IRS Publishes Final PFIC Regs

Internal Revenue Service

The IRS has published the official version of final regs (T.D. 9936) on determining whether a foreign corporation is treated as a passive foreign investment company and the application and scope of specified rules that determine whether a U.S. person that indirectly holds stock in a PFIC is treated as a shareholder of the PFIC. Effective January 14, 2021, the final regs adopt proposed regs (<a href="/lr/resolve//29q89">REG-105474-18</a>) under sections 1291, 1297, and 1298 that were issued in July 2019 (2019 proposed regs). Proposed regs (<a href="/lr/resolve//29zz9">REG-104223-18</a>) on the repeal of section 958(b)(4) were issued in October 2019 (section 958 proposed regs). The final regs adopt the portion of those regs regarding the treatment of foreign corporations for purposes of section 1297(e). The IRS has simultaneously released proposed regs (<a href="/lr/resolve//2gv6b">REG-111950-20</a>) that provide additional guidance on the treatment of income and assets of a foreign corporation for purposes of the PFIC rules and on the exception from passive income under section 1297(b)(2)(B) (2020 proposed regs). T.D. 9936, which was posted to the Federal Register website on January 14, 2021, is the official version of the final regs.  The final regs retain the basic approach and structure of the proposed regs, with some changes. Regarding the taxation of U.S. persons that are shareholders of section 1291 funds, the regs do not adopt the proposal to amend the rules of reg. section 1.1291-1(b)(8)(iii) regarding passthrough entities. The final regs apply a top-down approach to the attribution of ownership through all tiered ownership structures and include a new rule addressing the application of the successive application rule to tiered ownership structures. The 2019 proposed regs provided general rules and definitions, including rules on the application of the income and asset tests of section 1297(a), clarification on the scope of the section 1297(b)(1) cross-reference to section 954(c) for purposes of defining passive income, and general rules that address some computational and characterization issues that arise in applying the asset test. The 2020 proposed regs treat qualifying income of some taxpayers that satisfy the requirements of section 954(h) as income derived in the active conduct of a banking business under section 1297(b)(2). The 2019 proposed regs also provided additional guidance on the application of the section 1297(b)(2)(C) related-person exception for dividends, interest, rents, and royalties. The final regs made some changes to those regs and provided further guidance in response to comments. Under the final regs, for purposes of the asset and income tests, corporations and partnerships owned in whole or in part by a tested foreign corporation are generally classified into one or more of three categories. Lower-tier entities generally are treated as one or more of (1) a look-through subsidiary or look-through partnership, (2) a related person, or (3) an entity that is neither a look-through entity nor a related person. Regarding the related-person exception, the final regs make some changes to the treatment of interest and dividends. The regs finalize the portion of the section 958 proposed regs concerning the definition of a controlled foreign corporation for purposes of the asset test. The regs also expand the definition of publicly traded corporation for purposes of section 1297(e) to include more circumstances in which a tested foreign corporation is treated as a publicly traded foreign corporation. Under the final regs, a publicly traded corporation must apply the asset test based on value. The regs also make some clarifications and further guidance for measuring assets of other entities.  Under the final regs, a tested foreign corporation is treated as directly owning the assets of, and directly deriving the gross income of, a look-through subsidiary or look-through partnership. The tested foreign corporation disregards the equity interest in the look-through entity for purposes of the asset test. Dividends from a lower-tier subsidiary and distributions and the distributive share of income from a lower-tier partnership generally are treated as if they do not exist for purposes of the income test. For income test purposes, the proposed regs provided that the disposition of the stock of a look-through subsidiary is treated as the disposition of stock and provided rules for the calculation of gain. The final regs also include rules addressing the disposition of partnership interests in a look-through partnership and in a partnership described in section 954(c)(4)(B). When both rules could apply, the disposition is subject to the rules of section 954(c)(4). Payments of interest, rent and royalties, and the related debt obligation, lease, or license between the tested foreign corporation and the look-through entity or between look-through entities generally also are eliminated for purposes of both the income and the asset tests. If the obligation is between look-through entities that are not wholly owned by the tested foreign corporation, a proportionate part of the obligation and income from it is eliminated. A subsidiary of a tested foreign corporation is treated as a look-through subsidiary if both an asset test and an income test are satisfied. The definition of look-through partnership in the final regs is revised to align with the definition of look-through subsidiary more closely. For purposes of determining when a foreign corporation is a qualifying insurance corporation (QIC), the final regs clarify the definition of applicable insurance liabilities. The regs also make changes regarding some situations involving foreign corporations that are predominantly engaged in an insurance business, such as clarifying the alternative facts and circumstances test and the election to apply the test, removing a requirement that a runoff company have a liquidation plan, and revising the rating-related circumstances standard and exception. In response to comments, the regs modify the proposed rules limiting the amount of applicable insurance liabilities. Section 1297(b)(2)(B) provides an exclusion from the definition of passive income for income derived in the active conduct of an insurance business by a QIC. In response to comments, the active conduct test should be amended to provide more flexibility in determining whether a QIC is engaged in the active conduct of an insurance business. Therefore, the IRS issued the 2020 proposed regs for determining whether an insurance company is engaged in the active conduct of an insurance business. The final regs do not include the proposed qualifying domestic insurance corporation attribution exception. The 2020 regs propose a new limitation. In response to comments, the special look-through rule for assets and income of a subsidiary entity held by a QIC has been modified to apply in all cases in which a QIC is treated as owning the assets or earning the income of the subsidiary entity under the general look-through rules. However, the amount of assets or income that can be treated as non-passive under the revised rule is limited to the greater of two amounts. Section 1298(b)(7) provides a special characterization rule that applies when a tested foreign corporation owns at least 25 percent of the value of the stock of a domestic corporation and is subject to the accumulated earnings tax. The 2019 proposed regs included rules that disregarded the application of section 1298(b)(7) for purposes of determining whether a foreign corporation is a PFIC for purposes of the ownership attribution rules (domestic subsidiary attribution rules). The final regs eliminate those proposed rules. The regs also make changes to the domestic subsidiary antiabuse rules, withdrawing the qualified stock antiabuse rule and narrowing the scope of the principal purpose antiabuse rule. Because the final regs have removed rules turning off the qualifying domestic insurance corporation rule and section 1298(b)(7) for purposes of testing for indirect ownership of a PFIC and the rules defining active conduct of an insurance business have been revised and reproposed, the regs are significantly less burdensome than as originally proposed. The final PFIC insurance regs apply to tax years beginning on or after January 14, 2021. Taxpayers may choose to apply the final PFIC insurance regs to any tax year beginning after December 31, 2017, if some conditions are met. The preamble to the final regs addresses the applicability dates regarding other rules. A taxpayer may apply the final regs (other than the PFIC insurance exception rules), for a particular tested foreign corporation, to any open tax year of the taxpayer if some conditions are met.

(1) T.D. 9936, which was posted to the Federal Register website on January 14, 2021, is the official version of the final regs. The IRS released a <a href="/lr/resolve//2d8r7">prior version</a> on December 4, 2020. (2) At 86 FR 12821, March 5, 2021, the IRS issued <a href="/lr/resolve/corrections/3k57g" title="corrections">corrections</a> to the following Treasury Decision which have been incorporated below. (3) At 86 FR 13647-13648, March 10, 2021, the IRS issued <a href="/lr/resolve/corrections/3k5sw" title="corrections">corrections</a> to the following Treasury Decision which have been incorporated in the associated regulations.

The IRS has published the official version of final regs (T.D. 9936) on determining whether a foreign corporation is treated as a passive foreign investment company and the application and scope of specified rules that determine whether a U.S. person that indirectly holds stock in a PFIC is treated as a shareholder of the PFIC.

The IRS has published the official version of final regs (T.D. 9936) on determining whether a foreign corporation is treated as a passive foreign investment company and the application and scope of specified rules that determine whether a U.S. person that indirectly holds stock in a PFIC is treated as a shareholder of the PFIC. Effective January 14, 2021, the final regs adopt proposed regs (REG-105474-18) under sections 1291, 1297, and 1298 that were issued in July 2019 (2019 proposed regs). Proposed regs (REG-104223-18) on the repeal of section 958(b)(4) were issued in October 2019 (section 958 proposed regs). The final regs adopt the portion of those regs regarding the treatment of foreign corporations for purposes of section 1297(e). The IRS has simultaneously released proposed regs (REG-111950-20) that provide additional guidance on the treatment of income and assets of a foreign corporation for purposes of the PFIC rules and on the exception from passive income under section 1297(b)(2)(B) (2020 proposed regs). T.D. 9936, which was posted to the Federal Register website on January 14, 2021, is the official version of the final regs.  The final regs retain the basic approach and structure of the proposed regs, with some changes. Regarding the taxation of U.S. persons that are shareholders of section 1291 funds, the regs do not adopt the proposal to amend the rules of reg. section 1.1291-1(b)(8)(iii) regarding passthrough entities. The final regs apply a top-down approach to the attribution of ownership through all tiered ownership structures and include a new rule addressing the application of the successive application rule to tiered ownership structures. The 2019 proposed regs provided general rules and definitions, including rules on the application of the income and asset tests of section 1297(a), clarification on the scope of the section 1297(b)(1) cross-reference to section 954(c) for purposes of defining passive income, and general rules that address some computational and characterization issues that arise in applying the asset test. The 2020 proposed regs treat qualifying income of some taxpayers that satisfy the requirements of section 954(h) as income derived in the active conduct of a banking business under section 1297(b)(2). The 2019 proposed regs also provided additional guidance on the application of the section 1297(b)(2)(C) related-person exception for dividends, interest, rents, and royalties. The final regs made some changes to those regs and provided further guidance in response to comments. Under the final regs, for purposes of the asset and income tests, corporations and partnerships owned in whole or in part by a tested foreign corporation are generally classified into one or more of three categories. Lower-tier entities generally are treated as one or more of (1) a look-through subsidiary or look-through partnership, (2) a related person, or (3) an entity that is neither a look-through entity nor a related person. Regarding the related-person exception, the final regs make some changes to the treatment of interest and dividends. The regs finalize the portion of the section 958 proposed regs concerning the definition of a controlled foreign corporation for purposes of the asset test. The regs also expand the definition of publicly traded corporation for purposes of section 1297(e) to include more circumstances in which a tested foreign corporation is treated as a publicly traded foreign corporation. Under the final regs, a publicly traded corporation must apply the asset test based on value. The regs also make some clarifications and further guidance for measuring assets of other entities.  Under the final regs, a tested foreign corporation is treated as directly owning the assets of, and directly deriving the gross income of, a look-through subsidiary or look-through partnership. The tested foreign corporation disregards the equity interest in the look-through entity for purposes of the asset test. Dividends from a lower-tier subsidiary and distributions and the distributive share of income from a lower-tier partnership generally are treated as if they do not exist for purposes of the income test. For income test purposes, the proposed regs provided that the disposition of the stock of a look-through subsidiary is treated as the disposition of stock and provided rules for the calculation of gain. The final regs also include rules addressing the disposition of partnership interests in a look-through partnership and in a partnership described in section 954(c)(4)(B). When both rules could apply, the disposition is subject to the rules of section 954(c)(4). Payments of interest, rent and royalties, and the related debt obligation, lease, or license between the tested foreign corporation and the look-through entity or between look-through entities generally also are eliminated for purposes of both the income and the asset tests. If the obligation is between look-through entities that are not wholly owned by the tested foreign corporation, a proportionate part of the obligation and income from it is eliminated. A subsidiary of a tested foreign corporation is treated as a look-through subsidiary if both an asset test and an income test are satisfied. The definition of look-through partnership in the final regs is revised to align with the definition of look-through subsidiary more closely. For purposes of determining when a foreign corporation is a qualifying insurance corporation (QIC), the final regs clarify the definition of applicable insurance liabilities. The regs also make changes regarding some situations involving foreign corporations that are predominantly engaged in an insurance business, such as clarifying the alternative facts and circumstances test and the election to apply the test, removing a requirement that a runoff company have a liquidation plan, and revising the rating-related circumstances standard and exception. In response to comments, the regs modify the proposed rules limiting the amount of applicable insurance liabilities. Section 1297(b)(2)(B) provides an exclusion from the definition of passive income for income derived in the active conduct of an insurance business by a QIC. In response to comments, the active conduct test should be amended to provide more flexibility in determining whether a QIC is engaged in the active conduct of an insurance business. Therefore, the IRS issued the 2020 proposed regs for determining whether an insurance company is engaged in the active conduct of an insurance business. The final regs do not include the proposed qualifying domestic insurance corporation attribution exception. The 2020 regs propose a new limitation. In response to comments, the special look-through rule for assets and income of a subsidiary entity held by a QIC has been modified to apply in all cases in which a QIC is treated as owning the assets or earning the income of the subsidiary entity under the general look-through rules. However, the amount of assets or income that can be treated as non-passive under the revised rule is limited to the greater of two amounts. Section 1298(b)(7) provides a special characterization rule that applies when a tested foreign corporation owns at least 25 percent of the value of the stock of a domestic corporation and is subject to the accumulated earnings tax. The 2019 proposed regs included rules that disregarded the application of section 1298(b)(7) for purposes of determining whether a foreign corporation is a PFIC for purposes of the ownership attribution rules (domestic subsidiary attribution rules). The final regs eliminate those proposed rules. The regs also make changes to the domestic subsidiary antiabuse rules, withdrawing the qualified stock antiabuse rule and narrowing the scope of the principal purpose antiabuse rule. Because the final regs have removed rules turning off the qualifying domestic insurance corporation rule and section 1298(b)(7) for purposes of testing for indirect ownership of a PFIC and the rules defining active conduct of an insurance business have been revised and reproposed, the regs are significantly less burdensome than as originally proposed. The final PFIC insurance regs apply to tax years beginning on or after January 14, 2021. Taxpayers may choose to apply the final PFIC insurance regs to any tax year beginning after December 31, 2017, if some conditions are met. The preamble to the final regs addresses the applicability dates regarding other rules. A taxpayer may apply the final regs (other than the PFIC insurance exception rules), for a particular tested foreign corporation, to any open tax year of the taxpayer if some conditions are met. 

Sec. 1291 Interest on tax deferral

Sec. 1297 Passive foreign investment company

Search Connectors

Retrieving Documents With a Tax Analysts’ Citation:

Field Restricted Searching:

IRS Publishes Final PFIC Regs