December 29, 2015

Recent U.S. International Tax Development: The PATH Act

Recent U.S. International Tax Development: The PATH Act Tax & Business

On Friday, December 18, President Obama signed the Protecting Americans from Tax Hikes Act of 2015 (“the PATH Act”) which provides more certainty for international tax planning going into 2016 and future years. The PATH Act extends certain international tax provisions temporarily and makes others permanent as follows:

Makes permanent the active financing exception for Subpart F income, which has been extended over the last decade on a temporary basis. The U.S. parent of a foreign subsidiary engaged in a banking, financing, or similar business is eligible for deferral of tax on that subsidiary’s earnings if the subsidiary is predominantly engaged in that business and conducts substantial activity with respect to the business. The subsidiary also must pass an entity-level income test to demonstrate that the income is active income and not passive income. Thus, this income from the active conduct of a banking, financing or similar business, or from the conduct of an insurance business, is excluded from the definition of Subpart F income. This exemption allows for the potential deferral of income from financing overseas operations for U.S. corporations, as it has been viewed to date as preventing a competitive disadvantage on the part of U.S. businesses that have been expanding overseas. Code Sec. 953(e)(10) and Code Sec. 954(h)(9).

Extends for five years the application of the look-through rule to taxable years of foreign corporations through year 2019, and to taxable years of U.S. shareholders with or within which such taxable years of foreign corporations end. Under the “look-through rule” (Code Sec. 954(c)(6) ), dividends, interest (including factoring income that is treated as equivalent to interest under Code Sec. 954(c)(1)(E) ), rents, and royalties received or accrued by one controlled foreign corporation (CFC) from a related CFC are not treated as foreign personal holding company income to the extent attributable or properly allocable to income of the payor that is neither Subpart F income nor treated as effectively connected income (ECI). For this purpose, a related CFC is a CFC that controls or is controlled by the other CFC, or a CFC that is controlled by the same person or persons that control the other CFC. Ownership of more than 50 percent of the CFC’s stock (by vote or value) constitutes control for these purposes.

Provides that a spin-off involving a real estate investment trust (REIT) will qualify as tax-free only if, immediately after the distribution, both the distributing and controlled corporation are REITs. In other words, capital gains tax on any appreciation in the property cannot be avoided. In addition, neither a distributing nor a controlled corporation can elect to be treated as a REIT for 10 years following a tax-free spin-off transaction.

Modifies some of the provisions of the Foreign Investment in Real Property Tax Act (FIRPTA):

  • Withholding tax on dispositions of U.S. real estate by a foreign person has been increased from 10% to 15%. The increased rate of withholding, however, does not apply to the sale of a personal residence where the amount realized is $1 million or less. (The PATH Act also increases the FIRPTA withholding exemption for sales of residences from $300,000 to $1.0 million). In this situation, where Code Sec. 1445(b)(5) (above) does not apply, a 10% rate of withholding applies.
  • The maximum ownership threshold has been increased to 10% from 5% for the public investor exception.
  • A qualified foreign pension fund is now exempt from FIRPTA.
  • Purchasers of U.S. real estate from foreign sellers need to be aware of these tax law changes to ensure that the proper amount of tax is withheld so penalties are avoided. Even though the FIRPTA withholding tax on disposing of U.S. real estate has increased, a foreign seller must still file a U.S. tax return, determine the actual U.S. tax and pay the tax. The increased FIRPTA will be applied to taxes due and if it exceeds the tax liability is refundable.

Should you have any questions concerning this Tax Flash, please contact your Marcum LLP tax representative.

A special thanks to Victoria Tarakanova, Tax & Business Services for her contributions.

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