The IRS adopted final regulations (TD 9806) on determining the ownership of a passive foreign investment company (PFIC), reporting requirements for shareholders of PFICs to file Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund and on an exception to the requirement for certain shareholders to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations.

These regulations adopt proposed regulations that were issued in December of 2013 with certain changes. As well, the related temporary regulations are removed. The changes are effective December 28, 2016.

Passive Foreign Investment Companies are defined at IRC §1297(a) as follows:

(a) In general For purposes of this part, except as otherwise provided in this subpart, the term “passive foreign investment company” means any foreign corporation if—

(1) 75 percent or more of the gross income of such corporation for the taxable year is passive income, or

(2) the average percentage of assets (as determined in accordance with subsection (e)) held by such corporation during the taxable year which produce passive income or which are held for the production of passive income is at least 50 percent.

IRC §§1291-1298 provide three different methods for taxing PFIC shareholders:

Under IRC §1291’s excess distribution rules under which a special tax and interest charge are imposed on a U.S. shareholder that receives an “excess distribution” or recognizes gain from a distribution of stock in a PFIC that is classified as an excess distribution pursuant to IRC §1291(a)(2).
Under IRC §1293’s qualified electing fund (QEF) rules where a shareholder must include in income his/her share of the PFIC’s earnings and profits (with certain adjustments). The fund’s ordinary income and net capital gain are passed through to the shareholder and retain their normal tax treatment.
Under IRC §1293’s mark to market rules (MTM) where an electing shareholder includes in income each year an amount equal to the excess (if any) of the fair market value of the stock over the shareholder’s adjusted basis of the stock, computed as of the end of the year. A deduction is allowed for the excess of the stock basis over the FMV at the end of the year or the unreversed inclusions with respect to the stock. These amounts, along with any gain or loss on the disposition of the PFIC stock are taxed as ordinary income/loss.

Below are described some of the more significant provisions of these regulations.

The regulations provide that a person is not treated as a shareholder of a PFIC to the extent the shares are owned through a tax-exempt entity or an account described in Reg. §1.1298-1(c)(1). That provision reads:

(1) Exception if shareholder is a tax-exempt entity. A shareholder that is an organization exempt under section 501(a) to the extent that it is described in section 501(c), 501(d), or 401(a), a state college or university described in section 511(a)(2)(B), a plan described in section 403(b) or 457(b), an individual retirement plan or annuity as defined in section 7701(a)(37), or a qualified tuition program described in section 529, a qualified ABLE program described in 529A, or a Coverdell education savings account described in section 530 is not required under section 1298(f) and these regulations to file Form 8621 (or successor form) with respect to a PFIC unless the income derived with respect to the PFIC stock would be taxable to the organization under subchapter F of Subtitle A of the Code.

The final regulations also address the concern that the rules for attribution of ownership via domestic corporation could cause a duplication of ownership when applied mechanically. The IRS gives the following example of both how the rule was supposed to apply and how it could create duplication in the preamble:

For example, assume that A, a United States person, owns 49 percent of the stock of FC1, a foreign corporation that is not a PFIC, and separately all the stock of DC, a domestic corporation that is not an S corporation. DC, in turn, owns the remaining 51 percent of the stock of FC1, and FC1 owns 100 shares of stock in a PFIC (which is not a controlled foreign corporation within the meaning of section 957(a)). DC is an indirect shareholder with respect to 51 percent of the PFIC stock held by FC1 under § 1.1291-1T(b)(8)(ii)(A). Absent the application of § 1.1291-1T(b)(8)(ii)(C), because A directly or indirectly owns less than 50 percent of the value of the stock of FC1 and thus § 1.1291-1T(b)(8)(ii)(A) does not apply, A would not be treated as an indirect shareholder with respect to any of the PFIC stock directly owned by FC1 when, from an economic perspective, A indirectly owns all the PFIC stock held by FC1. Therefore, without a rule treating A as owning DC's stock in FC1, the remaining 49 percent of the PFIC stock held by FC1 would not be treated as owned by any United States person.

On the other hand, the literal language of § 1.1291-1T(b)(8)(ii)(C) could have been interpreted to create overlapping ownership by two or more United States persons in the same stock of a section 1291 fund. Thus, in the foregoing example, A may have been considered as owning 100 percent of the stock of FC1, and therefore as indirectly owning all 100 shares of the PFIC stock held by FC1, even though 51 of those shares are considered indirectly owned by DC, a United States person. This outcome is inconsistent with the intended purpose of the rule to attribute stock through a domestic C corporation in certain circumstances if, absent such attribution, the stock of a PFIC would not be treated as owned by any United States person.

The final regulations adopt an anti-duplication rule described as follows in the preamble:

To address this concern, the final regulations include a non-duplication rule. Specifically, the final regulations provide under § 1.1291-1(b)(8)(ii)(C)(1) that, solely for purposes of determining whether a person owns 50 percent or more in value of the stock of a foreign corporation that is not a PFIC under § 1.1291-1(b)(8)(ii)(A), a person who directly or indirectly owns 50 percent or more in value of the stock of a domestic corporation is considered to own a proportionate amount (by value) of any stock owned directly or indirectly by the domestic corporation. However, the non-duplication rule in § 1.1291-1(b)(8)(ii)(C)(2) states that a United States person will not be treated, as a result of applying § 1.1291- 1(b)(8)(ii)(C)(1), as owning (other than for purposes of determining whether a person satisfies the ownership threshold of § 1.1291-1(b)(8)(ii)(A)) stock of a PFIC that is directly owned or considered owned indirectly under § 1.1291-1(b)(8) by another United States person (determined without regard to § 1.1291-1(b)(8)(ii)(C)(1)).

Applying the non-duplication rule to the example above, to the extent that the 51 shares of PFIC stock are indirectly owned by DC (a United States person) under § 1.1291-1(b)(8)(ii)(A), those shares are not also treated as indirectly owned by A (other than for purposes of determining whether A satisfies the ownership threshold of § 1.1291-1(b)(8)(ii)(A)). Only the remaining 49 shares of PFIC stock are considered to be indirectly owned by A.

The final regulations also add the following two clarifications to the rule as described in the preamble:

First, the final regulations clarify, under § 1.1291-1(b)(8)(ii)(C)(3), that the ownership rule of § 1.1291-1(b)(8)(ii)(C)(1) does not apply to stock owned directly or indirectly by an S corporation; rather, the indirect ownership rule under § 1.1291-1(b)(8)(iii)(B) applies in those instances. Second, the final regulations clarify that the attribution rule in § 1.1291-1(b)(8)(ii)(C) applies to all PFICs and not only section 1291 funds, in order to ensure that United States persons who are treated as indirect shareholders of PFICs are permitted to make qualified electing fund elections under section 1295.

The final regulations make changes to the exceptions to the reporting requirements under IRC §1298(f) for filing Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.

The final regulations adopt the relief from reporting for certain PFIC stock marked to market under other provisions. As the preamble notes:

The final regulations, in accordance with Notice 2014-51, add § 1.1298-1(c)(3), which provides that United States persons that own PFIC stock that is marked to market under a non-section 1296 MTM provision are not subject to section 1298(f) reporting unless they are subject to section 1291 under the coordination rule in § 1.1291-1(c)(4)(ii). Generally, under § 1.1291-1(c)(4)(ii), when a United States person's PFIC stock is marked to market under a non-section 1296 MTM provision in a taxable year after the year in which the United States person acquired the stock, the United States person is subject to section 1291 for the first taxable year in which the United States person marks to market the PFIC stock. Thus, the United States person is subject to section 1291 with respect to any unrealized gain in the stock as of the last day of the first taxable year in which the stock is marked to market, as if the person disposed of the stock on that day. See § 1.1291-1(c)(4)(ii) and § 1.1296-1(i)(2) and (3).

Also consistent with Notice 2014-51, the final regulations add § 1.1298-1(c)(2)(ii)(C), pursuant to which a United States person's PFIC stock that is marked to market under a non-section 1296 MTM provision is not taken into account in determining whether the person qualifies for the exceptions from section 1298(f) reporting set forth in § 1.1298-1(c)(2)(i)(A)(1) or (c)(2)(iii), provided that the rules of § 1.1296-1(i)(2) and (3) do not apply with respect to the PFIC stock pursuant to § 1.1291-1(c)(4)(ii) for the taxable year. See Section B.7 of this preamble for a description of these exceptions.

The final regulations also add a provision exempting certain partnerships from having to file a Form 8621 when none of the partnership’s direct or indirect partners are subject to the PFIC rules. As the preamble notes:

Requiring reporting under section 1298(f) by a domestic partnership when none of its direct and indirect owners are subject to the PFIC rules may result in undue compliance costs and burdens. Accordingly, consistent with the exception in § 1.1298-1(c)(1), the final regulations adopt and expand upon this comment and provide a final rule in § 1.1298-1(c)(6) that exempts a domestic partnership from section 1298(f) reporting with respect to an interest in a PFIC for a taxable year when none of its direct or indirect partners are required to file Form 8621 (or successor form) with respect to the PFIC interest under section 1298(f) and these regulations because the partners are not subject to the PFIC rules.

Thus, for example, if all the partners of a domestic partnership are tax-exempt organizations exempt from PFIC taxation under § 1.1291-1(e) with respect to PFIC stock held by the partnership, and accordingly are exempt from reporting pursuant to § 1.1298-1(c)(1), the partnership, in turn, is exempt from filing Form 8621 under section 1298(f) with respect to the PFIC stock held by the partnership. Likewise, if all the partners of a domestic partnership are foreign corporations that are not considered to be shareholders under § 1.1291-1(b)(7) of PFIC stock held by the partnership, and no United States person is an indirect shareholder of the PFIC stock under § 1.1291-1(b)(8), the partnership, in turn, is exempt from filing Form 8621 under section 1298(f) with respect to the PFIC stock held by the partnership.

In contrast, a domestic partnership is not exempt from filing Form 8621 under § 1.1298-1(c)(6) with respect to stock it holds in a section 1291 fund when some or all of its partners are exempt from filing Form 8621 with respect to that stock but otherwise would be subject to tax on distributions on, or dispositions of, that stock. PFIC information reporting by the domestic partnership in these circumstances is appropriate because it furthers PFIC tax compliance and enforcement.

The regulations also contain provisions related to the filing of Form 8621. If a taxpayer who is required to file Form 8621 is not otherwise required to file an income tax return, the final regulations provide that the taxpayer is to file the Form 8621 in accordance with the instructions for the form.

The final regulations also have provisions dealing with statements to be filed by individuals exempted from filing Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations.

The first provision makes as revision to Reg. §1.6038-2(j)(3) that provides that if a person is exempted from being required to file a Form 5471 due to Reg. §1.6038-2(j)(1) (that is, another person is required to furnish the information on the foreign corporation and a joint return is filed with that person’s return) must “file a statement with his income tax return indicating that such requirement has been (or will be) satisfied and identifying the return with which the information was or will be filed and the place of filing.” This provision applies to returns filed on or after December 31, 2013.

The final regulations also provide at Reg. §1.6046-1(e)(5) that if a person is required to file a Form 5471 of which he is an officer or director “may, if such item of information is furnished by another person having an equal or greater stock interest (measured in terms of either the total combined voting power of all classes of stock of the foreign corporation entitled to vote or the total value of the stock of the foreign corporation) in such foreign corporation, satisfy such requirement by filing a statement with his return on Form 5471 indicating that such requirement has been satisfied and identifying the return in which such item of information was included.”

The rules generally apply to returns filed on or after December 31, 2013, which is the date the temporary regulations were published. As well, Notices 2014-28 and 2014-51 are both obsoleted as of December 28, 2016.