Is a U.S. REIT that is more than 50%-owned by publicly traded foreign REIT-type entities a 'captive REIT' under Illinois law, requiring it to add back its federal dividends-paid deduction?

Subject

Captive Real Estate Investment

Plain-English summary

The Illinois Department of Revenue ruled that a U.S. real estate investment trust (REIT), taxable as part of an Illinois combined group, is not a "captive REIT" under Illinois law -- even though it is majority-owned by non-U.S. entities -- because those foreign owners satisfied all five criteria of the statutory exception.

Illinois, like a number of other states, taxes "captive REITs" differently from ordinary REITs: a captive REIT must add back the federal dividends-paid deduction under 35 ILCS 5/203(b)(2)(E-15), which erases the tax benefit a REIT normally gets from distributing its income to shareholders. A REIT is captive if its shares aren't regularly traded on an established securities market and more than 50% of it is owned (by vote or value), directly, indirectly, or constructively, by a single corporation -- unless one of several statutory exceptions applies.

Here, the taxpayer (a U.S. REIT holding Illinois real estate through partnership interests) was owned, in a chain, by a U.S. entity ("COMPANY1") that in turn was owned by a Dutch REIT-type entity ("COMPANY2"). COMPANY2's Class A shares traded on non-U.S. securities markets, and its Class B shares (about 40% of COMPANY2) were held by a French REIT-type entity ("COMPANY3") as part of a "stapled securities" arrangement -- COMPANY3's own publicly traded shares were stapled to COMPANY2's Class A shares. Neither COMPANY2 nor COMPANY3 was itself majority-owned by any single shareholder, since their organizing documents capped any single shareholder's interest at a stated low percentage.

Illinois law (35 ILCS 5/1501(a)(1.5)(B)(i)(e)) excludes a REIT from captive status if it is more than 50%-owned by a qualifying foreign entity that meets five tests: (1) at least 75% of the foreign entity's assets are real estate assets, cash, or U.S. government securities; (2) the foreign entity isn't taxed on amounts distributed to its owners (or is exempt from entity-level tax); (3) it distributes at least 85% of its taxable income annually; (4) its shares are either regularly traded on an established securities market, or no single holder controls more than 10% of it; and (5) it's organized in a country with a U.S. tax treaty. The taxpayer represented, and the Department accepted, that COMPANY2 and COMPANY3 each met all five criteria -- including that COMPANY2's stapled-security structure with COMPANY3 counted as "regularly traded on an established securities market" for purposes of criterion (4), even though COMPANY3 separately held a 40% stake in COMPANY2's non-publicly-traded Class B shares.

Based on these representations, the Department ruled the taxpayer is not a captive REIT, and that conclusion extends to the members of the taxpayer's Illinois combined group that the taxpayer owns more than 50%.

What this means for you

REITs with foreign parent structures

If your REIT is more than 50%-owned by a foreign entity, you are not automatically a "captive REIT" subject to the federal-dividends-paid-deduction addback under 35 ILCS 5/203(b)(2)(E-15) -- but you must be able to show your foreign owner independently satisfies all five criteria in 35 ILCS 5/1501(a)(1.5)(B)(i)(e): sufficient real estate asset concentration, no (or exempt) entity-level tax, at least 85% annual income distribution, either public trading or no single holder above 10%, and organization in a tax-treaty country. A "stapled securities" arrangement between two foreign REIT-type entities can satisfy the public-trading prong, based on this ruling's facts, even where one of the stapled entities separately owns a non-traded minority class of the other's stock.

Combined groups with a REIT member

Where a REIT is not a captive REIT because of a qualifying foreign owner, that conclusion can carry through to other members of the same Illinois combined group that the REIT itself owns more than 50% -- so the analysis isn't limited to the REIT that requested the ruling.

Structuring caution

The Department noted approvingly that the taxpayer's ownership structure "was not related to any tax planning or tax avoidance" but was established for legitimate business reasons -- to let foreign investors invest in U.S. real estate. Businesses relying on similar structures should be prepared to document the non-tax business purpose, since the ruling's facts and analysis specifically address that point.

Common questions

Q: What makes a REIT a "captive REIT" under Illinois law in the first place?
A: Under 35 ILCS 5/1501(a)(1.5)(A), a captive REIT is a REIT (as defined in IRC Section 856) whose shares are not regularly traded on an established securities market and which is more than 50% owned (by vote or value), directly, indirectly, or constructively, by a single corporation during the last half of the taxable year.

Q: Why does captive REIT status matter for taxes?
A: A captive REIT must add back the federal dividends-paid deduction for Illinois purposes under 35 ILCS 5/203(b)(2)(E-15) -- eliminating the tax benefit that lets ordinary REITs avoid entity-level tax on income they distribute to shareholders.

Q: Can a foreign parent's ownership still keep a REIT out of "captive" status?
A: Yes -- if the foreign entity is organized outside U.S. law and satisfies all five criteria in 35 ILCS 5/1501(a)(1.5)(B)(i)(e)(1)-(5): (1) at least 75% real estate/cash/U.S. government securities asset concentration, (2) no entity-level tax on distributed amounts, (3) at least 85% annual distribution of taxable income, (4) public trading or no single holder above 10%, and (5) organization in a U.S. tax-treaty country.

Q: Does a "stapled securities" structure count as being "regularly traded on an established securities market"?
A: In this ruling, the Department accepted that it did: COMPANY3's publicly traded shares were stapled to COMPANY2's Class A shares, and the Department treated COMPANY2's shares as regularly traded on an established securities market for purposes of the fourth criterion, even though COMPANY3 also held a separate, non-traded 40% Class B stake in COMPANY2.

Q: Does this ruling apply to any other taxpayer?
A: No. As a Private Letter Ruling issued under 2 Ill. Adm. Code 1200.110, it binds the Department only as to the taxpayer that requested it (and the members of its Illinois combined group), and only to the extent the facts recited are correct and complete. The ruling states it binds the Department for the taxable year ending December 31, 20XX and subsequent years, subject to review of the underlying facts and to 2 Ill. Adm. Code 1200.110(d) and (e), and it ceases to bind the Department if there is a pertinent change in statutory law, case law, rules, or the material facts recited.

Q: Was the taxpayer under audit or in litigation when it requested this ruling?
A: The ruling doesn't say the taxpayer was under audit; rather, issuance was conditioned on the taxpayer and its combined-group members not being currently under audit or involved in litigation concerning the issues in the ruling request, and the taxpayer represented that the Department had not previously ruled on the same or a similar issue for it or a predecessor.

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2020.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2020/it20-0001-plr.pdf

Original ruling text

IT 20-0001-PLR 01/24/2020 CAPTIVE REAL ESTATE INVESTMENT
REIT More Than 50%-Owned by Publicly Traded Foreign REIT is not Captive
REIT (This is a PLR.)

January 24, 2020

Re:

Request for Private Letter Ruling

Dear Mr. Xxxx:
This is in response to your letter dated February 15, 2019 in which you request a
Private Letter Ruling on behalf of COMPANY and members of its Illinois combined
group. Review of your request for a Private Letter Ruling indicates that all information
described in paragraphs 1 through 8 of subsection (b) of 2 Ill. Adm. Code 1200.110 is
contained in your request. This Private Letter Ruling will bind the Department only with
respect to COMPANY. and the members of its Illinois combined group. Issuance of this
ruling is conditioned upon the understanding that COMPANY. and/or any related
taxpayer(s) is not currently under audit or involved in litigation concerning the issues
that are the subject of this ruling request.
The facts and analysis as you have presented states as follows:
AGENT, as authorized agent for COMPANY. (“COMPANY” “Company” or
“taxpayer”) requests a Private Letter Ruling as to whether its foreign parents
meet the Illinois statutory requirements under Illinois Income Tax Act Section
(“IITA”) 1501(a)(1.5) and none of its U.S. subsidiaries, for Illinois corporate and
replacement tax, would be deemed a “captive Real Estate Investment Trust”
(“REIT”).
In accordance with 2 Ill. Adm. Code Section 1200.110(b)(3), the subject of this
request is not being examined as part of an audit by the Illinois Department of
Revenue (“Department”).
In accordance with 2 Ill. Adm. Code 1200.110(b)(4), to the best of the taxpayer
and the taxpayer’s representative’s knowledge, the Department has not
previously ruled on the same or a similar issue for the taxpayer or a predecessor.
In addition, neither the taxpayer nor its representatives have previously submitted
the same or a similar issue to the Department and withdrew it before a letter
ruling was issued.
The ruling is requested for tax years ended on or after December 31, 20XX.
For purposes of this request, COMPANY includes itself and all of its affiliates
included in its combined Illinois income tax return. COMPANY is submitting this

IT 20-0001-PLR
Page 2
Private Letter Ruling request in accordance with 2 Ill. Adm. Code Section
1200.110(a)(3)(A)(ii), which permits one ruling request by a member of a unitary
group with reference to issues common to it and other members of the unitary
group. COMPANY has a calendar year ending December 31st.
COMPANY is a U.S. REIT as defined in Internal Revenue Code (“IRC”) Section

856. COMPANY owns directly or indirectly partnership interests which holds
     property located in Illinois. Included in the COMPANY Illinois unitary return is a
     U.S. Incorporated entity (“COMPANY1”) that is current not a REIT but intends to
     elect REIT status for federal income tax purposes sometime in the next few
     years.
     COMPANY is not regularly traded on an established securities market. Currently,
     COMPANY is owned %% by COMPANY1 which in turn is owned %% by a
     COMPANY2 (“COMPANY2”). The other %% of COMPANY is directly owned by
     a COMPANY3 (“COMPANY3.”). COMPANY2 and COMPANY3 are stapled
     securities comprised on COMPANY3 shares and the COMPANY2 Class A
     Shares, which are traded on non-U.S. established securities markets and
     COMPANY2’s Class B Shares that are owned by COMPANY3. COMPANY1
     does not conduct a trade or business and does not own any other assets apart
     from its ownership interest in COMPANY.
     COMPANY1 is not regularly traded on an established securities market.
     COMPANY1 is owned %% by COMPANY2 which is an entity organized by the
     laws of the COUNTRY, which has a tax treaty with the United States.
     COMPANY2 operates a Dutch version of a U.S. REIT.
     COMPANY2 assets consist nearly exclusively of its ownership interest in
     COMPANY1 whose most significant is COMPANY’s stock, which is a U.S. REIT.
     Over %% of COMPANY2’s total asset value at the end of its taxable year consist
     of COMPANY1, which would qualify as a real estate asset under IRC Section
     856(c)(5)(B). Further, COMPANY2 is not taxed on amounts distributed to
     COMPANY2’s beneficial owners and COMPANY2 does not pay tax in the
     COUNTRY. In addition, COMPANY3 calculates taxable income according to
     Dutch law and distributes over %% of its taxable income to its shareholders.
     COMPANY2 has two classes of stock: Class A and Class B. Its Class A stock is
     regularly traded on established securities markets. Its Class B stock is owned by
     COMPANY3, which operates the French version of a U.S. REIT. COMPANY3’s
     ownership of COMPANY2’s Class B stock represents a 40 percent ownership
     interest in COMPANYB. Class B shares are substantially identical to the Class A
     shares held by the public. Class B shares are convertible 1 for 1 for Class A
     shares. Class B shares have substantially identical voting rights as Class A
     shares. Class B shares have the same rights to any distribution and liquidation
     proceeds as the Class A shares.

IT 20-0001-PLR
Page 3
The purpose of COMPANY2’s Class B stock is to meet French banking law
requirements so that COMPANY3 can provide guarantees to COMPANY2 and
COMPANY2 can be consolidated with COMPANY3 for financial statement
purposes.
Although COMPANY3 owns a %% percent ownership interest in COMPANY2
and COMPANY3’s articles of formation inhibit a single shareholder from owning
more than % percent in the stapled entities. The purpose of this organizational
structure was not related to any tax planning or tax avoidance. Rather, it was
established as a legitimate structure for good and valid business reasons to allow
foreign investors to invest in U.S. real estate.
COMPANY requests the Department to issue a ruling that COMPANY2 and
COMPANY3 meet all the statutory requirements under IITA Section 1501(a)(1.5)
and for Illinois corporation income and replacement tax purposes, none of its
U.S. subsidiaries will be deemed a captive REIT.
While most states conform to IRC Section 856, some states including Illinois
have enacted captive REIT legislation. The purpose behind captive REIT state
legislation was to prevent corporations from income tax planning which would
allow a corporation to avoid paying state income tax from its own real estate
holdings. Illinois enacted IITA Section 203(b)(2)(E-15) which requires captive
REITs to addback the federal dividends paid deduction for Illinois purposes.
Illinois, like many states that have similar provisions, provides for a definition of
what constitutes a captive REIT.
IITA Section 1501(a)(1.5)(B)(i)(e)(1)-(5) provides that a captive real estate
investment trust does not include a REIT of which more than 50% of the voting
power or value of the beneficial interest or shares is owned or controlled, directly,
indirectly, or constructively, by an entity that is organized outside the laws of the
U.S. provided that such foreign entity satisfies 5 stated criteria. Listed below are
the five stated criteria and how the taxpayer maintains that its ultimate foreign
parent meets the Illinois statutory requirements and the taxpayer and its U.S.
parent should not be classified as captive REITs.
IITA Section 1501(a)(1.5)(B)(i)(e)(1) states that at least 75% of the entity’s total
asset value at the close of its taxable year is represented by real estate assets
(as defined under IRC Section 856(c)(5)(B), thereby including shares or
certificates of beneficial interest in any real estate investment trust), cash and
cash equivalents and U.S. Government securities.
While Dutch REITs are permitted to invest in passive, portfolio investments which
include investing in real estate but are not restricted to real estate, the assets in
COMPANY2 consist nearly exclusively of its ownership of COMPANY1 whose
only asset is the stock of the taxpayer.

IT 20-0001-PLR
Page 4
Over %% of COMPANY3’s asset value consists of investments in real estate and
real estate subsidiaries, including COMPANY2 and COMPANY1.
Taxpayer maintains that COMPANY2 and COMPANY3 meet the first criteria
because over %% of their total asset value are represented by real estate assets
as defined in Section 856.
IITA Section 1501(a)(1.5)(B)(i)(e)(2) states that the entity is not subject to tax on
amounts that are distributed to its beneficial owners or is exempt from entity-level
taxation.
The COUNTRY tax rate on Dutch REITs is zero percent. While COUNTRY does
not have a formal exemption, the amounts distributed to its beneficial owners are
not taxed.
COMPANY3 is not taxed on amounts that it distributes to its beneficial owners
and is exempt from entity-level tax on its passive real estate investment income.
Taxpayer maintains that COMPANY2 and COMPANY3 meet the second criteria
of the Illinois statute that requires no entity level tax.
IITA Section 1501(a)(1.5)(B)(i)(e)(3) states that the entity distributes at least 85%
of its taxable income (as computed in the jurisdiction in which it is organized) to
the holders of its shares or certificates of beneficial interest on an annual basis.
Dutch REITs are required to distribute 100% of its taxable income. It is
interesting to note that Dutch regulations allow capital gains to be removed from
taxable income and added to a reinvestment reserve.
Since the capital gain would not be a part of taxable income, the Dutch REIT
regulations which requires a distribution of 100% of taxable income would meet
the third criteria as the distribution exceeds the state threshold of 85%.
COMPANY3 distributes at least %% of its taxable income to its public
shareholders.
Both COMPANY2 and COMPANY3 meet the third criteria of the Illinois statute.
IITA Section 1501(1.5)(B)(i)(e)(4) states that either (i) the shares or beneficial
interests of the entity are regularly traded on an established securities market or
(ii) not more than 10% of the voting power or value in the entity is held, directly,
indirectly, or constructively, by a single entity or individual.
As previously stated, the French and Dutch REITs are stapled entities with
stapled securities comprised of the French REIT’s shares and the Class A
Shares of the Dutch REIT, which are traded on non-US established securities

IT 20-0001-PLR
Page 5
market. Taxpayer believes that clause (i) has been met despite the fact that the
French REIT owns a class of the Dutch REIT’s shares representing
approximately a 40% interest in the Dutch REIT (the Class B shares) which are
not traded on an established securities market. The purpose of the Class B
shares is to meet French banking regulations to allow the French REIT to provide
guarantees to the Dutch REIT and to allow the Dutch REIT to consolidate with
the French REIT for financial statement purposes. The taxpayer does not believe
that this should impact its ability to meet the criteria of 4(i), as the state does not
reference whether or not all different classes of shares must be traded on an
established securities market.
In addition, taxpayer believes that they meet the condition of 4(ii). The articles of
incorporation of the taxpayer’s French and Dutch REITs are written to inhibit a
single shareholder to own more than 10% in the stapled entities. While the
French REIT owns 40% of the stock of the Dutch REIT, the French REIT is
ultimately traded on an established securities market as a stapled entity and not
one shareholder owns greater than 10% of the stock.
The taxpayer maintains that COMPANY2 and COMPANY3 meet the fourth
criteria of the Illinois statute.
IITA Section 1501(1.5)(B)(i)(e)(5) states that the entity is organized in a country
that has entered into a tax treaty with the United States.
The U.S. has a tax treaty with the COUNTRY and COUNTRY1. Taxpayer
maintains that COMPANY2 and COMPANY3 meet the final statutory requirement
that the country of the foreign REIT have a tax treaty with the U.S.
As a result of COMPANY2 and COMPANY2 meeting all the requirements of IITA
Section 1501(a)(1.5)(B)(i)(e)(1)-(5), COMPANY1 nor the taxpayer should be
classified as captive REITs for Illinois corporation income and replacement tax
purposes.

RULING
Section 1501(a)(1.5)(A) of the Illinois Income Tax Act (“IITA” ; 35 ILCS 5/1501) defines
the term “captive real estate investment trust” to mean a real estate investment trust
(REIT) as defined under Section 856 of the Internal Revenue Code, the shares or
beneficial interests of which are not regularly traded on an established securities
market, and which is more than 50% owned (by vote or value) at any time during the
last half of the taxable year, directly, indirectly, or constructively, by a single corporation.
However, subparagraph (B) of such section provides:
(B) The term “captive real estate investment trust” does not include:

IT 20-0001-PLR
Page 6
(i) a real estate investment trust of which more than 50% of the voting
power or value of the beneficial interest or shares is owned or controlled,
directly, indirectly, or constructively, by:
(a) a real estate investment trust, other than a captive real estate
investment trust;
…
(e) an entity that is organized outside of the laws of the United
States and that satisfies all of the following criteria:
(1) at least 75% of the entity's total asset value at the close
of its taxable year is represented by real estate assets (as
defined in Section 856(c)(5)(B) of the Internal Revenue
Code, thereby including shares or certificates of beneficial
interest in any real estate investment trust), cash and cash
equivalents, and U.S. Government securities;
(2) the entity is not subject to tax on amounts that are
distributed to its beneficial owners or is exempt from entitylevel taxation;
(3) the entity distributes at least 85% of its taxable income
(as computed in the jurisdiction in which it is organized) to
the holders of its shares or certificates of beneficial interest
on an annual basis;
(4) either (i) the shares or beneficial interests of the entity
are regularly traded on an established securities market or
(ii) not more than 10% of the voting power or value in the
entity is held, directly, indirectly, or constructively, by a single
entity or individual; and
(5) the entity is organized in a country that has entered into a
tax treaty with the United States.

Section 318(a)(2)(c) of the Internal Revenue Code, regarding constructive ownership of
stock, provides:
If 50 percent or more in value of the stock in a corporation is owned, directly or
indirectly, by or for any person, such person shall be considered as owning the
stock owned, directly or indirectly, by or for such corporation, in that proportion

IT 20-0001-PLR
Page 7
which the value of the stock which such person so owns bears to the value of all
the stock in such corporation.
Your letter represents that %% of the outstanding shares of Taxpayer, a REIT, are
owned by COMPANY1., and that %% of the outstanding shares of COMPANY1. are
owned by COMPANY2. Accordingly, COMPANY2 constructively owns %% of the
outstanding shares of Taxpayer.
Regarding COMPANY2, your letter represents as follows:
(1) over %% of COMPANY2’s total asset value at the close of its taxable year is
represented by real estate assets (as defined in Section 856(c)(5)(B) of the
Internal Revenue Code);
(2) COMPANY2 is not subject to tax on amounts that are distributed to its
beneficial owners or is exempt from entity-level taxation;
(3) COMPANY2 distributes at least %% of its taxable income. as computed in the
jurisdiction in which it is organized (COUNTRY), to the holders of its shares on
an annual basis;
(4) the shares of COMPANY2 are regularly traded on an established securities
market;
(5) COMPANY2 is organized in a country (COUNTRY) that has entered into a tax
treaty with the United States.
Regarding item (4) above, you indicate that COMPANY2 has two classes of stock
outstanding. Class A shares, which represent %% of the ownership interest, and Class
B shares, which represent %% of the ownership interest. The Class A shares are
regularly traded on an established securities market. All of the Class B shares, which
are not publicly traded, are owned by COMPANY3. Your letter represents that
COMPANY3 also meets items (1)-(5) specified above. In addition, the shares of
COMPANY3, which are regularly traded on an established securities market, are
stapled securities with the Class A shares of COMPANY2. Accordingly, the shares of
COMPANY2 are regularly traded on an established securities market for purposes of
IITA Section 1501(a)(1.5)(B)(i)(e)(4). Your letter further represents that this
organizational structure was not related to tax planning or tax avoidance purposes.
Based on the representations made in your letter, Taxpayer is not a captive real estate
investment trust pursuant to IITA Section 1501(a)(1.5)(B)(i). It follows that members of
Taxpayer’s combined group which are more than 50% owned or controlled by Taxpayer
are not captive real estate investment trusts.
Except as provided herein, this ruling shall bind the Department for the taxable year
ending December 31, 20XX and subsequent taxable years. The facts upon which this

IT 20-0001-PLR
Page 8
ruling is based are subject to review by the Department during the course of any audit,
investigation or hearing and this ruling shall bind the Department only if the material
facts as recited and incorporated in this ruling are correct and complete. This ruling shall
bind the Department for the taxable years specified above, except as limited pursuant to
2 Ill. Adm. Code 1200.110(d) and (e). In addition, this ruling will cease to bind the
Department if there is a pertinent change in statutory law, case law, rules or in the
material facts recited in this ruling.
Sincerely,

Brian L. Stocker
Chairman, PLR Committee (Income Tax)