Skadden Arps Seeks Parity for Long-Term Investors Under PFIC Regs

September 10, 2019

David J. Kautter, Assistant Secretary for Tax Policy
U.S. Department of the Treasury
1500 Pennsylvania Ave., NW
Washington, D.C. 20220

Charles P. Rettig, Commissioner of Internal Revenue
Michael J. Desmond, Chief Counsel and Assistant
General Counsel
c/o Courier's Desk
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, D.C. 20224

cc:
Regina L. Johnson, Publication Regulation Specialist
Rose Jenkins, Special Counsel, Office of Associate
Chief Counsel (International)

Attn: CC:PA:LPD:PR (REG-105474-18)

Re: Comments on Proposed Regulations under Sections 1291, 1297 and 1298

Dear Assistant Secretary Kautter, Commissioner Rettig, and Chief Counsel and Assistant General Counsel Desmond:

We respectfully submit this letter on behalf of Unibail-Rodamco-Westfield SE in response to the request for comments in the recently proposed regulations (REG-105474-18) under sections 1291, 1297 and 1298 of the Internal Revenue Code, published on July 11, 2019 (such regulations, the “Proposed Regulations”).¹

Sections 1291-1298 contain a comprehensive series of rules governing the taxation of shareholders of “passive foreign investment companies” (“PFICs”). Section 1297(c) provides that for purposes of determining whether a foreign corporation is a PFIC, such entity is treated as directly holding its proportionate share of the assets of any other corporation in which it owns at least 25 percent (by value) of the equity, and as directly receiving its proportionate share of the income of such other corporation. Under this rule, the PFIC status of a foreign corporation has historically been generally unaffected by whether such corporation conducts some or all of its operations through wholly-owned subsidiaries, through disregarded entities, or directly. This is the case even though the classification of the income of such foreign corporation and its foreign subsidiaries as active or passive for purposes of subpart F could be significantly altered by such distinctions were such foreign corporation to become a controlled foreign corporation. The Proposed Regulations provide certain detailed rules for clarifying the application of section 1297(c) to assets held, and income earned, through such corporate subsidiaries.

No similar rule has appeared to historically exist for partnerships in which a foreign corporation owned a 25 percent or greater interest, however. In particular, prior to the Proposed Regulations, it appeared that a foreign corporation owning a partnership interest would be required to test for PFIC status by determining the active or passive status of rental or royalty income earned through a partnership (even a partnership in which the foreign corporation was a majority owner) by taking into account only the activities of the partnership, as generally required for purposes of the foreign personal holding company rules under Section 954.² Thus, the PFIC status of a foreign corporation could be altered by whether it chose to conduct joint ventures earning such types of income through entities regarded as corporations for U.S. tax purposes as opposed to entities regarded as partnerships for such purposes.

As noted in the preamble to the Proposed Regulations, the Internal Revenue Services and the Treasury Department have rightly determined that, for purposes of testing PFIC status, income earned through a partnership should be treated similarly to income earned through a corporate subsidiary. As a result of this determination, the Proposed Regulations, when adopted, may cause certain foreign corporations that historically operated in whole or in part through joint ventures classified as partnerships to no longer qualify as PFICs. In particular, the Proposed Regulations will provide more favorable results for foreign structures where certain assets are held in a joint venture partnership while associated employees and activities may be held by/conducted by the foreign parent itself or one or more of its other subsidiaries (outside of the joint venture partnership). We will refer to foreign corporations who historically were classified as a PFIC due to the lack of a partnership look-through rule, but who would not have been classified as a PFIC had the Proposed Regulations applied, as “Affected Foreign Corporations” for purposes of the following discussion.

While the Proposed Regulations are to apply to taxable years of U.S. investors beginning on or after the date of publication of the Treasury decision adopting them as final regulations, taxpayers are permitted to apply the Proposed Regulations (other than portions under §§1.1297-4 and 1.1297-5) in their entirety to all open tax years as if they were final regulations provided that taxpayers consistently apply such rules. Under this approach, a taxpayer who invests in an Affected Foreign Corporation following publication of the Proposed Regulations as final regulations will not be treated as holding stock in a PFIC. Similarly, a taxpayer who invests in an Affected Foreign Corporation while the Proposed Regulations are outstanding will likewise not be treated as holding stock in a PFIC, so long as such taxpayer consistently applies the Proposed Regulations to the taxable years preceding and including their finalization. Finally, a taxpayer who has already invested in an Affected Foreign Corporation during a past taxable year that remains open will not be treated as holding stock in a PFIC, so long as such taxpayer consistently applies the Proposed Regulations to the open taxable years preceding and including their finalization.

In addition to allowing application of the Proposed Regulations to all open tax years, however, taxpayers should further be permitted to determine PFIC status of Affected Foreign Corporations they may have invested in during closed tax years under the Proposed Regulations for purposes of applying section 1298(b)(1). Under section 1298(b)(1), commonly referred to as the “Once a PFIC, Always a PFIC” rule, stock held by a taxpayer is generally treated as stock in a PFIC if, at any time during the holding period of the taxpayer with respect to such stock, such corporation was a PFIC which was not a qualified electing fund. This rule can be avoided only if the taxpayer elects to recognize gain as of the last day of the last taxable year for which the company was a passive foreign investment company as if the stock were sold for its fair market value at such time. Thus, a taxpayer who invested in an Affected Foreign Corporation during a closed taxable year would, absent an election to recognize gain, be treated as holding stock in a PFIC even though the Affected Foreign Corporation would not have qualified as a PFIC during any open taxable year (assuming the taxpayer consistently applies the Proposed Regulations).

Recognizing that the Proposed Regulations provide a more logical and more consistent approach for testing income earned through certain partnerships, it appears preferable to afford taxpayers who may have been longer-term investors in an Affected Foreign Corporation the same relief as more recent investors. To illustrate, assume a pool of U.S. individual taxpayers who have invested, of may now invest, in the stock of an Affected Foreign Corporation, all of whom continue to own such stock, and none of whom have been provided with information sufficient to make a “qualified electing fund” election. Assume that all such taxpayers timely filed federal tax returns on April 15 of each year (for the preceding calendar year) and that none of the taxpayers are otherwise under audit. It would appear that taxpayers who invested in the Affected Foreign Corporation during the 2016, 2017, 2018, 2019 or later taxable years would be able to avoid the reach of section 1298(b)(1), and would be able to later dispose of stock of the Affected Foreign Corporation without application of the PFIC rules, while taxpayers who invested in 2015 or earlier taxable years would be subject to the PFIC rules on a later disposition of their stock. Given that at least some retroactive application of the rules is clearly desired (as shown by the ability to apply the Proposed Regulations to all open taxable years), it is unclear why an arbitrary cut-off of this sort is appropriate, particularly when it would appear to turn on a given taxpayer's period of open tax years, which could be significantly impacted by issues entirely unrelated to their investments in potential PFICs.

We believe that, so long as the Affected Foreign Corporation would never have qualified as a PFIC during a given taxpayer's holding period had the Proposed Regulations applied, the proper approach would be to allow such taxpayer to apply the Proposed Regulations to all years of their holding period for purposes of section 1298(b)(1), and thereby avoid an ongoing PFIC taint that would have arisen solely due to the lack of a historic partnership look-through rule in the same manner that more recent investors are permitted to do. It would seem particularly inappropriate if a longer-term investor in an Affected Foreign Corporation were able to avoid PFIC status due to a lengthened statute of limitations (and hence longer look-back period for applying the Proposed Regulations) by reason of an audit of such taxpayer, but an investor not subject to audit were to be “caught” by the application of 1298(b)(1) to their holding of an Affected Foreign Corporation and hence subject to PFIC consequences on a later disposition. Adopting the approach that we suggest would not require reopening closed taxable years, but would simply allow long-term investors in entities that conduct significant JV activity but are not truly passive (as recognized by the Proposed Regulations) the same treatment of open and forthcoming taxable years as more recent investors. In addition, such an approach would seem to minimize the need for any debate as to whether the portions of the Proposed Regulations providing a partnership look-through rule could be viewed as merely clarifying the law.

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If there is any additional information or background that you need or if you believe a follow up call or meeting would be helpful, please do not hesitate to contact us. You may reach Nathan Giesselman at (650) 470-3182 and nathan.giesselman@skadden.com and David Polster at (312) 407-0736 and david.polster@skadden.com. Thank you very much for your attention to this matter.

We look forward to working with you and your staff on these concerns.

Sincerely,

Nathan W. Giesselman

David Polster

Skadden, Arps, Slate, Meagher & Flom LLP
Palo Alto, CA