The Tax Cuts and Jobs Act (TCJA) of 2017 established several incentives to attract investments in certain state-designated areas (qualified opportunity zones) throughout the United States.
Non-U.S. investors with certain gains that are treated as effectively connected income may defer paying tax on capital gains from the sale of property in these areas if those gains are timely invested in a qualified opportunity fund. That fund must invest 90% of its assets in businesses or property used in one of these designated low-income communities.
In addition to deferring the tax, the investor may exclude 10percent of the deferred gain from federal income taxation if the investor is invested in the qualified opportunity zone for at least five years with an additional 5% excluded from the deferred gain if the investment is held for at least seven years. Additionally, the investor may exclude any gain from the qualified opportunity zone investment from federal income taxation provided the investor holds the investment for at least 10 years.
Currently, there is no coordination of the deferred taxation with the U.S. federal withholding tax rules, meaning that the non-U.S. investor may be withheld upon even though the tax liability is deferred. On Monday, April 12, 2021, the Internal Revenue Service (IRS) released an outline of proposed withholding tax rules designed to alleviate withholding in certain deferred gain cases, although imposing additional conditions on the deferral itself. Taxpayers should note to note that these proposed rules are not effective until the IRS releases the rules as final regulations in the Federal Register.
The proposed regulations require that a non-U.S. investor obtain an eligibility certificate in order to make the deferral election, regardless of whether withholding has occurred. Non-U.S. investors may also provide the eligibility certificate to a U.S. withholding agent for purposes of reducing withholding on gains where a deferral election is made. Partnerships (foreign or domestic) must obtain an eligibility certificate provided it meets a foreign ownership test, is closely held test and meets a ‘gain or asset’ threshold. The proposed regulations also put forth rules related to which transactions of non-U.S. investors may be eligible for the deferral election.
Below is a summary of the application requirements for non-U.S. investors to be able to obtain an eligibility certificate. The application should include:
1) Certain information about the eligible non-U.S. investor and transaction eligible for deferral,
2) An agreement for the deferral of tax and provision of security,
3) An agreement with a U.S. agent,
4) The US taxpayer identification number of the applicant and
5) Acceptable security that secures the amount of eligible deferral gain for which the eligibility certificate is being obtained.
The provision of security is defined as an irrevocable standby letter of credit issued by a U.S. bank that meets certain capital and other requirements specified in these proposed regulations. The proposed regulations provide that the IRS may identify in published guidance additional financial institutions that may qualify as issuers of letters of credit.
The IRS also provided additional regulatory guidance regarding the operation of the 24-month extension for the working capital safe harbor included in the qualified opportunity zone regulations for federally declared disasters.