In a 2015 blog post, the White House said America needs more private investment in its infrastructure and estimated $3.6 trillion would needed by 2020. With an increased focus on cross-border investment in infrastructure, it is important for investors / fund managers to understand the international tax framework for structuring investments in infrastructure assets. Prior to June 19, 1980, gains realized from the disposition of certain U.S. property (including U.S. oil and gas interests) by a non-U.S. investor were generally not subject to U.S. taxation, unless such gains were “effectively connected” with the non-U.S. investor’s U.S. trade or business. Thus, it was possible for a non-U.S. investor to structure its investments and subsequent dispositions in a manner that would escape U.S. taxation.
In 1980, Congress enacted the Foreign Investment in Real Property Tax Act (FIRPTA) to ensure non-U.S. investors would be subject to U.S. tax on income from the actual or deemed disposition of any U.S. real property interests (USRPIs), which generally include U.S. real property as well as interests in certain U.S. real property heavy partnerships and corporations. FIRPTA is generally enforced through a tax regime that places an obligation on a buyer to withhold a portion of the gross proceeds payable to a seller in a sale transaction (currently 15 percent). FIRPTA withholding is required even if a tax treaty would otherwise provide a more favorable result.
To encourage foreign investment in U.S. infrastructure projects, among other things, on December 18, 2015, President Obama signed into law the Protecting Americans from Tax Hikes (PATH) Act which made extensive changes to the FIRPTA rules. The act created exemptions from FIRPTA for certain qualified foreign retirement funds, certain qualified shareholders in REITs, increased the amount of a publically traded REIT a foreign investor may own and repealed the “cleansing rule” for REITs, paving the way for a shareholder of a foreign-controlled private REIT to claim a stock loss resulting from a liquidation of an unprofitable investment in certain circumstances. The act, however, also increased the rate of withholding on dispositions of USRPIs from 10 percent to 15 percent. Time will tell how significantly these tax law changes impact the appetite of foreign investors for U.S. real estate and infrastructure projects, but this removal of certain barriers to such investments appears to be a move in the right direction.
So while the PATH Act created some favorable provisions for foreign pension plan investments and loosened restrictions on ownership of publically traded REITs, the complexity of the FIRPTA rules, and the potentially harsh results (e.g. 15 percent withholding of gross proceeds), remain. That said, with careful consideration and planning, FIRPTA can be managed, and such management can often be critical to the successful completion of U.S. infrastructure investments.