Update: June 7, 2013 - See IRS issues Rev. Rul. on Fideicomisos
Yesterday the I.R.S. released PLR 201245003, which concluded that a Mexican fideicomiso (or Mexican Land Trust) was not a trust for U.S. tax purposes. If a Mexican fideicomiso is not a trust, then it is not a foreign trust and no Form 3520 or 3520-A would need to be filed.
In the ruling, a U.S. corporation (“X”) was formed that was owned by a husband and wife (“A and B”). A and B caused X to purchase a condominium in Mexico. X signed a fideicomiso or Mexican Land Trust (“MLT”) agreement with a Mexican Bank (“Bank) and the public deed to the condominium was recorded in the name of the Bank.
The Mexican Federal Constitution prohibits non-Mexican citizens from owning real property located within 100 kilometers of Mexico’s inland borders or within 50 kilometers of its coastline. These areas are known as the “restricted zone” and only Mexican citizens (or Mexican corporations whose bylaws forbid the ownership of stock by non-Mexican citizens) are allowed to directly own real property within the restricted zone.
The condominium was located within the restricted zone. X, A, and B are not Mexican citizens and are thus prohibited from directly owning the condominium. Accordingly, in order for X to acquire the condominium, X was required to obtain a permit from the Mexican Ministry of Foreign Affairs and to purchase the beneficial interests in the MLT under which legal title to the condominium was held by the Bank, a Mexican bank.
A and B negotiated directly with the seller of the condominium regarding the terms of the sale, paid the seller directly, and had no interactions with the Bank. X has the unrestricted right to sell or mortgage the condominium and does not require the permission of the Bank to do either. X is directly responsible for all tax obligations and is required to pay any taxes due directly to the Mexican taxing authority. A and B, through X, have the exclusive right to possess the condominium and to make any desired modifications, limited only by the need to obtain the proper licenses and permits. If the condominium is leased, X directly receives the rental income and must pay taxes on the income. X represents that the condominium is not ordinarily leased and if it is leased in the future, the income will be reported on the appropriate U.S. federal income tax return. The Bank collects an annual fee and disclaims all responsibility for the condominium, including obtaining clear title, and has no duty to defend or maintain the condominium. As part of the arrangement, the Bank holds only legal title to the condominium. Accordingly, the Bank does not hold or accept cash or any other property under the MLT arrangement other than legal title to the condominium.
X sought, and received, a private letter ruling that its MLT agreement with Bank was not a trust for U.S. federal income tax purposes. The private letter ruling relied on Rev. Rul. 92-105. Under the facts of Rev. Rul. 92-105, a single taxpayer created an Illinois land trust and named a domestic corporation as trustee. Under the deed of trust, the taxpayer transferred legal and equitable title to real property to the trust, subject to the provisions of an accompanying land trust agreement. The land trust agreement provided that the taxpayer retained exclusive control of the management, operation, renting, and selling of the real property, together with an exclusive right to the earnings and proceeds from the real property. Under the agreement, the taxpayer was required to file all tax returns, pay all taxes, and satisfy any other liabilities with respect to the real property.
Rev. Rul. 92-105 concluded that, because the trustee’s only responsibility was to hold and transfer title at the direction of the taxpayer, a trust, as defined in Treas. Reg. §301.7701-4(a), was not established. Instead, the trustee was a mere agent for the holding and transfer of title to real property, and the taxpayer retained direct ownership of the real property for federal income tax purposes.
PLR 201245003 held that the above described fideicomiso was similar to an Illinois Land Trust. The sole purpose of the fideicomiso/MLT was to satisfy the Mexican Federal Constitution by vesting legal title to the property in the name of the trustee. The trustee’s sole responsibility for the property was to hold and transfer title at the exclusive direction of the taxpayer. The trustee had no duty and no right to defend, maintain, or manage the property.
The taxpayer retained sole authority to manage and control the property, the direct right to collect any rents or proceeds generated by the property, and the direct obligation to pay all taxes and liabilities related to the property.
The I.R.S. also noted that there was no arrangement between Bank, X, A, B or any other person to utilize the condominium in an activity for profit, such that ownership of the condominium could be classified as a business entity.
This ruling has broad implications for many taxpayers owning real estate in Mexico. Taxpayers for years have had questions about whether Mexican fideicomisos are trusts. Some of these taxpayers may have even entered into voluntary disclosure programs and paid significant penalties over the fear that they may be subject to various penalties. However, if a Mexican fideicomiso is not a trust, then it is not a foreign trust, and no Form 3520 or Form 3520-A would be required to be filed.
Of course, private letter rulings are directed only to the taxpayer requesting it and they may not be used or cited as precedent. However, Rev. Rul. 92-105 is a ruling on which taxpayers can rely and can cite as precedent. Because there can be huge penalties for failing to file Forms 3520 and 3520-A and because the terms of each fideicomiso will vary, taxpayers should be cautious in determining whether they need to file Forms 3520 and 3520-A for Mexican fideicomisos.