~ Immigration Tax Planning ~
Passive Foreign Investment Company "PFIC"
Definition of a PFIC
A foreign corporation with one or more U.S. shareholders is a PFIC if 75% or more of its income is passive income or if at least 50% of its assets would be invested in instruments which produce interest, dividends and/or capital gains. Unlike a controlled foreign corporation or a foreign personal holding company , there is no minimum percentage ownership by U.S. shareholder to trigger application of the PFIC rules. If a foreign corporation has a high enough percentage of passive income or assets, it is a PFIC as regards any U.S. shareholder no matter how small their ownership percentage of the foreign corporation and regardless of whether the U.S. shareholders, individually or in the aggregate, have the ability to control the business or investments of the foreign corporation.
Consequences of Owning Stock in a PFIC
The consequences to a U.S. resident or citizen of owning stock in a PFIC are rather severe. Certain "excess distributions" from a PFIC and gains from the sale of PFIC stock are characterized as ordinary income even if they would otherwise qualify for capital gains treatment. Moreover, tax due with respect to excess distributions or gain from the sale of PFIC stock is subject to an interest charge to reflect the deferral since the income was earned by the PFIC. In addition, shares of PFIC stock are not entitled to a Section 1014 step-up in basis at death.
Availability of QEF Election
It
is possible for the U.S. shareholders of a PFIC to make an election to
treat the PFIC as a qualified electing fund ("QEF"), but then the U.S.
shareholders of the PFIC must pay tax currently on the PFIC's income,
even if it is not distributed. This can cause cash flow problems for the
U.S. shareholder. If the corporation is not a QEF for every year in which
it is a PFIC, then the conversion from capital gain to ordinary income
and interest charge rules continue to apply to the extent of the company's
earnings while it was a non-QEF. In other words, only a so-called "pedigreed"
QEF which has been a QEF in every year in which it was a PFIC is excused
from the interest charge and character conversion rules. In addition,
a "pedigreed" QEF can engage in mergers, share exchanges and other reorganizations
on a tax-free basis, whereas a PFIC or a non-pedigreed QEF would be taxed
(or the shareholders would be taxed) if they engaged in the same transaction.
Coordination with Other Anti-Deferral Rules
There are coordination rules which determine how to tax income which is subject to both the PFIC and CFC rules. Generally, so long as the U.S. persons are deemed to be Ten Percent Shareholders with respect to that foreign corporation, income subject to both regimes it is treated as Subpart F income taxable under the CFC rules and is not taxed again as QEF income or as an excess distribution from a PFIC. Since Subpart F income generally retains its character in the hands of a U.S. Shareholder, being taxed on a pro rata share of Subpart F income should not differ substantially from being taxed on the income from the corporation's assets as if the Ten Percent Shareholders owned their share of the corporation's assets directly, unless the foreign corporation generates substantial earnings and profits which are not taxable income but which generate a current inclusion under Section 956 (earnings and profits invested in U.S. situs assets) or Section 956A (earnings and profits invested in passive assets). This ability to retain the character of capital gains is one of several reasons why it is advisable to make a QEF or mark-to-market election for any PFIC owned by a U.S. citizen or resident which is not a CFC or where the person is not a Ten Percent Shareholder.
Reporting Rules
In addition to the substantive rules, there are significant record-keeping and reporting burdens placed on U.S. shareholders of a foreign corporation that is a PFIC or CFC. Transfers to foreign corporations must be reported on Form 926, and the information required under Section 6038B must be attached to the form. U.S. shareholders of CFCs must annually file Form 5471 regarding U.S. ownership and control of foreign corporations and the corporation must file Form 5472 regarding transactions with related parties. In addition, each U.S. shareholder of a PFIC (which in the case of an S corporation includes both the corporation and its shareholders and in the case of a partnership includes both the partnership and its partners) must annually file Form 8621.