Structuring for non-US investors

Non-US investors want to avoid US tax filing requirements and minimize US tax on their returns. The key concerns are effectively connected income (ECI), FIRPTA withholding on US real property, and branch profits tax. Get the structure wrong and your non-US investors file US tax returns, pay US tax, and question why they invested in your deal.

What non-US investors want to avoid

Effectively connected income (ECI)

Non-US investors pay US tax at regular rates on ECI and must file US tax returns (Form 1040-NR for individuals, Form 1120-F for corporations).

What constitutes ECI:

Income from assets used in a US trade or business
Pass-through income from partnerships engaged in US business
Certain income effectively connected with a US permanent establishment

What constitutes a US trade or business:

Active lending operations in the US (originating loans, making credit decisions on US soil)
Management of US real property
Regular trading in securities as a dealer (not just as an investor)
Operating a business with US employees or offices

Key point: Passive investment in US assets is generally not a US trade or business. But pass-through from a partnership that conducts US business is ECI even if the non-US investor is purely passive.

FIRPTA withholding

The Foreign Investment in Real Property Tax Act requires withholding on dispositions of US real property interests by non-US persons.

What triggers FIRPTA:

Sale of US real estate
Sale of interest in partnership that holds US real property
Sale of stock in US real property holding corporation (USRPHC)
Certain distributions from REITs

Withholding rates:

Generally 15% of gross proceeds
Can be reduced with IRS withholding certificate
Real property includes land, buildings, and certain associated assets

Impact on ABF:

Portfolios backed by real property (SFR, bridge loans, CMBS) have FIRPTA exposure
Consumer loans, auto loans, equipment: generally no FIRPTA concern
Even mortgage loans can create FIRPTA issues in certain structures

Branch profits tax

Non-US corporations conducting US business through a branch (not a subsidiary) pay an additional 30% tax on earnings removed from the US.

When it applies:

Non-US corporation has ECI
Earnings are effectively distributed to home country
Tax treaties may reduce or eliminate

Impact on ABF:

Relevant when non-US investor is a corporation with ECI exposure
Another reason to structure investments to avoid ECI

Safe harbors for non-US investors

Portfolio interest exemption

Interest on debt is generally subject to 30% withholding tax for non-US recipients. But “portfolio interest” is exempt from withholding.

Requirements for portfolio interest:

Debt must be in registered form or bearer with appropriate legend
Holder must provide W-8BEN or W-8BEN-E certifying non-US status
Holder cannot be a 10% shareholder of the borrower
Borrower cannot be a bank (for this exemption)

What this means:

Non-US investor can receive interest without US withholding
Must provide proper documentation (W-8BEN-E)
Cannot own 10%+ of borrower
Most ABF debt structures qualify

Practical application:

Structure non-US investment as debt
Ensure proper documentation at closing
Confirm no 10% ownership threshold issues
Result: no US tax, no US filing

Trading safe harbor

Trading in stocks, securities, or commodities through a US broker or for your own account is generally not a US trade or business.

Requirements:

Trading for own account (not as dealer)
Not otherwise engaged in US business
IRC Section 864(b)(2) safe harbor

What this means:

Passive investment in securities is not a US trade or business
But actively managed funds may not qualify
Structure matters

Investment vs. business

The critical distinction is between:

Investment: Holding assets passively, not ECI
Business: Active operations in the US, creates ECI

Passive holding of loan portfolios is generally investment. Originating loans, making credit decisions, servicing in-house may cross into business.

Solutions for non-US investors

Solution 1: invest as debt (portfolio interest)

The simplest solution: structure the non-US investment as debt qualifying for portfolio interest exemption.

How it works:

Non-US investor provides loan to US entity
Loan qualifies for portfolio interest exemption
No withholding, no ECI, no US filing

Requirements:

Registered debt with proper terms
W-8BEN-E from investor
No 10% ownership by investor
Interest payments, not partnership distributions

Advantages:

Clean treatment, well understood
No US tax connection
No blocker needed

Disadvantages:

Capped returns (no equity upside)
May not achieve target returns
Debt must be properly documented

Works for:

Senior and mezzanine positions
Any situation where debt economics are acceptable
Investors who prioritize tax efficiency over upside

Solution 2: blocker corporation

Insert a US corporation between the non-US investor and the pass-through entity.

How it works:

Non-US investor owns stock in US C-corporation
Corporation owns the pass-through interest
ECI stops at corporation level
Corporation pays dividends to non-US investor
Dividends subject to 30% withholding (or treaty rate)

Economics:

Corporation pays 21% federal tax on pass-through income
After-tax income distributed as dividends
Non-US investor pays 30% withholding on dividends (or treaty rate)
Combined effective rate: approximately 45% (21% + 30% of 79%)

This is painful but may still be better than the alternative of ECI exposure with filing requirements.

Treaty benefits:

Many treaties reduce dividend withholding to 15% or 5%
Combined rate drops to approximately 33% with 15% treaty rate
Check specific treaty with investor’s home country

Costs:

Formation: $5,000-$15,000
Annual maintenance: $5,000-$15,000
Tax leakage: As calculated above

Solution 3: offshore issuing vehicle

Use a non-US entity (typically Cayman Islands) to issue securities.

How it works:

Cayman company issues notes to investors
Cayman company lends to US entities holding assets
Non-US investors have no US connection
US investors may need to deal with PFIC/CFC rules

Advantages:

No US tax for non-US investors
Clean structure for international investor base
Standard approach for international capital markets

Disadvantages:

Complexity for US investors (PFIC/CFC issues)
Higher formation and maintenance costs
More complex tax reporting
May not work if investor base is primarily US

When offshore makes sense:

Significant non-US investor base (50%+ or key anchor)
International note issuance in Eurobond markets
Investor base demands familiar Cayman/Ireland structure

Solution 4: REIT blocker

Similar to tax-exempt structuring, a REIT can work for non-US investors.

How it works:

REIT holds real property investments
REIT distributes 90%+ of income
Dividends to non-US investors subject to 30% withholding
But no entity-level tax, so single layer

Advantages:

Single layer of tax (30% withholding on dividends)
Better than blocker plus dividends in many cases
Treaty rates may apply

Limitations:

Only works for real property income
Complex REIT requirements
High compliance costs

ECI in detail

What creates a US trade or business

For ABF purposes, the key activities that may create US business include:

Loan origination:

Making credit decisions in the US
Having US-based employees who process applications
Operating origination platforms with US nexus

Servicing:

Active loan servicing with US employees
Collecting payments, handling defaults, managing workouts
Subservicing to third party may help but isn’t automatic

Asset management:

Active portfolio decisions in the US
Buying and selling loans as a business
Managing real property

Key distinction:

Passive holding of loans: generally not US business
Active origination and management: potentially US business

Pass-through creates ECI

If a partnership conducts US business, each partner has ECI equal to their share of the partnership’s US business income. This is true even if the partner:

Never sets foot in the US
Has no US employees
Does nothing except hold a partnership interest

This is the critical issue. Non-US investors in pass-through equity of US operating entities often have ECI and must file US tax returns.

Withholding on ECI

Partnerships must withhold on allocations to non-US partners:

Generally 37% withholding on ECI allocated to non-US individuals
Generally 21% withholding on ECI allocated to non-US corporations
Filed with Form 8804/8805

This creates cash flow complications even if investor eventually recovers excess withholding.

FIRPTA considerations for real property-backed ABF

What triggers FIRPTA

For ABF structures backed by real property:

Direct real property:

SFR portfolios: real property
Bridge loans secured by real estate: may create real property interest
Foreclosure on real property: definitely real property

USRPHC status:

If entity is a “US real property holding corporation” (50%+ of assets are US real property)
Sale of stock triggers FIRPTA
Partnership interest in USRPHC: also triggers

REIT exception:

Domestically controlled REIT shares: generally not USRPI
Can provide FIRPTA planning opportunity

FIRPTA planning

For non-US investors in real property-backed ABF:

Structure as debt:

Debt secured by real property is not itself a USRPI
Interest income: portfolio interest exemption
Foreclosure: may create FIRPTA exposure

Cleansing:

If entity disposes of real property and becomes less than 50% real property
USRPHC status may be eliminated
Technical requirements apply

REIT wrapper:

Domestically controlled REIT shares
More favorable FIRPTA treatment
Complex requirements

Documentation requirements

W-8BEN-E

Every non-US investor must provide Form W-8BEN-E (for entities) or W-8BEN (for individuals).

What it certifies:

Non-US status
Treaty benefits claimed (if any)
FATCA status (covered separately)
Chapter 3 status (withholding)

Validity:

Generally valid for 3 years
Must be refreshed upon expiration
Invalid without date and signature

FIRPTA certifications

If FIRPTA is a concern, non-US investors may need:

Certification that interest is not a USRPI
Withholding certificates from IRS (for reduced withholding)
Domestic control certification (for REIT shares)

Treaty documentation

If claiming treaty benefits:

W-8BEN-E with treaty claim
Limitation on benefits (LOB) certification
Potential additional documentation depending on treaty

Common mistakes

Mistake 1: pass-through equity to non-US

Issuer structures deal as LLC with non-US equity investors. LLC conducts activities constituting US business. Non-US investors have ECI, must file US returns, pay US tax.

Fix: If non-US investors want equity, use blocker or offshore vehicle.

Mistake 2: ignoring partnership withholding

Partnership has non-US partners with ECI. Partnership fails to withhold on allocations. Partnership liable for unpaid withholding plus penalties.

Fix: Build withholding compliance into partnership administration.

Mistake 3: assuming portfolio interest applies

Non-US investor holds debt but owns 10%+ of borrower. Portfolio interest exemption doesn’t apply. Investor subject to 30% withholding on interest.

Fix: Confirm no 10% threshold issues before relying on portfolio interest.

Mistake 4: FIRPTA surprise

Non-US investor in partnership that forecloses on real property. Foreclosure creates USRPI. Disposition triggers FIRPTA withholding.

Fix: Identify FIRPTA exposure in structures with real property collateral.

Practical checklist for non-US investor participation

Before marketing to non-US investors:

Identify structure:

Debt position: Portfolio interest exemption available?
Equity position: Blocker or offshore needed?
Real property exposure: FIRPTA planning needed?

If pass-through equity:

Does entity conduct US trade or business?
Will partners have ECI?
Is withholding infrastructure in place?
Should blocker be used instead?

Documentation:

W-8BEN-E collection process
Validity tracking and refresh
FATCA/GIIN compliance
Withholding certificate applications (if needed)

Tax analysis:

Confirm no ECI (or quantify ECI exposure)
Confirm portfolio interest availability (for debt)
Confirm FIRPTA treatment (for real property)
Identify treaty benefits (if applicable)

Working with non-US investor counsel

Non-US investors often have their own tax advisors who will scrutinize the structure. Prepare for their diligence:

Provide clear structure chart
Identify tax classification of each entity
Explain ECI/FIRPTA analysis
Provide draft tax opinions
Be ready to discuss treaty positions

The structure should work for the investor’s home country as well as the US. International tax planning is complex and requires specialist counsel on both sides.