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EisnerAmper Blog

Building Success: An EisnerAmper Real Estate Blog

Ken Weissenberg Hosts One-on-One Interview with RXR’s Scott Rechler for BisnowTV

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February 11, 2016

EisnerAmper’s Real Estate group is proud to be participating in an exciting new monthly series of videos for BisnowTV. The project involves interviews with top real estate movers and shakers. The first video features a one-on-one interview with RXR Realty CEO and Chairman Scott Rechler, conducted by EisnerAmper Real estate Services Group Chair Ken Weissenberg.  Scott and Ken discussed  a number of topics, including what’s in store for downtown Manhattan, what office tenants are looking for in New York, and how RXR has taken on the task of historic redevelopment. Stay tuned for the next interview in the series!

bisnowtv-video 

 

CLICK HERE TO VIEW THE VIDEO

 

 

New IRS Guidance on Arm’s Length Interest Rates on Inbound Intercompany Loans

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February 9, 2016

Dhar AnindaBy Aninda Dhar

While there are numerous structures by which foreigners may invest in U.S. real estate, the use of intercompany debt is ubiquitous in these ventures. In a typical structure, the foreign parent lends an amount to its U.S. subsidiary which in turn makes periodic interest payments to the foreign parent. For the U.S. subsidiary holding the real estate, its operational income (e.g., rental revenue) will be heavily offset by depreciation deductions and interest payments. With these deductions for interest and depreciation oftentimes completely eradicating taxable income, the U.S. subsidiary consequently has no tax liability (and likely has net operating losses).  

The mechanics of the debt in leveraged transactions is a critical component in such transactions. For example, if the debt fails to qualify as debt for U.S. tax purposes, the debt is likely recast as equity. Consequently, the payments which were supposed to be deductible interest payments will subsequently be classified as nondeductible dividends paid to the foreign parent.     

The IRS employs a 2-step methodology to analyze a financing arrangement. First, the IRS gauges if the financing arrangement is debt or equity. Second, if the financing arrangement is determined to be bona fide debt for U.S. tax purposes, the IRS then determines if the intercompany interest rate meets the arm’s length standard for bona fide debt.  

For the first part, the debt-vs. -equity analysis, the IRS will consider the following factors: 

  • Intercompany loan agreement;
  • Duration of the loan;
  • Business purpose of the loan;
  • Actual principal repayments and interest payments;
  • Source of the principal repayment and actual interest payments (it may involve tracing all the payments over the life of the loan);
  • Repeated loan extensions;
  • Debtors' financial risk, credit risk, and debt/equity ratios;
  • Code Sec. 385 (guidance on the treatment of certain interests in corporations as stock or debt); and
  • Debt-vs.-equity established under case law (including name of the financing arrangement, presence or lack of a maturity date, principal repayment, source of payments, subordination, thin capitalization, and independent creditor test, among other things). 

For the second part, the IRS must determine if an arm’s length interest rate has been charged. In general, an arm’s length interest is the rate of interest that would have been charged, at the time of debt formation, in an independent transaction with or between unrelated parties in a similar situation. In a new International Practice Unit (“IPU”), the IRS has issued guidance to its examiners on this issue. Specifically, the IPU addresses whether the interest on a loan or advance from a foreign parent corporation to a U.S. subsidiary meets the arm’s length standard for U.S. tax purposes.  

In the IPU, IRS offers 3 potential methods to determine whether interest on an intercompany loan or advance is at an arm's length rate:  

  • Method 1: Funds obtained at situs of borrower. If the foreign parent borrows money from an independent third party in the U.S. (“third party loan”) to fund its loan to the U.S. subsidiary (“intercompany loan”), the interest rate on the intercompany loan must equal the interest rate on the third party loan, increased by other costs or deductions incurred by the foreign partner on the third party loan. 
  • Method 2: Safe haven interest rates. The interest rate on an intercompany loan may fall within a safe haven range, defined as not less than 100% or not greater than 130%, of the applicable federal rate (“AFR”). This method may not apply in certain cases, including if Method 1 above applies. 
  • Method 3: Interest rates on unrelated transactions. If the U.S. subsidiary uses neither Method 1 nor 2, it must substantiate that the interest rate on the intercompany loan is arm's length in the manner set forth under the applicable regulations. For this method, all relevant factors must be considered, including the principal amount and duration of the intercompany loan or advance, the security involved, the credit standing of U.S. subsidiary, and the interest rate prevailing at the situs of foreign parent for comparable loans between unrelated parties (e.g., a transfer pricing study).   

If none of these methods are able to establish that the interest rate in question is arm’s length, the IRS will adjust the interest rate to reflect an arm's length rate, said the IPU.

While IPUs are not official pronouncements of law or directives and cannot be used, cited, or relied upon as such, they do provide insight on how IRS examiners may conduct their analysis during an audit


Impact of the PATH Act on FIRPTA

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February 2, 2016

By Aninda Dhar and Ariel Cabral 

 

On December 18, 2015, Congress passed and President Obama signed into law the Protecting Americans from Tax Hikes Act of 2015 (“PATH Act” or the “Act”), enacting several changes to the Foreign Investment in Real Property Tax Act (“FIRPTA”). This particular post highlights the new interplay of the PATH Act and FIRPTA.  

Publicly Traded REITs:

Generally, gain derived from the disposition of stock in a “foreign-controlled” publicly traded REIT (i.e., a REIT more than 50% owned by foreign person during the testing period) is subject to FIRPTA. Naturally, a determination if a REIT is foreign controlled or domestic is potentially difficult if underlying shareholder information is not readily available. The PATH Act addresses the issue in 2 ways. First, the PATH Act simplifies the process for determining whether a REIT is foreign-controlled, and subject to FIRPTA, by creating a presumption that any shareholder owning less than 5% of the REIT is a U.S. person unless the REIT has knowledge to the contrary. Second, the PATH Act modifies an exemption allowing foreign persons to own up to 5% of a publicly traded REIT without triggering FIRPTA, by raising this threshold ownership percentage from 5% to 10%. Accordingly, a foreign person may now hold up to 10% of a publicly traded REIT, domestic or foreign, without being subject to FIRPTA on the sale of the REIT stock. Consequently, any distribution from a publicly traded REIT to a foreign person owning less than 10% of the REIT is treated as a dividend rather than ECI under FIRPTA. 

This change is in effect for dispositions and distributions on or after December 18, 2015. 

Pension Funds:

Under the PATH Act, qualified foreign pension plans will no longer be subject to FIRPTA on gain from the sale or disposition of U.S. real property interests (“USRPI”) held through a partnership, or on capital gains distributions received from a REIT attributable to such dispositions. The PATH Act essentially places foreign and domestic funds on equal footing. 

This change is in effective for disposition and distributions on or after December 19, 2015. 

Withholding on FIRPTA Distributions:

Another significant change to FIRPTA involves the 10% withholding tax rate imposed on gross proceeds from sales. The PATH Act increases the rate on FIRPTA withholding from 10% to 15%. Readers should note that original 10% withholding rate remains in effect where the transferee acquires a personal residence and the purchase price does not exceed $1 million. 

This change is in effect for dispositions occurring 60 days after December 15, 2015.

Elimination of the “Cleansing Rule” for RICs and REITs

The PATH Act alters the FIRPTA “cleansing rule.” The pre-PATH “cleansing rule” provided that an interest in a corporation was not U.S. real property interest if, as of the date of disposition, the corporation owned no USRPIs and all USRPIs held by said corporation during the testing period were disposed of in transactions in which the full gain was subject to U.S. tax. 

Under the PATH Act, the cleansing rule does not apply to any USRPHC that was a RIC or REIT at any time during the relevant testing period. This change applies to dispositions on or after December 18, 2015. 

EisnerAmper is an independent member of Allinial Global.
EisnerAmper is an independent member of EisnerAmper Global.