Guidance on the Definition of Domestically Controlled Qualified Investment Entities

<RULE> DEPARTMENT OF THE TREASURY <SUBAGY>Internal Revenue Service</SUBAGY> <CFR>26 CFR Part 1</CFR> <DEPDOC>[TD 9992]</DEPDOC> <RIN>RIN 1545-BQ36</RIN> <SUBJECT>Guidance on the Definition of Domestically Controlled Qualified Investment Entities</SUBJECT> <HD SOURCE="HED">AGENCY:</HD> Internal Revenue Service (IRS), Treasury. <HD SOURCE="HED">ACTION:</HD> Final regulations. <SUM> <HD SOURCE="HED">SUMMARY:</HD> This document contains final regulations that address the determination of whether a qualified investment entity is domestically controlled, including the treatment of qualified foreign pension funds for this purpose. In particular, these final regulations provide guidance as to when foreign persons are considered to hold directly or indirectly stock in a qualified investment entity. The final regulations primarily affect foreign persons that own stock in a qualified investment entity that would be a United States real property interest if the qualified investment entity were not domestically controlled. </SUM> <EFFDATE> <HD SOURCE="HED">DATES:</HD> <E T="03">Effective date:</E> These regulations are effective on <E T="03">April 25, 2024.</E> <E T="03">Applicability date:</E> For the date of applicability, <E T="03">see</E> §§ 1.897-1(a)(2) and 1.1445-2(e). </EFFDATE> <FURINF> <HD SOURCE="HED">FOR FURTHER INFORMATION CONTACT:</HD> Milton Cahn at (202) 317-4934 (not a toll-free number). </FURINF> <SUPLINF> <HD SOURCE="HED">SUPPLEMENTARY INFORMATION:</HD> <HD SOURCE="HD1">Background</HD> On December 29, 2022, the Treasury Department and the IRS published proposed regulations (REG-100442-22), relating to the treatment of certain entities, including qualified foreign pension funds (“QFPFs”), for purposes of the exemption from taxation afforded to foreign governments under section 892 of the Internal Revenue Code (the “Code”), and the determination of whether a qualified investment entity (“QIE”) is domestically controlled under section 897(h)(4)(B) of the Code, in the <E T="04">Federal Register</E> (87 FR 80097) (the “proposed regulations”). This Treasury decision finalizes the proposed regulations, other than those portions addressing the section 892 exemption (which will be addressed in a separate rulemaking), after taking into account and addressing comments with respect to the proposed regulations. Terms used but not defined in this preamble have the meaning provided in the final regulations. Comments outside the scope of this rulemaking are generally not addressed but may be considered in connection with future regulations. All written comments received in response to the proposed regulations are available at <E T="03">www.regulations.gov</E> or upon request. A public hearing on the proposed regulations was not held because there were no requests to speak. <HD SOURCE="HD1">Summary of Comments and Explanation of Revisions</HD> The final regulations retain the general approach and structure of the proposed regulations, with certain revisions. This section of the preamble discusses the comments received in response to the proposed regulations and explains the revisions reflected in the final regulations. <HD SOURCE="HD2">I. Domestic Corporation Look-Through Rule</HD> <HD SOURCE="HD3">A. Background</HD> The proposed regulations set forth proposed rules for determining whether stock of a QIE is considered “held directly or indirectly” by foreign persons for purposes of defining a domestically controlled QIE under section 897(h)(4)(B). The proposed regulations defined stock in a QIE that is held “indirectly” by taking into account stock of the QIE held through certain entities under a limited “look-through” approach. As described in the preamble to the proposed regulations, this approach gives effect to both the policy of the exception for domestically controlled QIEs in section 897(h)(2) (“DC-QIE exception”), which is limited to QIEs controlled by United States persons, and the requirement in section 897(h)(4)(B) to take into account “indirect” ownership of QIE stock by foreign persons in determining whether a QIE is domestically controlled. 87 FR 80100. The preamble to the proposed regulations also explained that this approach prevents the use of intermediary entities to achieve results contrary to the purposes of the DC-QIE exception. <E T="03">Id.</E> at 80100-01. The proposed regulations addressed the meaning of direct or indirect ownership by setting forth two categories of potential QIE owners, “look-through persons” and “non-look-through persons.” Proposed § 1.897-1(c)(3)(ii). The proposed regulations generally treated a “domestic C corporation,” defined as any domestic corporation other than a regulated investment company (“RIC”) under section 851, a real estate investment trust (“REIT”) under section 856, or an S corporation under section 1361, as a non-look-through person. Proposed § 1.897-1(c)(3)(v)(A) and (D). However, the proposed regulations treated non-publicly traded domestic C corporations as look-through persons if foreign persons hold a 25 percent or greater interest (by value) in the stock of the corporation (the “domestic corporation look-through rule”). Proposed § 1.897-1(c)(3)(iii)(B) and (c)(3)(v)(B). Comments generally did not raise concerns with the general look-through approach for determining domestic control of a QIE as it applied to most entities (for example, the treatment of partnerships) but asserted that the domestic corporation look-through rule raises significant issues and should be withdrawn or, if retained, modified to reduce its scope. These comments are addressed in turn in parts I.B. and I.C. of this Summary of Comments and Explanation of Revisions. <HD SOURCE="HD3">B. Comments Recommending Withdrawal of the Domestic Corporation Look-Through Rule</HD> Comments generally recommended that the domestic corporation look-through rule be withdrawn on three related grounds: first, that the rule is based on an incorrect reading of the Code, which for this purpose does not permit look-through treatment for domestic C corporations, including because there are no explicit rules providing for constructive ownership (such as those in section 318) under section 897(h)(4)(B); second, that the enactment of other related legislation (or consideration of legislation) demonstrates the rule is inconsistent with congressional intent; and third, that the rule is not necessary because domestic C corporations are subject to U.S. tax. Certain comments also based their recommendation to withdraw the domestic corporation look-through rule on the contention that the rule would negatively impact the U.S. real estate market or otherwise harm the broader U.S. economy. The Treasury Department and the IRS have determined that it is necessary and appropriate to provide guidance regarding the meaning of “indirect” for determining whether foreign persons are considered to hold less than 50 percent of the value of the stock of a QIE. Every word in a statute must be given effect, and both the proposed and final regulations give effect to the term “indirectly” as used in section 897(h)(4)(B) by adopting a limited look-through approach that includes the domestic corporation look-through rule (as modified in the final regulations). The domestic corporation look-through rule does not apply specific constructive ownership rules like those in section 318. Rather, the guidance gives meaning to indirect ownership under section 897(h)(4)(B) in light of the purpose of the DC-QIE exception. Because the final regulations carry out the statute's mandate to determine indirect ownership rather than constructive ownership, the fact that other parts of section 897 refer to section 318 is irrelevant to the determination of whether a QIE is domestically controlled. The Treasury Department and the IRS do not agree that the enactment of section 897(h)(4)(E) in section 322(b)(1)(A) of the Protecting Americans from Tax Hikes Act of 2015, Public Law 114-113, div. Q (the “PATH Act”), informs whether the domestic corporation look-through rule should be applied under section 897(h)(4)(B). The rules added in section 897(h)(4)(E) do not prescribe how to interpret the meaning of “indirectly” in section 897(h)(4)(B), nor do they suggest that Congress intended for that provision to set out the only rules for QIE stock held by domestic corporations. Although section 897(h)(4)(E) provides certain rules for looking through QIE stock held by another QIE for purposes of the DC-QIE exception, the absence of other specific rules in the statute on whether domestic C corporations (or any other type of entity) should be looked through does not mean that all other entities should be non-look-through persons. The Treasury Department and the IRS also disagree with the observation in comments that Congress sanctioned the approach taken by a 2009 private letter ruling (the “2009 PLR”) that treated QIE stock held by a domestic C corporation as owned by a domestic person. <SU>1</SU> <FTREF/> The brief citation to that ruling in a report by the Joint Committee on Taxation is neutral and merely restates the holding in the ruling in its description of the then current law. <E T="03">See</E> STAFF OF THE JOINT COMM. ON TAX'N, General Explanation of Tax Legislation Enacted in 2015 (JCS-1-16) 279 (2016) (the “JCT Report”). <SU>2</SU> <FTREF/> The JCT Report did not express any view regarding the effect of the 2009 PLR or indicate that Congress endorsed a rule that precludes looking through domestic C corporations in all cases, and it caveated that a private letter ruling may only be relied on by the specific taxpayer to which it was issued and only provided “some indication of administrative practice.” <E T="03">See</E> section 6110(k)(3). This is in contrast to other instances where Congress has explicitly endorsed an approach taken by ━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━ Preview showing 10k of 110k characters. Full document text is stored and available for version comparison. ━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━━