Is the Mexican Land Trust (“Fideicomiso”) Subject to U.S. Taxation?
How About Other Arrangements with Foreign Trustees with U.S. Beneficiaries?
Written By: Coleman Jackson, P.C.
Immigration & Tax Law Firm
Firm Site www.cjacksonlaw.com
Date: June 27, 2013 at 2:36PM
A Mexican Land Trust is commonly referred to as the ‘fideicomiso’. What is a fideicomiso? Well in short, a Mexican Land Trust is how non-Mexican persons hold residential real property located in restricted zones in Mexico. By the constitutional laws of Mexico, non-Mexican persons cannot directly own residential real property in “restricted zones” of Mexico. Therefore many foreign nationals hold residential real property in Mexican Land Trust or ‘fideicomiso’.
There is a potential tax reporting requirement triggered whenever persons residing in the United States invest in businesses or other forms of assets in a foreign country. Because, as a general rule, United States Citizens and Legal Permanent Residence must file an annual report to the U.S. States Treasury to report transactions with foreign trusts and receipts of certain foreign gifts. Failure to do so could subject the nondisclosures to a $10,000 penalty for each occasion. These and other tax laws potentially places a tax filing duty on any U.S. person with offshore assets, such as ownership in offshore trusts. You should consult an offshore assets lawyer to discuss your interest in foreign trusts or interest in other offshore assets. U.S. laws such as the Foreign Account Tax Compliance Act (FATCA) and the Foreign Bank Account Report (FBAR) could apply, also, with respect to ownership of offshore assets. We don’t address those rules at all in this paper. Follow our tax and immigration law firm’s blog because, in it, we discuss various immigration and tax issues throughout the year that could be of interest to permanent resident immigrants as well as U.S. citizens.
This particular discussion is limited to situations described in a recent Revenue Ruling (Rev. Rul. 2013-14). The question addressed in that ruling was whether the fideicomiso or Mexican Land Trust arrangement (“MLT”) are considered a trust under Treasury Regulation §301.7701-4(a).
In particulars, Treasury Regulation §301.7701-4(a) says the following:
§ 301.7701–4 Trusts.
(a) Ordinary trusts. In general, the term ‘‘trust’’ as used in the Internal Revenue Code refers to an arrangement created either by a will or by an inter vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries under the ordinary rules applied in chancery or probate courts. Usually the beneficiaries of such a trust do no more than accept the benefits thereof and are not the voluntary planners or creators of the trust arrangement. However, the beneficiaries of such a trust may be the persons who create it and it will be recognized as a trust under the Internal Revenue Code if it was created for the purpose of protecting or conserving the trust property for beneficiaries who stand in the same relation to the trust as they would if the trust had been created by others for them. Generally speaking, an arrangement will be treated as a trust under the Internal Revenue Code if it can be shown that the purpose of the arrangement is to vest in trustees responsibility for the protection and conservation of property for beneficiaries who cannot share in the discharge of this responsibility and, therefore, are not associates in a joint enterprise for the conduct of business for profit.
(b) Business trusts. There are other arrangements which are known as trusts because the legal
Title to property is conveyed to trustees for the benefit of beneficiaries, but which are not classified as trusts for purposes of the Internal Revenue Code because they are not simply arrangements to protect or conserve the property for the beneficiaries. These trusts, which are often known as business or commercial trusts, generally are created by the beneficiaries simply as a device to carry on a profit making business which normally would have been carried on through business organizations that are classified as corporations or partnerships under the Internal Revenue Code.
However, the fact that the corpus of the trust is not supplied by the beneficiaries is not sufficient reason in itself for classifying the arrangement an ordinary trust rather than as an association or partnership.
The fact that any organization is technically cast in the trust form, by conveying title to property to trustees for the benefit of persons designated as beneficiaries, will not change the real character of the organization if the organization is more properly classified as a business entity under § 301.7701–2.
(c) Certain investment trusts – (1) An “investment” trust will not be classified as a trust if there is owner under the trust agreement to vary the investment of the certificate holders.
See Commissioner v. North American Bond Trust, 122 F. 2d 545 (2d Cir. 1941), cert. denied, 314 U.S. 701 (1942). An investment trust with a single class of ownership interests, representing Undivided beneficial interests in the assets of the trust, will be classified as a trust if there is no power under the trust agreement to vary the investment of the certificate holders.
An investment trust with multiple classes of ownership interests ordinarily will be classified as a business entity under § 301.7701–2; however, an investment trust with multiple classes of ownership interests, in which there is no power under the trust agreement to vary the investment of the certificate holders, will be classified as a trust if the trust is formed to facilitate direct investment in the assets of the trust and the existence of multiple classes of ownership interests is incidental to that purpose.
The above rules could possibly apply to U.S. persons with offshore assets or trust interest in India, China, Korea, and Ethiopia, Spain and Columbia, Italy or any other foreign country. Consult an offshore assets attorney with regards to particular questions about your foreign trust or other offshore assets. We limit our discussion to the situations described in Rev. Rul. 2013-14 as it relates to the fideicomiso or Mexican Land Trust arrangement (“MLT”) as it relates to the application of Treasury Regulation §301.7701-4(a). This discussion is an academic discussion with regards to the application of Treasury Regulation §301.7701-4(a) to the MLT. The situations described are hypothetical and has no basis in real facts. This discussion is not intended to be legal advice, tax advice or any other form of advice with regards to any particular taxpayer or person. You should consult a tax advisor or tax attorney for any particular applications of these or any other laws or rules.
Now, what did Rev. Rul. 2013-14 say concerning the fideicomiso and the application of Treasury Regulation §301.7701-4(a)?
Dallas, a U.S. citizen, is the sole owner of Alejandro Ranchero, a limited liability company organized under the laws of Texas in the United States. Alejandro Ranchero is disregarded as an entity separate from its owner under §301.7701-2(a) (a disregarded entity). Dallas, through Alejandro Ranchero, wanted to purchase Blanca Marco Ranchero. Blanca Marco Ranchero is Mexican residential real property located in a restricted zone. Neither Dallas nor Alejandro Ranchero may hold title directly to Blanca Marco Ranchero under Mexican law.
Dallas obtained a permit from the Mexican Ministry of Foreign Affairs and signed an MLT agreement with Banco Azteca, a Mexican bank. Alejandro Ranchero negotiated the purchase of Blanca Marco Ranchero directly with the seller of the property and paid the seller directly. The seller had no interactions with Banco Azteca. At the settlement, legal title to Blanca Marco Ranchero was transferred from the seller to Alejandro Ranchero, subject to the MLT agreement, as of the date of sale. No property other Blanca Marco Ranchero is subject to the MLT agreement.
Under the terms of the MLT agreement, Alejandro Ranchero has the right to sell Blanca Marco Ranchero without the permission of Banco Azteca. Further Banco Azteca must grant security interest in Blanca Marco Ranchero to a third party, such as a mortgage lender, if Alejandro Ranchero so requests. Alejandro Ranchero is directly responsible for the payment of all liabilities relating to Blanca Marco Ranchero. Alejandro Ranchero must pay any taxes due in Mexico with respect to Blanca Marco Ranchero directly to the Mexican taxing authority. Alejandro Ranchero has the exclusive right to possess Blanca Marco Ranchero and to make any desired modifications, limited only by the need to obtain the proper licenses and permits in Mexico. If Blanca Marco Ranchero is occasionally leased, Alejandro Ranchero directly receives the rental income and Dallas, as the owner of Alejandro Ranchero, reports the income on Dallas’ U.S. federal income tax return.
Although Banco Azteca is identified as a fiduciary in the MLT agreement, it disclaims all responsibility for Blanca Marco Ranchero, including obtaining clear title. Banco Azteca has no duty to defend or maintain Blanca Marco Ranchero. Banco Azteca collects a nominal annual fee from Alejandro Ranchero. There is no other agreement or arrangement between or among Dallas, Alejandro Ranchero, Banco Azteca, or a third party that would cause the overall relationship to be classified as a partnership (or any other type of entity) for U.S. federal income tax purposes.
Rev. Rul. 2013-14 says the situation described in Situation 1 is not a trust subject to taxation under §301.7701-4(a) because:
- Banco Azteca’s only duties under the MLT arrangement are –
- Hold legal title,
- Transfer legal title at direction of Dallas
- Dallas retains the right to manage and control Blanca Marco Ranchero,
- Dallas has the right to collect all rents on Blanca Marco Ranchero,
- Dallas has the obligation to pay directly any taxes,
- Dallas has the obligation to pay directly any liabilities due with respect to Blanca Marco Ranchero,
- Blanca Marco is treated as a disregarded entity under U.S. tax laws,
- Dallas is treated as the owner of Blanca Marco Ranchero under U.S. tax laws.
The only differences in the facts are that Blanca Marco Ranchero is organized under the corporation laws of the state of Texas.
The MLT arrangement is not a trust, and the analysis is the same as in Situation 1 except that, because Alejandro Ranchero is treated as a corporation under §301.7701-2(a), Alejandro Ranchero is treated as the owner of Blanco Marco Ranchero. If income is earned, Alejandro Ranchero reports such rental income on its corporate tax return assuming no Subchapter S selections have been made. If an S selection has been made, the shareholders would report their share of the income or losses associated with the corporation.
The only differences in the facts as described in Situation 1 are:
- Dallas deals directly with Banco Azteca and does not use any other entity or party,
- Dallas obtains the permit from the Mexican Ministry of Foreign Affairs,
- Dallas signs the MLT arrangement directly with Banco Azteca,
- Dallas negotiates the residential property purchase,
- Dallas receives all rental income received from the rental of Blanca Marco Ranchero,
- There are no partnerships, joint venture, or any other form of arrangements between Dallas and anyone relating to the residential property that would subject the entity to Subchapter K of the Internal Revenue Code.
- Other than the changes 1 through 6, the facts are exactly as they were in Situation 1
Because Banco Azteca’s only duties under the MLT agreement are to hold the legal title to Blanca Marco Ranchero and transfer title at the direction of Dallas, the MLT is not a trust. Dallas retains the right to manage and control Blanca Marco Ranchero. Dallas has the right to collect any rent on Blanca Marco Ranchero. In addition, Dallas has the obligation to pay directly any taxes and other liabilities due with respect to Blanca Marco Ranchero. Accordingly, Dallas is treated as the owner of Blanca Marco Ranchero.
The MLT agreement is the same as Situation 1, but now, in addition to holding the title to Blanca Marco Ranchero, Blanco Azteca is required to collect all rents and pay all expenses associated with maintenance and upkeep of the property.
In Situation 4, the MLT arrangement is considered a trust within the meaning of §301.7701-2(a) because Rev. Rul. 2013-14 says that if Banco Azteca perform any services other than holding legal title to Blanca Marco Ranchero, the MTL arrangement would create tax responsibilities pursuant to the applicable provisions of the Internal Revenue Code as determinable by its federal tax classification.
The MLT agreement is the same as Situation 1, but in this instance, in addition to holding the title to Blanca Marco Ranchero, Blanca Azteca is permitted, but not required to collect the rents and pay the expenses associated with maintenance and upkeep of the property. But Blanca Marco Ranchero is permitted to hire a property management company to perform these duties.
In Situation 5, Rev. Rul. 2013-14 does not apply because Banco Azteca is permitted to collect rental income on Blanca Marco Ranchero; therefore the MLT arrangement creates tax responsibilities under the appropriate provisions of the Internal Revenue Code.
The MLT agreement is the same as Situation 1, but in this instance, Blanca Marco Ranchero is owned by a partnership between Dallas and a non-banking division of Banco Azteca. Banco Azteca holds title to Blanca Marco Ranchero and several other assets for the partnership.
In Situation 6, there is a partnership that holds several different assets; in which case, Rev. Rul. 2013-14 is not applicable. In this situation the rules of §§301.7701-1 through 301.7701-4 will determine the federal tax classification of the MLT arrangement.
In Situation 7, all of the facts remain the same as Situation 1, except:
1.The country where the property is located is India and we assuming for analysis sake that India law likewise prohibit non-Indian persons from directly owning real property in certain areas of India, and
2.We are assuming India has a similar regulatory scheme as Mexico as far as “Ministry of Foreign Affairs”.
In Situation 7, the rules set out in Rev. Rul. 2013-14 would not be applicable because the ruling answers the question, “Is the fideicomiso or Mexican Land Trust arrangement (“MLT”) a trust under Treasury Regulation 301.7701-4. Therefore, factual situations which create (foreign) trustee and U.S. person (beneficiary) situations must be carefully examined under all of the appropriate tax laws.
COLEMAN JACKSON, P.C.
Professional Legal Services Corporation
Immigration & Tax Law Firm
6060 North Central Expressway
Dallas, Texas 75206.
Office Phone: (214) 599-0431
Firm Site: www.cjacksonlaw.com