IRS Announces Notice of Proposed Rulemaking Relating to U.S. Taxation of Foreign Investors in Certain Infrastructure Investments
October 31, 2008
On October 30, 2008, the Internal Revenue Service (the “IRS”) and the Treasury Department (the “Treasury”) issued a notice of proposed rulemaking (the “Notice”) stating that they are considering issuing regulations that would treat as “real property” investments in governmental licenses acquired in connection with ownership of U.S. infrastructure assets (e.g., toll bridges and toll roads). Non-U.S. persons, including non-U.S. investors in investment funds that own U.S. infrastructure assets, are likely to be affected if such regulations are indeed promulgated. Because the scope of the Notice is unclear, it is possible that these regulations would also affect non-U.S. shareholders in certain U.S. corporations operating in regulated industries.
FIRPTA Generally. Under the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”), gain or loss derived by non-U.S. persons from the disposition of a U.S. real property interest (a “USRPI”) is treated as “effectively connected” with a trade or business in the United States, and any such net gain is therefore subject to U.S. federal income tax. FIRPTA generally defines a USRPI to include both (i) an interest in real property located in the United States and (ii) shares of a domestic corporation if USRPIs represent 50% or more of the value of such corporation’s real property assets and its other assets held for use in a trade or business (any such corporation, a “USRPHC”). For purposes of determining whether it is a USRPHC, a domestic corporation is treated as owning its proportionate share of the assets of any partnership in which it is a partner.
Summary of Notice of Proposed Rulemaking. The Notice describes a “typical” transaction in which a domestic partnership (a “DP”) leases or purchases U.S. infrastructure assets and the land on which the infrastructure assets are built (the “Infrastructure Assets”). The DP’s partners include domestic corporations with foreign shareholders, such as the domestic “blocker” corporation structure widely employed by U.S. investment funds with respect to investments in active U.S. businesses. In the “typical” transaction, DP is required to obtain a governmental license or permit in order to operate the Infrastructure Assets and to collect tolls for their use (a “Governmental License”). The Notice states that, because of the physical attributes of, and the terms and conditions related to, the Infrastructure Assets (e.g., a leasehold interest with respect to a narrow roadway that the lessee is required to operate as a roadway), the economic value of the leasehold or fee interest in the Infrastructure Assets derives from the rights granted under the Governmental License (e.g., the right to charge and collect tolls).
The Notice states that the IRS and Treasury are aware that taxpayers may be taking the position that the Governmental License is not a USRPI. Further, some taxpayers take the position that a significant portion of the fair market value of a DP’s assets is allocable to the Governmental License rather than the Infrastructure Assets. In such a case, the taxpayer’s position reduces the likelihood that a domestic corporation holding an interest in a DP will be treated as a USRPHC.
The Notice provides that IRS and Treasury are of the view that, in certain circumstances, a Governmental License should be treated as a USRPI. The IRS and Treasury are therefore considering promulgating regulations that would address the circumstances under which Governmental Licenses that are related to the value of the use or ownership of an interest in real property are to be treated as USRPIs. The Notice does not indicate the approach that the IRS and Treasury will take in crafting regulations and requests comments in this regard.
Although the scope of the Notice is unclear, it appears intended, at a minimum, to address blocker corporation structures employed by investment funds that hold traditional U.S. infrastructure assets. It is possible, however, that other regulated activities that derive value from interests in U.S. real estate (for example, telecommunications) would also be covered by the future regulations. Although these regulations would apply prospectively, the Notice cautions that “no inference is intended as to how [Governmental Licenses] are treated or characterized under current law.”
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