International Taxation in a Nutshell (Nutshells) by Herzfeld Mindy & Doernberg Richard

Author:Herzfeld,Mindy & Doernberg,Richard [Herzfeld,Mindy & Doernberg,Richard]
Language: eng
Format: epub
ISBN: 9781640209053
Publisher: West Academic
Published: 2018-08-30T18:30:00+00:00

§ 8.08

PASSIVE FOREIGN INVESTMENT COMPANIES (PFICs)

The subpart F rules are anti-deferral provisions that apply to “U.S. shareholders”—those U.S. persons who own at least 10 percent of the vote or value of a CFC. However, these anti-deferral provisions do not apply to U.S. persons who own less than 10 percent of the stock of a CFC or to any U.S. persons who own stock of a foreign entity that is not a CFC. Yet, these U.S. taxpayers potentially may be able to defer U.S. taxation on passive income. To address this issue, Congress enacted a separate set of anti-deferral rules for passive foreign investment companies (“PFICs”). A PFIC is defined as a foreign corporation which meets either an income or an asset test. Under the income test, at least 75 percent of the corporation’s income must be passive income for the PFIC rules to apply. I.R.C. § 1297(a)(1). Passive income includes dividends, interest, passive rents and other income treated as foreign personal holding company income for purposes of subpart F. I.R.C. § 1297(b).

The passive income test is based on gross income. For example, if a foreign corporation earns interest income, the fact that deductions exceed the interest income does not change the fact that the foreign corporation would be a PFIC with respect to a U.S. owner. In applying the passive income test, under I.R.C. § 1297(c) described below, the income of 25 percent owned subsidiaries can be taken into account. There is also another look-through rule under I.R.C. § 1297(b)(7) for certain foreign 280

corporations that own at least 25 percent (by value) of the stock of a U.S. corporation. If the conditions of this rule are met, the stock itself is not treated as a passive asset and any dividends with respect to that stock are not treated as items of passive income.

Under the asset test, a foreign corporation is a PFIC if at least 50 percent of the corporation’s assets (by value) are held for the production of passive income. I.R.C. § 1297(a)(2). Such a corporation would be a PFIC even if it did carry on an active business such as manufacturing. A non-publicly traded foreign corporation can elect to use adjusted basis rather than fair market value as a measuring rod, but once the election is made it cannot be revoked without IRS consent. I.R.C. § 1297(e)(2).

Under § 1297(c), where a foreign corporation owns, directly or indirectly, at least 25 percent by value of the stock of another corporation (a “subsidiary”), the subsidiary look-through rule generally applies. Where the subsidiary look-through rule applies, the foreign corporation being tested for PFIC status is treated as if it held directly its proportionate share of the subsidiary’s assets (both passive and active), and directly earned its proportionate share of the subsidiary’s income (both passive and active). Second and more remote tiers of foreign corporations are also subject to this treatment if they are 25 percent or more indirectly owned by the foreign corporation being evaluated for PFIC status.

In Rev. Rul. 87–90, 1987–2 C.

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