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March 18, 2016

INTERNET SALES TAX
U.S. Business Groups Renew Effort to Work with House Judiciary Chairman on Internet Sales Tax Issue

CAPITAL & CREDIT POLICY
Fed Signals Slower Pace of Interest Rate “Normalization,” Trims GDP Forecast Amid Lingering Global Weakness and Mixed Economic Indicators; Roundtable Warns of CMBS Market Impacts from Basel “Step-In Risk” Proposal

TAX POLICY / FIRPTA
New Congressional Report Supports Broad Interpretation of FIRPTA Foreign Pension Fund Exemption

TAX POLICY / 'BAD BOY' LOAN GUARANTEES
Roundtable Asks IRS to Withdraw Chief Counsel Advice on “Bad Boy” Loan Guarantees


INTERNET SALES TAX

U.S. Business Groups Renew Effort to Work with House Judiciary Chairman on Internet Sales Tax Issue   

The Roundtable, International Council of Shopping Centers (ICSC), and a diverse array of business groups on Tuesday urged House Judiciary Committee action on “e-fairness” or Internet sales tax legislation, warning that the confusing patchwork of state laws and regulations is not good for businesses or consumers; 

13 states pursuing a strategy aimed at forcing Congress to act — or the Supreme Court to revisit its 1992 Quill decision;

House Judiciary Chair x200 Bob Goodlatte

The Real Estate Roundtable, ICSC, and over two dozen business organizations on Tuesday wrote to House Judiciary Committee Chairman Bob Goodlatte (R-VA) urging the Committee to consider Internet sales tax legislation

The Real Estate Roundtable, International Council of Shopping Centers (ICSC), and over two dozen business organizations on Tuesday wrote to House Judiciary Committee Chairman Bob Goodlatte (R-VA) urging the Committee to consider Internet sales tax legislation and offering to “be a constructive participant in this process,” with the goal of “providing clarity, uniformity and parity to America’s merchants in today’s multichannel marketplace.”

The 26 signatories — which included representatives of real estate and other economic sectors as well as the U.S. Chamber of Commerce — urged formal consideration of the two leading approaches to the Internet sales tax dilemma.  These include the “Remote Transactions Parity Act” (RTPA), H.R. 2775 — unveiled by Rep. Jason Chaffetz (R-UT) and 15 other lawmakers last June; and Goodlatte’s forthcoming “Online Sales and Simplification Act.”

By basing Internet sales tax collection on the location of the customer  (i.e. “destination sourcing”), the Chaffetz bill is similar in design to the “Marketplace Fairness Act” (MFA), S. 698, which cleared the Senate in 2013 and which is backed by a broad coalition of real estate and retail groups, GOP governors and the White House. The RTPA — which enjoys the support of more than 60 co-sponsors — differs in several key ways from the Senate bill, primarily relating to the small-seller exemption; protections for certified software providers; audit protections; and definitions of remote sellers (National Law Review, June 16).

By contrast, Goodlatte has embraced an “origin sourcing” approach that bases the tax on the location of the retailer (Roundtable Weekly, Jan. 16, 2015).  More recently and in response to stakeholder input, Chairman Goodlatte has modified his approach and developed a hybrid “destination rate, origin base” proposal.  In general, this hybrid approach would apply the buyer’s sales tax rate to goods sold by internet retailers, provided the good was subject to sales tax in the seller’s jurisdiction.

This week’s (March 15) letter to the House Judiciary Committee noted problems that are surfacing across the country due to congressional inaction on this issue as well as potential ramifications for businesses and consumers — and the urgency of a resolution.

  2016-03-17 image Goodlatte letter

The  March 15 letter to the House Judiciary Committee noted problems that are surfacing across the country due to congressional inaction on this issue as well as potential ramifications for businesses and consumers — and the urgency of a resolution.

“The lack of movement from Congress on the issue of remote sales tax collection has left states, local governments and our merchants with no choice but to seek disjointed and confusing remedies through individual state activity,” the March 15 letter stated.  As Roundtable Weekly reported Feb. 26, thirteen states are pursuing a confrontational strategy aimed at forcing Congress to act — or the Supreme Court to revisit its 1992 Quill decision, under which states can only compel the collection of sales tax by retailers with a physical presence, or “nexus,” in the state.

“The business community is highly concerned that these state efforts could lead to the issue being decided by the courts. Further, this state-by-state approach prevents businesses from benefiting from simplification measures such as uniform definitions or free tax software that could be achieved by federal legislation,” The Roundtable and its coalition partners stated in their letter this week.

A U.S. appeals court recently upheld Colorado’s 2010 “Amazon tax law” requiring out-of-state Internet vendors to notify customers of state sales tax obligations, and to notify state tax authorities of purchases made by their residents. To date, four other states have enacted similar reporting laws.

Rather than a confusing patchwork of state-by-state regulation, the coalition is “hopeful the U.S. House of Representatives will vote on a federal legislative solution this year to move this issue toward a final resolution.”

Although the Senate overwhelmingly approved the Marketplace Fairness Act in 2013 — and is expected to take up Internet sales tax legislation again this year [per a recent promise by Senate Majority Leader Mitch McConnell (R-KY)] — “the real heavy lifting will be in the House . . . where passage is less certain” and where competing proposals have been put forth by Reps. Chaffetz and Goodlatte (R-VA), The Hill reported Feb. 16.

The Marketplace Fairness Coalition, whose membership includes some of the groups that signed this week’s letter to Goodlatte, reportedly expressed support for the groups’ call to action. “The longer Congress waits, the more harm it does to local job creators and states that are faced with having to cut services or raise alternate taxes to make up for lost online sales tax revenue,” the coalition said.

Roundtable President and CEO Jeffrey DeBoer has similarly warned that states’ inability to enforce sales tax collection on Internet purchases increases pressure to raise taxes on other taxpayers — including physically-based stores and property owners.

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CAPITAL & CREDIT POLICY

Fed Signals Slower Pace of Interest Rate “Normalization,” Trims GDP Forecast Amid Lingering Global Weakness and Mixed Economic Indicators; Roundtable Warns of CMBS Market Impacts from Basel “Step-In Risk” Proposal   

Amid mixed economic signals, Fed leaves interest rates unchanged at mid-March meeting, but cuts 2016 GDP forecast to 2.2 percent and signals only two further interest rate hikes this year;

“Caution is appropriate,” says Fed Chair Janet Yellen;

June more likely than April for next possible interest rate hike, but next move will depend on “realized and expected economic conditions” — i.e. any further tightening will be gradual and data-dependent;

March 17 comment letter to Basel Committee: Dec. 2015 “Step-In Risk” proposal could hurt commercial mortgage securitization and raise borrowing costs — on top of other Basel, Dodd-Frank policy changes with implications for real estate capital and credit;

Mid-April Roundtable meeting to feature Senate and House policymakers — including author of committee-passed bill exempting prudently underwritten Single Asset/Single Borrower (SASB) CMBS transactions.

As widely expected, Fed policymakers this week left interest rates unchanged, citing “soft” business investment and exports, below-target inflation and ongoing risks associated with global economic weakness and financial market volatility. Despite some positive economic indicators — such as rising household spending, a 4.9 percent unemployment rate, and improved labor-force participation — the Federal Open Market Committee (FOMC) now foresees the economy growing at a 2.2 percent pace this year — down from the 2.4 percent GDP forecast the central bank made in December (Washington Post, March 16).

Federal Reserve dusk x225 edit

Fed policymakers this week left interest rates unchanged, citing “soft” business investment and exports, below-target inflation and ongoing risks associated with global economic weakness and financial market volatility.

“Our decision to keep this accommodative policy stance reflects both our assessment of the economic outlook and the risks associated with that outlook,” Fed Chair Janet Yellen said Wednesday.  She noted that the committee’s baseline expectations for economic activity, the labor market and inflation “have not changed much since December.”

Fed officials also dialed back individual forecasts about further rate increases for the rest of this year, as well as 2017 and 2018 — “effectively slashing their expectations for how quickly they’ll be able to normalize policy after more than seven years at near-zero interest rates.”

In December, for example, when the Fed raised interest rates for the first time in almost a decade, the median “dot plot” forecast for the federal funds rate in 2016 was 1.4 percent.  On Wednesday, the Fed said the median collective forecast was now 0.9 percent, implying only two rate hikes for the rest of the year (vs. four).

As for the timing of any subsequent interest rate hikes, Yellen said, “April remains a live meeting,” adding, “There will be additional data on the labor market, and on various factors that pertain to inflation. So that’s certainly a live possibility.”

However, a Wall Street Journal report said the new, lower dot-plot forecast for the year “implies officials are tentatively looking at June for their next move.” Fed officials underscored that any subsequent interest rate increase will depend on “realized and expected economic conditions” and that they plan to move gradually.

Careful Interest Rate Tightening Especially Important Amid Softening Real Estate Values, Liquidity Challenges Stemming From Dodd-Frank, Basel III

The real estate sector has warned for some time that abrupt changes in interest rates could hurt real estate valuations and increase borrowing costs, while potentially risking price declines in interest-rate-sensitive classes — or worse, renewed economic and financial market challenges.

 Fed Statement Prudent Lending image x150 

The tightening in bank lending for CRE appears to be a reaction to a Dec. 18, 2015 Interagency Statement on Prudent Risk Management for Commercial Real Estate Lending .

The case for gradual interest rate normalization is even stronger, given recent signs of softening in commercial real estate values.  As reported in Roundtable Weekly last week, Moody’s on March 7 reported a 0.3 percent decline in its Commercial Property Price Indices (CPPI) in January, the first such decline since 2010.

A Moody’s official said the “pause” in price growth “signals [that] a shift in sentiment among commercial property investors is underway.”

Also of concern is an apparent contraction in bank lending to commercial real estate — documented in the Fed’s Q4-2015 Senior Loan Officer Opinion Survey on Bank Lending Practices — which is expected to push borrowing costs higher for the industry.

The tightening in bank lending for CRE appears to be a reaction to a Dec. 18, 2015 Interagency Statement on Prudent Risk Management for Commercial Real Estate Lending, warning lenders to reinforce prudent CRE lending risk-management practices amid an increase in many banks’ CRE concentration levels.

Overlapping regulatory changes under Dodd-Frank as well as Basel III also appear to be contributing to the apparent slowdown in banks’ CRE lending —  as well as illiquidity and volatility in the commercial mortgage-backed securities (CMBS) market.

At a House Financial Services subcommittee hearing several weeks ago, the Commercial Real Estate Finance Council (CREFC) testified that overlapping Dodd-Frank and Basel III regulations governing CMBS are causing an erosion of “institutional [commercial real estate debt] capacity” that could have “dire” consequences in the long term (watch video of CREFC’s testimony).

Basel Committee’s “Step-in Risk” Proposal Could Further Hurt CMBS Market, Raise Borrowing Costs

Yesterday, The Roundtable, CREFC, CREFC Europe, and the Global Financial Markets Association submitted a joint comment letter to the Basel Committee on Banking Supervision (BCBS) warning that its December 2015 consultative document on the “Identification and Measurement of Step-In Risk” could hurt the origination of CMBS loans and impair overall real estate market liquidity — exacerbating negative impacts arising from other Basel III and Dodd-Frank policies.

 2016-03-18 Basel ltr cover x150

March 17, 2016 joint comment letter to the Basel Committee on Banking Supervision .

As The Roundtable explained in a memo to its Real Estate Capital Policy Advisory Committee (RECPAC), the BCBS proposals seek to determine whether banks should hold capital specifically to cover the risk that they may be required to step in and provide financial support to non-bank financial entities at a time of financial stress — even in the absence of clear contractual obligations to do so.

As the comment letter noted, the Basel III Liquidity Coverage Ratio (LCR) already forces banks to determine the liquidity impact of non-contractual contingent funding obligations. Thus, asking banks to hold additional capital for step-in liquidity could amount to “double counting” and could unnecessarily increase CMBS securitization, issuance and borrowing costs.

The outlook on the U.S. economy and interest rates — as well as issues surrounding commercial real estate pricing and liquidity — will be key topics at The Roundtable’s Spring Meeting on April 13 in Washington, DC.  In addition to leading members of the U.S. Senate and House Judiciary Chairman Bob Goodlatte (R-VA), the program will feature Dr. Peter Linneman (Wharton) and Rep. French Hill (R-AR), whose “Preserving Access to CRE Capital Act” (H.R. 4620) recently cleared the House Financial Services Committee

As The Roundtable and others have urged, H.R. 4620 would exempt certain high-quality, single-loan commercial real estate securitizations — as well as low-risk, qualified commercial real estate loans — from Dodd-Frank’s CMBS risk-retention requirements. It would also increase flexibility in terms of how CMBS transactions are structured, in order to better accommodate how investors raise capital and divide risk in the capital stack. 

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TAX POLICY / FIRPTA

New Congressional Report Supports Broad Interpretation of FIRPTA Foreign Pension Fund Exemption   

Report from the Joint Committee on Taxation (JCT) adds new support for a broad and expansive interpretation of the foreign investors who qualify for the FIRPTA foreign pension fund exemption.

The recently enacted reform of the Foreign Investment in Real Property Tax Act (FIRPTA), long advocated by The Real Estate Roundtable, is already having a positive effect on the mobilization of foreign capital for U.S. real estate projects.  As the full effect of these FIRPTA changes takes hold, the new investment is going to strengthen local communities, create jobs, and expand the tax base.  The FIRPTA reforms received another boost on Monday when the non-partisan congressional Joint Committee on Taxation (JCT) released a report that takes a broad, expansive view of the types of foreign plans that qualify for the new FIRPTA exemption for “qualified foreign pension plans.”

 JCT Blue book 2015 cover

JCT released its latest Blue Book — The General Explanation of Tax Legislation Enacted in 2015 — that addressed several questions that Roundtable members have raised regarding FIRPTA. 

The professional staff of the JCT assists both houses of Congress on tax legislation by preparing the official revenue estimates of all tax legislation and drafting the legislative histories for tax-related bills and is involved in drafting of statutory provisions.   JCT regularly issues so-called “Blue Book” explanations of recently enacted tax legislation.  Probably because of JCT’s close involvement in the legislative process—federal courts, the Treasury Department, and the IRS regularly cite the Blue Book as authority when interpreting federal tax laws, and the federal tax regulations cite the Blue Book as a source of legal authority that taxpayers can use as support for their tax position. 

Notably, JCT in its latest Blue Book — The General Explanation of Tax Legislation Enacted in 2015 — addressed several questions that Roundtable members have raised in recent weeks. 

According to the Blue Book, qualifying foreign pension funds “may be structured in a variety of ways, and may comprise one or more separate entities. The word ‘arrangement’ encompasses such alternative structures.”  Perhaps most importantly, the Blue Book states that “[m]ulti-employer and government-sponsored public pension funds that provide pension and pension-related benefits may satisfy this prong of the definition.  For example, such pension funds may be established for one or more companies or professions, or for the general working public of a foreign country.”

By clarifying that qualifying funds include funds established for one or more professions, or for “the general working public,” the JCT report may provide a higher level of confidence to certain foreign investors, such as broad-based governmental retirement funds, that they are covered by the new FIRPTA foreign pension fund exemption.  

The Roundtable’s Tax Policy Advisory Committee (TPAC) has been in regular communication with the tax-writing committees since enactment of the FIRPTA reforms in December to promote technical corrections and implementing rules that ensure the new law achieves its intended objectives.  While Congress has not yet acted on technical corrections legislation and the Treasury Department has not yet issued implementing regulations, the JCT Blue Book is a meaningful step forward.  Moreover, it should serve as a helpful guide to Treasury officials as they work to prepare to more detailed guidance.  

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TAX POLICY / 'BAD BOY' LOAN GUARANTEES

Roundtable Asks IRS to Withdraw Chief Counsel Advice on  “Bad Boy” Loan Guarantees 

Roundtable delegation meets with IRS chief counsel, asks IRS to withdraw controversial legal memorandum on “bad-boy guarantees,” which are commonly included in CMBS and commercial real estate loans; 

A Roundtable delegation recently met with IRS Chief Counsel William Wilkins and other attorneys from the IRS Chief Counsel’s office to urge the Service to withdraw an IRS Chief Counsel Advice memorandum that contradicts long–standing views and assumptions in the real estate industry regarding the tax consequences of certain types of loan guarantees commonly included in real estate loan documents.

IRS Chief Counsel William Wilkens

A Roundtable delegation recently met with IRS Chief Counsel William Wilkins,  above, and other attorneys from the IRS Chief Counsel’s office to urge the Service to withdraw an IRS Chief Counsel Advice memorandum that contradicts long–standing views and assumptions in the real estate industry regarding the tax consequences of certain types of loan guarantees commonly included in real estate loan documents.

As Roundtable Weekly reported on March 4, if the position taken by the IRS  in the recently disclosed internal legal memorandum  is applied broadly, it could alter the tax treatment of billions of dollars in outstanding commercial mortgage-backed securities and commercial real estate loans.

Commercial real estate loans frequently include “nonrecourse carve-out (or NRCO)” provisions that convert nonrecourse debt to recourse if a specific condition is met. So-called “bad-boy” guarantees are one particular type of NRCO.

These guarantees protect lenders from voluntary bad acts committed by the borrower that would undermine the lender’s ability to recover amounts owed.   Over the years, a considerable amount of tax law has developed around NRCOs.  Under Treasury regulations, the inclusion of an NRCO in a loan agreement does not, by itself, convert the debt to recourse if the triggering event would only occur in the future after an event that is not determinable with reasonable certainty. 

IRS Chief Counsel Advice (CCA) 201606027 concluded that a set of seven bad-boy guarantees effectively converted a nonrecourse real estate loan to a recourse loan.  The specific bad-boy guarantee targeted by the IRS—a provision that converts a loan to full recourse if the borrower admits in writing or in a legal proceeding that it is insolvent or unable to pay its debts when they are due—is a provision regularly included in commercial real estate loans and CMBS documents.

An IRS decision to treat this guarantee as a provision that converts a loan from nonrecourse to recourse for tax purposes would have severe and unexpected, adverse consequences for real estate partnerships around the country.

Although CCAs do not have precedential value, they are generally viewed as reflective of the government’s position on a matter.  If the chief counsel’s advice were applied across the marketplace, real estate investors would have to recapture billions of dollars in losses from previous years and could not share in losses in excess of their equity capital going forward.

The Roundtable delegation included Tax Policy Advisory Committee (TPAC) Chairman Frank Creamer, Jr., Roundtable President’s Council members Joseph Forte, Blake Rubin, and Richard Lipton, and RER Senior Vice President Ryan McCormick.  Partnership tax experts Blake Rubin and Richard Lipton addressed the substantive tax issues and Joseph Forte, one of the nation’s leading authorities on the legal and drafting issues involved in CMBS and commercial real estate loans, walked through the history, meaning, and purpose of the specific “admission of insolvency” bad-boy guarantee that has drawn attention from the IRS.

TPAC will continue to engage the IRS on this issue, encouraging the IRS to withdraw its legal memorandum and revisit its view on the tax consequences of certain bad-boy guarantees.

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For questions about content/editorial matters, please contact The Roundtable's Xenia Jowyk at xjowyk@rer.org or (202) 639-8400. For layout or email delivery issues, contact RER's Scott Sherwood at rweekly@rer.org or (202) 639-8400.

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