Consequences of PFIC status for Non-U.S. SPACs

August 2021

BY

Wilson BrakefieldManager, National International Tax Services

David HemmerlingManaging Director, National Corporate Tax and Mergers & Acquisitions

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Special purpose acquisition companies—commonly known as SPACs—have become an increasingly popular investment alternative. A SPAC is a company with no commercial operations that is formed specifically to raise capital through an initial public offering (IPO) for the purpose of acquiring an existing U.S. or foreign company.

In cases where a non-U.S. SPAC is used, various U.S. tax implications should be considered at the outset to mitigate—or prevent—the foreign SPAC from falling within the scope of the U.S. passive foreign investment company (PFIC) rules, which could have adverse tax consequences for U.S. shareholders.
 

Foreign SPACs and PFIC Rules

A SPAC is essentially a “blank check” company with no business operations and no assets other than cash raised in an IPO, which means there is a potential risk that a foreign SPAC would be treated as a PFIC.

With certain exceptions for start-ups and controlled foreign corporations (CFCs), a foreign corporation generally is considered a PFIC if it meets one of the following two tests: 
  • The “income test” is met if at least 75% of the foreign corporation’s gross income for the tax year is passive income. Passive income generally means income of a kind that would be considered foreign personal holding company income if the foreign corporation were a CFC, such as dividends, interest, rents and royalties.
  • The “asset test” is met if at least 50% of the average percentage of assets held by the foreign corporation during the tax year are assets that either produce or are held for the production of passive income.
 

PFIC Implications for U.S. Investors

Adverse tax consequences that potentially could arise for U.S. investors in a PFIC include:
  • Tax and interest charges are imposed on “excess distributions” and gains derived from the disposition of appreciated PFIC stock, with tax imposed at the highest ordinary rate.
  • A U.S. investor in a foreign SPAC/PFIC is taxable even on what would otherwise be a qualified tax-free reorganization in a SPAC IPO transaction.
A U.S. shareholder of a PFIC may be able to mitigate the adverse consequences of the PFIC regime by making an election to mark the stock to market at the end of each year and include the unrealized appreciation as ordinary income or make a “protective” QEF (qualified electing fund) election.
 

How BDO Can Help

While SPACs offer a number of advantages, U.S. investors need to be cognizant of the potential tax risks when they form and operate a non-U.S. SPAC. BDO Tax professional can advise on mitigating or avoiding the adverse tax consequences of non-U.S. SPACs for U.S. shareholders.