructurings). Requesting Relief under Revenue Procedure IRS Revenue Procedure provides a procedure for persons to request relief for late FIRPTA-related filings and notifications consisting of: Statements of Non-USRPI Status required to be provided to a foreign transferor and a transferee or to a foreign distributor and Notices of Non-USRPI Status provided to the IRS in connection with the disposition of an interest in a US corporation that can rebut the presumption of its stock s USRPI status. Notices of Nonrecognition Transfer required to be provided by a transferor of a USRPI to the transferee and by either a transferee or distributor of USRPI to the IRS in connection with dispositions of USRPI qualifying for nonrecognition treatment under the FIRPTA rules. Although requesting relief under this procedure is more time-consuming than using one of the other two methods for eliminating FIRPTA-related tax liability, the benefit to this method is that, if granted, the relief eliminates not only the relevant tax liabilities but also all related interest and penalties. Alternatively, the transferee or distributor can pay its withholding tax liability to the IRS, and this amount can be claimed by the transferor or distributor as a credit against its substantive 14

15 Under Revenue Procedure , a person that misses the deadline for the relevant FIRPTA-related filing formally requests the IRS to conclude that the missed deadline was due to reasonable cause by: Filing the missed statement(s) and/or notice(s) (with the phrase FILED PURSUANT TO REV. PROC included at the top) with the appropriate person(s) and the IRS, as applicable. Attaching an explanation to the statement(s) and/or notice(s) filed with the IRS describing why the failure to timely file the statement or notice was due to reasonable cause. Revenue Procedure does not define the term reasonable cause. However, courts have defined this term in interpreting other provisions of the Code, and the IRS has addressed the application of this term in both the Penalty Handbook of the Internal Revenue Manual (IRM) and the section of the IRM describing how the IRS will process requests for relief under Revenue Procedure The Supreme Court and the Tax Court have recognized that a taxpayer may generally establish reasonable cause by the exercise of ordinary care and business prudence (see United States v. Boyle, 469 U.S. 241 (1985), and Stevens Bros. Found., Inc. v. Comm r, 39 T.C. 93 (1962)). Reasonable and good faith reliance on the tax advice of a tax professional with respect to a substantive tax issue is another factor that may constitute reasonable cause. To qualify for a reasonable cause determination in this situation, the tax advisor must have sufficient knowledge in the relevant aspects of federal tax law to justify the reliance, and the taxpayer must provide the advisor with all necessary information (see Ellwest Stereo Theatres of Memphis v. Comm r, T.C. Memo ). indicating that the request has been received and assigned for review. The IRS will then determine whether the requirements for granting the request have been satisfied. If the taxpayer is not notified again by the IRS within 120 days of the first IRS letter, Notice provides the taxpayer will be deemed to have established reasonable cause. However, the IRS practice is to send a second letter confirming that relief has been granted (or alternatively, indicating that relief has not been granted) (IRM and ( )). If a person is granted reasonable cause relief under Revenue Procedure , it will be treated as having timely filed the FIRPTA statement(s) and/or notice(s) for which relief was requested. As a result, the person will not be subject to any substantive tax liability under FIRPTA, or any related interest and penalties that would otherwise be imposed because of the missed statement(s) and/or notice(s). Practical Law Company provides practical legal know-how for law firms, law departments and law schools. Our online resources help lawyers practice efficiently, get up to speed quickly and spend more time on the work that matters most. This resource is just one example of the many resources Practical Law Company offers. Discover for yourself what the world s leading law firms and law departments use to enhance their practices. To request a complimentary trial of Practical Law Company s online services, visit practicallaw.com or call The IRM s Penalty Handbook provides that: Reasonable cause is based on all the facts and circumstances in each situation and allows the IRS to provide relief from a penalty that would otherwise be assessed. Reasonable cause relief is generally granted when the taxpayer exercised ordinary business care and prudence in determining its tax obligations but nevertheless failed to comply with those obligations. (IRM ( ).) The section of the IRM dealing with requests for a reasonable cause determination under Revenue Procedure describes the following instances that may constitute reasonable cause: Miscommunication between the taxpayer s tax advisors. Circumstances beyond the taxpayer s control. Reasonable reliance on a paid professional who gave erroneous advice on the filing requirement. Unavoidable delay in obtaining a necessary signature. (IRM ( ).) On receiving a request for a reasonable cause determination, the IRS will send a letter to the person that submitted the request Use of PLC websites and services is subject to the Terms of Use ( and Privacy Policy (