When a foreign person sells U.S. real estate to an unrelated buyer on the installment basis, normally the interest on the future installments will be subject to 30% U.S.
Withholding tax if the foreign seller is not a treaty resident entitled to a U.S. treaty reduction. However, the “portfolio debt” rules provide the foreign seller with an exemption from U.S. withholding tax if the installment note is structured to qualify as a “portfolio debt.” At a minimum, the foreign seller cannot be a commercial bank or a 10% or greater equity owner of the issuer of the installment note ( i . e, the, buyer). Assuming these statutory requirements are met, there is a further issue as to whether the interest would be “effectively connected” to any FIRPTA gain which is recognized under the installment method in the future. This is an unresolved issue. As a result, the more prudent course would be to not elect the installment method for reporting gain from the USRPI sale, so that all of the gain would be taxable in the year of sale and there would be n o future FIRPTA gain to which the interest might be deemed “effectively connected.” Assuming the foreign seller is prepared to forego the opportunity to defer the FIRPTA gain recognition and opt, instead, for the portfolio bond exemption, then the installment note must meet the requirements of the “portfolio debt” rules.
- Requirements To Qualify for Portfolio Interest Exemption.
- Original Requirements. The Tax Reform Act of 1984 added Code § 871(h), which provides an exemption from withholding tax for interest paid to foreign holders with respect to certain “portfolio debt instruments” issued after July 18, 1984. Different requirements apply to “registered bonds” and “bearer bonds.” This outline will o n l y discuss the requirements applicable to “registered bonds.” In the original portfolio interest regulations issued in 1984, the Treasury took the position that only interest with respect to obligations of a type described in S 163(f)(2)(A) could qualify for the portfolio interest exemption. Therefore, interest on obligations issued by natural persons, obligations with maturities o f less than one year, and obligations not of a type offered to the public could not qualify for the portfolio interest exemption. After receiving much criticism for this position, the Treasury abandoned the requirement in revisions to the portfolio interest regulations released December 16, 1986./ Thus, interest on privately placed debt obligations (i.e., of a type not offered to the public) as well as obligations issued by individuals and obligations with a maturity of less than one year may also now qualify for the portfolio interest exemption. However, as will be discussed more fully below, proposed regulations would apply certain more stringent reporting requirements to such privately placed obligations.
- Oualification Requirements Under the New Treasury Regulations. Payments of interest on non-bearer, privately placed debt instruments issued after July 18, 1984 are exempt from withholding tax subject to the following conditions.
- Registration Requirement. The obligation must be registered with the issuer as to both principal and interest and the obligation may be transferred only by one or both of the following methods: (1) by surrendering the original instrument in exchange for a new instrument or (2} by transfer on a book entry system maintained by the issuer.
- (A) Language to be Inserted in Obligation. The foregoing requirements must be reflected in the language of the debt instrument itself.
- Proposed and Temporary regulation impose an excise tax upon unauthorized transfers. Temporary regulations issued on May 18, 1988 provide that any person who holds a registration required obligation that is in registered form and who transfers the obligation through a method not described in i. above, is considered the issuer of the obligation transferred for purpose of the excise tax imposed under Code § 4701.
- Administrative Requirements. The foregoing statement must be received by the payor in the calendar year in which the payment is made. The payor, however, may require the statement from the payee each time it makes a payment to the payee. The payor must retain the statement for at least four calendar years after the amount to which the statement relates is paid. If the person providing the statement becomes a United States citizen or resident during the period to which the statement relates such person shall notify the payor within 30 days of such change in status.
- Information Return. Payor shall make on or before March 15 an annual information return on IRS Form 1042S of all items of interest subject to the foregoing provisions paid during the previous calendar year. IRS Form W-8 shall be attached to the information return.
- Proposed Regulations Would Apply Additional Disclosure Requirements for Privately Placed Obligations. Proposed Treasury Regulations would impose additional disclosure requirements for payments under privately placed obligations. These disclosure requirements would consist of a written statement under penalty of perjury (the “Affidavit”) made by each of the foreign payee stating: (1) that the interest is not received by a 101 shareholder of payor;
- (2) the name and address of the person making the statement; and (3) information sufficient on its face to confirm the validity of the statement. Such information must identify the ultimate individual beneficial owner(s) of the person making the statement, and identify the stock in the other party held actually and constructively by the person making the statement. The written statement must be attached to the yearly information return to be filed by payor.
Cav. Piero Salussolia , Esq.
Monica Tirado, Abg. (admitted in Colombia only)
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