International negotiations have given Canadian investors a reprieve from threatened higher costs of doing business in the United States commercial real estate market. On June 26, U.S. Treasury Secretary Scott Bessent called for punitive provisions to be removed from the tax bill that is progressing through debate stages in the U.S. Senate and House of Representatives.
Those provisions, contained in Section 899 of the massive bill, targeted corporations and individuals from countries deemed to have tax measures that are discriminatory to U.S. businesses. These are primarily defined as countries that levy a tax on digital services and/or have implemented the Organisation for Economic Co-operation and Development’s (OECD) undertaxed profits rule (UTPR) as part of a global minimum tax.
Senate leaders have now agreed to Bessent’s request. This sets aside earlier recommendations that would have exposed Canadian real estate companies and partnerships that have U.S. subsidiaries to a so-called super base erosion and anti-abuse tax (BEAT), reducing their ability to claim deductions on income earned in the United States, as a consequence of Canada’s digital services tax. Investors from a larger group of countries — including European Union members, the United Kingdom, Japan, South Korea, Australia and New Zealand — would have been subject to higher withholding tax rates on rents, interest and capital gains because their governments apply the UTPR.
“The current BEAT really only comes into play with quite large companies and large cross-border payments, like multinational car companies that are paying huge royalties to a German parent or something like that,” explains Jennifer Hanna, a senior counsel specializing in tax law with Borden Ladner Gervais LLP. “Super BEAT is basically the BEAT, but applied to a lot broader range of companies where the owners are in one of these designated countries that are on the naughty list.”
Bessent signalled that the U.S. administration had suspended its erstwhile naughty list in a June 26 posting on the social media platform, X. Section 899 had been characterized as more of a deal-making tactic than straight fiscal policy, and an agreement is expected with G7 countries and OECD members to address U.S. displeasure with the premise of the global minimum tax and related mechanisms for collecting it.
“At our last G7 Finance Ministers and Central Bank Governors meeting we agreed to work together to restore greater stability and predictability for the world economy. We welcome Secretary Bessent’s work to have Section 899 removed from consideration in the bill before Congress,” Canada’s Finance Minister, François-Phillippe Champagne, stated in his own follow-up X posting.
U.S. CRE industry opposes Section 899
Advocates for the U.S. commercial real estate industry also welcome the news since they had been lobbying against Section 899. Several prominent organizations — including the CRE Finance Council, NAIOP, National Association of Real Estate Investment Trusts (Nareit), International Council of Shopping Centers and National Multifamily Housing Council — sent a joint letter to Senate leaders earlier this month to warn the measures could discourage foreign investment, reduce access to capital, increase financing costs and saddle American borrowers with contractual penalties.
“A key reason foreign investors are attracted to U.S. commercial real estate is the stability and predictability of U.S. tax laws,” the June 12 correspondence states. “Due to the unique nature of Section 899 as a retaliatory tax, even in draft form, it is having a chilling effect on potential foreign investment in U.S. real estate. Foreign real estate investors are pausing or delaying potential investments due to this abrupt policy shift.”
It’s estimated that foreign investors have channelled USD $213 billion (CAD $290 billion) into the U.S. commercial real estate over the past five years, including USD $57 billion (CAD $77.5 billion) into multifamily housing. Beyond direct investment in real estate assets, the CRE Finance Council (CREFC), representing more than 420 member companies in the U.S. finance industry, voiced concern about the potential impact on foreign lenders and foreign investors in U.S. funds, including debt funds providing real estate financing.
Prior to Bessant’s new exhortation, the Senate had proposed a 5 per cent annual increase in the withholding tax rate for businesses and investors from the specified “offending foreign countries”, beginning in 2027, to take it up to a maximum of 15 per cent on top of the existing corporate tax rate. That would change the number-crunching on price for foreign investors’ acquisitions and inadvertently capture U.S. borrowers with foreign financing.
“CRE loans frequently include provisions in which the borrower contractually agrees to bear the risk of changes due to international tax law. For existing loans, any additional tax imposed under Section 899 would be the responsibility of the borrower, typically in the form of a gross-up payment to the foreign lender,” CREFC noted.
Foreseen Canadian fallout averted
Analysts on this side of the border also flagged potential issues for Canadian investors’ U.S. portfolios even if Canada wasn’t targeted for the higher withholding tax rate.
“This could reduce overall exit liquidity for certain deals, as fewer foreign buyers are likely to be present,” observes Mitch Strohminger, director of market analytics with the commercial real estate data provider, CoStar Group.
Meanwhile, the proposed super BEAT would create complications for cross-border financial arrangements that are now fairly common for Canadian real estate entities that have U.S. subsidiaries. For example, Hanna advises that it is often “tax-efficient” for a Canadian parent to finance the purchase of a U.S. asset with an interest-bearing loan to its subsidiary. The subsidiary could then deduct the interest payments from U.S. taxable income, while the interest payments to the Canadian parent may have a lesser tax impact here, particularly if they are made to a fund that has tax-exempt investors like pension funds.
“With super BEAT, for these really standard cross-border structures, you’d have to do a recalculation to see if the interest can be deducted on the U.S. side, and, if not, it would have to be restructured. You can’t have interest coming into Canada that’s not invested in the U.S.; that’s double tax,” Hanna says. “Also, if you’re paying your Canadian parent for management services, those amounts may not be deductible in the U.S.. Anything that would have been deductible in the U.S. could be affected by a super BEAT.”
For now, the threat appears to have abated. Once conjured, though, there are questions of whether it could cast lingering uncertainty over the U.S. market or, alternatively, augment Canada’s safe haven reputation.
“Canada has a somewhat unfriendly withholding tax regime for foreign investors when it comes to a sale. A non-resident may have to go through some certification and clearance processes,” Hanna says. “But, at the end of the day, if there’s a capital gain, the Canadian tax is 12.5 or 13 per cent, including the provincial rate, and many foreign investors will be able to get a credit for that.”
Strohminger suggests finding assets to buy to could be more of a challenge.
“Foreign investors who targeted the U.S. may, in some cases, look to Canada as an alternative, but our investible real estate universe is much smaller and is dominated by large domestic players. So the effect will likely be limited,” he muses.
