IRS Issues Regulations Regarding Ownership and Information Reporting of Passive Foreign Investment Companies

Transcription

1 IRS Issues Regulations Regarding Ownership and Information Reporting of Passive Foreign Investment Final and Temporary Regulations Provide Guidance Regarding Ownership of Passive Foreign Investment and Implement the Annual Report Requirement for Shareholders of Passive Foreign Investment SUMMARY On December 30, 2013, the IRS and Treasury Department issued Temporary and Final Regulations providing guidance on the ownership of passive foreign investment companies and implementing an annual reporting requirement for shareholders of such companies. The regulations replace and expand certain provisions of regulations that had been proposed on April 1, The Temporary and Final Regulations are effective December 30, Generally, adverse U.S. tax consequences apply to U.S. persons who directly or indirectly own shares of a passive foreign investment company (a PFIC ), a foreign corporation that has passive income or passive assets in excess of certain thresholds. The Temporary Regulations set forth rules for determining indirect ownership of PFICs, which are largely consistent with the rules contained in the proposed regulations, and clarify the rules for attributing PFIC stock held by trusts. The Temporary Regulations also provide guidance with respect to the requirement that a PFIC shareholder file information returns regarding its investment in the PFIC, including IRS Form 8621 Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund. Under the Temporary Regulations, Forms 8621 are not required to be filed for taxable years New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney

2 ending before December 30, 2013 to the extent that the requirement to file such forms was previously suspended under IRS Notice In addition, the Temporary and Final Regulations reduce the filing requirements for certain U.S. shareholders who indirectly or constructively own shares of a controlled foreign corporation ( CFC ). BACKGROUND The PFIC rules are intended to discourage U.S. taxpayers from deferring (on an interest-free basis) U.S. taxation on passive investments, or converting ordinary income to capital gains, by making those investments through foreign corporations. 1 A PFIC is defined as any foreign corporation that meets either of the following two tests: (i) 75 percent or more of its gross income for the taxable year is passive income, or (ii) the average percentage of assets held by the corporation during the taxable year which produce passive income or which are held for the production of passive income is at least 50 percent. 2 Under the PFIC rules, a U.S. shareholder of a PFIC (other than a U.S. shareholder that makes one of the elections described below to mitigate the adverse effects of owning shares of a PFIC) is subject to special rules with respect to any excess distribution. Generally, any distributions received by the shareholder on PFIC stock in a taxable year that are greater than 125% of the average annual distributions received by the U.S. shareholder on the shares in the three preceding taxable years (or, if shorter, the U.S. shareholder s holding period in the shares) are excess distributions. 3 In addition, any gain on the disposition of PFIC stock is treated as an excess distribution. Excess distributions are generally allocated ratably over the U.S. shareholder s holding period, and the amount allocated to each taxable year other than the current taxable year (and any year prior to the year in which the corporation was a PFIC) is subject to tax at the highest rate of tax in effect for the applicable class of taxpayer for that year and an interest charge for the deemed deferral benefit is imposed with respect to the tax attributable to each such year. A U.S. shareholder may avoid these consequences in certain circumstances by making an election to be taxed currently on its share of the PFIC s undistributed income (a qualified electing fund, or QEF election) or by making an election to mark to market its PFIC stock each year See STAFF OF J. COMM. ON TAX N, 99 th Cong., General Explanation of the Tax Reform Act of 1986, at 1023 (J. Comm. Print 1987) ( Blue Book ) (noting as a reason for the enactment of the PFIC rules that Congress did not believe that U.S. persons who invest in passive assets should avoid the economic equivalent of current taxation merely because they invest in those assets indirectly through a foreign corporation ). See Section 1297(a). amended (the Code ). See Section 1291(b). All Section references are to the Internal Revenue Code of 1986, as -2-

3 On April 1, 1992, the IRS and Department of the Treasury published Proposed Regulations (the Proposed Regulations ) concerning, among other things, the determination of when a person will be treated as owning shares in a PFIC and the taxation of such shareholders upon the direct, indirect or deemed receipt of distributions from the PFIC or disposition of the stock of the PFIC. 4 Prior to March 18, 2010, a U.S. shareholder of a PFIC was generally required to file Form 8621 Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund with respect to stock in a PFIC only for a taxable year in which such stockholder received certain direct or indirect distributions from the PFIC, recognized gain on a direct or indirect disposition of the PFIC stock, or included an amount in income pursuant to a QEF or mark-to-market election. Effective March 18, 2010, Congress enacted the Hiring Incentives to Restore Employment Act of 2010 ( HIRE Act ) 5 which requires a U.S. shareholder of a PFIC to file an annual report with such information that the Secretary of the Treasury may require, even in the absence of any such distributions, dispositions or inclusions. 6 The HIRE Act also extended the statute of limitations for assessment of tax for a shareholder that fails to comply. 7 In Notice , 8 the IRS and Treasury Department announced that, pending further guidance regarding the reporting requirements under the HIRE Act, PFIC shareholders that previously had not been required to file Form 8621 would not be required to file an annual report for taxable years beginning before March 18, In Notice , 9 the IRS and Treasury Department further announced their intention to revise Form 8621 and suspended the new reporting requirement until the release of such revised Form The notice provided that upon release of the revised Form 8621, PFIC shareholders for which the requirement for filing the form had been suspended would be required to attach a Form 8621 for the suspended taxable years to their next income tax or information return filed with the IRS. THE REGULATIONS A. DEFINITIONS The Temporary Regulations set forth certain definitions for purposes of the PFIC rules which largely track the definitions set forth in the Proposed Regulations. The definitions appear to have been adopted See 57 Fed. Reg. 11,024. Pub. L. No , 124 Stat. 71. See Section 1298(f). See Section 6501(c)(8). See C.B. 612 (April 26, 2010). See C.B. 663 (July 18, 2011). -3-

4 primarily for the purpose of implementing the PFIC information reporting rules (discussed below), but are also relevant for other purposes of the PFIC rules. 1. Shareholder The definitions of shareholder and indirect shareholder of a PFIC in the Temporary Regulations generally track the definitions from the Proposed Regulations, with certain modifications. Under the Temporary Regulations, a shareholder of a PFIC is a United States person that directly or indirectly owns PFIC stock. 10 A domestic partnership or S corporation is treated as a shareholder of a PFIC for information reporting purposes only, including Form 8621 filing requirements, discussed below. 11 Under the Temporary Regulations, an indirect shareholder of a PFIC is a United States person that is treated as indirectly owning stock of a PFIC under the attribution rules in the Temporary Regulations. 12 The Temporary Regulations make explicit that a United States person treated as owning PFIC stock under these rules is an indirect shareholder even if the PFIC stock is owned through another United States person. a. Attribution from C Corporations The rules for attribution from C corporations under the Temporary Regulations substantively follow the Proposed Regulations. A person that directly or indirectly owns 50 percent or more in value of the stock of a non-pfic foreign corporation is treated as owning a proportionate amount of any stock owned directly or indirectly by the corporation. 13 Under the Temporary Regulations, as under the Proposed Regulations, the 50-percent threshold does not apply for purposes of attributing stock owned by a PFIC to its shareholders. 14 To reflect subsequent statutory amendments, the Temporary Regulations provide that a PFIC that is also a CFC is treated as a PFIC for purposes of determining whether the 50-percent threshold applies. b. Attribution from Partnerships and S Corporations The rules for attribution from partnerships and S corporations under the Temporary Regulations also substantively follow the Proposed Regulations. A partner in a partnership or a shareholder in an S corporation is treated as owning its proportionate share of the stock owned by the partnership or S See Treas. Reg T(b)(7). In addition, the Temporary Regulations modify the Proposed Regulations by providing that a domestic grantor trust is treated as a shareholder of a PFIC for purposes of the special information reporting rules applicable to domestic liquidating trusts and fixed investment trusts, discussed below. See Treas. Reg T(b)(8)(i). See Treas. Reg T(b)(8)(ii)(A). See Treas. Reg T(b)(8)(ii)(B). -4-

5 corporation. The Temporary Regulations explicitly clarify that the attribution rules apply to both domestic and foreign partnerships. c. Attribution from Trusts and Estates The attribution rules from estates and nongrantor trusts set forth in the Temporary Regulations generally follow the rules set forth in the Proposed Regulations: A beneficiary of an estate or nongrantor trust is treated as owning its proportionate share of the stock owned by the estate or trust. 15 The preamble to the Temporary and Final Regulations states that, until further guidance is issued, beneficiaries of estates and nongrantor trusts that hold PFIC stock should use a reasonable method to determine their ownership interests in a PFIC held by the estate or nongrantor trust. The preamble also states that the special rules regarding excess distributions must be applied in a reasonable manner with respect to estates and trusts and their beneficiaries, and that it would be unreasonable for shareholders of a PFIC subject to these rules to take the position that neither the beneficiaries nor the estate or trust are subject to the tax and interest charge under such rules. The regulations do not elaborate on what methods would be considered reasonable. 16 The Temporary Regulations provide a new special rule for grantor trusts. If a foreign or domestic grantor trust directly or indirectly owns PFIC stock, a person that is treated as the owner of any portion of the trust that holds the stock is considered to own the stock held by that portion of the trust Section 1291 Fund and Pedigreed QEF The Temporary Regulations set forth definitions of section 1291 fund and pedigreed QEF without substantive modification from the Proposed Regulations (updated to reflect subsequent statutory changes). B. FORM 8621 REPORTING 1. Requirement to File For taxable years ending on or after December 30, 2013, the Temporary Regulations generally require a United States person that directly or indirectly owns shares in a PFIC at any time during such person s taxable year to file Form 8621 (or a successor form) to satisfy the annual reporting requirement under the See Treas. Reg T(b)(8)(iii)(A)-(C). In one Technical Advice Memorandum, the IRS used historical distributions from a trust as the basis for determining the beneficiaries ownership interests in PFIC stock owned by the trust. See T.A.M (October 26, 2006). The trust was found to have been historically administered consistent with equal ownership by two beneficiaries, including equal distributions to each of the beneficiaries. The IRS accordingly treated stock held by the trust as 50-percent owned by each beneficiary. See Treas. Reg T(b)(8)(iii)(D). -5-

6 HIRE Act. 18 The filing requirement is imposed on the first United States person in the chain of ownership (i.e., the lowest tier United States person) that is a PFIC shareholder (including an indirect shareholder). In addition, except as described below, a United States person that owns PFIC stock through another United States person is also required to file Form 8621 for a taxable year during which such indirect shareholder is treated as receiving an excess distribution from the PFIC, is treated as recognizing gain treated as an excess distribution from a disposition of stock of the PFIC, or includes an amount in income pursuant to a QEF or mark-to-market election. 19 In general, the Form 8621 filing requirements apply to domestic estates and domestic nongrantor trusts, as well as to owners of any portion of a foreign or domestic grantor trust that owns PFIC stock, under rules generally applicable to United States persons. 20 However, beneficiaries of foreign estates and foreign nongrantor trusts that have not made a QEF or mark-to-market election with respect to PFIC stock held by the estate or nongrantor trust are exempt from filing Form 8621 for taxable years in which the beneficiary is not treated as receiving an excess distribution or gain treated as an excess distribution with respect to the PFIC stock. 21 To eliminate duplicative reporting obligations, the Temporary Regulations provide an exception to the Form 8621 filing requirement for United States persons holding PFIC stock through other United States persons. Under the exception, a United States person holding PFIC stock through another United States person is not required to file Form 8621 if (i) the United States person indirectly holding the PFIC stock is required to include amounts in income only as a result of a QEF or mark-to-market election (presumably, as a result of an election made by the direct holder) and (ii) the United States person directly holding the PFIC stock timely files Form 8621 with respect to the PFIC. 22 The exception does not apply if the United States person that made a QEF election with respect to the PFIC 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. The Temporary Regulations also provide an exception to the Form 8621 filing requirement for (i) shareholders with de minimis holdings of PFIC stock (generally, if aggregate holdings of PFIC stock See Treas. Reg T(b)(1). See Treas. Reg T(b)(2)(i). However, a United States person that is treated as the owner of any portion of a domestic liquidating trust created in certain bankruptcy proceedings or of any portion of a widely held fixed investment trust, is generally not required to file Form Rather, the trust itself must file Form See Treas. Reg T(b)(3)(i). See Treas. Reg T(b)(3)(iii). See Treas. Reg T(b)(2)(ii). -6-

7 are at or below $25,000) that satisfy certain other requirements, 23 (ii) certain tax exempt organizations, unless income derived from a PFIC would be taxable 24 and (iii) United States persons treated as the owners of certain foreign grantor trusts that are foreign pension funds if a tax treaty to which the United States is a party permits taxation on income earned by the pension fund only when the income is paid to or for the benefit of the owner Coordination with Other Reporting Requirements The Temporary Regulations do not affect a shareholder s obligation to file Form 8621 other than under the Temporary Regulations and the annual reporting requirement of the HIRE Act. For example, as was the case prior to the enactment of the HIRE Act, a shareholder is required to file a Form 8621 annually in respect of stock for which a QEF election has been made. 26 Form 8621 must also be filed to make the QEF or mark-to-market election, as well as certain other elections. However, if a shareholder is required to file a Form 8621 with respect to a PFIC both under the Temporary Regulations and under another requirement, a single Form 8621 will satisfy both requirements. 27 Under Section 6038D of the Code, an individual who holds an interest in a specified foreign financial asset during a taxable year is generally required to provide information with respect to such asset. 28 United States persons that own an interest in a PFIC may be subject to both the specified foreign financial asset reporting requirements and the PFIC reporting requirements. The preamble to the Temporary and Final Regulations states that under existing temporary regulations to Section 6038D, 29 a United States person is not required to report a PFIC under the specified foreign financial asset information reporting requirements if the person timely files Form 8621 with respect to the PFIC and indicates on Form 8938, Statement of Specified Foreign Financial Assets, that the person complied with its filing requirements with respect to the PFIC See Treas. Reg T(c)(2). To qualify for the exception, shareholder must not be subject to tax with respect to any excess distributions received from the PFIC (including gains treated as excess distributions with respect to the PFIC) during the taxable year and must not have made a QEF election with respect to the PFIC stock. The exception also generally applies to PFIC stock owned by the shareholder through another PFIC if the value of the shareholder s proportionate share of the upper-tier PFIC s interest in the lower-tier PFIC is $5,000 or less. In addition, the $25,000 threshold is increased to $50,000 for shareholders filing joint returns. A shareholder may rely on account statements provided at least annually to determine value of a PFIC for these purposes unless the shareholder has reason to know based on readily accessible information that the statements do not reflect a reasonable estimate of such value. See Treas. Reg T(c)(1). See Treas. Reg T(b)(3)(ii). See Treas. Reg (f)(2)(i). See Treas. Reg T(f). See Section 6038D. See Treas. Reg D-1T to -8T. -7-

8 3. Time and Manner for Filing For taxable years ending on or after December 30, 2013, a United States person that is required to file Form 8621 with respect to a PFIC must attach Form 8621 to its Federal income tax return (or partnership or exempt organization return). 30 If a United States person is required to file Form 8621 with respect to more than one PFIC for a taxable year, a separate Form 8621 must be filed for each PFIC. 31 Joint return filers may file a single Form 8621 with respect to the same PFIC. 32 The preamble to the Temporary and Final Regulations states that since Notice was issued, the IRS and Treasury Department have determined that it is not necessary for taxpayers to file Form 8621 for those taxable years for which the requirement to file the form was suspended by the notice. Accordingly, the Temporary Regulations provide an exception to the Form 8621 filing requirement for taxable years ending before December 30, 2013 to PFIC shareholders not previously required to file the form for such years. 33 C. FORM 5471 REPORTING The Temporary and Final Regulations also modify rules under which certain United States persons are required to file Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations. Generally, a U.S. shareholder (within the meaning of Section 951 of the Code) of a CFC is required to file annually Form 5471 with respect to the CFC. Under the constructive ownership exception, a United States person is not required to file a Form 5471 with respect to a foreign corporation if (i) the United States person does not directly own an interest in the foreign corporation, (ii) the United States person would otherwise be required to furnish the information solely by reason of attribution of stock ownership from a United States person and (iii) the person from whom the stock ownership is attributed furnishes all of the information required to be reported by the person to whom stock ownership is attributed. 34 United States persons relying on the constructive ownership exception were previously 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 filed and the place of filing. 35 The requirement to provide such a statement presented compliance difficulties, especially in the context of joint ventures. For example, if two multinational corporations formed a joint venture structured as a domestic partnership, in order to rely on the constructive ownership exception, the joint venture would See Treas. Reg T(d). See Treas. Reg T(e)(1). See Treas. Reg T(e)(2). See Treas. Reg T(c)(3). See Treas. Reg (j)(2) and Treas. Reg (e)(4)(iii). See Treas. Reg (j)(3) and Treas. Reg (e)(5). -8-

9 have to have been provided with information in respect of each multinational s CFCs. The Temporary Regulations remove the requirement to provide such a statement. 36 On April 17, 1991, the Treasury Department and IRS published proposed regulations concerning Form 5471 filing requirements for persons treated as U.S. shareholders of a CFC under Section 953(c) of the Code relating to captive insurance companies. Under the proposed regulations, a U.S. shareholder of a captive insurance company that is a CFC was generally subject to additional Form 5471 filing requirements relative to U.S. shareholders of other CFCs. The Final Regulations adopt the proposed regulations without substantive changes. 37 * * * Copyright Sullivan & Cromwell LLP See Treas. Reg T(j)(3). See Treas. Reg (a)(2) & (c). -9-

10 ABOUT SULLIVAN & CROMWELL LLP Sullivan & Cromwell LLP is a global law firm that advises on major domestic and cross-border M&A, finance, corporate and real estate transactions, significant litigation and corporate investigations, and complex restructuring, regulatory, tax and estate planning matters. Founded in 1879, Sullivan & Cromwell LLP has more than 800 lawyers on four continents, with four offices in the United States, including its headquarters in New York, three offices in Europe, two in Australia and three in Asia. CONTACTING SULLIVAN & CROMWELL LLP This publication is provided by Sullivan & Cromwell LLP as a service to clients and colleagues. The information contained in this publication should not be construed as legal advice. Questions regarding the matters discussed in this publication may be directed to any of our lawyers listed below, or to any other Sullivan & Cromwell LLP lawyer with whom you have consulted in the past on similar matters. If you have not received this publication directly from us, you may obtain a copy of any past or future related publications from Stefanie S. Trilling ( ; trillings@sullcrom.com) in our New York office. CONTACTS New York Andrew S. Mason masona@sullcrom.com Andrew P. Solomon solomona@sullcrom.com David C. Spitzer spitzerd@sullcrom.com Davis J. Wang wangd@sullcrom.com Isaac J. Wheeler wheeleri@sullcrom.com London S. Eric Wang wangs@sullcrom.com -10- SC1: