New Rules Benefit Foreign Investors in U.S. QOFs, But There’s a CatchBy Alan M. Blecher | July 30, 2021
Foreign investors in U.S. Qualified Opportunity Funds (QOFs) may be able to reduce or eliminate withholding requirements, under a new regulation proposed by the Internal Revenue Service (IRS). However, a short window of opportunity to apply for the waiver could discourage all but those with the most substantial gains.
The IRS recently issued proposed regulations that would permit certain foreign persons and foreign owned partnerships to reduce or eliminate withholding imposed on eligible gains deferred and invested in a QOF, in certain circumstances. However, this will require that such taxpayers receive an “eligibility certificate” from the IRS and provide security pursuant to an agreement with the IRS.
Commentators have been skeptical that these proposed regulations will incentivize much foreign investment into QOFs, citing the following reasons:
There are time constraints that must be met to invest in a QOF generally and to elect the deferral and it is unclear whether the IRS can catch up with all the above-described paperwork in time.
Complying with the security requirement is itself time consuming.
One of the benefits of the opportunity zone regime – a 10% reduction in the amount of tax on the gain invested in a QOF – is only available for investments made by year end 2021. (Another benefit, the ability to defer the tax on gains invested, does remain until 2026).
The proposed regulations will apply to any transfer that occurs after the date that these regulations are published as final in the Federal Register. Applications for eligibility certificates prior to said date will not be processed by the IRS, further adding to the skepticism.
To include gain from specified dispositions that would otherwise be subject to withholding or that would be included in determining a foreign investor’s “effectively connected income,” in a QOF election – thus reducing or eliminating the U.S. withholding tax – a taxpayer must apply for an eligibility certificate. The proposed regulations reduce or eliminate withholding if the certificate is obtained prior to the transaction. If the certificate is not obtained before the transfer – and thus the full amount of withholding is applied – an eligible taxpayer must still obtain an eligibility certificate to make the QOF deferral election. The eligibility certificate must be obtained from the IRS by the date on which the deferral election is filed with the IRS.
An application for an eligibility certificate must include:
Information about the security-required person and the transfer involved;
An agreement for the tax deferral and the accompanying security (“deferral agreement”);
An agreement with a US agent, and
Acceptable security, such as an irrevocable standby letter of credit from a U.S. bank meeting certain requirements.
If there is a default of the deferral agreement, then the gain previously deferred is immediately taxable.
The final regulations relating to covered transfers have yet to be published, but will take effect upon publication in the Federal Register. At that point, the regulations will apply to any covered transfer that occurs after publication. We will keep you informed as to the status of these regulations. In the meantime, if you have any questions please contact us.
About Alan M. Blecher
Alan M. Blecher, JD, is a Principal at Marks Paneth LLP. Mr. Blecher has considerable experience serving high-income and high-net-worth individuals and their closely held businesses. He focuses especially on partnerships, limited liability companies and S corporations. He has been in public accounting since 1985 and has been involved in tax planning for numerous transactions. These include transactions involving public debt offerings, sales of family businesses and restructurings of distressed entities, among others. Mr. Blecher... READ MORE +