Global Tax Alert | 10 January 2014

US IRS issues final, temporary and proposed regulations on determining PFIC ownership and annual filing requirements for PFIC shareholders

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Executive Summary

On 31 December 2013, the Internal Revenue Service (IRS) and the Treasury Department published in the Federal Register new temporary (T.D. 9650) and proposed (REG-140974-11) regulations on reporting requirements applicable to shareholders of a passive foreign investment company (PFIC).1 The temporary regulations implement Section 1298(f) (enacted in 2010), which requires each “United States person” (US person) that is a shareholder of a PFIC (PFIC shareholder) to file an annual report (Form 8621), except as otherwise provided. The regulations impose a filing requirement (if any) only for taxable years of a PFIC shareholder ending on or after 31 December 2013, and waive filing for prior years (which Notice 2011-55 previously had indicated would be required) (see Tax Alerts: Section 6038D and 1298(f) Information Reporting Requirements Temporarily Suspended, dated 24 June 2011, Publication of Revised Form 8621 Does Not Reinstate Suspended Filing Requirement for Certain PFIC Shareholders, dated 3 January 2012 and IRS issues revised instructions for Form 8621 on PFIC reporting, dated 7 February 2013.) The failure to file a report required by Section 1298(f) can result in the extension of the statute of limitations for the entire return, per Section 6501(c)(8) (also enacted in 2010). The regulations also set out special rules and exceptions applicable to the filing requirement and finalize portions of the proposed regulations under Section 1291 that define terms used throughout the PFIC regulations. Lastly, new temporary and final regulations, published concurrently, coordinate the requirement to file an annual report under Section 1298(f) with the requirement to file an annual report under other provisions of the Code and make other clarifying changes to the regulations under Sections 6038 and 6046. The temporary and final regulations are effective 31 December 2013.

Detailed Discussion

Background

Congress enacted Section 1298(f), effective 18 March 2010, as part of the Hiring Incentives to Restore Employment Act of 2010 (the HIRE Act). Section 1298(f) requires each US person that is a PFIC shareholder to file an annual report, “[e]xcept as otherwise provided by the Secretary.”2 The HIRE Act also amended Section 6501(c)(8) to extend the statute of limitations for assessment of tax for a shareholder that fails to comply with the reporting requirements imposed by certain enumerated sections, including Section 1298(f). As amended, the statute of limitations for assessment of tax—with respect to any item reported on the PFIC shareholder’s tax return to which the Section 1298(f) annual report was required to be attached—will not lapse until three years after the shareholder submits a complete annual report to the IRS (absent reasonable cause).3

In Notice 2010-344 and Notice 2011-55,5 the IRS suspended the Section 1298(f) filing requirement (and thus the potential impact of Section 6501(c)(8)) prior to the promulgation of regulations under Section 1298(f) for PFIC shareholders not otherwise required to file an annual report. Notice 2011-55 specified, however, that once the regulations were issued, such PFIC shareholders would have to submit annual reports with respect to suspended taxable years beginning on or after 18 March 2010, and that a failure to furnish Form 8621 for a suspended taxable year could result in the extension of the statute of limitations for such year under Section 6501(c)(8) (as well as penalties).

Filing requirements under the new regulations

The new temporary regulations provide that the filing requirements under Section 1298(f), as described in the regulations, apply only to taxable years ending on or after 31 December 2013, and they withdraw the filing requirement under Section 1298(f) for taxable years that had been suspended under Notice 2010-34 and Notice 2011-55.6 For any such year, these PFIC shareholders must attach a completed Form 8621 (or successor form) for each PFIC to their timely-filed federal income or information return.7 A failure to do so will extend the statute of limitations with respect to the entire return, unless the failure is due to reasonable cause.8

In general, the temporary regulations mandate that the “lowest-tier” US person that is a shareholder of a PFIC at any time during the shareholder’s taxable year file a separate annual report on Form 8621 with respect to each PFIC it owns.9 The report is required regardless of whether the PFIC has a taxable year ending within the shareholder’s taxable year (unlike certain Form 5471 filing requirements).10 In certain circumstances a “higher-tier” US person (i.e., one that owns PFIC stock through another US person) must also file Form 8621, including when the higher-tier US person must include an amount in income with respect to the PFIC or is subject to taxation under Section 1291 as a result of receiving (or being treated as receiving) an “excess distribution”11 from the PFIC.12 The higher-tier US person need not file Form 8621 under the temporary regulations, however, if (i) the person must include an amount in income with respect to the PFIC only under the “qualified electing fund” (QEF) or “mark-to-market” (MTM) regimes of Sections 1295 and 1296, respectively, and (ii) the lower-tier US person through which the person owns the PFIC stock timely files Form 8621 with respect to the PFIC.13

Special rules and exceptions

The temporary regulations provide special rules for estates and trusts. In general, domestic estates and nongrantor trusts are required to file an annual report under the rules generally applicable to US persons.14 US persons treated as the owners of domestic and foreign grantor trusts that own PFIC stock generally are also required to file an annual report.15 The temporary regulations specify, however, that this filing requirement does not apply to a US person treated as the owner of any portion of a domestic “liquidating trust” or a domestic “widely held fixed investment trust” that itself owns an interest in a PFIC.16 The filing requirement also does not apply to a US person that is treated as the owner of any portion of a foreign grantor trust that is a foreign pension fund operated principally to provide pension or retirement benefits, if, pursuant to an income tax convention to which the US is a party, income earned by the pension fund is taxed as income of the US person only when and to the extent it is paid to, or for the benefit of, the US person.17 Finally, under the temporary regulations, a US person that is a beneficiary of a foreign estate or nongrantor trust that itself owns an interest in a PFIC need not file an annual report with respect to a particular taxable year if the US person neither (i) has made an election under Section 1295 (QEF election) or Section 1296 (MTM election) with respect to the PFIC nor (ii) received (or was treated as receiving) an excess distribution from the PFIC in that taxable year.18

The temporary regulations contain two exceptions to the filing requirements. First, certain exempt organizations are only required to file an annual report under Section 1298(f) with respect to a PFIC if the income derived with respect to the PFIC would be taxable to the organization under subchapter F of Subtitle A of the Code.19 Second, under a de minimis exception, certain shareholders of “Section 1291 funds” are not required to file an annual report under Section 1298(f).20 The latter exception applies only if (i) the shareholder is not subject to tax under Section 1291 with respect to an excess distribution received (or treated as received) from the PFIC during the shareholder’s taxable year; (ii) an election under Section 1295 has not been made to treat the Section 1291 fund as a QEF with respect to the shareholder; and (iii) either (A) the aggregate value of all PFIC stock owned by the shareholder at the end of its taxable year does not exceed $25,000, or (B) the PFIC stock is owned by the shareholder through another PFIC, and the value of the shareholder’s proportionate share of the upper-tier PFIC’s interest in the lower-tier PFIC does not exceed $5,000.21

Definitions under Section 1291

The temporary regulations define certain terms under Section 1291. In 1992, the IRS and the Treasury Department issued proposed regulations under Section 1291 (the 1992 proposed regulations) that included definitions of certain terms.22 The temporary regulations adopt several of those definitions, with minor modifications.23 For example, to reflect the changes introduced in the Taxpayer Relief Act of 1997, the definition of the term “indirect shareholder” in the temporary regulations specifies that Section 1297(d) does not apply in determining whether a US person owns a PFIC indirectly through a foreign corporation.24 They make clear that the attribution of indirect ownership from partnerships, estates, and trusts applies whether the pass-through entity is domestic or foreign.25 Moreover, with respect to the term “shareholder,” the temporary regulations clarify that a domestic partnership, S corporation, and domestic grantor trust is treated as a PFIC shareholder only for purposes of certain information reporting requirements (including those imposed by Section 1298(f)).26

Request for Comments

The temporary regulations provide generally that if a foreign or domestic estate or nongrantor trust directly or indirectly owns PFIC stock, each beneficiary is considered to own a proportionate amount of stock.27 The IRS and the Treasury Department apparently recognize that the determination of a beneficiary’s proportionate share can be complex, and they request comments on the proper manner to make this determination. The preamble to the temporary regulations indicates that, until additional guidance is provided, beneficiaries of estates or nongrantor trusts should use a reasonable method to determine their ownership interest in a PFIC.28 The preamble advises that, until further guidance is provided, such beneficiaries should apply Section 1291 and the principles of subchapter J in a reasonable manner, but that taxpayers should not take a position that neither the beneficiaries nor the estate or trust is subject to the rules of Section 1291.29

Coordination with other filing requirements

The temporary regulations coordinate the Section 1298(f) filing requirements with other filing requirements. If a PFIC shareholder is required to file Form 8621 (or successor form) both under Section 1298(f) as well as pursuant to another PFIC information reporting obligation,30 the shareholder may file a single Form 8621 that contains all of the required information.31

Form 5471 and Schedule O

New temporary regulations also provide guidance on an exception to the requirement to file Form 5471 under Sections 6038 and 6046 that applies to US persons who own an interest in a foreign corporation under the constructive ownership rules. Under the regulations, shareholders that are excepted from filing Form 5471 under the constructive ownership exception are no longer required to file a statement with their returns (indicating that the requirement to provide information has been satisfied and identifying the return with which the information was or will be filed).32 This change aligns the regulations with the statute and Form 5471 instructions. Lastly, new final regulations under Section 6046 have been updated to reflect statutory changes, including with respect to the reporting requirements under Section 6046 for persons treated as United States shareholders under Section 953(c), among others,33 and the ownership threshold for Section 6046 reporting (the regulations now reflect the 1997 statutory change to 10%)34

Implications

As mentioned, the new regulations require a PFIC shareholder to file Form 8621 only for years ending on or after 31 December 2013. This is good news for taxpayers as they will not be required to file amended returns for suspended years, as suggested by prior notices. Taxpayers should also welcome the inclusion of rules clarifying when an indirect owner must report, and the exemptions to reporting, even though, arguably, these exemptions are fairly limited. Taxpayers must be mindful that, when required, the Form 8621 must be timely filed. Remember, failure to file the Form 8621 may result in suspension of the statute of limitations for the taxpayer’s entire return, per Section 6501(c)(8). With regard to the regulations under Sections 6038 and 6046, the changes align the regulations with the statute and Form 5471 instructions, removing some discrepancies that previously existed.

Endnotes

1. The text of the temporary regulations is identical to the proposed regulations.

2. Prior to the enactment of Section 1298(f), PFIC shareholders were required to file an annual report (on Form 8621) only upon the occurrence of certain reportable events.

3. Section 6501(c)(8). Even in the case of reasonable cause, however, Section 6501(c)(8)(B) provides that, with respect to items on the Section 1298(f) annual report itself, the statute of limitations will not lapse until three years after the report is submitted to the IRS.

4. 2010-1 CB 612 (26 April 2010).

5. 2011-29 CB 663 (18 July 2011).

6. Section 1.1298-1T(c)(3). See also T.D. 9650 (30 December 2013) (“The rules described in Notice 2011-55 for suspended taxable years (as defined in Notice 2011-55) with respect to Section 1298(f) and Form 8621 are no longer applicable.”). Treasury Decision 9650 obsoleted Notice 2010-34 and partially obsoleted Notice 2011-55.

7. Section 1.1298-1T(d). A US person that is required to file Form 8621 with respect to more than one PFIC must file a separate Form 8621 for each PFIC. Section 1.1298-1T(e).

8. Section 6501(c)(8).

9. Section 1.1298-1T(b)(1). Specifically, each US person that is a shareholder of a PFIC must complete and file Form 8621 if, during the shareholder’s taxable year, the shareholder (i) directly owns stock of the PFIC, (ii) is an indirect shareholder that holds any interest in the PFIC through one or more entities, each of which is foreign, or (iii) is an indirect shareholder that is treated as the owner of any portion of a grantor trust that owns, directly or indirectly through one or more entities, each of which is foreign, any interest in the PFIC. Id. Note, under Section 1.1298-1T(e), US persons filing a joint return may file a single Form 8621 with respect to a PFIC in which they jointly or individually own an interest.

10. Sections 1.1298-1T(b)(1) and 6038(a)(2).

11. Section 1291(b)(1).

12. Section 1.1298-1T(b)(2)(i)(A) – (D). In addition, the higher-tier US person must file Form 8621 with respect to a taxable year in which it is required to report the status of a Section 1294 election with respect to the PFIC. Section 1.1298-1T(b)(2)(i)(E).

13. Section 1.1298-1T(b)(2)(ii). This exception does not apply if the US person made a QEF election with respect to the PFIC and then transferred the shares of the PFIC to a domestic partnership or S corporation that did not itself make a QEF election with respect to the PFIC. Id.

14. Sections 1.1298-1T(b)(1) and (b)(2).

15. Sections 1.1298-1T(b)(1)(iii).

16. Section 1.1298-1T(b)(3)(i).

17. Section 1.1298-1T(b)(3)(ii).

18. Section 1.1298-1T(b)(3)(iii).

19. Section 1.1298-1T(c)(1). Specifically, the exception applies to an organization exempt under Section 501(a) because 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 or 530. Id.

20. Section 1.1298-1T(c)(2)(i).

21. Special rules for determining whether the $25,000 threshold is met in the case of indirect ownership are provided. See Section 1.1298-1T(c)(2)(ii). Shareholders may rely upon annual account statements to determine the value of a PFIC, unless the shareholder has reason to know that the statements do not reflect a reasonable estimate of the PFIC’s value. See Section 1.1298-1T(c)(2)(iv).

22. See 57 F.R. 11,024 (1 April 1992). The temporary and proposed regulations were accompanied by a withdrawal (REG-113350-13) of part of the 1992 proposed regulations relating to certain definitions and reporting requirements for some PFIC shareholders.

23. For the definitions of the term “shareholder,” “indirect shareholder,” pedigreed QEF,” and “Section 1291 fund” see Sections 1.1291-1T(b)(7), 1.1291-1T(b)(8), 1.1291-1T(b)(2)(ii) and Section 1.1291-1T(b)(2)(v), respectively.

24. Section 1.1291-1T(b)(8)(ii)(B). Thus, in the case of a person that owns stock of a PFIC that is also a controlled foreign corporation (CFC), notwithstanding that under Section 1297(d) the corporation may not be treated as a PFIC with respect to certain shareholders, the corporation is treated as a PFIC with respect to the shareholder for purposes of determining whether the shareholder owns an interest in any stock of a PFIC held by the corporation. IId.

25. Section 1.1291-1T(b)(8)(iii)(A), (C).

26. Section 1.1298-1T(b)(7). In the case of a domestic partnership or S corporation, all PFIC information reporting requirements apply. Id. In the case of a domestic grantor trust, the only information reporting requirements that apply are those imposed by Section 1.1298-1T(b)(3)(i) (with respect to domestic liquidating trusts and fixed investment trusts). Id.

27. Section 1.1291-1T(b)(8)(iii)(C).

28. T.D. 9650 (30 December 2013).

29. Id.

30. For example, the shareholder may be required to file Form 8621 in connection with a QEF election under Section 1.1295-1(f)(2)(i) or a deemed sale election under Section 1.1297-3(b)(4).

31. Section 1.1298-1T(f). The regulations under Section 6038D (reporting with respect to specified foreign financial assets, which would include PFICs) provide guidance coordinating the two reporting requirements to eliminate duplicative reporting. Pursuant to those regulations, in order to avoid duplicative reporting of assets, a US person is not required to report a PFIC under Section 6038D if the person reports the PFIC on a timely filed Form 8621 and the person’s report under Section 6038D (on Form 8938) indicates, as provided on the form, that the person complied with its Form 8621 filing requirement with respect to the PFIC.

32. Sections 1.6038-2T(j)(3) and 1.6046-1T(e)(5).

33. Section 1.6046-1(a)(2) and (c).

34. Section 1.6046-1.

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP, International Tax Services, Washington, DC
  • Peg O’Connor
    +1 202 327 6229
    margaret.oconnor@ey.com
  • John Morris
    +1 202 327 8026
    john.morris@ey.com
  • Allen Stenger
    +1 202 327 6289
    allen.stenger@ey.com
  • Andreia Leite Veríssimo
    +1 202 327 6034
    andreia.leiteverissimo@ey.com
Ernst & Young LLP, Human Capital, Atlanta
  • David Moskowitz
    +1 732 516 4505
    david.moskowitz@ey.com
Ernst & Young LLP, Human Capital, Cleveland
  • Toby Kaye
    +1 216 583 1058
    toby.kaye@ey.com
Ernst & Young LLP, Human Capital, Chicago
  • Renee Zalatoris
    +1 847 904 7047
    renee.zalatoris@ey.com
Ernst & Young LLP, Personal Financial Services, Washington, DC
  • Ben Wright
    +1 202 327 6036
    ben.wright@ey.com
  • Justin Lynch
    +1 202 327 6035
    justin.lynch@ey.com
Ernst & Young LLP, Personal Financial Services, San Francisco
  • Susan K. Graham
    +1 415 894 4314
    susan.graham1@ey.com

EYG no. CM4097