Treasury Issues Guidance on Passive Foreign Investment Companies

Summary

On July 11, 2019, the Department of the Treasury and the Internal Revenue Service (collectively, Treasury) issued proposed regulations under Sections 1291, 1297, and 1298 of the Internal Revenue Code regarding the determination of ownership in a passive foreign investment company within the meaning of Section 1297(a) (PFIC) and the treatment of certain income received or accrued by a foreign corporation and assets held by a foreign corporation for purposes of Section 1297. The regulations provide guidance regarding when a foreign corporation is a qualifying insurance corporation (QIC) under Section 1297(f) and the amounts of income and assets that a QIC excludes from passive income and assets pursuant to Section 1297(b)(2)(B) (PFIC Insurance Exception) for purposes of Section 1297(a). The regulations also clarify the application and scope of certain rules that determine whether a U.S. person that directly or indirectly holds stock in a PFIC is treated as a shareholder of the PFIC, and whether a foreign corporation is a PFIC. The regulations affect U.S. persons with direct or indirect ownership interests in certain foreign corporations.

 

Details

The proposed regulations are essentially divided into two parts, the first part provides general guidance regarding PFICs and the second part relates specifically to the implementation of the PFIC Insurance Exception. This alert highlights some of the key items included in the proposed regulations.

 

1. General Guidance

The general guidance regarding PFICs includes, among other items, rules and clarifications on the following:

• Rules for determining whether a partner, S corporation shareholder, or beneficiary in a partnership, S corporation, estate, or nongrantor trust is considered under §1.1291-1(b)(8)(ii)(A) to own a portion of stock of a PFIC owned indirectly by the partnership, S corporation, estate, or trust through a non-PFIC foreign corporation. See proposed §1.1291-1(b)(8)(iii) for additional details.
• Guidance regarding certain exceptions to passive income for purposes of the PFIC Income Test in Section 1297(b)(1). See proposed §1.1297-1(c)(1)(i) for additional details.
• Rules for income earned through partnerships. See proposed §1.1297-1(c)(2)(i) and (ii) for additional details.
• Guidance on the Section 1297(b)(2)(C) exception to passive income for certain interest, dividends, rents, and royalties, received from a related person. See proposed §1.1297-1(c)(3)(i) and (ii) for additional details.
• Rule and clarifications on how to apply the PFIC Asset Test in Section 1297(a)(2). See proposed §1.1297-1(d) for additional details.
• Rules regarding the characterization of dual character assets which generally adopt the rules in Notice 88-22. See proposed §1.1297-1(d)(2) for additional details.
• Rules providing that for purposes of the PFIC Asset Test, a foreign corporation that directly or indirectly owns an interest in a partnership is treated as if it held its proportionate share of the assets of a partnership, provided the foreign corporation owns, directly or indirectly, at least 25 percent, by value, of the interests in the partnership. If a foreign corporation owns less than 25 percent of the value of the partnership, its interest in the partnership is treated as a passive asset. See proposed §§ 1.1297-1(d)(3)(i) and 1.1297-1(d)(3)(ii) for additional details.
• Rules clarifying the characterization of dealer property for purposes of the PFIC Asset Test. See proposed §1.1297-1(d)(4) for additional details.
• Rules providing that for purposes of determining whether any stapled entity is a PFIC, all entities that are stapled entities with respect to each other are treated as one entity. See proposed §1.1297-1(e).
• Rules for determining a foreign corporation’s ownership of a look-through subsidiary and proportionate share of a look-through subsidiary’s assets and income. See proposed §1.1297-2(b)(2)(ii)(B) for additional details.
• Rules coordinating the interplay between the look-through rule in Section 1297(c) and the rules regarding 25-percent owned domestic corporations in Section 1298(b)(7). See proposed §1.1297-2(b)(2)(iii) for additional details.
• Rules providing that, notwithstanding the general coordination rule between Section 1297(c) and Section 1298(b)(7) in proposed §1.1297-2(b)(2)(iii), Section 1298(b)(7) does not apply for purposes of determining if a foreign corporation is a PFIC for purposes of the ownership attribution rules in Section 1298(a)(2) and Treas. Reg. §1.1291-1(b)(8)(ii). See proposed §1.1298-4(e) for additional details.
• Anti-abuse rules, one of which provides that Section 1298(b)(7) will not apply if the foreign corporation would be a PFIC if the qualified stock or any income received or accrued with respect thereto were disregarded. See proposed §1.1298-4(f)(1) for additional details. Under a second anti-abuse rule, Section 1298(b)(7) will not apply if a principal purpose for the foreign corporation’s formation or acquisition of the 25-percent owned domestic corporation is to avoid classification of the foreign corporation as a PFIC. A principal purpose will be deemed to exist if the 25-percent owned domestic corporation is not engaged in an active trade or business in the United States. See proposed §1.1298-4(f)(2) for additional details.
• Rules that eliminate certain assets and income to avoid double counting for purposes of applying Section 1297(a). See proposed §1.1297-2(c)(1) and (2) for additional details.
• Rules attributing activities of a look-through subsidiary and certain partnerships to a foreign corporation. See proposed §1.1297-2(e)(1) for additional details.
• Rules for determining gain on the disposition of stock of a look-through subsidiary for purposes of the PFIC Income Test. See proposed §1.1297-2(f)(1) for additional details.
• Rules regarding the Section 1298(b)(3) change of business exception, including dispositions of stock of a look-through subsidiary. See proposed §1.1298-2 for additional details.
• Rules providing that a foreign corporation is considered subject to the tax imposed by Section 531 for purposes of Section 1298(b)(7), regardless of whether the tax actually is imposed on the corporation and regardless of whether the requirements of §1.532-1(c) are met. See proposed §1.1298-4(d)(1) for additional details.
• Rules for how a foreign corporation must waive benefits under a treaty for purposes of Section 1298(b)(7). See proposed §1.1298-4(d)(2) for additional details.

 

2. PFIC Insurance Exception

The proposed regulations provide guidance regarding whether the income of a foreign corporation is excluded from passive income pursuant to the PFIC Insurance Exception in Section 1297(b)(2)(B). In particular, the proposed regulations include, among other items, guidance on the following:

• Rules for determining whether a foreign corporation is a QIC. See proposed §1.1297-4 for additional details.
• Rules defining the term insurance business. See proposed §1.1297-5(c)(2) for additional details.
• Rules regarding the active conduct of an insurance business. See proposed §1.1297-5(c) for additional details.
• Rules regarding the treatment of income and assets of certain domestic insurance corporations owned by a QIC. See proposed §1.1297-5(d) for additional details.
• Rules regarding the application of the Section 1297(b)(2)(B) exception to items of income treated as received or accrued or assets treated as held by a QIC pursuant to Section 1297(c). See proposed §1.1297-5(f) for additional details.
• Rules prohibiting the double counting of any item for purposes of proposed §§ 1.1297-4 and 1.1297-5. See proposed §1.1297-5(g) for additional details.

The proposed regulations are proposed to apply to taxable years of U.S. persons that are shareholders in certain foreign corporations beginning on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register. However, until these regulations are finalized, taxpayers may choose to apply these proposed regulations (other than the proposed regulations under §§1.1297-4 and 1.1297-5) in their entirety to all open tax years as if they were final regulations, provided that taxpayers consistently apply the rules of these proposed regulations. Until finalization, U.S. persons that are shareholders in certain foreign corporations may apply the rules of §§1.1297-4 and 1.1297-5 for taxable years beginning after December 31, 2017, provided those U.S. persons consistently apply the rules of §§1.1297-4 and 1.1297-5 as if they were final regulations. In addition, taxpayers may continue to rely on Notice 88-22 until these regulations are finalized.
 
For additional details regarding these rules as well as other guidance included in the proposed regulations that are not discussed in this alert, see the proposed regulations.

 

BDO Insights

The proposed regulations provide helpful guidance in resolving uncertain PFIC issues as well as guidance on the PFIC Insurance Exception. Please contact a BDO international tax specialist if you need assistance with understanding and applying the proposed regulations.