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Insurer Recommends Change to Proposed PFIC Regs

APR. 14, 2021

Insurer Recommends Change to Proposed PFIC Regs

DATED APR. 14, 2021
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April 14, 2021

The Honorable Mark Mazur
Acting Assistant Secretary (Tax Policy) and Deputy Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, D.C. 20220

The Honorable Charles P. Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, D.C. 20224

The Honorable William M. Paul
Acting Chief Counsel and Deputy Chief Counsel (Technical)
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, D.C. 20224

Re: REG-111950-20 (2021 Proposed Regulations on Passive Foreign Investment Companies)

Dear Messrs. Mazur, Rettig, and Paul:

Assured Guaranty Ltd. (“AGL”) welcomes the opportunity to provide comments in response to the Notice of Proposed Rulemaking, Passive Foreign Investment Companies, issued January 15, 2021 (the “2021 Proposed Regulations”).1 We appreciate the work of the staff at the Department of the Treasury (“Treasury”) and the Internal Revenue Service (the “Service”) to implement the qualifying insurance corporation (“QIC”) exception to the passive foreign investment company (“PFIC”) rules in a timely fashion and to answer some additional long-standing questions regarding the PFIC rules. Our comments address the following two issues:

(1) We commend Treasury and the Service for providing in the 2021 Final Regulations that the qualifying domestic insurance company (“QDIC”) rule applies to determine whether a foreign corporation is a PFIC for all purposes. We recommend that the QDIC limitation rule provided in the 2021 Proposed Regulations be eliminated.

(2) We commend Treasury and the Service for providing in the 2021 Final Regulations relief from having to make the Alternative Facts and Circumstances Election (as defined below) for shareholders of publicly traded foreign corporations owning stock with a value of $25,000 or less. However, we recommend that the threshold ownership be eliminated to avoid traps for the unwary. Alternatively, we recommend increasing the threshold or modifying it to reflect a minimum percentage of outstanding shares.

I. Background

In order to qualify for the QIC exception, the corporation's applicable insurance liabilities must constitute more than 25 percent of its total assets as reported on the company's applicable financial statement for the last year ending with or within the taxable year (the “25% Test”).2 Should a corporation fail to qualify as a QIC solely because it does not meet this 25% Test, a U.S. shareholder may elect to treat such the corporation as a QIC if (1) the corporation's applicable insurance liabilities constitute at least 10 percent of its total assets, and (2) based on the applicable facts and circumstances, the corporation is predominantly engaged in an insurance business, and its failure to qualify under the 25% Test is due solely to runoff-related or rating-related circumstances involving such insurance business (the “Alternative Facts and Circumstances Election”).3

On July 11, 2019, Treasury and the Service issued proposed regulations on the QIC exception to the PFIC rules (the “2019 Proposed Regulations”).4 Following the notice and comment process, these regulations were finalized in substantial part (the “2021 Final Regulations”)5 and re-proposed in part (the “2021 Proposed Regulations”) on January 15, 2021. In particular, the 2021 Final Regulations provide that financial guaranty insurance companies that fail to meet the 25% Test are deemed to satisfy the rating-related circumstances requirement. We believe this rule is appropriate and commend Treasury and the Service for clarifying the treatment of financial guaranty companies. In addition, the 2021 Final Regulations provided additional rules regarding the mechanics of the Alternative Facts and Circumstances Election, which are discussed further below.

The 2021 Final Regulations also provide that the income and assets of a QDIC are treated as nonpassive or “active” for purposes of determining whether a foreign corporation qualifies as a PFIC. The 2021 Proposed Regulations, in part, limit the amount of QDIC assets and income that are treated as active, which is discussed further below.

II. Discussion of Comments

1. Qualifying Domestic Insurance Company Rule

Background

Under section 1297(c), a proportionate share of the income and assets of a tested foreign corporation's (“TFC”) 25-percent owned subsidiaries (“Look-Through Subsidiaries”) are treated as if they are the income and assets of the TFC itself for purposes of determining whether the income or assets are passive. The 2021 Final Regulations generally provide that the income and assets of a QDIC are per se active for purposes of determining whether a TFC is a PFIC (the “QDIC Rule”).6 Accordingly, the income and assets of that QDIC that are treated as the income and assets of the TFC under section 1297(c) are considered active.

We commend the Treasury and the Service for providing the QDIC Rule, which is consistent with the objectives and design of the PFIC regime. The PFIC regime is intended to apply to U.S. shareholders of foreign investment companies — that is, foreign corporations with predominately passive income or assets. It is not intended to apply to foreign corporations that are primarily engaged in active business operations, either directly or through subsidiaries.7 Accordingly, TFCs that are primarily engaged in the conduct of active business operations through subsidiaries should not be treated as PFICs. The QDIC Rule is necessary to ensure that a proportionate share of the income and assets of a U.S. Look-Through Subsidiary that is predominately engaged in active business operations — namely, insurance operations — are treated as active income and assets of the TFC for PFIC purposes, consistent with the mandate of section 1297(c).

In addition, we commend the Treasury and the Service for providing that the QDIC Rule applies to determine whether a TFC qualifies as a PFIC for all purposes, including the application of the stock attribution rule of section 1298(a)(2). The 2019 Proposed Regulations had provided that the QDIC Rule did not apply for purposes of section 1298(a)(2). The income and assets of Look-Through Subsidiaries conducting active business operations should be treated as active for all purposes of the PFIC rules. That should be the case regardless of whether the Look-Through Subsidiary conducting active business operations is foreign or domestic, or whether the active business operation being conducted is an active industrial business, or an active technology business, or an active insurance business.

The 2021 Proposed Regulations provide a new rule that limits the amount of QDIC assets and income that are treated as active to a cap based on an applicable percentage of the QDIC's total insurance liabilities (the “QDIC Limitation Rule”).8 Under this rule, the amount of a QDIC's assets that are treated as active may not exceed an applicable percentage of the QDIC's total insurance liabilities.9 For nonlife insurance companies, the applicable percentage is 400 percent10. The preamble to the 2021 Proposed Regulations explains that the QDIC Limitation Rule is intended to limit the amount of QDIC assets and income that are treated as active in cases where the QDIC holds substantially more passive assets than necessary to support its insurance obligations. The preamble explains that the QDIC Limitation Rule provides an appropriate disincentive for a foreign corporation to shift excessive passive assets into a U.S. insurance subsidiary in order not to qualify as a PFIC. Treasury and the Service requested comments on the QDIC Limitation Rule, in particular on whether the specified appliable percentages are reasonable and whether the final regulations should allow for the applicable percentages to be adjusted or supplemented in subregulatory guidance.11

Recommendation

We respectfully recommend that the QDIC Limitation Rule be removed. Because the QDIC Rule applies only with respect to domestic insurance companies that are subject to net basis federal income tax under subchapter L,12 it extends only to a company whose income is subject to U.S. income tax and in which greater than 50 percent of its business during the taxable year is the issuing of insurance or annuity contracts or the reinsuring of risks underwritten by insurance companies.13 The QDIC Limitation Rule could inadvertently provide a disincentive at the margin for TFCs primarily engaged in the conduct of active insurance operations to maintain or increase their investments in active business operations in the United States. We do not believe that the policies underlying the PFIC rules support such a result.

We understand that Treasury and the Service believe that the QDIC Limitation Rule is necessary to prevent foreign corporations from shifting excess passive assets into U.S. insurance subsidiaries to avoid the application of the PFIC rules. If the QDIC Limitation Rule is maintained, then in general we believe that, as applied to nonlife insurance companies, the applicable percentage and the definition of total insurance liabilities are not unreasonable. Arguably the applicable percentages should be increased to better target the anti-abuse concerns expressed in the preamble without affecting the capital allocation decisions of bona fide insurance company groups. As noted by the preamble to the 2021 Final Regulations, some insurance companies may require a higher level of capital as compared to insurance liabilities, for example monoline companies providing mortgage or financial guaranty insurance that experience significant losses on a low frequency but high severity basis.14 The preamble further notes that these additional assets may be viewed as necessary to meet insurance obligations in high loss years. To the extent such insurance companies are operating through U.S. insurance subsidiaries, the assets (and associated income) of those insurance companies should be treated as non-passive.

In response to the preamble's request for comments on whether the final regulations should allow for the applicable percentage to be adjusted or supplemented in subregulatory guidance, we believe that it is preferable to maintain objective regulatory guidance in this area that cannot be altered by subregulatory guidance in a manner that is detrimental to taxpayers. The notice-and-comment process provides an important opportunity for stakeholders to provide input to policymakers, in particular to ensure that rules do not produce unintended outcomes.

2. Election Mechanics

Background

Similar to the 2019 Proposed Regulations, the 2021 Final Regulations provide that a U.S. person may make the Alternative Facts and Circumstances Election in section 1297(f)(2) if the foreign corporation provides directly to the U.S. person, or makes publicly available (such as in a public filing or disclosure), a statement to shareholders that it satisfied the requirements of section 1297(f)(2) during the corporation's taxable year.15 The election must be made by a U.S. person that owns stock in the foreign corporation filing a limited-information Form 8621 with its original federal income tax return and attaching the statement provided by the corporation.16 The 2021 Final Regulations also provide that a U.S. person may file the Form 8621 with an amended return if the U.S. person can demonstrate reasonable cause for not filing it with the original return.17

The 2021 Final Regulations also added a deemed election for the benefit of small shareholders of publicly traded companies.18 Specifically, a U.S. person will be deemed to make the Alternative Facts and Circumstances Election if the stock of the foreign corporation owned by the U.S. person (directly and indirectly) has a value of $25,000 or less on the last day of the taxable year.19 The $25,000 threshold was chosen in part because it was consistent with the threshold for the exception to the requirement to report the information required by Part I of Form 8621.20

Recommendation

We commend Treasury and the Service for providing relief for shareholders of publicly traded foreign corporations by providing for a deemed Alternative Facts and Circumstances Election in certain circumstances and by permitting the election to be made on amended returns. However, we believe that the $25,000 threshold is too low. We understand that the $25,000 threshold is consistent with the exception to the reporting requirements for PFIC shareholders, but the two provisions have different purposes and impose different burdens on shareholders.

The reporting requirement is imposed on U.S. persons owning shares of a corporation that has been determined to be a PFIC and requires the shareholder to report information about the shares held and the amount of any excess distribution. The $25,000 reporting exception only applies of the shareholder is not subject to tax under section 1291 with respect to any excess distribution.21 If a shareholder is unaware of the exception, the only consequence is that they may end up reporting information that they do not need to report.

The Alternative Facts and Circumstances Election, on the other hand, applies to shareholders of companies that have determined they are not PFICs. If a shareholder is unaware of the deemed election, they do not benefit from the QIC exception. Thus, the consequences of missing the election are severe. In addition, the Alternative Facts and Circumstances Election would almost universally be made if the taxpayer were fully aware of it. Thus, the election requirement creates a trap for the unwary.

We recommend eliminating the $25,000 threshold to eliminate this trap for the unwary.22 Eliminating the $25,000 threshold will also reduce administrative burden on the electing taxpayer, as well as on the Service, since it will avoid the filing of amended returns that will invariably have to filed for any missed elections that are identified by the taxpayer or the Service. If Treasury and the Service decide to retain a value threshold, we recommend that the threshold be substantially increased in order to minimize the trap for the unwary. In addition, we recommend that Treasury and the Service provide that an appraisal is not necessary, similar to the reporting exception.23 Another alternative is to adopt a minimum percentage of outstanding shares as the threshold (e.g., 5 or 10 percent). Although this differs from the approach taken in the 2021 Final Regulations, a percentage threshold has the benefit of being more consistent across companies of different sizes. It is also consistent with exceptions for small shareholders adopted by Treasury and the Service in other areas of the tax law.24

Thank you for your consideration of the recommendations contained in this comment letter. Please let us know if you have any questions.

Sincerely,

Robert A. Bailenson
Chief Financial Officer
Assured Guaranty Ltd.
Hamilton, Bermuda

cc:
Jose Murillo, Deputy Assistant Secretary for International Tax Affairs, Department of the Treasury
Kevin Nichols, Acting International Tax Counsel, Department of the Treasury
Brett York, Deputy Tax Legislative Counsel, Department of the Treasury
Angela Walitt, Attorney-Advisor, Department of the Treasury
Peter Merkel, Branch Chief, Branch 5 (CC:INTL:B05), Internal Revenue Service
Je Baik, Senior Technician Reviewer, Branch 5 (CC:INTL:B05), Internal Revenue Service
Josephine Firehock, Attorney-Advisor, Branch 5 (CC:INTL:B05), Internal Revenue Service

FOOTNOTES

1 REG-111950-20, 86 Fed. Reg. 4582 (Jan. 15, 2021).

2 Code § 1297(f)(1). Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended (the “Code”) or to the regulations thereunder.

4 REG-105474-18, 84 Fed. Reg. 33,120 (July 11, 2019).

5 TD 9936, 86 Fed. Reg. 4516 (Jan. 15, 2021).

6 Treas. Reg. §§ 1.1297-6(b)(2), -6(c)(2).

7 See 84 Fed. Reg. at 33,127 (“Section 1297(c) was enacted to prevent 'foreign corporations owning the stock of subsidiaries engaged in active businesses [from being] classified as PFICs.”) (Citing H.R. Rep. No. 99-841, at II-644 (1986)).

8 Prop. Reg. § 1.1297-6(e)(2).

9 Prop. Reg. § 1.1297-6(e)(2)(ii).

10 Prop. Reg. § 1.1297-6(e)(2)(iii). The term “total insurance liabilities” means the sum of unearned premiums and unpaid losses. Prop. Reg. § 1.1297-6(e)(2)(iv)(B).

11 See 86 Fed. Reg. at 4592-93.

12 Prop. Reg. § 1.1297-6(e)(1).

13 See Code §§ 816(a), 831(c).

14 See 86 Fed. Reg. at 4535-36.

15 Reg. § 1.1297-4(d)(5)(i). The statement must include the ratio of applicable insurance liabilities to total assets and a statement indicating whether the failure to satisfy the 25% Test was the result of runoff-related or ratings-related circumstances and a brief description of these circumstances. Reg. § 1.1297-4(d)(5)(ii). The statement may be relied on by the U.S. shareholders unless they knew or had reason to know that the foreign corporation's statement was incorrect. Reg. § 1.1297-4(d)(5)(i).

17 Id.

18 See Preamble to Reg. § 1.1297-4, 86 Fed. Reg. at 4550.

20 See Preamble to Reg. § 1.1297-4, 86 Fed. Reg. at 4550; Reg. § 1.1298-1(c)(2). The reporting regulation provides that a shareholder need not obtain an appraisal for its shares, but rather may rely upon periodic account statements provided at least annually to determine the value of the PFIC, unless the shareholder has actual knowledge or reason to know based on readily accessible information that the statements do not reflect a reasonable estimate of the PFIC's value. Reg. § 1.1298-1(c)(2)(iv).

22 This approach is consistent with numerous other deemed elections that are taxpayer-favorable. See, e.g., Reg. §1.195-1(b) (deemed election to amortize start-up expenditures); Reg. § 1.248-1(c) (deemed election to amortize organizational expenditures); Reg. § 301.7701-3(c)(1)(v) (deemed entity classification elections for entities that claim to be tax-exempt or that elect to be real estate investment trusts or S corporations); Prop. Reg. § 1.1400Z2(a)-1(b)(10)(i)(B)(3) (election under section 362(e)(2) to reduce stock basis deemed made if loss property transferred to qualified opportunity fund); Reg. § 20.2010-2(a)(2) (portability election deemed made upon filing of Form 706 unless elect out); Reg. § 1.1272-3(b) (debt holder that elects to accrue interest on a constant yield basis is deemed to elect to amortize bond premium on a yield-to-maturity basis and to determine accrued market discount on a constant yield basis).

24 See, e.g., Treas. Reg. § 1.355-6(f)(4) (distributing corporation may presume that no less-than-five-percent shareholder of a corporation acquired stock or securities by purchase under section 355(d)(5) or (8)); Treas. Reg. § 1.367(a)-3(b)(1)(i) (less-than-five-percent shareholders excepted from gain recognition rules related to outbound stock transfers).

END FOOTNOTES

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