In April 2013, the Treasury Department released general explanations of the Obama Administration’s 2014 revenue proposals. Included was a proposal to exempt foreign pension funds from U.S. tax under the Foreign Investment in Real Property Tax Act, or FIRPTA, for dispositions of U.S. real property interests occurring after December 31, 2013.
FIRPTA generally subjects foreign investors in U.S. real property to tax upon the disposition of U.S. real property interests (including interests in U.S. real property holding corporations) as if the foreign investor’s gain on the disposition were effectively connected with the conduct of a U.S. trade or business. The Administration views the purpose of FIRPTA as placing foreign and domestic investors in U.S. real property on equal footing. Because U.S. pension funds are generally exempt from U.S. tax (including upon the disposition of U.S. real property interests), the Administration has proposed to extend similar treatment to foreign pension funds by exempting them from FIRPTA tax.
To be classified as a foreign pension fund, a foreign investor would have to be exempt from income tax in its home jurisdiction and would have to devote substantially all its activities to administering or providing pension or retirement benefits.
The proposal does not appear to protect foreign pension funds from U.S. federal income tax on operating income, or state taxes on income or gains, derived from U.S. real property interests held directly or through a tax-transparent entity such as a partnership. In appropriate circumstances, however, such taxes can be reduced or eliminated by investing through real estate investment trusts, or REITs. While not expressly addressed in the Treasury Department summary, the proposed exemption for foreign pension funds appears to cover FIRPTA taxes otherwise incurred on REIT capital gain dividends.