Proposed rules for PFIC provide clarity

Tax Hot Topics newsletterThe IRS issued proposed regulations (REG-105474-18) on July 10 with respect to the passive foreign investment company (PFIC) regime.

The new set of proposed rules under Sections 1291, 1297 and 1298 contain a mix of taxpayer-favorable and taxpayer-unfavorable provisions, and provide clarity with respect to a number of questions that have long been a point of uncertainty for taxpayers. Among the various areas covered in the proposed regulations are:

  • Ownership of PFIC stock and attribution of such stock through partnerships
  • Various issues that impact the income and asset tests
  • The look-through rule for 25%-owned foreign corporations and certain domestic subsidiaries
  • The PFIC insurance exception

The proposed rules will apply to tax years of shareholders that begin on or after the date the final regulations are published in the Federal Register. However, the insurance rules included in the package may be relied up for tax years beginning after Dec. 31, 2017, and the balance of the proposed rules may be relied upon for all open years of the taxpayer prior to finalization.

Select highlights are included below.

  • Determination of ownership and attribution through partnerships: The proposed rules clarify that the application of the attribution rules under Section 1298 to a tiered-ownership structure should be applied from the “top down.” The top-down approach starts with a United States person that is a shareholder and determines what stock is owned at each lower tier on a proportionate basis. This generally has a positive outcome for taxpayers as opposed to the results when applying a “bottom-up” approach, starting with a PFIC and attributing ownership of its stock upwards each level. However, this approach is limited in its application to attribution through partnerships.

  • Clarification regarding which Subpart F exceptions apply for PFIC testing purposes: The proposed regulations provide guidance as to which Subpart F exceptions under Section 954 would apply for purposes of excluding income from passive income when determining if a foreign corporation is a PFIC.

  • Treatment of dividends when applying the general look-through rule: Dividends paid by a 25% or greater subsidiary would be eliminated from income by the tested foreign corporation when applying the general look-through rule only if the subsidiary accumulated the earnings while it was a 25% subsidiary of the tested foreign corporation.

  • Treatment of certain partnership income as per se passive: Where a tested foreign corporation does not own at least 25% of the value of a partnership, such corporation’s distributive share of income from the partnership will be treated as per se passive.

  • Favorable departure from Subpart F active rents and royalties exception for PFICs: Tested foreign corporations are able to use the “Active Rent and Royalties” exception when evaluating whether certain income is from passive sources. Generally, under Subpart F, employees of the same corporation that owns the income-producing assets must undertake the activities that result in the rents or royalties to be treated as active. The proposed rules permit tested foreign corporations to take into account activities of officers, directors and employees of more than 50%-owned corporations when determining if the exception applies.

David Sites
Washington National Tax Office 
T +1 202 861 4104

David Zaiken
Managing Director
Washington National Tax Office 
T +1 202 521 1543

Cory Perry
Senior Manager
Washington National Tax Office 
T +1 202 521 1509

Mike Del Medico
Washington National Tax Office 
T +1 202 521 1522
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