by Tony M. Edwards
NAREIT's primary goals always have been government relations and investor outreach. These twin objectives often overlap, and never so more than in our efforts to remove impediments facing non-U.S. investors in REITs.
Since World War II, the United States has entered into dozens of bilateral income tax treaties designed to promote international commerce and investment. A principal tool embodied in these treaties is the lowering of withholding tax rates on foreign investment. For example, the Internal Revenue Code requires a U.S. corporation to withhold and remit to the IRS 30 percent of its ordinary dividends paid to non-U.S. shareholders.1 Tax treaties override this withholding rate by imposing lower rates, thereby encouraging residents of the signatory countries to invest in the companies of the other.
Before 1988, the lower withholding rates in tax treaties applied with equal force to REITs and non-REIT companies. However, in the late 1980s Congress and the Treasury Department became concerned that some European investors were obtaining these lower withholding rates by using captive REITs under which the investor would own virtually all of the REIT's equity. Therefore, starting with the U.S.- Germany treaty going into effect in 1990, the Treasury Department adopted as its tax treaty negotiating policy a position that all REITs must withhold the full statutory rate of 30 percent on ordinary dividends to non-individual shareholders. However, in deference to the Congressional policy of creating REITs to make real estate accessible to individual investors, the Treasury Department continued its treaty negotiation policy of allowing REITs to withhold only 15 percent on ordinary dividends to non-U.S. individuals, but only so long as an individual did not own more than 10 percent of the REIT's stock.
In 1996, NAREIT was advised by some of its members that the 30 percent withholding rate was a significant barrier to non-U.S. institutional investors considering REIT investments. After NAREIT conducted a year-long dialogue with Congress and the Executive Branch, in October 1997 the Treasury Department announced a change in its tax treaty negotiation policy.2
Under this revised policy, the Treasury Department will seek a 15 percent withholding rate on REIT ordinary dividends to institutional investors resident in a treaty country under two scenarios. First, the 15 percent rate will apply if the dividend is paid with respect to a class of stock that is publicly traded and the shareholder owns no more than 5 percent of any class of the paying REIT's stock. Alternatively, the 15 percent rate will apply when the stockholder holds less than 10 percent of the REIT's stock if the REIT's property is "diversified," i.e., no property is worth more than 10 percent of the REIT's real estate holdings. Under the revised policy, the withholding rate remains at 30 percent on dividends to institutional investors that do not qualify for these two rules.
The United States has signed and ratified a number of tax treaties since the revised REIT policy was announced in 1997. The accompanying chart summarizes the withholding rates on REIT ordinary dividends for the 62 countries the United States has negotiated an income tax treaty.
Tony M. Edwards is NAREIT's senior vice president and general counsel.
1 I.R.C. §§ 871(a) and 872(a). REITs must withhold and remit to the IRS 35 percent of its capital gains distributions made to non-U.S. shareholders. Treas. Reg. § 1.1445-8. However, REITs need not withhold on ordinary dividend distributions to shareholders that are integral parts of a foreign government, e.g., a governmental pension plan. I.R.C. § 892.
2 Testimony of the Chief of Staff of the Joint Committee on Taxation and the International Tax Counsel describing this new policy can be found in the Government Relations area of www.nareit.com under "Foreign Tax Treaties."
