NAREIM Fund Structuring Discussion

Transcription

1 NAREIM Fund Structuring Discussion May 1, 2013 John M. Ferguson Goodwin Procter LLP Goodwin Procter LLP

2 Structuring Exercise Investor(s)? Investment Strategy(ies)

3 Diff ere nt ial Structuring Investors Fund Terms Inv esto r Participation in Carry Inv est or Re dempt ion Rights Management Fee vs. Pri ori ty Distribution Limits on Own ership Qualified Organizations U.S. Tax Exempt Investors Management Fee Transferability of Interests U.S. Investors In vest or Obli gat ion to Ret ur n Distributions Li mit s on In vest or s % Int ere st Potential Fund Investors? Equity Fract ions Rule Merchant Builde r Act ive Lot Sales Rental Residential Condo Unleveraged Join t Ven tur e Pref err ed Eq uity Participating Deb t CM BS In d us tr ia l Tr ip le Ne t Leased Parking Commercial Of f ice Leveraged Joint Venture Fr action s Rul e Part icipatin g Deb t Timber Hote l Marina Pr eferr ed E quit y Other Real Estate Strategy Investment Strategy

4 Primary U.S. Tax Issues Key issues: a. Unrelated Business Taxable Income ( UBTI ) for U.S. tax-exempt investors b. Effectively-Connected Income ( ECI ) for non-u.s. investors c. State tax liability and filings

5 Remember the Basics: Entities taxed as Partnerships (generally LLCs or limited partnerships) No entity level tax Pass through character of income Entities taxed as Corporations (including LLCs that check the box to be taxed as corporations) Pay tax unless they qualify as REITs Character of income to shareholders is dividends and gains

6 Building Blocks of Fund Structures: 5 Key Tools: 1. Partnership 2. REIT 3. C Corporation 4. Leverage 5. Hybrid (e.g., Partnership with REIT and other corporate subsidiaries)

7 Unrelated Business Taxable Income Issue: Tax-exempt investors are subject to tax on UBTI, notwithstanding their otherwise tax-exempt status. UBTI: Incurred by a tax-exempt entity regularly carrying on a trade or business not substantially related to performing its exempt purpose or function. Exclusion exists for certain investment income Typically not relevant to state and local governments/plans Two types of UBTI: 1. Operational While passive investment income is generally not UBTI, income from an operating business (including dealer gains) generates UBTI 2. Leverage Acquisition indebtedness financed property, including certain passive investment income, generates UBTI (i.e., leverage can turn otherwise good income bad)

8 Examples of UBTI Exclusions (i.e., Good Income ) Interest Rents from real property Gain from property sales (other than dealer gains) Other investment portfolio income (e.g., dividends)

9 Generating UBTI because of the Character of the Income Rent based on percentage of net rather than gross revenue Rent if services are not usual and customary (e.g., valet parking, maid services, cafeterias and health clubs) Rent for personal property (e.g., kiosks, carts, machinery, office equipment or furniture, refrigerators or grocery counters) Trade or business income (e.g., hotel operating revenues, but not capital gain from sale of hotel) Dealer property Income from parking

10 1. Fractions Rule UBTI Solutions Technical tax rules which cleanse UBTI from leverage for certain limited investors (and limited leveraged real property) Only eliminates debt-financed UBTI (i.e., does not eliminate operating income or dealer gains) for qualified organizations Fractions rule compliance often is a focus of qualified organization investors 2. REITS and Corporations Complicates economic issues like divergent management fees based on capital commitment Also requires focus on joint venture deals entered into by fund to ensure that those deals are fractions rule compliant Domestically-controlled REITs and leveraged blocker corporations may be used to accommodate tax-exempt, non-u.s., and sovereign investors Economic issues due to discount that often accompanies sale of REIT stock Additional costs associated with operating property through a REIT

11 Effectively-Connected Income Issue: ECI: Non-U.S. investors engaged in a U.S. trade or business are taxed at regular graduated U.S. income tax rates on ECI. Income effectively-connected to operating a U.S. trade or business. Under FIRPTA, the sale of U.S. real property interests are treated as ECI. Partners in a partnership without a blocker would take in their pro rata share of ECI.

12 Consequences of ECI Withholding Investor must file U.S. tax return In the case of ECI capital gains, non-resident individuals and certain nonresident pension trusts are taxed at currently lower capital gains rates (20%-25%) Non-U.S. corporate investors (e.g., sovereign wealth funds) generally taxed at 35% State taxes Corporate investors also may pay branch profits tax of 30% on remaining 65% No treaties call off FIRPTA, but do reduce/eliminate branch profits tax

13 Examples of Activities Generating ECI Lending trade or business (i.e., loan origination) in partnerships (without blockers ) engaged in a trade or business or holding U.S. real property Direct investments in U.S. real property Gains from selling stock in domestic corporations treated as U.S. real property holding corporations

14 Mitigating U.S. Tax on Non-U.S. Investors Use domestically-controlled REIT and sell REIT stock Gain from sale of domestically-controlled REIT stock is not subject to U.S. tax Non-U.S. investors may wish assets to be held in single purpose REITs to facilitate exit via stock sale and negotiate for covenant to use reasonable/best efforts to sell REIT stock U.S. tax-exempt investors may prefer asset sale (due to pricing concerns with stock sale) Distributions attributable to gain from sale of U.S. real property are ECI and subject to tax; non-u.s. investors have U.S. tax return filing obligation Ordinary REIT dividends are subject to 30% withholding unless rate is reduced by an applicable treaty Capitalize C corp with debt and equity; liquidate assets before making distributions Corporation pays U.S. tax If interest on debt is portfolio interest, not subject to withholding Must comply with its 10 percent voting power limitation to qualify as portfolio interest

15 Non-U.S. Sovereign Investors Sovereign investors have concerns where they are the majority investor in a partnership Proposed regulations eliminate attribution of commercial activity to minority LPs with limited management rights. Prop. Treas. Reg (d) (5)(iii)(A) Under the new proposed regulation, an entity that is not otherwise engaged in commercial activities will not be deemed to be engaged in commercial activities solely because it holds an interest as a limited partner in a limited partnership Sovereign investors need some kind of blocker to block income from a commercial activity, although blocker itself could be a controlled commercial entity so that all income from the blocker would be subject to tax with respect to the sovereign investor Concern that blocker is a U.S. Real Holding Corporation ( USRPHC ), which will be treated as a controlled commercial entity if the Sovereign investor owns 50% or more of such entity Sovereign investors try to hold significant (i.e., more than 50%) non-u.s. real estate in same entity to prevent entity from being a USRPHC

16 Considerations Use of blocker entities can implicate after-tax return of sponsor depending on whether blockers are above or below the fund Tax cost associated with blocker C corporations reduces after-tax return of sponsor when carry is taken above blocker Blocker C corporation or REIT can limit ability of sponsor to take losses with respect to capital investment Effort to take carry below the blockers can implicate combined economics of multiple partnerships (i.e., investors may require crossing of the carry and possibly clawback across multiple investments held in separate entities), which may compromise stand-alone nature of the entities for tax purposes Domestically-controlled REITs and leveraged blocker corporations may be used to accommodate tax-exempt, non-u.s., and sovereign investors Economic issues due to discount that often accompanies sale of REIT stock Additional costs associated with operating property through a REIT

17 Pension Charity Govt. Taxable U.S.Taxables U.S. Individual U.S. Corp. U.S. Govt. U.S. Plan Endowment U.S. Tax Exempts ERISA Plan Foundation Differential Fee Investors Redemption Right Triple Net Leased LP Shares Carry Investment Dealer Strategy Fund Structure? Fund Terms Limit Limit on % TransferProhibited Give Back Fee Structure Fractions Pref. Equity Leveraged Unleveraged

18 Pension Charity Govt. Taxable U.S.Taxables U.S. Individual U.S. Corp. U.S. Govt. U.S. Plan Endowment U.S. Tax Exempts ERISA Plan Foundation Differential Fee Investors Redemption Right Triple Net Leased LP Shares Carry Investment Dealer Strategy Partnership Fund Terms Limit Limit on % TransferProhibited Give Back Fee Structure Fractions Pref. Equity Leveraged Unleveraged

19 Pension Charity Govt. Taxable U.S.Taxables U.S. U.S. Individual Corp. U.S. Tax Exempts U.S. Govt. U.S. Plan Endowment ERISA Plan Foundation Differential Fee Investors Redemption Right Triple Net Leased LP Shares Carry Investment Dealer Strategy Fractions Rule Partnership Fund Terms Limit Limit on % TransferProhibited Give Back Fee Structure Fractions Pref. Equity Leveraged Unleveraged

20 Pension Charity Govt. Taxable U.S.Taxables U.S. Individual U.S. Corp. U.S. Govt. U.S. Plan Endowment U.S. Tax Exempts ERISA Plan Foundation Differential Fee Investors Redemption Right Triple Net Leased LP Shares Carry Investment Dealer Strategy REIT Fund Terms Limit Limit on % TransferProhibited Give Back Fee Structure Fractions Pref. Equity Leveraged Unleveraged

21 Pension Charity Govt. Taxable U.S.Taxables U.S. Individual U.S. Corp. U.S. Govt. U.S. Plan Endowment U.S. Tax Exempts ERISA Plan Foundation Differential Fee Investors Redemption Right Triple Net Leased LP Shares Carry Investment Dealer Strategy Domestically Controlled REIT Fund Terms Limit Limit on % TransferProhibited Give Back Fee Structure Fractions Pref. Equity Leveraged Unleveraged

22 Pension Charity Govt. Taxable U.S.Taxables U.S. Individual U.S. Corp. U.S. Govt. U.S. Plan Endowment U.S. Tax Exempts ERISA Plan Foundation Differential Fee Investors Redemption Right Triple Net Leased LP Shares Carry Investment Dealer Strategy Leveraged C Corp Fund Terms Limit Limit on % TransferProhibited Give Back Fee Structure Fractions Pref. Equity Leveraged Unleveraged

23 Pension Cha rity Govt. Fore ign Taxable U.S.Taxables U.S. Individual U.S. Corp. U.S. Go vt. U.S. Plan Endowment U.S. Tax Exempts ERISA Plan Foundation Differential Fee Investors Rede mption Right Triple Net Leased Investment Pro pert y Dealer Strategy REIT and Leveraged C Corp. investing in Partnership Fund Terms Transfe rprohibited Give Back Fee Structure Fractions Pref. Equity Fixe d CMB S Leveraged Unleve raged

24 Pension Cha rity Govt. Fore ign Taxable U.S.Taxables U.S. Individual U.S. Corp. U.S. Go vt. U.S. Plan Endowment U.S. Tax Exempts ERISA Plan Foundation Differential Fee Investors Rede mption Right Triple Net Leased Dealer Strategy Leveraged C Corp. investing in Leveraged Partnership Fund Terms Limit Lim it on % Transfe rprohibited Give Back Fee Structure Fractions Pref. Equity Fixe d CMB S Leveraged Unleve raged

25 A Complex Structure Third Party Investors LPs GP II GP LLC (DE LLC) GP Third Party Investors GP Accommodation Shareholders 100% Series A Preferred Shares Capital Partners II LP ( Fund A ) (DE LP) 100% Common Shares Common Shares II Principals LP (Fund B ) (DE LP) LPs Senior Professionals Capital Partners II (AIV) LP (Fund C ) (DE LP) Common Shares LPs Capital II Business Trust (MD Business Trust) Capital II Business Trust (MD Business Trust) Capital II Limited (Cayman Co.) Capital II Inc. (DE Corp.) Capital II (AIV) Inc. (DE Corp.) Capital II Inc. (DE Corp.) Capital II Inc. (DE Corp.) Capital II Inc. (DE Corp.) Capital II Pooling REIT LLC (DE LLC) Capital II Pooling REIT LLC (DE LLC) Capital II Pooling International LLC (DE LLC) Capital II Pooling International LLC (DE LLC) Capital II Pooling Domestic LLC (DE LLC) Capital II Pooling LLC (DE LLC) Additional Delaware Corporations (as required)

26 IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.