On Dec. 27, 2016, the IRS and the Treasury Department released final regulations providing guidance on determining ownership of a passive foreign investment company (PFIC), annual filing requirements for ownership in a PFIC and updating certain rules relating to Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations, reporting requirements. The regulations finalize proposed regulations and withdraw temporary regulations published on Dec. 31, 2013. The regulations also incorporate prior guidance issued by the IRS in Notices 2014-28 and 2014-51.
A PFIC is a foreign corporation that has passive assets or generates passive income in excess of certain thresholds (50 percent passive asset test or 75 percent passive income test). Adverse U.S. tax consequences could apply to U.S. persons that are shareholders in PFICs.
There are generally three tax regimes for shareholders that invest in a PFIC:
- The excess distribution rules under section 1291 (section 1291 fund)
- The qualified electing fund regime under section 1293
- The mark to market regime under section 1296
PFIC ownership determination
The regulations define a PFIC shareholder to mean any U.S. person that owns stock of a PFIC directly or indirectly. A domestic partnership or S corporation is treated as a shareholder of a PFIC only for purposes of the information reporting rules described below.
However, under the regulations, a U.S. person is not a shareholder of a PFIC to the extent that the person owns the PFIC stock through a tax-exempt organization or account. For example, a U.S. person that owns stock in a PFIC through an individual retirement account would not be a shareholder with respect to such PFIC stock under the regulations. In addition, a U.S. person is an indirect shareholder of PFIC stock if that person owns over 50 percent of the stock of a foreign corporation that in turn owns shares in a PFIC.
In 2010, the Hire Act added new section 1298(f) of the Code requiring a shareholder in a PFIC to file an annual information return reporting his ownership in the PFIC and other such information as the Treasury Secretary may require. The regulations adopt certain exceptions to the reporting requirements under section 1298(f):
- U.S. persons that own PFIC stock that is marked to market under other non-PFIC provisions of law are not subject to section 1298(f) reporting unless they are subject to section 1291 and certain other rules apply.
- A domestic partnership is exempt from section 1298(f) reporting when none of its direct and indirect owners are subject to the PFIC rules. For example, if all the partners in a domestic partnership are tax-exempt organizations exempt from PFIC taxation with respect to PFIC stock held by the partnership, the partnership in turn is exempt from filing Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, under section 1298(f).
- The exception for filing Form 8621 with respect to PFIC stock owned by a foreign trust that is a foreign pension fund covered under a U.S income tax treaty is expanded to apply generally to all foreign pension funds, regardless of whether the foreign pension fund is treated as a trust for U.S. income tax purposes.
- Dual resident taxpayers who are treated as residents of a treaty country and, accordingly, not subject to tax under the PFIC provisions are exempt from filing Form 8621.
- A shareholder is not required to file Form 8621 with respect to stock of a section 1291 fund that it acquired either during its taxable year or the immediately preceding year when the shareholder (1) does not own any stock of the section 1291 fund for more than 30 days during the period beginning 29 days before the first day of the shareholder’s taxable year and ending 29 days after the close of the shareholder’s taxable year, and (2) did not receive an excess distribution (including gain treated as an excess distribution) with respect to the section 1291 fund.
- Bona fide residents of Guam, the Northern Mariana Islands or the U.S. Virgin Islands are not required to file Form 8621. However, bona fide residents of Puerto Rico and American Samoa still must file.
The regulations clarify that a U.S. person that is not otherwise required to file a U.S. income tax return must still file Form 8621 in accordance with the instructions for the form.
Certain suggestions provided on the temporary regulations were not adopted, including for example, proposals to allow for a ‘protective’ Form 8621, increasing the exemption threshold for taxpayers living abroad and consolidated Form 8621 filings.
Form 5471 filing obligations
U.S. persons generally must file Form 5471 to report their interest in a controlled foreign corporation. However, the so-called ‘constructive ownership exception’ exempts certain U.S. persons otherwise required to file Form 5471 if (1) the U.S. person does not directly own an interest in the foreign corporation, (2) the U.S. person is otherwise required to furnish the information solely by reason of attribution of stock ownership from a U.S. person, and (3) the person from whom the stock ownership is attributed furnishes all of the information required to be reported by the person to whom the stock ownership is attributed. The regulations adopt the 2013 temporary regulations’ elimination of the requirement that U.S. persons taking advantage of the constructive ownership exception file a statement with his or her tax return stating that the requirement to file has been satisfied by another shareholder and identifying the return with which the information was or will be filed and the place of filing.