Updated PFIC Rules and Relaxed Reporting

The alternative investment industry welcomed the final regulations that were recently published by the IRS and the Treasury Department, which have the effect of minimizing the reporting burden for certain investors in passive foreign investment companies (“PFIC”). The PFIC regime is a set of anti-abuse rules that are intended to eliminate the benefits of tax deferral by U.S. persons who invest in certain offshore corporations that satisfy either an asset or an income test. The income test is met if a minimum of 75 percent of the foreign corporation’s gross income is passive income. The asset test is met if a minimum of 50 percent of the foreign corporation’s assets are assets that produce, or are held to produce, passive income. The recent rules, which are effective as of December 28, 2016, are intended to provide clarity and minimize reporting where the IRS deemed it unnecessary. Please note that this article is not an exhaustive analysis of the final regulations but is intended to focus on the impact these final regulations will have on the alternative investment industry.

Definition of a Shareholder

The final regulations codify prior IRS guidance related to the definition of a shareholder of a PFIC. Specifically, owners of an interest in a PFIC that is held through a tax-exempt entity are removed from the definition of PFIC shareholders. Therefore, for example, neither beneficiaries of pension funds, nor owners of an IRA should be treated as shareholders of a PFIC if the pension or IRA is invested in an offshore feeder fund (blocker) that is formed as a foreign corporation. This clarified definition should be a welcome relief to a significant portion of alternative investors who are now exempt from filing Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.

Direct and Indirect Shareholder

The final regulations adopt a “non-duplication” rule, which is designed to ensure that the same shares of a PFIC are not attributed to multiple U.S. persons. To illustrate, the preamble to the final regulations addresses a tiered structure where a U.S. person wholly owns a domestic U.S. corporation that in turn owns a majority interest in a foreign (non-PFIC) corporation. Additionally, the U.S. person directly owns the minority interest in the aforementioned non-PFIC foreign corporation. The foreign corporation in turn holds 100 percent of all the shares of a lower tier PFIC. Prior to these final regulations, the existing regulations could have been interpreted to attribute ownership of 100 percent of the non-PFIC’s shares to the U.S. person, resulting in duplicate ownership of the 51 percent ownership that is held by the domestic corporation. Under the prior rules both the U.S. owner and the domestic corporation could have been treated as majority owners of the PFIC and required to file Form 8621.

The non-duplication rule has the effect of disregarding attributable ownership in a tiered structure. Therefore, a U.S. person should no longer be treated as the owner of PFIC shares that are directly or indirectly owned by another U.S. person (including a U.S. corporation). While this rule may have limited application to hedge fund structures, it may be more relevant in private equity deals that include multiple tiers.

Exemptions for Filing Form 8621

The final regulations also include certain classes of PFIC shareholders that would no longer have to file Form 8621. Notably this group includes-

  1. Shareholders that already report under another mark-to-market regime such as a trader fund with an IRC section 475(f) election;
  2. Domestic partnership whose investors are all tax-exempt. (Note that this exemption may not provide significant relief to hedge fund investors since it’s unlikely that tax-exempt investors would invest through a domestic U.S. pass-through entity for fear of generating UBTI where the underlying master fund is leveraged);
  3. Expanded exception for all PFIC stock that is owned by a foreign pension fund, which is covered by a U.S. income tax treaty. Previously this exemption was limited to retirement accounts that were formed as a trust;
  4. Dual resident taxpayers who under certain “tie-breaker” provisions of an income tax treaty are treated as residents of the treaty country (and not the U.S.);
  5. Shareholders that hold PFIC shares for less than 30 days, provided that the shareholder did not receive a distribution from the PFIC. The Preamble illustrates this exemption with an example where two PFICs merge, resulting in ownership of both PFICs for less than 30 days; and
  6. Taxpayers who are present in Guam, the Northern Mariana Islands or the U.S. Virgin Islands for at least 183 days during the taxable year and therefore, qualify as bona fide residents are not required to file Form 8621. However, residents of Puerto Rico and American Samoa must continue to file the Form regardless of their day-count in those territories.
Form 5471 Reporting

The final regulations codify the Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations reporting exemption for filers who qualify under the constructive ownership exception. These final regulations adopt prior guidance that exempt such taxpayers from filing if they include a statement detailing certain identifying information of the filer upon whose reporting they rely.


For more information regarding these changes and how you or your investors may be affected, please contact your Arthur Bell advisor at 855-787-0001 or via email at contactus@arthurbellcpas.com.

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