Guidance Requested on PFIC Regime’s Look-Through Rules

June 20, 2018

The Honorable David J. Kautter
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable David J. Kautter
Acting Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

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

Lafayette “Chip” G. Harter III
Deputy Assistant Secretary (International Tax Affairs)
Department of the Treasury

Douglas L. Poms
International Tax Counsel
Department of the Treasury

Dear Sirs/Madams:

We note that the Department of the Treasury's 2017-2018 Priority Guidance Plan released on May 9, 2018 includes guidance under sections 1297 and 1298 applicable to a passive foreign investment company (“PFIC”).¹ Although the precise intended scope for this guidance was not detailed in the released plan, it appears that certain of the 'indirect' rules of sections 1297 and 1298 might be addressed. In this regard, we respectfully request guidance issued in accordance with the authority granted to the Secretary under section 1298(g) with respect to (i) the inter-relationship of the indirect or look-through rules of section 1297(c) and section 1298(b)(7) for purposes of determining whether or not a foreign corporation is a PFIC for purposes of the rules of sections 1291 through 1298 (the “PFIC regime”) and (ii) the impact on the indirect ownership rules if an election is made to apply the section 1296 mark-to-market regime for marketable stock of a PFIC. A summary of the requested guidance is as follows:

We submit this letter on our own behalf, but we note that one or more of our clients may be affected by action or inaction in response to this request for guidance and clarification.

I. Background

A. General Rules

The PFIC regime was enacted as an anti-deferral regime in the Tax Reform Act of 1986,² in order to subject to current tax (or to a deferred tax charge with interest) income derived by U.S. persons who invest in passive assets indirectly through a foreign corporation that is not otherwise subject to the Subpart F regime applicable to controlled foreign corporations. The stated reason for the regime was to eliminate an incentive otherwise available if such U.S. persons were to invest in foreign corporations to hold such assets, when income and gains from such passive assets would not be currently taxable, rather than a domestic corporation to hold such assets.³

Section 1297 defines a PFIC as any foreign corporation where either (i) 75 percent or more of its gross income for any year is passive income, or (ii) 50 percent or more of its average assets held during the year produces or is held for the production of passive income.⁴ For this purpose, “passive income” is generally defined as income that would be foreign personal holding company income under section 954(c), with additional exceptions for (i) interest, dividends, rents and royalties paid by a related person, but only to the extent that such amounts are attributable to the related party's non-passive income, (ii) active banking and insurance income and (iii) export trade income.⁵

There are no minimum U.S. ownership requirements for a foreign corporation to become a PFIC. If a foreign corporation is or becomes a PFIC, a shareholder who is a U.S. person (i) would be subject to an interest charge under section 1291 on the disposition of its shares in the foreign corporation or on “excess distributions” from the foreign corporation or (ii) could elect to be alternatively subject to current tax on a pro rata share of the foreign corporation's qualified earnings and net capital gains for a taxable year pursuant to sections 1293-1295 or, if the stock of the foreign corporation is publicly traded, subject to current tax on a mark-to-market basis pursuant to section 1296.⁶

The PFIC regime potentially applies to a U.S. person who is a shareholder of a foreign corporation that is directly or indirectly held by the U.S. person. For this purpose, section 1298(a) provides attribution rules to treat shares of a foreign corporation that are indirectly held by or through a corporation or partnership or held by attribution under an option “as owned” by the U.S. person.⁷ For example, in the context of indirect ownership through a corporation, section 1298(a)(2) provides in relevant part as follows:

(A) In general. If 50 percent or more in value of the stock of a corporation is owned, directly or indirectly, by or for any person, such person shall be considered as owning the stock owned directly or indirectly by or for such corporation in that proportion which the value of the stock which such person so owns bears to the value of all stock in the corporation.

(B) 50-percent limitation not to apply to PFIC. For purposes of determining whether a shareholder of a passive foreign investment company is treated as owning stock owned directly or indirectly by or for such company, subparagraph (A) shall be applied without regard to the 50-percent limitation contained therein.

As a result, for a foreign multinational group with U.S. and foreign subsidiaries, it is often necessary to test whether one or more of the foreign corporate members of that group are or are not PFICs with respect to an indirect U.S. shareholder of the parent company of the group.

B. Look-Through Rule of Section 1297(c)

For purposes of the PFIC income and assets tests, a foreign corporation that directly or indirectly owns at least 25 percent (as measured by value) of the stock of another corporation is required to take into account its proportionate share of the gross income and assets of such other corporation.⁸ Specifically, section 1297(c) provides as follows:

(c) Look-thru in the case of 25-percent owned corporations. If a foreign corporation owns (directly or indirectly) at least 25 percent (by value) of the stock of another corporation, for purposes of determining whether such foreign corporation is a passive foreign investment company, such foreign corporation shall be treated as if it —

(1) held its proportionate share of the assets of such other corporation, and

(2) received directly its proportionate share of the income of such other corporation.

Section 1297(c) was enacted as part of the Tax Reform Act of 1986 and added to the bill in conference.⁹ The 1986 Conference Report described the purpose behind the look-through rule as follows:

The conferees do not intend that foreign corporations owning the stock of subsidiaries engaged in active businesses be classified as PFICs. To this end, the agreement attributes a proportionate part of assets and income of a 25-percent owned corporation to the corporate shareholder in determining whether the corporate shareholder is a PFIC under either the asset test or income test.¹⁰

As enacted in 1986, section 1297(c) provided “If a foreign corporation owns at least 25 percent (by value) of the stock of another corporation,. . . .” (emphasis added). As part of the Technical and Miscellaneous Revenue Act of 1988, section 1297(c) was amended to provide “If a foreign corporation owns (directly or indirectly) at least 25 percent (by value) of the stock of another corporation,. . . .” (emphasis added).¹¹ This technical correction was made retroactively effective as if enacted as part of the Tax Reform Act of 1986. This technical correction made it clear the intent of Congress that the look-through rule of section 1297(c) was to be successively applied through tiers of subsidiary corporations for purposes of testing PFIC status of each indirectly owned foreign corporation.¹²

The section 1297(c) look through rule had as its stated purpose avoiding treatment of stock in corporations engaged in active businesses as passive assets, and that intent should inform the choice of interpretive alternatives when formal guidance is issued. Stated differently, guidance on the look-through rule should try to avoid interpretations that might convert stock in active businesses into stock in corporations engaged primarily in the collection of passive assets and income.

C. Limited Look-Through and Character Rule of Section 1298(b)(7)

For purposes of the PFIC income and assets tests, if a foreign corporation that owns at least 25 percent (as measured by value) of the stock of a domestic corporation (and meets certain other requirements), and the domestic corporation in turn owns the stock of a second-tier domestic corporation, then the stock of that second-tier domestic corporation and dividends arising on that stock will be treated as non-passive.¹³ Specifically, section 1298(b)(7) provides as follows:

(7) Treatment of certain foreign corporations owning stock in 25-percent owned domestic corporation.

(A) In general. If —

(i) a foreign corporation is subject to the tax imposed by section 531 (or waives any benefit under any treaty which would otherwise prevent the imposition of such tax), and

(ii) such foreign corporation owns at least 25 percent (by value) of the stock of a domestic corporation,

for purposes of determining whether such foreign corporation is a passive foreign investment company, any qualified stock held by such domestic corporation shall be treated as an asset which does not produce passive income (and is not held for the production of passive income) and any amount included in gross income with respect to such stock shall not be treated as passive income.

(B) Qualified stock. For purposes of subparagraph (A), the term "qualified stock" means any stock in a C corporation which is a domestic corporation and which is not a regulated investment company or real estate investment trust.

Section 1298(b)(7) was enacted as part of the Technical and Miscellaneous Revenue Act of 1988, regime.¹⁴ The legislative history of this limited look-through and character rule states as follows:

The bill further treats stock of certain U.S. corporations owned by another U.S. corporation which is at least 25-percent owned by a foreign corporation as a non-passive asset. Under this rule, in determining whether a foreign corporation is a PFIC, stock of a regular domestic C corporation owned by a 25-percent owned domestic corporation is treated as an asset which does not produce passive income (and is not held for the production of passive income), and income derived from that stock is treated as income which is not passive income. Thus, a foreign corporation, in applying the look-through rule applicable to 25-percent owned corporations, will be treated as owning non-passive assets in these cases. . . . This rule is designed to mitigate the potential disparate tax treatment between U.S. individual shareholders who hold U.S. stock investments through a U.S. holding company and those who hold those investments through a foreign holding company. If a foreign investment company attempts to use this rule to avoid the PFIC provisions, it will be subject to the accumulated earnings tax and, thus, the shareholders of that company will be subject to tax treatment essentially equivalent to that of the shareholders of PFICs.¹⁵

The Reports describe the point of the “domestic look-through rule” that the two-tier domestic ownership structure is itself intended to establish a “non-passive asset” when held “by a foreign corporation” that is “applying the look-through applicable to 25-percent owned corporations, will be treated as owning non-passive assets in these cases.” The “25-percent owned corporations” are nowhere delineated as only domestic corporations. The point of equalizing investment in U.S. and non-U.S. holding companies was to avoid disparate treatment held through a domestic holding company and a foreign holding company. Establishing disparate treatment between the most common holding structure for foreign multinational companies (a publicly traded parent holding an intermediate holding company) and a single-tier foreign parent appears to be diametrically opposite the point of section 1298(b)(7).

D. Mark-to-Market Regime for Marketable Stock

As noted above, if a foreign corporation is a PFIC and the shares of stock of such corporation is publicly treated, a shareholder of that foreign corporation can elect, in lieu of the interest charge regime, to annually include in income as ordinary income (and, with limitations, as ordinary loss) gains and losses on such shares determined on a mark-to-market basis. Specifically, section 1296(a) provides as follows:

(a) General rule. In the case of marketable stock in a passive foreign investment company which is owned (or treated under subsection (g) as owned) by a United States person at the close of any taxable year of such person, at the election of such person —

(1) If the fair market value of such stock as of the close of such taxable year exceeds its adjusted basis, such United States person shall include in gross income for such taxable year an amount equal to the amount of such excess.

(2) If the adjusted basis of such stock exceeds the fair market value of such stock as of the close of such taxable year, such United States person shall be allowed a deduction for such taxable year equal to the lesser of —

For this purpose, the term “marketable stock” is defined in section 1296(e) as follows:

(e) Marketable stock. For purposes of this section —

(1) In general. The term "marketable stock" means —

(A) any stock which is regularly traded on —

(i) a national securities exchange which is registered with the Securities and Exchange Commission or the national market system established pursuant to section 11A of the Securities and Exchange Act of 1934, or

(ii) any exchange or other market which the Secretary determines has rules adequate to carry out the purposes of this part,

(B) to the extent provided in regulations, stock in any foreign corporation which is comparable to a regulated investment company and which offers for sale or has outstanding any stock of which it is the issuer and which is redeemable at its net asset value, and

(C) to the extent provided in regulations, any option on stock described in subparagraph (A) or (B).

The section 1296 mark-to-market regime was enacted as part of the Taxpayer Relief Act of 1997.¹⁶ The legislative history of this mark-to-market regime reflects the intent of Congress to provide an efficient means for U.S. taxpayers to comply with the PFIC regime when making investments minor, passive investments in the shares of a publicly traded foreign corporation where information would not otherwise be available to comply with the PFIC regime, including obtaining information on lower tier entities held directly or indirectly by that public company. Specifically, the House Report provides as follows:

The Committee also understands that the interest-charge method for income inclusion provided in the PFIC rules is a substantial source of complexity for shareholders of PFICs. Even without eliminating the interest-charge method, significant simplification can be achieved by providing an alternative income inclusion method for shareholders of PFICs. Further, some taxpayers have argued that they would have preferred choosing the current-inclusion method afforded by the qualified fund election, but were unable to do so because they could not obtain the necessary information from the PFIC. Accordingly, the Committee believes that a mark-to-market election would provide PFIC shareholders with a fair alternative method for including income with respect to the PFIC.¹⁷

As further explained in the House Report, “[e]xcept as provided in the coordination rules described [in section 1296(j)], the rules of section 1291 (with respect to nonqualified funds) do not apply to a shareholder of a PFIC if a mark-to-market election is in effect for the shareholder's taxable year.”¹⁸ This rule is reflected in section 1291(d)(1), which states that, subject to section 1296(j) (applicable if the PFIC was a nonqualified fund prior to the election under section 1296), the deferred tax charge rules of section 1291 will not be applicable to the U.S. person that receives an excess distribution in respect of stock in a PFIC.

II. Inter-relationship of the Look-Through Rule of Section 1297(c) and the Limited Look-Through and Character Rule of Section 1298(b)(7)

There is limited guidance on how the look-through rule of section 1297(c) and the limited look-through and character rule of section 1298(b)(7) inter-relate. In two private pronouncements (as further described below), the IRS ruled that the limited look-through and character rule of section 1298(b)(7) 'trumps' the more general look-through rule of section 1297(c). However, even if these pronouncements are ultimately reflected in regulations under the PFIC regime, additional issues need to be addressed in order for taxpayers to comply with the purpose and policy of the PFIC regime.

A. Private Pronouncements

1. PLR 201322009

In PLR 201322009 (January 31, 2013), Corp X, a Country M corporation, owned all the outstanding shares of US Corp Y, a domestic corporation, and US Corp Y owned all the outstanding shares of US Corp Z, a domestic corporation.

In addition to holding the stock of US Corp Z, US Corp Y was engaged in a business involving the development, marketing and support of certain applications of software to business. US Corp Z was engaged in the conduct of a financing business.

Given the above ownership structure, both the look-through rule of section 1297(c) and the limited look-through and character rule of section 1298(b)(7) are potentially applicable for purpose of determining the passive or non-passive character of the gross income and the assets held by US Corp Z for purposes of testing Corp X's status as a PFIC under either the income or asset test of section 1297.

In this regard, the IRS ruled in PLR 201322009 that pursuant to section 1298(b)(7), Corp X was not treated as receiving any portion of the gross income earned by US Corp Z, and Corp X was treated as not owning the assets held by US Corp Z. Further, any dividend received by US Corp Y from US Corp Z, and any other income received by US Corp Y, was treated under section 1297(c) as being received directly by Corp X. All of US Corp Y's assets, including the shares of US Corp Z, was treated under section 1297(c) as owned directly by Corp X. Finally, pursuant to section 1298(b)(7), any dividend received by US Corp Y from US Corp Z was treated as not being passive income, and the shares of US Corp Z were treated as not producing passive income and as not being held for the production of passive income.

2. PLR 201515006

In PLR 201515006 (November 21, 2014), under similar facts as PLR201322009, Corp X, a publicly traded Country M corporation, owned all the outstanding shares of US Corp Y, a domestic corporation, and US Corp Y owned all the outstanding shares of US Corp Z, a domestic corporation.

In addition to holding the stock of US Corp Z, US Corp Y conducted operations related to Corp X's pharmaceutical, research and development business. The activities of US Corp Z were not disclosed.

Again, as in PLR 201322009, given the above ownership structure, both the look-through rule of section 1297(c) and the limited look-through and character rule of section 1298(b)(7) are potentially applicable for purpose of determining the passive or non-passive character of the gross income and the assets held by US Corp Z for purposes of testing Corp X's status as a PFIC under either the income or asset test of section 1297.

In this regard, the IRS ruled in PLR 201515006 that pursuant to sections 1298(b)(7) and 1297(c), (i) the shares of US Corp Z were treated as directly held by Corp X that did not produce passive income (and not held for the production of passive income) and (ii) any dividend paid by US Corp Z to US Corp Y were treated as directly received by Corp X that was not passive income.

B. Application of Section 1297(c) and Section 1298(b)(7) with Multiple Foreign Tiers

The inter-relationship of the look-through rule of section 1297(c) and the limited look-through and character rule of section 1298(b)(7) as applied in the above two private pronouncements is in accord with tax practitioners' expectations and analyses. However, the simple facts of PLR 201322009 and PLR 201515006 leave several issues unanswered for many typical fact patterns for which testing of PFIC status is relevant.

For example, for many foreign parented multinational groups, especially when the foreign parent is publicly traded, the stock of the top-tier U.S. subsidiary is often not directly held by the foreign parent, but is instead held by a regional holding company or another intermediate holding company.¹⁹ In this regard, assume the facts of PLR 201322009 and PLR 201515006 are modified so that the stock of US Corp Y is held directly by an intermediate holding company (“FHC”), which, in turn, is held directly by Corp X.

In this fact pattern, some tax practitioners are of the view that it is arguable that the limited look-through and character rule of section 1298(b)(7) is not applicable for purposes of testing the PFIC status of Corp X, but is only applicable for purposes of testing the PFIC status of FHC.²⁰ This position is based on the view that section 1298(b)(7) requires that the tested foreign corporation “owns” the stock of the top-tier U.S. subsidiary, which implies direct ownership. This position is then supported by the fact that section 1298(b)(7) and its use of the term “owns” was enacted as part of the Technical and Miscellaneous Revenue Act of 1988, the same tax act that amended section 1297(c) to replace the term “owns” by the phrase “owns (directly or indirectly)” as discussed above.

However, we believe that this view is too narrow, and indeed would introduce “disparate treatment” inconsistent with the stated intention of each of the Senate Finance Committee and the House Committee on Ways and Means in their respective reports on this new provision. Although section 1298(b)(7) does not mimic the “owns (directly or indirectly)” language of section 1297(c), section 1298(b)(7) also does not explicitly require that the tested foreign corporation “owns (directly)” the top-tier U.S. subsidiary. Section 1298(b)(7)(A)(ii) simply requires that the tested foreign corporation “owns” the stock of the top-tier U.S. subsidiary. Moreover, if the direct or indirect ownership threshold of section 1297(c) is satisfied, that general look-through rule provides that “for purposes of determining whether such foreign corporation is a passive foreign investment company, such foreign corporation shall be treated as if it — (1) held its proportionate share of the assets of such other corporation, and (2) received directly its proportionate share of the income of such other corporation.”²¹ Thus, for purposes of testing the PFIC status of Corp X in the context of the above modified fact pattern and in accord with the IRS's rulings in PLR 201322009 and PLR 201515006, section 1297(c) causes Corp X to be a “direct” shareholder of US Corp Y for purposes of then applying section 1298(b)(7) with respect to US Corp Y's share ownership in US Corp Z.

This application of the rules is fully in accord with the purpose and policy for the enactment of section 1298(b)(7), namely: “mitigate the potential disparate tax treatment between U.S. individual shareholders who hold U.S. stock investments through a U.S. holding company and those who hold those investments through a foreign holding company.” Given that the US Corp Y/US Corp Z group is subject to full U.S. federal income tax, it is difficult to perceive a purpose for not permitting the application section 1298(b)(7) simply because an intermediate foreign holding company is between the tested foreign parent and the top-tier U.S. subsidiary (noting that the intermediate foreign holding company is ignored for all other PFIC testing purposes pursuant to section 1297(c)).

Requested Guidance. Guidance to provide that the look-through rule of section 1297(c) applies to determine if a tested foreign corporation “owns” the stock of a U.S. corporate subsidiary for purposes of then applying section 1298(b)(7) by that tested foreign corporation.

As indicated above, one of the pre-requisites for the application of the limited look-through and character rule of section 1298(b)(7) is for the foreign corporation to be subject to the tax imposed by section 531 (or waives any benefit under a treaty that would otherwise prevent the imposition of that tax).²² As drafted, this requirement to be subject to section 531 is statutorily limited to the tested foreign corporation. An issue might arise if a foreign parent being tested for PFIC status is subject to section 531 (or otherwise waives treaty benefits) but the intermediate foreign holding company (FHC) for the top-tier U.S. subsidiary is not subject to section 531 (or fails to waive treaty benefits). In such a fact pattern, Treasury and the IRS should consider adding as a condition (pursuant to its grant of authority under section 1298(g) to issue “such regulations as may be necessary or appropriate to carry out the purpose of [the PFIC regime]”) for applying section 1297(c) look-through to enable access to the limited look-through and character rule of section 1298(b)(7) that the tested foreign corporation and each intermediate foreign holding company must be subject to section 531 or otherwise must waive treaty benefits that would otherwise prevent the imposition of that tax. In this regard, it is noted that “any foreign corporation” that is directly or indirectly held by any shareholder that is subject to U.S. federal income tax will be subject to the additional tax imposed under section 531 on its inappropriately accumulated U.S. source income.²³

C. Application of Section 1297(c) and Section 1298(b)(7) with Multiple Subsidiaries

The simple facts of PLR 201322009 and PLR 201515006 also leave unanswered the inter-relationship of the look-through rule of section 1297(c) and the limited look-through and character rule of section 1298(b)(7) when the second tier U.S. subsidiary itself owns one or more tiers of U.S. or foreign subsidiaries.

For example, for many foreign parented multinational groups, U.S. operations are generally conducted through a U.S. affiliated group that could include multiple tiers of U.S. business entities as well as foreign operations conducted through one or more controlled foreign corporations of that affiliated group. In this regard, assume that the facts of PLR 201322009 and PLR 201515006 are modified so that there are one or more corporate subsidiaries held directly or indirectly by US Corp Z (“US Corp A” and “CFC”).

In this fact pattern, although no direct authority exists, tax practitioners are generally of the view that for purposes of testing the PFIC status of Corp X, sections 1297(c) and 1298(b)(7) apply to treat (i) the shares of US Corp Z as directly held by Corp X that does not produce passive income (and not held for the production of passive income) and (ii) any dividend paid by US Corp Z to US Corp Y as directly received by Corp X that is not passive income. Further, this treatment means that the asset and gross income of US Corp A and CFC are not taken into account in testing the PFIC status of Corp X, even though only the stock of US Corp Z would be “qualified stock” as defined in section 1298(b)(7)(B).

Again, this application of the rules is fully in accord with the purpose and policy for the enactment of section 1298(b)(7) namely: “mitigate the potential disparate tax treatment between U.S. individual shareholders who hold U.S. stock investments through a U.S. holding company and those who hold those investments through a foreign holding company.”

If section 1298(b)(7) does not apply to “block” look-through to entities and assets below the issuer of the qualified stock (i.e., US Corp Z in this example) for purposes of testing the PFIC status of Corp X, then the alternative would be to apply (i) section 1298(b)(7) to treat dividends and the stock of US Corp Z as not passive and (ii) section 1297(c) to take into account Corp X's pro rata share of the gross income and assets of US Corp A and CFC. This alternative would result in double counting in that (i) some portion of the gross income of US Corp A and CFC will eventually be reflected in the dividends paid by US Corp Z treated as non-passive under section 1298(b)(7) and (ii) some portion of the fair market values of the assets of US Corp A and CFC will be reflected in the fair market value of the stock of US Corp Z treated as non-passive under section 1298(b)(7).

Requested Guidance. Guidance to provide that once section 1298(b)(7) applies to characterize qualified stock of a domestic subsidiary and dividends on that stock as non-passive, (i) the look-through rules of section 1297(c) will not apply to corporate subsidiaries of such domestic subsidiary and (ii) the indirect ownership rules of section 1298(a) will not apply to treat a shareholder of a tested foreign corporation as an owner of any foreign corporate subsidiary through the qualified stock of such domestic subsidiary.

III. Clarification of Scope of the Section 1296 Mark-to-Market Regime

Although limited guidance has been issued to date on the scope and application of the mark-to-market regime for marketable shares of a PFIC under section 1296,²⁴ the guidance provided to date might still cause this election to be risky for electing taxpayers, which thereby inhibits the use of section 1296 to the full extent intended by Congress in enacting the section 1296 regime.

Specifically, if a shareholder who is a U.S. person directly or indirectly owns the shares of a publicly traded foreign corporation that has issued marketable stock (“section 1296 stock”) makes an election in accordance with section 1296(k) and the regulations thereunder to apply the section 1296 mark-to-market regime to such stock, the U.S. shareholder might arguably remain subject to the PFIC regime for any foreign corporate subsidiaries indirectly held through that publicly traded foreign corporation.

Although, as indicated above, section 1291(d)(1) provides that the deferred tax charge rules of section 1291 will not apply to U.S. person that receives an excess distribution in respect of stock in a PFIC for the period the mark-to-market regime of section 1296 is in place, it is unclear whether this non-application is limited to just the marketable stock of the publicly traded foreign corporation that is itself subject to section 1296 or whether this non-application of section 1291 also applies to the stock of foreign corporate subsidiaries that are PFICs that are indirectly held by such a publicly traded foreign corporation. The House Report statement that “[e]xcept as provided in the coordination rules described [in section 1296(j)], the rules of section 1291 (with respect to nonqualified funds) do not apply to a shareholder of a PFIC if a mark-to-market election is in effect for the shareholder's taxable year”²⁵ suggests that non-application of section 1291 should include indirectly held foreign corporate subsidiaries. However, the counter-argument might be that, because section 1298(a) causes the U.S. shareholder to be a deemed direct shareholder of indirectly held foreign corporate subsidiaries, section 1297 remains applicable to test the status of those lower tier entities as “PFICs” subject to the PFIC regime as no election under section 1296(k) would be in place with respect to these lower tier foreign corporate subsidiaries.

In this regard, it is noted that if the publicly traded foreign corporation is a PFIC (even if the section 1296 regime is elected), the 50 percent ownership threshold for indirect ownership attribution under section 1298(a)(2)(A) is not applicable.²⁶ As a result, for example, if a shareholder who is a U.S. person directly or indirectly owns 0.1% of the shares of a publicly traded foreign corporation that is a PFIC, it could make the section 1296 election for that corporation, but then remain potentially subject to the section 1291 PFIC interest charge regime for any foreign corporation indirectly held by or through that publicly traded foreign corporation. Moreover, it is highly unlikely that a minority shareholder of a publicly traded foreign corporation will be able to obtain the required information with respect to the publicly traded foreign corporation and/or its indirectly held foreign corporate subsidiaries to either comply with the section 1291 interest charge regime or to qualify and comply with the qualified electing fund regime of sections 1293-1295. This is precisely the reason for enacting the mark-to-market regime of section 1296.

In addition, if a shareholder who is a U.S. person makes an election under section 1296 but yet remains liable to the full PFIC regime with respect to foreign corporate subsidiaries held directly or indirectly by that publicly traded foreign corporation, there will be a double counting of income inclusions by the electing shareholder in that the mark-to-market gains taken into account with respect to the section 1296 stock presumably fully reflects the shareholder's pro rata share of the income, earnings and growth in asset values of all subsidiaries of the publicly traded foreign corporation group.

Requested Guidance. Although implicit under the current rules of section 1291(d)(1), clarification that the indirect ownership rules of section 1298(a) will not apply with respect to section 1296 stock of a publicly traded foreign corporation while an election in accordance with section 1296(k) and the regulations thereunder is in force with respect to that stock.

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We appreciate your consideration of our comments. We would be happy to discuss any questions you may have in person or by phone.

Sincerely,

Robert H. Dilworth
Jeffrey M. O'Donnell
Washington, DC