The Impact of Sec. 897 on an NRA or Foreign Corporation’s Sale of Domestic Stock
Authors’ note: The opinions expressed in this article are those of the authors and do not necessarily reflect the views of their firm.
1 For instance, dividend distributions from a domestic corporation to an NRA or foreign corporation generally are subject to a gross basis 30% withholding tax, unless reduced by treaty. See generally Secs. 871, 881, 1441, and 1442. See Regs. Sec. 1.1441-3(c), especially clause (c)(2)(i)(C), for the amount of withholding on corporate distributions. Moreover, certain distributions that result in a foreign person recognizing gain on stock of a USRPHC (e.g., a Sec. 301(c)(3) distribution) may implicate Secs. 897 and 1445. Whenever a foreign person invests in certain qualified investment entities (i.e., certain real estate investment trusts (REITs) and regulated investment companies), certain rules, including special rules relating to distributions attributable to gains from sales of USRPIs, need to be considered. See generally Secs. 897(h) and 1445(e).
2 Stock is generally treated as personal property. Sec. 865(a) provides that, subject to certain exceptions listed in Sec. 865, income from the sale of personal property by a nonresident shall be sourced outside the United States. See also Regs. Sec. 1.865-2 dealing with loss with respect to stock. The Code and regulations also provide some guidance on the interaction of transactions in stock and being engaged in a U.S. trade or business; see, e.g., Sec. 864(b)(2) and Regs. Secs. 1.864-2(c), -4(c), and -5. A taxpayer should carefully review its transaction to determine whether any exception to the general rule mentioned in the text applies and whether its gain on the sale of domestic stock is brought within the U.S. taxing net; see, e.g., Sec. 871(a)(2).
3 The implication of a treaty (if any) would need to be considered. It is worth noting that Article 13 of both the 2006 and 1996 Model Income Tax Conventions generally permits the United States to tax a foreign person’s disposition of USRPHC stock.
4 For the definition of a foreign person, see Temp. Regs. Sec. 1.897-9T(c). Sec. 897(a) also applies to dispositions of USRPIs by foreign governments, except to the extent provided under the Sec. 892 regulations. For a recent notice discussing the interaction of Secs. 892 and 897, see Notice 2007-55, 2007-27 IRB 13. Special rules may also apply when a foreign person owns interests in certain types of entities that own USRPIs, such as partnerships; see, e.g., Secs. 865(i)(5) and 897(g) and Temp. Regs. Sec. 1.897-7T(a).
It also is worth noting that several different types of exchanges may implicate the rules under Sec. 897, including certain nonrecognition exchanges. See, e.g., Secs. 897(d) and (e) and Temp. Regs. Secs. 1.897-5T and -6T, as modified by certain notices (e.g., Notices 89-85 and 2006-46). A discussion of these issues is beyond the scope of this article.
5 See, e.g., Sec. 897(c)(6) and Regs. Secs. 1.897-1(b), (c), and (d).
6 For what constitutes an interest “solely as a creditor,” see generally Regs. Sec. 1.897-1(d).
7 See Sec. 897(c)(2) and Regs. Sec. 1.897-2(b) for further details. Per Regs. Sec. 1.897-2(b)(1), the term “interest in real property located outside the United States” means an interest other than solely as a creditor in real property located outside the United States or Virgin Islands. For purposes of determining FMV, see Regs. Sec. 1.897-1(o). An alternative test may apply when the FMV of a corporation’s USRPIs is presumed to be less than 50% of the FMV of the aggregate of its assets described in Regs. Secs. 1.897-2(d) and (e) if, on an applicable determination date, the total book value of the USRPIs held by the corporation is 25% or less of the book value of the aggregate of the corporation’s assets described in Regs. Secs. 1.897-2(d) and (e). For further details and special rules relating to the book value test, see Regs. Sec. 1.897-2(b)(2).
8 See, e.g., Secs. 897(c)(5) and (c)(6) and Regs. Secs. 1.897-2(d) and (e).
9 See Regs. Sec. 1.897-2(g)(2). See Regs. Sec. 1.897-2(g)(3) for exceptions to the general presumption rule. If the lower-tier corporation is not a real property holding corporation, such interest often will not be taken into account in the USRPHC analysis. It should be recognized, however, that Regs. Sec. 1.897-2(e)(1) provides that, for purposes of determining whether any corporation is a USRPHC, an interest in a foreign corporation is treated as a USRPI unless it is established (as provided in the regulations) that the interest was not a USRPI on the applicable determination date.
10 See Sec. 897(c)(4)(B). For further details on this rule and an exception for trade or business assets of certain investment companies, see Regs. Sec. 1.897-2(e)(2). See Regs. Sec. 1.897-2(e)(4) for coordinating these rules.
11 See also Regs. Sec. 1.897-2(f)(2) for further details.
12 See also Sec. 897(c)(6)(C), which uses certain constructive ownership rules in applying the more-than-5% test, and Regs. Secs. 1.897-1(m), -2(g)(3), and -9T, which provide further guidance.
13 For further information on these exceptions, see Secs. 897(h)(2) and (h)(4) and Regs. Sec. 1.897-1(c)(2).
14 Regs. Sec. 1.897-2(c)(1). The first determination of a corporation’s status need not be made until the 120th day after the later of the incorporation date or the date on which the corporation first acquires a shareholder. Further, a special rule also applies to a liquidating corporation. Id. For valuation date methods, including a rule that permits an alternative valuation date method for determination dates other than the last day of the tax year, see Regs. Sec. 1.897-2(c)(4).
15 For further details, see Regs. Sec. 1.897-2(c).
16 This exception for regularly traded stock on an established securities market will not apply if the foreign person has held a more-than-5% interest in the domestic corporation during the period described in Sec. 897(c)(1)(A)(ii). See Regs. Sec. 1.897-2(g)(3) for further details on these exceptions.
17 For details and procedures on requesting an IRS determination, see Regs. Sec. 1.897-2(g)(1)(iii). Under this option, the foreign person generally will need to pay the tax and request a refund.
18 Regs. Sec. 1.897-2(g)(1)(ii). If a foreign person requests and obtains such a statement, it is not required to take any further action to establish that the interest is not a USRPI. Id. For further details and other special rules (e.g., if it is determined that the interest actually was a USRPI), see generally Regs. Sec. 1.897-2(g)(1)(ii). A foreign seller should consider the timing of the request in conjunction with the withholding rules under Sec. 1445. The IRS has granted 9100 relief in certain cases of failures to obtain the necessary statements. See, e.g., IRS Letter Ruling 200718017 (5/4/07).
19 Regs. Sec. 1.897-2(g)(2). This determination may be made by obtaining a statement from the second corporation under the provisions of Regs. Sec. 1.897-2(g)(2)(ii), obtaining an IRS determination under Regs. Sec. 1.897-2(g)(2)(iii), or making an independent determination under Regs. Sec. 1.897-2(g)(2)(iv). For further details, see Regs. Sec. 1.897-2(g)(2). See Regs. Sec. 1.897-2(g)(3) for exceptions to this general rule.
20 Regs. Sec. 1.897-2(h)(1)(i). The statement must be signed by a responsible corporate officer and must be under penalties of perjury. Id.
21 The requirements above are not applicable to certain domestically controlled REITs and to corporations any class of whose stock is regularly traded on an established securities market at any time during the calendar year (Regs. Sec. 1.897-2(h)(3)). There are also a number of other special rules relating to providing voluntary notice to the IRS (which may exempt such corporations from the requirements of Regs. Sec. 1.897-2(h)(2)) and supplemental filings that will need to be considered. See generally Regs. Secs. 1.897-2(h)(4) and (h)(5).
22 See Sec. 1445(b)(3). In addition, Regs. Sec. 1.897-2(g)(1)(ii)(B) provides that, under Sec. 1445 and the regulations thereunder, withholding tax is not required for a foreign person’s disposition of an interest in a domestic corporation if the transferee is furnished with a statement by the corporation under Regs. Sec. 1.897-2(h) that the interest is not a USRPI.
23 For further guidance on this exemption and a possible expansion of the rule, see Regs. Sec. 1.1445-2(c)(2). For other exemptions, limitations, and special rules on withholding, see generally Sec. 1445 and the regulations thereunder.
