Final and proposed regulations (2021 proposed regulations) for passive foreign investment companies (PFICs) were published on Jan. 15, 2021. A previous article focused on the potential impact of these regulations on offshore insurance entities. This article highlights changes affecting noninsurance companies.
The final regulations generally adopt the proposed regulations issued in July 2019 (2019 proposed regulations) but include certain important changes. The proposed regulations include additional guidance requested by comments to the 2019 proposed regulations. The final regulations generally are effective Jan. 14, 2021.
The PFIC rules were put in place to prevent taxpayers from circumventing the Subpart F rules when a foreign corporation is not a controlled foreign corporation (CFC). Under the Subpart F rules, U.S. shareholders of a CFC are deemed to receive distributions of earnings attributable to passive income (such as interest, dividends, rents, royalties). The PFIC rules address situations in which the U.S. person receiving distributions of earnings attributable to passive income is not described as a U.S. shareholder of a CFC under IRC Section 958 or the foreign corporation making the distribution is not a CFC.
A foreign corporation is a PFIC if at least 75% of its gross income in its tax year is passive income or if the average percentage of assets held during the tax year that produce passive income is 50% or more. Passive income is income that "is of a kind [that] would be foreign personal holding company income" under the Subpart F rules (such as interest, rents, royalties, dividends).
A U.S. person who owns directly (or potentially indirectly) stock in a PFIC and either sells the stock or receives an "extraordinary" dividend from the PFIC is subject to the following rules:
- The recipient of an "extraordinary" dividend (or gain treated as an extraordinary distribution) is required to allocate the dividend equally over the shareholder’s entire holding period.
- Any amounts allocable to any prior year during which the foreign corporation was a PFIC are subject to an additional tax at the highest rate applicable to ordinary income for that year, plus an interest charge for each PFIC shareholder.