Impact of Tax Cuts and Jobs Act: Part V – Certain Changes Affecting Cross-Border Withholding and Sourcing

Post by
November 6, 2017

Thursday, November 2, the House Ways and Means Committee released the Tax Cuts and Jobs Act (H.R. 1) (the “Bill”), a bill that, if enacted, would represent the most substantial overhaul of the U.S. tax code in decades.  We are releasing a series of posts to highlight the provisions of the Bill affecting the topics pertinent to our readers, where each post will cover a different area of importance.  Part I of this series covered potential changes to employer-provided benefits, Part II addressed entertainment expenses and other fringe benefits, Part III discussed changes to employee retirement plans, and Part IV covered changes to the Code section 162(m) deduction limitation for executive compensation.  In this Part V, we will discuss the Bill’s potential impact on two cross-border tax issues.

Reduced FIRPTA Withholding Rates.  Under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), gain or loss on the disposition of U.S. real property interests by a nonresident alien individual or foreign corporation is subject to U.S. income tax as though the taxpayer were engaged in a trade or business in the United State and such gain or loss were effectively connected with such trade or business.  Section 1445 applies a withholding mechanism to ensure the payment of any tax due.  When a domestic partnership, trust, or estate disposes of a U.S. real property interest, section 1445 requires that it (or the trustee or executor, in the case of a trust or estate, respectively) withhold 35 percent of the gain realized that is allocable to a foreign person (or allocable to a portion of a trust treated as owned by a foreign person).  Similarly, when a foreign corporation distributes a U.S. real property interest to its shareholders, it must withhold at a rate of 35 percent.  The same withholding rate applies to distributions that are treated as gains or losses from the disposition of a U.S. real property interest allocable to foreign persons from certain domestic entities (such as real estate investment trusts and registered investment companies that would be considered U.S. real property holding corporations if their shares were not publicly traded).  Section 3001 of the Bill, which reduces corporate tax rates in general, includes a corresponding reduction of the FIRPTA tax withholding rate, modifying paragraphs 1445(e)(1), 1445(e)(2), and 1445(e)(6) to require withholding at a 20 percent rate.  The reductions would take effect for tax years beginning after 2017.

Modification to Sourcing Rule for Sales of Inventory Property.  Currently, up to 50 percent of income from the sale of inventory property produced entirely within the United States and sold outside the United States (or vice-versa) can be treated as foreign-source income for purposes of calculating foreign tax credits.  Section 4102 of the Bill would require sales of inventory property to be sourced solely based on the location of production activity with respect to the inventory.  This change would be effective for tax years beginning after 2017.

IRS Corrects FIRPTA Final Regulations

Post by
April 27, 2016

Income tax withholding under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) applies to a foreign person’s disposition of a U.S. real property interest. On April 26, 2016, the IRS published a correcting amendment to the final regulations (T.D. 9751) addressing the taxation of and withholding on payments to foreign persons on certain dispositions of U.S. real property interests, under Internal Revenue Code Sections 897 and 1445. This correcting amendment is effective on April 26, 2016, and applicable on or after February 19, 2016 – the effective date of the final regulations.

In general, under Code Section 1445(e) and its regulations, certain entities must withhold tax upon certain dispositions and distributions of U.S. real property interests to “foreign persons.” The existing Treasury Regulation § 1445-5(b)(3)(ii)(A) states that “[i]n general, a foreign person is a nonresident alien individual, foreign corporation, foreign partnership, foreign trust, or foreign estate, but not a resident alien individual.” The final regulations affected certain holders of U.S. property interests and withholding agents that are required to withhold tax on certain disposition of, and with respect to, these property interests. While the final regulations initially did not impact the definition of a “foreign person,” the correcting amendment revised the “but not” clause to state that a foreign person is “not a qualified foreign pension fund (as defined in section 897(l)) or an entity all of the interests of which are held by a qualified foreign pension fund.” Code Section 897(l) – recently added by the Protecting Americans from Tax Hikes Act of 2015 – provides that federal income taxation does not apply to distributions received from a real estate investment trust by a qualified foreign pension fund or an entity wholly owned by a qualified foreign pension fund.