TAX 9869 Lecture 12: 20

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11 Aug 2020
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Class 13: July 22, 2020
Passive foreign investment company (PFIC)
- Leaving CFC world
- Probs not something anyone wants to own
- Imp to identify
- We see individuals investing and typically they may have inv in foreign hedge funds
which are corps for US tax purposes
- PFIC: Foreign corporation which earns passive inc (div/int/rent/royalties)
- PFIC rules refer you back to sub f to determine which items of income are passive
- PFIC earns passive income
Two tests to determine is it a PFIC or not: income OR asset test
- Income test: if 75% or more of income of foreign corp is passive income, then the FC is
a PFIC
- Take each item of foreign corporation and categorize it
- If passive then it goes in here, active there, if passive is 75% or more
- Asset test: at least 50% of average assets of foreign corp produce passive income then
foreign corp is a PFIC; if at least 50% of avg assets produce passive income = PFIC
- Look @ each asset; does this asset produce passive income?
- If so, say goes here, if active there
- If meets criteria, FC becomes PFIC
EXAMPLE:
-
- The way we test
- I have a FC and want to know if it’s a PFIC
- The FC1 owns 100% of FC2, 30% of FC3, and 5% of FC4
- If i want to know which one is a PFIC; im going to have to test
- If im a US indiv invested in FC1, im concerned w/ each FC1+2+3+4, test each one to
det. if PFIC; must look thru each one
- If US indiv (corp) owns 100% of FC 1 = CFC//FC2= CFC//don't know about FC3 or FC4
(don’t have enough info)
- Before we get into how to test; there is something called CFC PFIC overlap rule
FINAL EXAM
- If a foreign corporation is a CFC and If i am USSH of a CFC, then CFC rules
apply to me not the PFIC rules
- Possible for FC to be both a CFC + PFIC
If both CFC and PFIC , then anybody who is USSH; owns 10% or more of vote or
value, subpart F rules apply to him
- And anyone who’s not a USSH (owns <10%) PFIC rules apply to him
- If a FC is both a PFIC + a CFC, it must meet one of these two tests
- If meets income test; not only is it a PFIC but if it’s a CFC then subpart f
income
- If CFC and earning passive income = foreign personal holding income =
taxed
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- If CFC is also a PFIC then has passive income at least some passive income;
and then if some passive income, its sub f income
- If USSH of a CFC and a PFIC, CFC rules apply to you Subpart F, not PFIC rules
- Lets say US individual owned 1% of FC1 and very little of FC3/FC4(when it comes to
PFIC there is no minimum)
- USSH has to worry about PFC rules and must test all FCs
- First looks @ income of FC1 and assets of FC1
- but when u test FC that has subs you must look through to subs and use the
income or assets of subs in testing the parent
- Only do that if parent owns at least 25% or more of sub
- When testng FC1, don't only look @ FC1 income + assets
- But also look @ FC2 income + assets (bc it owns 100% of FC2)
- Since owns >25% of FC3, look@ 30% of FC3 income + assets
- Not FC4 bc own only 5%
- When doing testing of FC1 for income or asset tests [Assets of FC2 and 30% of
Assets of FC3]
- Important bc a lot of intl structures have holding companies that have v little
activity or only asset = cash bc you put it in a bank and earn interest income
- Cash for PFIC testing = bad asset bc its passive asset
- If you have a holding company structure, FC2 could be operational, but maybe
FC1 is a holding company with cash. If I didn’t look through to subs FC1 might be
a PFIC because of cash, this is a problem SO THEY LET YOU LOOK
THROUGH
- Once a PFIC; always a PFIC, can’t get out of it- deal with rules for year you were PFIC
- The point= allowed to look through: So when i test FC1 look through but also test
Fc2/3/4 (only test F2/3/4 in standalone) income vs. asset test
- Possible FC1, 2, 3 not PFICS, but FC4 IS a PFIC
- Proposed regs= if foreign corp owns a pship, apply the same thing- proportionate share
of income and assets and use as part of the testing
- In his example FC2 and 3 look through to assets and income for FC1, FC4 IS A
PASSIVE ASSET OF FC1 because FC4 all it does is pay dividends to FC1- this is the
income it generates- div income (passive)
- FC4- passive asset for this purpose
- When you characterize assets, machine that makes pens= active, stock of a corp that
owns less than 25%= passive asset
- If FC2 pays div to FC1, exclude from testing, look through to income and assets
Bad thing about PFIC; if u dont make certain elections on pFIC + u get distr out of PFIC as a US
person that owns shares you could end up paying ordinary tax rates but you might also pay on
that distribution penalties + interest to IRS
- IRS says youre investing in foreign corp that is earning passive income...you’re just
pushing income outside the US, why are you not earning it here??
- If invest in 2020 and don’t receive until 2025, rules might say view distribution that it
relates to inv from 2020- 2020-2025, if claim lookback to the one got in 2025, and look
as though got some in 2020, 2021, 2022,etc. You didn’t pay income tax on distribution,
owe penalties on lack of income tax payment
Recap:
- Meet either two tests to determine is it a PFIC or not: income or asset test
- Can be both a CFC and a PFIC, then 10% USSHs can treat CFC and rules apply to
them for Sub F and GILTI
- For Less than 10% of USSH, PFIC rules apply
- What congress was intending w/ PFIC rules (old rules + regs are old)
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