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PATH Act Resolves Tax Uncertainty Foreign Investors in Mutual Funds

Last month, President Obama signed the Protecting Americans from Tax Hikes Act of 2015 (“PATH Act”) which included a provision to make permanent provisions eliminating the withholding of taxes on certain dividends paid by registered investment companies to foreign investors. As K&L Gates explains, “[f]or many years, the dividends paid by a RIC to non-U.S. investors were subject to the withholding tax on dividends even if the RIC’s own income was comprised of portfolio interest and short-term capital gain, which would have otherwise been exempt from withholding tax if received directly by the non-U.S. investor.”

In 2004, Congress passed a law that exempted from tax withholding the portion of dividends that were “interest-related dividends” and “short-term capital gain dividends,” as calculated by the investment company. However, the law included sunset dates, originally set to terminate for taxable years after 2007, but subsequently periodically extended, sometimes retroactively. K&L notes that “the uncertainty surrounding the duration of these provisions limited the opportunities for marketing U.S. income-oriented funds to non-U.S. investors based upon the benefits of the provisions.”

The PATH Act makes permanent the exemptions, which “remov[es] the historical tax disadvantages caused by U.S. withholding taxes, particularly for RICs whose income is sourced substantially from QII (e.g., RICs that invest their assets in U.S. government securities, which in many instances will likely be 100 percent exempt from withholding).”