Tax treatment of U.S. REITs and RICs

04.03.2016

This information is intended to provide an overview of the tax treatment of the income distributed by U.S. Real Estate Investment Trusts (REITs) and U.S. Regulated Investment Companies (RICs).

U.S. Real Estate Investment Trusts (REITs)

Background

Income from REITs is subject to different U.S. withholding regulations depending on how the components of the income distribution are classified. Such income can include dividends, REITs capital gains dividends and return of capital.

Under the American Jobs Creation Act of 2004, REITs capital gains dividends could be considered as ordinary dividends and reported as such under the following conditions:

  • The distribution is received in respect of a class of stock that is regularly traded on an established securities market located in the U.S.A.;
  • The beneficial owner did not, in the aggregate, own more than 5% of the outstanding shares of the class of stock at any time during the taxable year; and
  • The beneficial owner is a non-U.S. person.

In December 2015, the President of the United States signed into Law H.R. 2029, the “Consolidated Appropriations Act, 2016”. The law has modified the holding threshold in order for REITs capital gains dividends to be classified as ordinary dividends from 5% to 10%.

At the time of the initial income distribution, the classification may not yet be known, in which case, the REITs income will be taxed as an ordinary dividend during the year of the distribution.

Dividends are consequently paid by Clearstream Banking1 according to the tax certification provided by customers for Chapter 3 (QI regime) and Chapter 4 (FATCA) purpose.

Reclassification

At the end of the tax period, REITs can reclassify their income payments as follows:

  • Ordinary dividends (income code 06), subject to 30% withholding tax rate (or the applicable Double Taxation Treaty rate);
  • REITs capital gains dividends (income code 24), taxable at 35%;
  • Return of capital (income 37), exempt of tax.

Under the American Jobs Creation Act of 2004, REITs capital gains dividends can be considered as ordinary dividends and reported as such under the following conditions:

  • The distribution is received in respect of a class of stock that is regularly traded on an established securities market located in the U.S.A.; and
  • The beneficial owner did not, in the aggregate, own more than 10% of the outstanding shares of the class of stock at any time during the taxable year; and
  • The beneficial owner is a non-U.S. person.

Clearstream Banking has opted to apply the market consensus that is to consider that the above conditions are met by default for all non-resident beneficial owners and, as a consequence, maintain the capital gains dividend portion under ordinary dividend classification.

During the year of the distribution, income distributed by REITs instruments will be taxed and reported as dividend. If a reclassification is announced at the beginning of the following tax year, Clearstream Banking will inform its customers accordingly via a notification (MT599, MT564) indicating the split of the distribution between the different income types.

By default for all non-resident beneficiaries, the REITs capital gains portion will remain considered as dividend and be reported under income code 06. Effectively, this portion will not undergo any reclassification amendments as already taxed and reported as dividend.

If the non-resident shareholder owned more than 10% of such stock at any time during the taxable year, a condition that would render the beneficial owner ineligible for such conversion, action must be taken by the customer to notify us accordingly. The requested instruction and respective deadline are provided in the next section. In such a case, the segregation of the dividend and the capital gains portions will be reflected in the customer’s 1042-S reporting and a tax adjustment will be performed.

Any return of capital distribution will be reflected in the 1042-S with the income code 37.

Refund of tax withheld at source is not possible when the dividend is reclassified under the non-taxable portion (return of capital). The QI agreement does not grant us the possibility of such refunds after 15 March and, therefore, Clearstream Banking has no possibility to claim and obtain a refund from the Internal Revenue Service (IRS). Only the final beneficial owner is allowed to claim such refund directly from the IRS.

The following tables summarises the reclassification and its impacts on non-resident beneficiaries:

Original payment
income
type
income
code
WHT
rate applied
----------------------------------------------------------------------------------------------------------
dividend0630% or DTT
----------------------------------------------------------------------------------------------------------
Reclassification, shareholder does not reach 10% holding threshold - no action required
Announced by issuerReported by Clearstream Banking
income
type
income
code
income
type
income
code
WHT
rate
tax
adjustment a
----------------------------------------------------------------------------------------------------------
dividend06dividend0630% or DTTN/A
----------------------------------------------------------------------------------------------------------
capital gains24dividend0630% or DTTN/A
----------------------------------------------------------------------------------------------------------
return of capital37return of capital370%30% or DTT reclaimable
by beneficiary from IRS
----------------------------------------------------------------------------------------------------------
Reclassification, shareholder reaches 10% holding threshold - action required from customer
Announced by issuerReported by Clearstream Banking
income
type
income
code
income
type
income
code
WHT
rate
tax
adjustment a
----------------------------------------------------------------------------------------------------------
dividend06dividend0630% or DTTN/A
----------------------------------------------------------------------------------------------------------
capital gains24capital gains2435%Credit of tax withheld at source;
debit of 35% WHT
----------------------------------------------------------------------------------------------------------
return of capital37return of capital370%30% or DTT reclaimable
by beneficiary from IRS

a. If applicable, depending on the U.S. tax status of the account.

Instruction requirements

As indicated above, if the final beneficiary is not eligible for the conversion of the REITs capital gains portion into dividend, the customer must advise us accordingly.

Upon receipt of our reclassification-related notification, the customer must provide us with an allocation, via SWIFT or CreationOnline, with the following details according to the U.S. tax status of the account:

  • QI customers: account number, security code and description, payment date, total holding, breakdown of the holding for which capital gains must be reported (that is for U.S. beneficiaries and non-resident beneficiaries that have the 10% threshold).
  • Non-QI customers: account number, security code and description, payment date, total holding, breakdown of the holding for which capital gains must be reported (that is for U.S. beneficiaries and non-resident beneficiaries that have the 10% threshold) along with the final beneficiaries details.
  • Own assets: account number, security code and description, payment date, total holding for which capital gains must be reported.

If the final beneficiary is not a U.S. person and did not, in the aggregate, own more than 10% of the outstanding shares of the class of stock at any time during the taxable year, no action from the customer is necessary.

U.S. Regulated Investment Companies (RICs)

Background

Before the American Jobs Creation Act of 2004 (the “Act”), RIC distributions were treated as ordinary dividends and subject to the same NRA withholding rate applied to ordinary dividend distributions.

In 2004, the Act provided for the relief from NRA withholding tax for short-term capital gains and interest-related dividends paid by RICs but for a limited period only. Since then, “tax extender” bills have extended the application of the provisions scheduled to expire.

On December 2015, the President of the United States signed into law H.R. 2029 the “Consolidated Appropriations Act, 2016”. The law retroactively reinstated the favourable tax provisions as of 1 January 2015 and made them permanent.

RICs distribution

As a result of the extension of the Act, an original payment reported as ordinary dividend could be reclassified at the end of the tax year as follows:

Distribution made by a RIC whose taxable year begins after 31 December 2011
Original paymentReclassified payment
income
type
income
code
WHT
rate applied
income
type
income
code
WHT
rate
tax
adjustment a
----------------------------------------------------------------------------------------------------------
dividend0630% or DTTdividend0630% or DTTN/A
----------------------------------------------------------------------------------------------------------
return of capital370%30% or DTT reclaimable by
beneficiary from IRS
interest-related dividend0130% or 0%30% reclaimable by
beneficiary from IRS
capital gain360%30% or DTT reclaimable by
beneficiary from IRS

At the time of the initial income distribution, the classification may not yet be known, in which case the RICs income will be taxed as an ordinary dividend during the year of the distribution.

Dividends are consequently paid by Clearstream Banking according to the tax certification provided by customers for Chapter 3 (QI regime) and Chapter 4 (FATCA) purpose.

Once notified by the RIC of the reclassification details of the income distribution, we will in turn reflect those details in our customer’s RIC income distribution, thereby amending accordingly the 1042-S reporting.

Refund of tax withheld at source is not possible when the dividend is reclassified as return of capital, interest-related dividend or as capital gains. The QI agreement does not grant us the possibility of such refunds after 15 March and, therefore, Clearstream Banking has no possibility to claim and get a refund from the IRS. Only the final beneficial owner is allowed to claim such refund directly from the IRS.

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1. Clearstream Banking refers collectively to Clearstream Banking AG, registered office at 61, Mergenthalerallee, 65760 Eschborn, Germany and registered in Register B of the Amtsgericht Frankfurt am Main, Germany under number HRB 7500, and Clearstream Banking S.A., registered office at 42, avenue John F. Kennedy, L-1855 Luxembourg, and registered with the Luxembourg Trade and Companies Register under number B-9248.