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Draft:Fideocomisos: U.S. Tax Implications

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Fideicomiso translates to "trust" in English. These agreements are between a trustee and a beneficiary in regards to real property. However, certain fideicomisos do not correspond with the conditions that form a U.S. common law trust. This yields different tax implications between Fideicomisos and U.S. common law trusts.

History

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The Mexican Constitution prohibits foreign persons from purchasing land within 100 kilometers from the border or 50 kilometers from the coast.[1] These sections are referred to as "restricted zones," and can only be owned by Mexican citizens/companies.[2] The Mexican government created a loophole for this in the 1970s when they realized how beneficial it would be to the country's economy. This change allowed foreign individuals to gain the ability to acquire indirect ownership stakes through a fideicomiso structure, all while the legal title of the property would be held in the name of a Mexican bank.[3] A foreigner could now possess uninhibited use of the property, as if they had now owned it, while the legal ownership of the property was still held in the name of a Mexican bank. This satisfied the Mexican Constitution's condition of a Mexican citizen/company legally owning the property and also permitted foreign persons to purchase this land.

Differences Between U.S. Common Law Trusts and Fideicomisos

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In order for a U.S. Common Law trust to be formed certain conditions must be met between the trustee and the beneficiary. These conditions being the following:

  • The trustee must have a fiduciary duty to the beneficiary to protect and conserve the property solely for their benefit[4]
  • The trustee is empowered to manage the property in the manner they deem most appropriate, regardless of the beneficiary's desires[5]
  • The trustee will pay all taxes and liabilities
  • The trustee is entitled to any and all income and proceeds generated by the property

With these conditions met, a U.S. common law trust will be formed under federal tax law.[6]. This section classifies arrangements as trusts only when the trustee is entrusted with the fiduciary duty to protect and conserve the property for a beneficiary. Revenue Ruling 92-105, relating to Illinois land trusts, also confirmed this. A trust was not created when a beneficiary had exclusive right to control the trustee's action when it came to the property. This revenue ruling also states that the beneficiary was responsible for paying any taxes or liabilities regarding the property. This prevented a trust being formed under federal tax law. [7]

With these conditions in mind, Fideocomisos are not considered trusts under Treasury Regulations. Instead, Fideicomisos operate under the following conditions:

  • the trustee holds the legal title to the property but has no fiduciary duty to maintain the property
  • the beneficiary has the sole right to direct the trustee's actions in regards to the property
  • the beneficiary solely earns any and all income and proceeds generated by the property, as well as pays any taxes and liabilities.

Unlike U.S. common law trusts, fideicomisos do not require the trustee to bear a fiduciary duty to maintain the property for the beneficiary. Although the trustee holds legal title to the land, this is done solely to fulfill the requirements set by the Mexican Constitution.[8]In addition to this difference, the beneficiary also has direct control over the property, and the trustee has no capacity to act independently in regards to the property. For a U.S. common law trust, the trustee has sole authority of the property and can direct it regardless of the beneficiary's wishes.[9] Lastly, fideocomisos allow the beneficiary to be directly entitled to any and all income and proceeds generated by the property. The beneficiary is also charged with paying any and all taxes and liabilities regarding the property. U.S. common law trusts give the trustee the ability to receive income and proceeds generated by the property, and require them to pay all taxes and liabilities.[9][10][10]

Foreign Trust Filings

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Foreign trusts fall under IRC Section 6048 and direct taxpayers to which forms they must file for their foreign trusts. These forms being 3520 ("Annual Return to report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts") and 3520-A ("Annual Information Return of Foreign Trust With a U.S. Owner). However, if an arrangement is not classified as a trust, then IRC Section 6048 is not applicable, and neither forms require filing. Therefore, fideicomisos do not need to be filed under Section 6048 due to them not constituting a trust.

Taxpayers who do not file forms 3520 or 3520-A are not utilizing fideicomisos as tax avoidance devices either. IRC Section 6048's reporting rules were broadened in 1996 to implement IRC Section 679,[11] which was established in 1976[12] to prohibit U.S. taxpayers from deferring their U.S. income tax liabilities by relocating income-generating assets to trusts outside the U.S.[13] However, due to fideicomisos allowing the beneficiary to directly receive income from the property, this makes it impossible for the beneficiary to conceal this income. This income would be reported on their U.S. tax returns.

Tax Implications

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In January of 2012, international estate planning attorney, Amy P. Jetel, requested a Private letter ruling for one of her clients,[14] in which the IRS found that her client's beneficial interest in the fideicomiso was not reportable as a foreign trust. Shortly threafter, the IRS turned this holding into a Revenue Ruling upon which all taxpayers can rely.[15] This revenue ruling established that certain fideicomisos are not considered U.S. common law trusts, and therefore do not fall under the the reporting rules of IRC Section 6048.

References

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  1. ^ Constitución Politicca de los Estados Unidos Mexicanos (Political Constitution of the United Mexican States), Art. 27, Section 1.
  2. ^ Ley de Inversion Extranjera (Foreign Investment Law) Art. 2, Section IV; Art. 10
  3. ^ Ley de Inversion Extranjera (Foreign Investment Law) Art. 11
  4. ^ Austin Wakeman Scott, William Franklin Fratcher, and Mark L. Ascher, Scott and Ascher on Trusts, Vol. 1, Section 2.1.5, 37-38 (5th ed. Aspen 2005)
  5. ^ Austin Wakeman Scott, William Franklin Fratcher, and Mark L. Ascher, Scott and Ascher on Trusts, Vol. 1, Section 2.1.7, 39 (5th ed. Aspen 2005)
  6. ^ "26 CFR § 301.7701-4 - Trusts".
  7. ^ Revenue Ruling 92-105, 1992-2 C.B. 204.
  8. ^ Jetel, A. P. (2009, November). Stop the Panic! Fideicomisos. Pacific Pearl, 6.
  9. ^ a b Jetel, A. P. (2013, February). Do you need to report your real estate fideicomiso as a Foreign Trust? The IRS told one taxpayer: No! Puerto Vallarta City Paper, 23.
  10. ^ a b Jetel, A. P. (2012, November). Fideicomisos: Clarity at Last? A recent private letter ruling provides guidance on foreign trust reporting requirements. Trusts & Estates, Special Report: The International Practice, 59–62.
  11. ^ P.L 104-188 (Small Business Job Protection Act of 1996).
  12. ^ P.L. 94-455 (Tax Reform Act of 1976).
  13. ^ See Committee report on P.L. 94-55; see also Notice 97-34, 1997-1 C.B. 422 ("One of the purposes of the reporting requirements in Section 6048(a) is to ensure that U.S. transferors comply with Section 679.
  14. ^ PLR 210245003
  15. ^ Rev. Rul. 2013-2014
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