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Final and proposed regs modify PFIC rules

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Tax Hot Topics newsletter The IRS issued final regulations (TD 9936) and proposed regulations (REG-111950-20) on the passive foreign investment company (PFIC) regime. The final regulations finalize 2019 proposed regulations under Sections 1291, 1297, and 1298. They address the determination of whether a foreign corporation may be treated as a PFIC, and the application and scope of certain rules that determine whether a United States (U.S.) person that indirectly holds stock in a PFIC is treated as a shareholder of the PFIC. See our prior coverage of the 2019 proposed regulations.

The new 2020 proposed regulations are issued under Sections 250, 951A, 1291, 1297, and 1298, and address the treatment of income and assets of a qualifying insurance corporation (QIC) that is engaged in the active conduct of an insurance business (PFIC insurance exception). The proposed regulations also address the treatment of qualified improvement property (QIP) under the alternative depreciation system (ADS) for calculating qualified business asset investment (QBAI) for purposes of the global intangible low-taxed income (GILTI) and the foreign-derived intangible income (FDII).

While the final regulations generally adopt the approach of the 2019 proposed regulations, they make several notable changes. Select highlights are included below:

  • Active financing exception: In a deviation from the 2019 proposed regulations, the final regulations do not include an exclusion from the definition of passive income for income by reference to Section 954(h). Thus, the active financing exception under Section 954(h) no longer applies for purposes of PFIC income testing. However, the 2020 proposed regulations include a proposed active banking exception that incorporates certain principles of Section 954(h) in determining eligibility for the exception.
  • Determination of ownership and attribution through partnerships: The 2019 proposed rules clarified that the application of the attribution rules under Section 1298 to a tiered-ownership structure should be applied from the “top down.” This approach previously was limited in its application to attribution through partnerships. However, the final regulations expand the approach to include all tiered ownership structures, including corporations.
  • Activity attribution rules: The final regulations extend the activity attribution rules to now attribute activities of any qualified affiliate for purposes of PFIC testing allowing the exception for active rents and royalties received from unrelated persons to apply taking into account the qualified affiliates activities.
  • Treatment of assets and related income subject to related person look-through rule: The final regulations provide that assets that give rise to income subject to Section 1297(b)(2)(C) are treated as a passive or non-passive asset to the extent the income that is received with respect to such asset is treated as passive or non-passive by the tested foreign corporation.
  • Treatment of certain partnership income as per se passive: The 2019 proposed regulations provide that 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. While the final regulations adopt the 25% threshold from the 2019 proposed regulations, it provides an exception for “active partners.”

The 2020 proposed regulations provide additional guidance on whether a foreign corporation is treated as a passive foreign investment company (PFIC). Notably, they cover the treatment of income and assets of a QIC for purposes of the PFIC insurance exception, as well as the treatment of QIP under ADS to calculate QBAI for purposes of GILTI and FDII.

With respect to QIP, the proposed regulations contain rules previously announced in Notice 2020-69. The notice clarified that the technical amendment to Section 168 enacted as part of the CARES Act was intended to apply as if it had been enacted as part of the Tax Cuts and Jobs Act (TCJA). The notice further stated that the IRS has determined that this clarification is consistent with congressional intent that the provisions of the technical amendment be given effect as if included in TCJA. The guidance provided certainty to taxpayers who placed QIP into service after Dec. 31, 2017, and were required to compute QBAI for Sections 951A or 250. The proposed regulations reiterates the rules provided in the notice and requests comments on whether a transition rule should be provided to allow a corrective adjustment for taxpayers that took a position that is inconsistent with proposed regulations under Sections 951A or 250 on a return filed before Sept. 1, 2020, and that do not file an amended return with respect to such year.

The final regulations apply to tax years beginning on or after the date of publication in the Federal Register, however, taxpayers may rely on the final regulations for prior years if applied consistently. In general, the proposed regulations are proposed to apply to tax years of U.S. persons with direct or indirect ownership interests in certain foreign corporations, United States shareholders of controlled foreign corporations, and domestic corporations eligible for the deduction for FDII. The proposed regulations addressing QIP are proposed to apply retroactively and will not be effective after they are finalized.

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

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

Yasmin Dirks
Manager
Washington National Tax Office
T +1 202 521 1506

Olivia Arnold
Manager
Atlanta Office
T +1 678 515 2490

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