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Proposed Regulations Provide Clarity for Qualified Foreign Pension Fund Exception

On June 7, 2019, the U.S. Treasury Department (“Treasury”) and the Internal Revenue Service (“IRS”) released proposed Treasury regulations under Sections 897, 1445 and 1446 (the “Proposed Regulations”) regarding the exception for qualified foreign pension funds (“QFPFs”) from taxation under the Foreign Investment in Real Property Tax Act (“FIRPTA”) provisions of the Internal Revenue Code of 1986, as amended (the “Code”).[1] This exception was added to the Code pursuant to the Protecting Americans from Tax Hikes Act of 2015 (the “PATH Act”).

The Proposed Regulations are taxpayer favorable because they broadly construe which entities may constitute QFPFs and the requirements that must be met under Section 897(l) in an effort to include a wide range of plans that are in substance foreign pension funds but that might not qualify under a strict interpretation of the statute. The Proposed Regulations should encourage further investment in U.S. real property by foreign pension plans by providing greater clarity regarding whether a plan meets the requirements to be treated as a QFPF. Rules for certifying an exemption from FIRPTA withholding and plans to revise IRS Form W-8EXP are also provided in the Proposed Regulations.


In general, in the case of a nonresident alien individual or a foreign corporation, Section 897(a)(1) provides that any gain or loss arising from the disposition of a U.S. real property interest (“USRPI”) is taxed as if such gain or loss is effectively connected with the conduct of a U.S. trade or business (commonly referred to as effectively connected income, or “ECI”) by the nonresident alien individual or foreign corporation. Furthermore, under Section 897(h), any distribution from a qualified investment entity (“QIE”), which includes any real estate investment trust (“REIT”) and certain regulated investment companies (“RICs”), to a nonresident alien individual, foreign corporation, or other QIE is treated as gain recognized from the sale or exchange of a USRPI to the extent such gain is attributable to sales or exchanges of USRPIs by the distributing QIE. However, the PATH Act added Section 897(l) to provide an exception for QFPFs by not treating them as nonresident alien individuals or foreign corporations for the purposes of Section 897 (referred to herein as the “Section 897 exception” or the “exception”). Please see our blog post and client alert relating to the enactment of the PATH Act for a more detailed background discussion.

Scope of the Exception

 Qualified Segregated Accounts

The Proposed Regulations limit the scope of the Section 897 exception to gain or loss attributable to one or more qualified segregated accounts maintained by the QFPF (together with qualified controlled entity, defined below, is referred to as a “qualified holder” in the Proposed Regulations). A qualified segregated account is defined to be an identifiable pool of assets maintained for the sole purpose of funding qualified benefits (generally, retirement, pension and certain ancillary benefits) to qualified recipients (generally, plan participants and beneficiaries). Whether each requirement under Section 897(l)(2) is satisfied is determined solely with respect to the income and assets held by an eligible fund in one or more qualified segregated accounts, including the qualified benefits funded by such accounts, the qualified recipients whose benefits are funded by such accounts, and the information reporting and regulation related to such accounts.

Qualified Controlled Entity

Under Section 897(l)(1), a QFPF is defined to include any entity all the interests of which are held by a QFPF (a “qualified controlled entity”).[2] It was unclear whether this meant that such an entity must be directly owned by the QFPF, rather than owned through a series of entities, or whether it could be owned by multiple QFPFs. The Proposed Regulations clarify that a qualified controlled entity may be owned directly or indirectly by one or more QFPFs through one or more qualified controlled entities. In addition, only corporations and trusts may be treated as qualified controlled entities. The Treasury and the IRS determined it is unnecessary to allow partnerships to be treated as qualified controlled entities because indirect ownership is permitted.

In order to determine the status of an entity as a qualified controlled entity, the Proposed Regulations exclude any interest solely as a creditor and ignore the more limited definition of controlled entity under Treasury regulation section 1.892-2T(a)(3) (relating to entities controlled by a foreign sovereign).[3] To prevent avoidance of tax by taxpayers other than QFPFs, de minimis ownership by a taxpayer other than a QFPF is explicitly prohibited, and an anti-abuse rule prohibits any entity or governmental unit that was not (or was not part of) a QFPF or a qualified controlled entity at any time during a specific testing period from qualifying for the exception under the Proposed Regulations.

Eligible Fund

The Treasury and the IRS, stating their intent to be consistent with congressional intent, provided for a broad range of structures (referred to as “eligible funds”) that may be treated as a QFPF under the Proposed Regulations. Section 897(l)(2) states that “any trust, corporation or other organization or arrangement” may be an eligible fund. One of the big questions about this language was how to interpret “organization or arrangement.” The Proposed Regulations specify that an “organization or arrangement” means one or more trusts, corporations, employers or governmental units. Furthermore, a “governmental unit” means any foreign government, or part thereof, and includes any person, body, group of persons, organization, agency, bureau, fund, instrumentality, however designated, of a foreign government.

 The Proposed Regulations, through the use of the terms “eligible fund,” “qualified controlled entity” and “qualified segregated accounts,” clarify that various types of pension plans can be QFPFs including: foreign private and government-sponsored public pension plans, multi-employer plans and pension plans of trade unions or professional associations. Furthermore, a plan may be structured as one or more segregated pools of assets.

Qualified Foreign Pension Fund Requirements

The additional five requirements under Section 897(l)(2) that must be met in order for an eligible fund to be treated as a QFPF are clarified and generally expanded by the Proposed Regulations as follows:

A. Created or organized under the law of a country other than the United States

Recognizing that it is common for pension plans to be organized or governed by local laws (e.g., provincial law in Canada), the Proposed Regulations provide that the reference to “country” may include states, provinces, or political subdivisions of a foreign country.

B. Established to provide retirement or pension benefits

Because foreign pension plans often provide some ancillary benefits, the Proposed Regulations permit a QFPF to provide some benefits other than retirement benefits and pension benefits. Certain “ancillary benefits” are treated as “qualified benefits” under the Proposed Regulations, including benefits payable upon the diagnosis of a terminal illness, death benefits, disability benefits, medical benefits, unemployment benefits, or similar benefits. However, no more than 15% of the present value of the qualified benefits that an eligible fund reasonably expects to provide in the future can be from ancillary benefits.

C. 5% limitation on right to assets or income

Section 897(l) contains no rule regarding constructive ownership. However, the Proposed Regulations apply the attribution rules under Section 267(b) or Section 707(b) to determine whether an individual has a right to more than 5% of a QFPF’s assets or income under Section 897(l)(2)(C). No specific computation rules are provided, and the Proposed Regulations instead require a facts and circumstance determination for calculating the 5% limitation.

D. Subject to governmental regulations and information reporting

A QFPF must be subject to government regulation and must provide or otherwise make available annual information about its beneficiaries to the relevant tax authorities in the country in which it is established or operates. The Proposed Regulations provide useful clarifications:

  • The Proposed Regulations require such information to include the amount of qualified benefits provided to each qualified recipient, but also provide that an eligible fund will not fail the information requirement if it is not required to provide information in a year in which no qualified benefits are provided to qualified recipients.
  • A government-sponsored pension plan that is administered by one or more governmental units, other than in its capacity as an employer, will automatically satisfy the regulation and information requirements under the Proposed Regulations.
  • Private foreign pension plans may be required to provide information to one or more governmental bodies responsible for regulating pensions in the relevant country. Those governmental bodies may be separate and distinct from the tax authorities. Accordingly, the Proposed Regulations provide that an eligible fund will satisfy the information requirement if, pursuant to the applicable foreign laws, it provides the required information, or makes it available, to one or more governmental bodies.

E. Preferential tax treatment in the foreign country in which it is established or operates

The laws of the foreign country in which an eligible fund is established or operates must provide either that (1) contributions to the eligible fund which would otherwise be subject to tax under such laws are deductible or excluded from gross income of such eligible fund or taxed at a reduced rate, or (2) any investment income of the eligible fund is deferred, excluded from gross income of the eligible entity or is taxed at a reduced rate. The Proposed Regulations relax this requirement and provide exceptions in cases where (i) the foreign country does not have an income tax, (ii) where at least 85% of the contributions or investment income is subject to the required tax treatment, and (iii) where the eligible fund is subject to a preferential tax regime that has a substantially similar effect as the required tax treatment under this provision. For purposes of this requirement, the Proposed Regulations specify that it is determined with respect to the national laws of a foreign country. It is important to note that although an eligible fund may be created or organized under the laws of states, provinces, or political subdivisions of a foreign country, it must receive preferential tax treatment on a national level (e.g., for a pension fund established under the laws of a Canadian province, the preferential tax treatment under Canadian federal tax rules is relevant, not a preference under provincial tax rules).


The IRS intends to revise Form W-8EXP to be used by qualified holders to certify their status as non-foreign for withholding tax purposes. In the interim, a certificate of non-foreign status may be used. It is also intended that withholding agents and partnerships may rely on the revised Form W-8EXP.

Note that withholding taxes other than FIRPTA, such as those imposed on payments to non-U.S. persons generally under Sections 1441 and 1442, and on certain allocations of ECI to foreign partners under Section 1446 may still be imposed.


The rules regarding QFPFs apply specifically for purposes of the FIRPTA rules. These rules do not impact the definition of “pension plan” under any income tax treaties between the United States and another country or under the Foreign Account Tax Compliance Act (“FATCA”). Accordingly, a pension plan may be a QFPF under the FIRPTA rules but may not be a pension plan under an applicable income tax treaty or FATCA.

REIT Related Observations

Publicly-Traded Exemption.  The Section 897 exception allows a QFPF to own more than 10% of a publicly traded REIT and not be subject to FIRPTA. Foreign investors in publicly traded REITs generally are exempt from ECI treatment under Section 897 on capital gain dividends attributable to gain from the sale of a USRPI by the REIT (pursuant to Section 897(h)(1)), and on gain from the sale of REIT stock (pursuant to Section 897(c)(3)), if the foreign investor owns no more than 10% of the REIT.[4] However, a QFPF could rely on the Section 897 exception to be exempt from ECI treatment under Section 897 even if it owns more than 10% of a REIT. In practice, REITs typically limit ownership of their shares to 9.8% or less of any class or series of shares unless the investor receives a waiver of the limitation. Accordingly, a QFPF would need to obtain a waiver of the ownership limit in order to own more than 10% of a REIT. Any REIT considering waiving its ownership limit for a QFPF should be careful that a large ownership position by the QFPF does not raise any related party rent issues if the QFPF owns a large interest in any of the REIT’s tenants.

Domestically-Controlled Exemption.  A QFPF may be able to own 50% or more of a private REIT (through a joint venture or other fund structure) and exit the investment through the sale of the underlying real property and liquidation of the REIT, rather than by selling REIT stock. Foreign investors in U.S. real property typically desire to structure their investment in U.S. real property through a domestically-controlled REIT[5] so that they can exit the investment through a sale of the REIT stock. Section 897(h)(2) exempts gain from the sale of stock of a domestically-controlled REIT from being treated as ECI under the FIRPTA rules. The alternative generally would be for the REIT to sell its assets and redeem the foreign investor’s shares in liquidation of the REIT. Shareholders generally are treated as recognizing capital gain or loss with respect to their stock in the complete liquidation of a REIT;[6] however, the IRS takes the view that liquidating distributions made by REITs to foreign investors are taxed under Section 897(h)(1) as ECI to the extent attributable to gain from the sale of a USRPI by the REIT. The Section 897 exception exempts QFPFs from tax on liquidating distributions under Section 897(h)(1) regardless of whether the REIT is domestically-controlled.

It is unclear what the impact of the Section 897 exception is on determining whether a REIT is domestically controlled. Section 897(l)(1) states that for purposes of the FIRPTA rules, a QFPF “shall not be treated as a nonresident alien individual or a foreign corporation,” but it does not go so far as to say that a QFPF is treated as a domestic entity. This creates an inherent tension between QFPFs that may not need to rely on the domestically-controlled exemption to avoid ECI, and other foreign investors that need to rely on this exemption. Guidance from the IRS would be welcome on this point.

Pension-Held REIT.  It is understood that the intention behind the Section 897 exception was to put QFPFs on a similar footing as domestic pension funds with respect to the taxation of their investment in U.S. real property. Whether a REIT acts as an effective blocker of unrelated business taxable income (“UBTI”) for domestic tax exempt entities depends on the REIT not being treated as a pension-held REIT. A REIT is treated as pension-held if its ownership is concentrated in trusts “described in Section 401(a) and exempt from tax under Section 501(a).”[7] A QFPF is not defined by reference to these Code Sections. Accordingly, absent further guidance to the contrary, it may be reasonable to assume that a QFPF could own more than 25% of a REIT and not cause the REIT to be treated as a pension-held REIT.

Effective Dates

The Proposed Regulations generally will apply to dispositions and distributions occurring on or after the date of the adoption of the rules as final Treasury regulations. However, certain provisions of the Proposed Regulations containing the general rule for the exception and several definitions are proposed to apply to dispositions and distributions occurring on or after June 6, 2019.[8] Taxpayers may rely on the Proposed Regulations with respect to dispositions or distributions occurring on or after December 18, 2015 and prior to the applicability date of the final Treasury regulations.


[1] References to “Section” are to the Code.

[2] Section 897(l)(1) provides that “an entity all the interests of which are held by a qualified foreign pension fund shall be treated as such a fund.”

[3] In order for an entity to be treated as a controlled entity under Treas. Reg. section 1.892-2T(a)(3), the entity must be organized in the same jurisdiction as its foreign sovereign owner, and may not be owned by more than one foreign sovereign.

[4] The exception is specific to the class of stock of the REIT owned by the foreign investor. The particular class of stock must be regularly traded and the foreign investor cannot own more than 10% of such class of stock, determined by applying certain constructive ownership rules.

[5] A REIT is domestically-controlled if 50% or more of the value of its stock is owned, directly or indirectly, by U.S. persons at all times during a testing period.

[6] Section 331 treats liquidating distributions as payment in exchange for the stock held by a shareholder.

[7] See Section 856(h)(3)(E).

[8] See Prop. Treas. Reg. sections 1.897(l)-1(b)(1) (containing the general rule that gain or loss of a qualified holder from the disposition of USRPI, including gain from a distribution described in Section 897(h), is not subject to tax under Section 897(a)), 1.897(l)-1(d)(5) (definition of “governmental unit”), 1.897(l)-1(d)(7) (containing the definition of “qualification date”), 1.897(l)-1(d)(9) (containing the definition of “qualified controlled entity”), 1.897(l)-1(d)(11) (containing the definition of “qualified holder”), 1.897(l)-1(d)(14) (containing the definition of “testing period”).

Upper Tribunal Rules in Favour of Taxpayer in Tax Residence Case

Development Securities plc and others v HMRC [2019] UKUT 169 (TCC)

The Original Judgment

As we reported in our August 2017 UK Tax Round-Up [], the UK’s First Tier Tribunal (“FTT”) found against the taxpayer in the Development Securities case, and ruled that certain Jersey-incorporated companies were, in fact, UK tax resident through central management and control.

By way of reminder, Development Securities plc (“DS”) – a UK company – had incorporated a number of Jersey subsidiaries intended to be Jersey tax resident as part of its implementation of a scheme which was intended to increase available capital losses on UK real estate. The facts showed that all the board of directors had a Jersey-resident majority of directors (three were Jersey-resident and one was UK-resident), the board meetings all took place in Jersey and decisions were actually taken at those board meetings.

However, the FTT pointed to the uncommercial nature of the transactions from the perspective of the Jersey subsidiaries themselves (which could only be justified in the context of the tax benefit to the DS group as a whole) and that Jersey corporate law meant that the Jersey subsidiaries could only enter into the uncommercial transactions with the approval of their UK-resident parent company.

Consequently, the FTT had held that central management and control of the Jersey companies had been undertaken by the UK DS parent and, in taking on their director appointments, the Jersey directors were simply agreeing to implement what the UK DS parent company had already decided to do.

The Upper Tribunal Decision

The Upper Tribunal (“UT”) has overturned that decision in a judgment published this month. The UT ruled that central management and control was exercised in Jersey and not the UK.

The UT found that the relevant assets were indeed acquired at an overvalue, but the overpayment by the Jersey companies was not funded by them. So the FTT’s decision that the transactions were “uncommercial” for the Jersey companies was doubtful.

The UT analyzed Jersey company law in some depth, looking at how the directors were obliged to act in the best interests of the (Jersey) company. Jersey company law requires the company to consider the interests of shareholders, employees and creditors. In this case, given that the Jersey Companies had no employees and the transactions that the Jersey Companies were to enter into, pursuant to the scheme, did not prejudice creditors, the UT decided that the primary consideration can only have been the interest of the shareholder (DS). The UT reported that the directors gave detailed consideration to the appropriateness of the scheme – including the apparently uncommercial nature of the options and the acquisition by the Jersey companies of the relevant assets – and concluded that the transactions were in the best interests of the shareholder and therefore in the best interests of the Jersey companies.

It is very clear from the judgment that, just because the transactions were uncommercial, they were not automatically to be treated as contrary to the best interests of the Jersey companies

Although the UT agreed that the UK resident director had acted as a puppet or “rubber stamp”, the FTT had not made a similar finding regarding the Jersey directors. The evidence pointed strongly to the Jersey directors properly applying their minds to the transactions. The UT noted that one board meeting lasted five hours; and that the Jersey directors sough clarification on a number of points including the potential stamp duty liability arising; and also noticed and raised with advisers an inconsistency between the terms of the option and the drafting of the option notice.

HMRC tried to argue that the FTT had excluded from consideration material factor(s) going to the question of central management and control because they had occurred outside a board meeting. The UT rejected that argument and said that the FTT had, correctly, focused on the board meetings, but clearly also took account of matters occurring outside these meetings: for example, actions by the group more generally and events pre-dating the incorporation of the Jersey companies.


This is a welcome decision in favour of the taxpayer. It demonstrates again the importance of running offshore companies properly. The evidence as to what happened in the Jersey board meetings proved critical here. The board minutes showed that the three Jersey-based directors had met in Jersey, and had spent some considerable time analyzing and discussing the terms of the deals over several board meetings. It was important to the UT’s decision that the board minutes demonstrated that the directors had asked meaningful questions about the transaction and had called for explanations where necessary. Well-prepared contemporaneous minutes of such meetings are vital.

UK Tax Round Up

UK General Tax Developments

HMRC updates guidance on what constitutes “ordinary share capital”

Following the decision by the First-tier Tribunal (FTT) in Warshaw V HMRC, reported in our UK tax blog earlier this month, HMRC has updated its guidance on what constitutes “ordinary share capital” for the purposes of most tax provisions using that term.

As well as providing further guidance in relation to certain non-UK entities, the guidance has updated HMRC’s view on certain categories of shares with particular rights. Following Warshaw, HMRC has included in its guidance reference to fixed rate preference shares where the dividend compounds over time or where a rate of interest is added if a dividend is unpaid. HMRC states that such shares would be “borderline” in respect of whether or not they are ordinary share capital. This update is in response to the Warshaw decision, in which the FTT held that cumulative, compounding fixed rate preference shares were ordinary share capital for the purposes of section 989 ITA 2007. This could be seen to contrast with HMRC’s previous guidance that stated that cumulative fixed rate shares (with no reference to whether there was compounding on any unpaid dividend) are not ordinary shares. HMRC describes the decision in Warshaw as of “persuasive rather than precedent authority” in its updated guidance.

Although this update to HMRC’s guidance is welcome in order to address the lack of detail in HMRC’s previous guidance on the point highlighted by the decision in Warshaw, it is unfortunate that there is no clarity for taxpayers on the potentially significant tax consequences for them which may arise depending on the specific terms of their shares, such as for entrepreneurs’ relief purposes. Taxpayers holding shares with fixed rate, cumulative, compounding dividends who expect the shares to be ordinary shares (or not) should seek advice on the possible consequences for them of this updated position from HMRC.

Anti-avoidance: two latest GAAR Advisory Panel opinions released

Two GAAR Advisory Panel opinions (Opinion 11 and Opinion 12) have been released, both agreeing with HMRC’s assertion that the schemes in question were not reasonable courses of action in the circumstances and so the general anti-abuse rule (GAAR) applied to them.

Under both schemes, the company and the shareholder(s) acquired a bond from the scheme promoter for consideration comprising, broadly, the company assuming debt guaranteed by the shareholder. Various swaps were entered into with third parties, immediately novated to the bond manager as additional contributions to the bond (i.e., the debt) and the bond manager then entered into mirror swaps. The whole process was reversed during the respective “cooling off” periods. The effect of such transactions was that the same amount payable by the company to the shareholder(s) was created in the company loan accounts of that shareholder.

In Opinion 11, the GAAR Advisory Panel determined that the credits were equivalent to remuneration as a cash bonus. In Opinion 12, it determined that the credits were equivalent to distributions to the shareholders. The Panel stated that the steps undertaken in both situations, although not unlawful, lacked any commercial purpose and were contrived and abnormal. The Panel further commented that any correspondence relating to, or disclosure under, the disclosure of tax avoidance schemes (DOTAS) rules did not preclude the scheme falling within the GAAR given the different requirements applicable for such rules compared with the GAAR.

The two opinions highlight both HMRC’s willingness to attack what they consider to be abusive schemes to avoid employment taxes and the GAAR Advisory Panel’s willingness to agree with HMRC in these cases.

Anti-avoidance: HMRC’s Spotlight 51 and Spotlight 52

HMRC has released new anti-avoidance spotlight guidance in relation to transactions using loans or fiduciary receipts (Spotlight 51) and using offshore trusts (Spotlight 52).

In Spotlight 51, HMRC confirms its awareness of tax avoidance schemes that, whilst marketed as wealth management strategies, attempt to disguise employment income and other profits as loans or fiduciary receipts. In Spotlight 52, HMRC highlights two recent FTT cases involving disclosure of schemes that utilised offshore trust structures to disguise income on which employment tax and NI contributions would otherwise be due. In both cases, the FTT agreed with HMRC that the schemes were notifiable under the DOTAS rules.

These Spotlights further highlight HMRC’s willingness to challenge artificial and contrived avoidance schemes aiming to avoid employment taxes and the support that HMRC expects to get, and is getting, in doing so at tribunal level (and from the GAAR Advisory Panel as discussed above).

UK Case Law Developments

Section 75A Finance Act 2003 – Stamp duty land tax and the general anti-avoidance rule

The case of Hannover Leasing Wachstumswerte Europa Beteiligungsgesellschaft mbH and another v HMRC concerned arrangements for the sale of a property which were found by the FTT to fall within the scope of the stamp duty land tax (SDLT) anti-avoidance rule in section 75A of Finance Act 2003 (section 75A) even though the arrangements were not tax avoidance arrangements.

The property in question was held by an English limited partnership which itself was owned by a Guernsey unit trust in a form of tax planning generally considered acceptable. The buyer requested that the seller move the property out of the English limited partnership, due to its concerns relating to historic liabilities within the partnership, and into the Guernsey unit trust and then move the partnership itself out of the unit trust prior to completion of the sale. £55,540 of SDLT was paid in respect of the various transfers and steps giving effect to the sale.

HMRC argued that SDLT was payable on the full value of the property (approximately £140 million) as section 75A applied in respect of any reduction in tax liability, regardless of whether one of the main purposes of the transactions was avoidance of tax. The taxpayers argued that there were no scheme transactions for the purpose of section 75A and that the right amount of SDLT had been paid in respect of the transaction. The taxpayers also drew the FTT’s attention to HMRC’s own guidance on section 75A which states that it is an anti-avoidance provision and that HMRC will not apply it where transactions have been taxed appropriately.

The FTT, agreeing with HMRC, held that section 75A did apply and that SDLT was chargeable on the full cost of the property despite the lack of a tax avoidance motive. The FTT considered HMRC’s guidance on section 75A either wrong or irrelevant. Interestingly, the FTT indicated that if the sale had proceeded with the partnership as the seller of the property, or if the steps had been undertaken in a different order, section 75A would not have applied. The taxpayer is expected to appeal.

Following this decision, there is more uncertainty on the application of section 75A to property transactions with corporate holding structures, especially where there is no tax avoidance motive. Those undertaking, and advising on, such property transactions should carefully consider the structures involved and whether they could be caught be the seemingly ever-widening scope of section 75A.

Redemption of QCBs crystallised a gain rolled over from earlier conversation of non-QCBs

In Hancock and another v HMRC, the Supreme Court dismissed the taxpayers’ appeal and held that the redemption of qualifying corporate bonds (QCBs) crystallised a gain previously rolled into the QCBs by the prior conversion of non-QCBs (and other QCBs).

The Supreme Court dismissed the taxpayers’ argument that because the previous conversion “included” QCBs as well as non-QCBs the crystallisation of a held over gain did not occur as the QCBs were outside of the scope of section 116 of the Taxation of Chargeable Gains Act 1992. The Supreme Court acknowledged that the taxpayers had a strong argument on a literal reading of the relevant provision but concluded that such interpretation would be contrary to the policy behind the legislation and create opportunities for abuse. The Supreme Court did not, however, follow the Court of Appeal and apply what might be considered to be a “strained” interpretation of the provisions. Instead, it placed weight on the fact that the relevant provisions had to be applied on their terms with “necessary adaptations” in respect of conversions of securities as part of a reorganisation. Accordingly, the Supreme Court felt able to rely on the wording of the legislation to determine that the prior conversion of the loan notes was two separate conversions, one of the QCBs and the other of the non-QCBs.

Given the focus on the wording of the legislation in the Supreme Court’s decision, it did not provide much further detail for taxpayers and their advisers on the approach the courts may take in situations where apparent clear statutory language could be set aside in favour of an approach requiring a strained interpretation of the relevant statutory language. The Court simply commented that the instances where such an approach can be applied must be limited.

Single composite supply for VAT purposes where two separate items acquired in one package

The case of HMRC v The Ice Rink Company concerned whether the supply of access to an ice rink and the hire of ice skates were together one composite supply or two separate supplies for VAT purposes.

The taxpayer offered various ice skating packages to customers, including access to an ice skating rink with or without skate hire as well as skate hire without access to the ice rink. If the supplies were separate supplies, the hiring of children’s ice skates was zero-rated whilst the access to the ice rink was standard-rated. If the ice skates were part of the access to the ice rink, the whole supply was standard-rated.

The Upper Tribunal (UT), overturning the decision of the FTT, held that there was one composite standard-rated supply as, considering only those customers purchasing the combined access to ice rink and skate hire package, the two aspects were acquired as a single supply.

The UT stated that the FTT had been wrong to consider not only the customers who purchased the combined package but also those customers who purchased other products and that the FTT should not have considered supplies made to persons other than the “typical customer” of the combined package as being relevant to the nature of the supply to a typical customer. Taking that approach, the UT held that it was not possible to extract the skate hire as a separate zero-rated supply and so the whole composite supply was standard-rated.

This case highlights that the nature of the supply for the actual customers involved is important in determining the nature of such supply for VAT purposes and that, where there is a supply comprising multiple elements, a particular element of the supply could not be extracted simply because it could be acquired on its own.

Overpayment of car parking charges was consideration for VAT purposes

In National Car Parks Ltd v HMRC, the Court of Appeal held that “overpayment” by customers in respect of car parking charges as result of not having the correct change to put in the machine was consideration for VAT purposes.

In reaching its decision, the Court stated that the meaning of “consideration” was autonomous across the EU and could differ from a domestic contract law interpretation. The VAT meaning was a subjective, not objective, value based on the amounts actually paid for the service. Therefore, it was the actual price paid for the services, including any overpayment, which was the relevant consideration for VAT purposes. Looked at another way, the customers had made their entire payment for the parking services notwithstanding that they could have paid less had they had the correct change.

The case illustrates that the key consideration in ascertaining consideration for VAT purposes is whether there is a direct link between the service provided and the payment made in respect of that service. In this instance, the fact that the payment made exceeded the market value and the original contractual offer price did not prevent this higher payment being the consideration.

International Developments

Guidance on new substance requirements in the Isle of Man, Guernsey and Jersey

Guidance has been released by the Crown Dependency (CD) governments of Guernsey, Jersey and the Isle of Man in relation to legislation outlining economic substance requirements.

Under pressure from the EU of being blacklisted as “uncooperative tax jurisdictions”, the governments have collaborated on the guidance following the introduction of new legislation at the end of 2018 by all three jurisdictions. The guidance confirms that companies that fall within the scope of the new legislation must perform their core income-generating activities in any relevant sector within the relevant jurisdiction. To fall within the scope of the legislation, companies must perform real commercial activities such as the sale or exchange of goods or provision of services for profit.

The guidance confirms that pure equity-holding companies that passively hold equity investments, broadly, will not be considered as carrying on an economic activity and so will not fall within the scope of the new substance requirements.

CD resident corporate managers (such as corporate general partners to fund partnerships) will fall within the scope of the new legislation and so whether the manager performs “core income generating-activity” within the relevant CD will be key in determining whether it meets the substance requirements. It will also be a requirement that the manager is directed and managed in the CD and the guidance provides a list of what is expected to satisfy this.

The guidance does not provide details as to the process that tax officials will use to determine if an entity has met the substance requirements and further guidance is expected in relation to particular sectors, as well as outlining the reduced requirements for pure equity-holding companies.

Funds and companies operating in any of the CD jurisdictions should consider their existing activities and substance status in response to the new legislative requirements.

Final IRS Regulations Sync Section 956 with TCJA Participation Exemption – Limits “Deemed Dividends” for U.S. Corporate Shareholders of CFCs

Implements 2018 Proposed Regulations, ending most limitations on investments in U.S. property, as well as pledges and guarantees by CFCs wholly-owned by U.S. corporations – also provides PTI guidance for CFC shareholders.


In anticipated and important guidance, the U.S. tax authorities have issued final regulations under I.R.C. Section 956 (the “New 956 Regulations”).[1] The New 956 Regulations are intended to eliminate, in most situations, the “deemed-dividend” issue with respect to controlled foreign corporations (“CFCs”) that are subsidiaries of U.S. corporations, including where the U.S. domestic corporation is a partner in a partnership.

The New 956 Regulations achieve this result by generally giving a U.S. corporation’s income inclusions under Section 956 the same benefit of the U.S.’s limited participation exemption[2] that is otherwise available to actual dividends received from a CFC. The impact of Section 956 on noncorporate U.S. entities (which generally do not benefit from the participation exemption), including where the noncorporate entity is a partner in a partnership, is generally unchanged by the New 956 Regulations. The New 956 Regulations finalize, with limited but important changes, proposed regulations from November 2018.

An immediate impact of the New 956 Regulations will be on the use of non-U.S. subsidiaries to secure borrowings by U.S. corporations. A U.S. borrower generally should now be able to grant lenders complete pledges of stock of CFCs and provide full security interests in the assets of CFCs (and so-called CFC Holdcos — i.e. borrower subsidiaries that hold CFC stock) as long as the CFCs are directly or ultimately owned, in whole, by U.S. domestic corporations and partnerships where all of the direct and indirect partners are either U.S. domestic corporations or entities not subject to U.S. income tax (e.g., tax-exempts, foreign investors) without negative U.S. federal income tax consequences. Under existing Section 956 regulations, the effective limit to avoid phantom dividend income was a pledge of 65% of the voting stock in the CFC, with no guarantee by the CFC. The New 956 Regulations should end the position that new loan agreements must include the old, limited 65% voting stock pledge to protect U.S. corporate borrowers – which was an arguable residual concern while the regulations were still proposed.

The New 956 Regulations also provide a welcome change for multinationals with substantial previously taxed income (“PTI”) under the CFC rules relating to certain hypothetical distributions under the ordering rules for PTI.

These final regulations were issued and became effective on May 23, 2019 (with lookback effectiveness to taxable years beginning after December 31, 2017 in certain circumstances).

Please contact any Proskauer tax lawyer, or your usual Proskauer contact, for further information about the New 956 Regulations and their effect on shareholders of CFCs, as well as lenders and borrowers in structures with non-U.S. subsidiaries or operations. A detailed description of the New 956 Regulations, along with background, a description of the U.S. tax authorities’ explanation of the provisions and discussion of differences from the proposed regulations, continues below.

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Section 1446(f) Proposed Regulations: Key Guidance on Partnership Interest Transfers by Non-U.S. Persons

On May 13, 2019, the U.S. Internal Revenue Service (“IRS”) and Treasury Department published proposed regulations providing guidance on the rules imposing withholding and reporting requirements under the Code[1] on dispositions of certain partnership interests by non-U.S. persons (the “Proposed Regulations”). The Proposed Regulations expand and in important ways modify earlier Notice 2018-29[2] on dispositions of non-publicly traded partnership interests.[3] Unless otherwise specified, this post focuses on the aspects of the Proposed Regulations affecting transfers of interests in non-publicly traded partnerships.

Enacted as part of the “Tax Cuts and Jobs Act”, Section 1446(f) generally requires a transferee, in connection with a disposition of a partnership interest by a non-U.S. person, to withhold and remit 10 percent of the “amount realized” by the transferor, if any portion of any gain realized by the transferor would be treated as effectively connected with the conduct of a trade or business in the United States under the substantive sourcing rule of Section 864(c)(8).[4]

Prior to issuing the Proposed Regulations, the IRS issued Notice 2018-08 and Notice 2018-29 to provide interim guidance with respect to these withholding and information reporting requirements. On December 27, 2018, the IRS issued proposed regulations under Section 864(c)(8), providing rules determining the amount of gain or loss treated as effectively connected gain or loss with a U.S. trade or business. Continue Reading

Are fixed rate preference shares “ordinary share capital” for entrepreneurs’ relief – more or less certainty?

There has been another development on the tricky but important subject of whether the rights attaching to preference shares mean that they are or are not ordinary shares for entrepreneurs’ relief (and other tax) purposes.

Recent cases have shown that share with no right to a dividend are ordinary shares. HMRC has published its view that cumulative fixed rate share are not ordinary shares but that non-cumulative fixed rate shares are.

In Warshaw v HMRC, the First-Tier Tribunal (FTT) has now held that cumulative fixed rate preference shares under which the fixed rate was also applied to the unpaid dividend (so the fixed rate dividend compounded) were ordinary share capital for entrepreneurs’ relief purposes (so the taxpayer was entitled to entrepreneurs’ relief).

The taxpayer held shares in a company that carried the right to a fixed rate of interest (10%) calculated on a compound basis (on the sum of the subscription price and the aggregate of any unpaid dividends from previous years). Therefore, if profits were not available in a certain year, the fixed rate of 10% would be calculated on an increased amount in subsequent years.

The definition of “ordinary share capital” in section 989 ITA 2007 provides that, broadly, all of a company’s issued share capital constitutes ordinary share capital except for those shares which give a right to “a dividend at a fixed rate” with “no other right to share in the company’s profits”.

In this case, HMRC, in line with its published view, argued that the shares were not ordinary share capital as the rate of the dividend remained fixed. However, the FTT accepted the taxpayer’s argument that the fixed rate looked at not only the rate but also the amount that it applied to (here an indeterminate amount depending on whether dividends were or were not paid in a particular year).

The decision can be taken to align with HMRC’s published view if HMRC’s position on cumulative fixed rate dividends is read to apply only to non-compounding cumulative shares. This and other decisions means that only such non-compounding cumulative fixed rate shares would not be ordinary share capital.

The decision does, however, highlight the very different (and very important) outcome that can result from seemingly minor differences in the terms of fixed rate dividend shares. Taxpayers expecting to rely on the terms of their shares to give particular tax results should check the position given this new decision.

The full transcript can be found here.

The Second Set of Proposed Opportunity Zone Regulations


On April 17, 2019, the Internal Revenue Service (the “IRS”) and the U.S. Department of the Treasury (the “Treasury”) issued a second set of proposed regulations (the “Proposed Regulations”) under section 1400Z-2 of the Internal Revenue Code (the “Code”) regarding the qualified opportunity zone program, which was enacted as part of the law commonly referred to as the “Tax Cuts and Jobs Act” (“TCJA”).[1]

The Proposed Regulations are very taxpayer friendly, and address some, but not all, of the questions that were left unanswered by the first set of proposed regulations issued in October 2018 (the “Initial Proposed Regulations”). The Initial Proposed Regulations were discussed here.

The Proposed Regulations generally are proposed to be effective on or after the date of the publication of final regulations. Nevertheless, taxpayers and qualified opportunity funds (“QOFs”) may generally rely on the Proposed Regulations, so long as the taxpayer and/or the QOF applies the Proposed Regulations consistently and in their entirety. However, taxpayers may not rely on the rules that permit a QOF partnership, S corporation, or REIT whose owners have held their QOF interests for at least 10 years to sell assets without its owners recognizing capital gains on the sale, until the Proposed Regulations are finalized.

Some states conform to federal tax law with respect to QOFs (and grant equivalent tax benefits); others do not and tax gains that would otherwise be deferred, reduced or eliminated under the opportunity zone program.

This blog summarizes some of the important aspects of the Proposed Regulations. It assumes familiarity with the opportunity zone program. For background, see our prior blog post.

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