Treasury Issues Final Regulations on FIRPTA Exemption for Qualified Foreign Pension Funds

January 13, 2023

The US Department of Treasury recently released final regulations providing guidance on the exception from taxation under the Foreign Investment in Real Property Tax Act of 1980 for “qualified foreign pension funds” under Section 897(l) of the Internal Revenue Code, as amended.

The final regulations, released on December 29, 2022 (the Final Regulations), also address withholding requirements under Sections 1441, 1445, and 1446. Proposed regulations under Sections 892 and 897 addressing foreign government investments in US real property and the tests used to determine whether a REIT is “domestically controlled” were issued the same day.

While the Final Regulations generally follow the approach taken in the proposed regulations (the Proposed Regulations) that were published on June 7, 2019, they also include helpful modifications that address a number of concerns raised by stakeholders. Specifically, the modifications in the Final Regulations clarify the eligibility for the “qualified foreign pension fund” (QFPF) exception, expand the scope of benefits that a QFPF may provide beneficiaries, and add flexibility to qualification tests that may provide relief for inadvertent failures to meet the QFPF qualification requirements in a particular taxable year.


Section 897 generally subjects nonresident aliens and foreign corporations to tax on gain from the disposition of “United States real property interests” (USRPIs) as if the gain constituted “effectively connected income.” In addition, Section 897(h)(1) provides a look-through rule that treats distributions from certain real estate investment trusts and regulated investment companies, to the extent attributable to gain from dispositions of USRPIs, as gain from the disposition of USRPIs (Section 897(h)(1) distributions).

Section 897(l) provides, however, that QFPFs (and any entity all of the interests of which are held solely by one or more QFPFs) are not treated as nonresident alien individuals or foreign corporations subject to tax under the Foreign Investment in Real Property Tax Act of 1980.  A QFPF is a trust, corporation, or other organization or arrangement (an eligible fund) that satisfies five requirements, including a purpose requirement that requires the eligible fund to provide retirement or pension benefits to current or former employees.

Consistent with Section 897(l), the Proposed Regulations allowed a broad range of arrangements to qualify for the QFPF exception and clarified that foreign trusts or corporations owned entirely by one or more QFPFs (qualified controlled entities), whether directly or indirectly through one or more qualified controlled entities or partnerships, qualified for the exception (QFPFs and such qualified controlled entities are referred to as “qualified holders”).

The Proposed Regulations also clarified and expanded on the five requirements that must be satisfied for QFPF qualification. In particular, the Proposed Regulations adopted objective thresholds that an eligible fund must satisfy to meet the purpose requirement. First, all of the benefits provided to the eligible fund’s beneficiaries must be retirement, pension, or ancillary benefits, which are referred to as qualified benefits. Second, 85% of the present value of the qualified benefits to be provided under the plan must be “retirement or pension benefits.”

In addition, the Proposed Regulations introduced an anti-abuse rule designed to address situations where a foreign person sells a foreign corporation that itself holds a USRPI to a QFPF or a “qualified controlled entity.” Absent an anti-abuse rule, the foreign corporation would be treated as a “qualified controlled entity” and a subsequent disposition of the USRPI by the foreign corporation would qualify for the QFPF exception, potentially allowing built-in gains attributable to the period prior to the sale of the foreign corporation to the QFPF or “qualified controlled entity” to escape taxation.

The anti-abuse rule provides that a QFPF or a “qualified controlled entity” may be treated as a qualified holder only if either (1) it was a QFPF, a part of a QFPF, or a “qualified controlled entity” at all times during an applicable testing period, which is the shortest of (i) the 10-year period preceding the disposition of a USRPI or a Section 897(h)(1) distribution, (ii) the period since December 18, 2015, or (iii) the period of the entity’s existence, or (2) it held no USRPIs at the time it became a QFPF, a part of a QFPF, or a “qualified controlled entity.”


While generally retaining the structure of the Proposed Regulations, the Final Regulations introduce a number of helpful changes to address concerns raised by commentators. Certain changes are highlighted below.

Modifications of the 85% Test

  • Commentators requested that the Final Regulations clarify how present value should be calculated for purposes of the 85% test and also requested guidance on how often the calculation needs to be made. In response, the Final Regulations provide that an eligible fund may utilize any reasonable method for calculating present value for this purpose. Although this change is intended to provide flexibility, the Internal Revenue Service may determine that an eligible fund does not satisfy the 85% test if the facts and circumstances indicate the method used to calculate present value was not reasonable. The Final Regulations also provide that present value calculations must be made on at least an annual basis.
  • Commentators also expressed concern that unanticipated events could cause an eligible fund to fail the 85% test in any particular year, despite meeting the test over an extended period. To address this risk, the Final Regulations provide that an eligible fund will satisfy the 85% test if the average of the present values of the retirement and pension benefits the eligible fund reasonably expected to provide over its life, as determined by the valuations made in the 48 months preceding (and including) the most recent valuation, exceeds 85%.

New and Revised Definitions Provide Clarity and Add Flexibility

  • Commentators requested that the Final Regulations include a definition of the term “retirement and pension benefits,” which was not defined in the Proposed Regulations. In response, the Final Regulations define retirement and pension benefits as distributions to qualified recipients made after the qualified recipient reaches retirement age as determined under or in accordance with applicable foreign law (including a benefit paid to a qualified recipient who retires on or after a stated early retirement age), or after a specified event that results in a qualified recipient being permanently unable to work, including any such distributions to a surviving beneficiary. The preamble to the Final Regulations states that this definition is designed to ensure that a wide variety of pension funds and foreign laws are accommodated. The Final Regulations also make clear that retirement and pension benefits can be based on one or more of the following factors: contributions, investment performance, years of service, or compensation amounts.
  • The Final Regulations modify the Proposed Regulations’ definition of ancillary benefits by providing a more detailed list of the specific types of benefits that are treated as ancillary benefits. The revised definition also provides that other health-related and unemployment benefits that are similar to the enumerated benefits qualify as ancillary benefits.
  • Commentators expressed concern that certain benefits permitted or required to be provided by eligible funds pursuant to foreign law would not meet the definition of retirement, pension, or ancillary benefits, with the result that such eligible funds would not satisfy the 100% qualified benefits requirement. In light of those concerns, the Final Regulations permit an eligible fund to provide a limited amount of benefits (no more than 5% of the present value of the qualified benefits reasonably expected to be provided) that are not retirement and pension benefits or ancillary benefits, provided that such other benefits are permitted or required to be provided under foreign law.

Withholding Rules

  • The Proposed Regulations introduced rules regarding exemptions from withholding under Section 1445 and Section 1446 with respect to QFPFs.
  • The Proposed Regulations helpfully provided that QFPFs and qualified controlled entities could avoid withholding under Section 1445 on the disposition of USRPIs by providing a certification of non-foreign status. Commentators requested that QFPFs holding interests in USRPIs through foreign partnerships, which do not qualify as qualified controlled entities, be exempt from withholding under Section 1445 through provision of a certification of non-foreign status. The Final Regulations address this concern by allowing a foreign partnership the interests of which are held solely by qualified holders (including through one or more partnerships) to certify its status as “withholding qualified holder,” which is not subject to withholding under Section 1445. The Preamble to the Final Regulations provides that a revised Form W-8EXP will be released to make this certification, but before its release a qualified holder or a foreign partnership owned solely by qualified holders can establish its status as a withholding qualified holder by providing a certification of non-foreign status.

Other Notable Changes

  • The Final Regulations provide that certain loan distributions (excluding loans that are not required to be repaid, in full or part, upon default), rollover distributions to similar retirement or pension arrangements, and withdrawals of funds before retirement age used to satisfy financial need under principles similar to the US hardship distribution rules are not taken into account in determining whether an eligible fund satisfies the 85% test and the 100% test.
  • The Final Regulations clarify that an eligible fund established by a foreign government, but that is administered by private investment managers, can qualify as QFPF.

Not All Comments Are Addressed

Notwithstanding the helpful changes made in the Final Regulations, the Treasury Department did not incorporate all the changes suggested by commentators. In particular, the Final Regulations do not incorporate requests to permit de minimis ownership of qualified controlled entities by non-QFPFs. The Final Regulations also did not modify the qualified holder anti-abuse rule or implement suggested alternatives to that rule.


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