Tax News

CCH (cch.taxgroup.com) reports:

The IRS has issued final regulations under Code Secs. 860A, 860G(b), 863, 1441
and 1442 regarding when income from a real estate mortgage investment conduit (REMIC) becomes taxable to foreign persons with interests in entities that hold residual interest in a REMIC. The final regulations adopt previously issued temporary and proposed regulations (T.D. 9272, NPRM REG-159929-02) without any substantive changes, and the preamble to T.D. 9272 functions as the explanation for the final regulations.
Background
The holder of a residual interest in a REMIC must take into account the holder's daily share of the income and loss of the REMIC for each day of the year in which the interest is held. The holder is, therefore, taxable on the income and loss, regardless of whether there is a distribution. However, if the holder is a nonresident alien or a foreign corporation, such amounts are only taken into account for tax purposes when they are actually distributed or when the residual interest is disposed of. A REMIC will often experience a period early in its existence when it receives a large amount of interest that it uses to pay for nondeductible items, which results in a residual interest holder being taxed on income the holder will not receive in a distribution. Such interest is generally referred to as a noneconomic REMIC residual interest and, although this income ("phantom income") is taxed, it is usually offset later by matching deductions ("phantom losses").
These holders are subject to rules relating to excess inclusions, which prevent the use of net operating losses to offset excess inclusions and preclude a reduction in withholding taxes. A residual interest holder cannot reduce its taxable income for the year below the excess inclusion, equal to the excess of net income passed through to the holder over its daily accrual, which is determined by its interest in the REMIC.
The tax on excess inclusions may be incentive for a noneconomic REMIC residual interest holder to transfer the interest in order to avoid the tax. To ensure that excess inclusions are properly taxed, Reg. §1.860E-1 and §1.860G-3
provide for the disregard of such transfers made to a foreign person that have tax-avoidance potential. However, a transfer will not be disregarded if the transferor reasonably expects the REMIC will distribute to the foreign transferee an amount equaling 30 percent of the excess inclusion.
This has resulted in transactions where a noneconomic REMIC residual interest holder has transferred the interest to a domestic partnership, and the domestic partnership subsequently transfers the phantom income to later-joining foreign partners. The transferor of the interest may argue that the requirements of Reg. §1.860E-1 and §1.860G-3
do not apply, and the partnership may take the position that the foreign partner holds a share of the interest and is not taxed on the phantom income until a distribution is made or the interest is disposed of.
Final Regulations
Like the temporary regulations, the final regulations provide for an acceleration of recognition of REMIC net income in the case of the foreign partner. Furthermore, the taxation on excess inclusion income allocated to foreign partners is also accelerated by the regulations in the case of real estate investment trusts (REITs), regulated investment companies (RICs), common trust funds or subchapter T cooperative organizations.
The final regulations provide that the foreign shareholder in a REIT, participant in a common trust fund, or patron in a subchapter T cooperative organization must take into account excess inclusion income at the same time as other income from the entity. Final regulations under Code Sec. 1441 also treat the excess income as having sources inside the U.S. and eliminate the withholding exemption available under certain circumstances to withholding agents who do not have custody of money or property.
The regulations regarding the acceleration of REMIC income apply to the first REMIC allocations to foreign persons on or after August 1, 2006. The regulations regarding the source of excess inclusions are applicable for tax years ending after August 1, 2006.
T.D. 9415, 2008FED ¶47,050
Other References:
Code Sec. 860A
CCH Reference - 2008FED ¶26,600A
CCH Reference - 2008FED ¶26,600D
CCH Reference - 2008FED ¶26,605
Code Sec. 860G
CCH Reference - 2008FED ¶26,720E
CCH Reference - 2008FED ¶26,720G
Code Sec. 863
CCH Reference - 2008FED ¶27,160B
CCH Reference - 2008FED ¶27,161
CCH Reference - 2008FED ¶27,161C
Code Sec. 1441
CCH Reference - 2008FED ¶32,702A
CCH Reference - 2008FED ¶32,704
CCH Reference - 2008FED ¶32,705
Tax Research Consultant
CCH Reference - TRC EXPAT: 15,110.30
CCH Reference - TRC RIC: 9,252.20