On December 27, 2016, the US Treasury Department and IRS published final regulations (TD 9806) that provide guidance on determining ownership of a passive foreign investment company (PFIC), as well as certain annual reporting requirements for shareholders of PFICs (Final Regulations). The Final Regulations essentially finalize the 2013 proposed regulations, withdraw the 2013 temporary regulations and implement the rules announced in Notice 2014-28 and Notice 2014-51. Ultimately, the Final Regulations do more to implement current guidance than provide additional insight into determining who is considered a shareholder of a PFIC and their annual filing requirements. That being said, there are some clarifications to the definitions of “Shareholder” and “Indirect Shareholder” in the PFIC context as well as clarification and additional exceptions to Form 8621 reporting.

The following discussion is an overview of the Final Regulations with a focus on who is considered a shareholder of a PFIC in the trust context and the reporting requirements and exceptions for trusts and beneficiaries of trusts.

Who is Considered a Shareholder of a PFIC?

General rules

The Final Regulations adopt the 2013 temporary regulations definition of the term shareholder, with a few notable revisions and clarifications in relation to an indirect shareholder of PFIC stock.

First, the Final Regulations modify the definition of shareholder as announced by the US Treasury and the IRS in Notice 2014-28, whereby a United States (US) person shall not be treated as a shareholder of a PFIC to the extent such person owns PFIC stock through a tax-exempt organization or account. This effectively extends the exemption that was already afforded to the tax exempt organization under the temporary and proposed regulations to the US shareholder(s) of such organization, and expands the exemption to encompass tax exempt accounts as well. As a result, for instance, a US person owning stock of a PFIC through an individual retirement account (IRA) described in Section 408(a) will not be treated as the shareholder of the PFIC stock, and in turn, is not subject to the PFIC rules. Because Notice 2014-28 originally provided for the aforementioned exemption, it will be effective for the taxable years of US persons who own stock of a PFIC through a tax-exempt organization or account ending on or after December 31, 2013.

In addition, the Final Regulations confirm that a grantor trust is not treated as a shareholder of PFIC stock held by the trust except for information reporting purposes relating to domestic grantor trusts qualifying as liquidating trusts or fixed investment trusts. Instead, under the indirect shareholder rules, the grantor of foreign (i.e. non-US) and domestic (i.e. US) grantor trusts is considered to own the interest of any PFIC stock held by the trust. In the context of a nongrantor trust, the Final Regulations confirm that each beneficiary of the nongrantor trust is considered to own a proportionate amount of any PFIC stock owned directly or indirectly by the trust. No guidance was provided on how to determine each beneficiary’s proportionate amount in the context of a discretionary trust.

Non-attribution rule through domestic (non-US) entities

Next, the Final Regulations revised (and attempted to clarify) the 2013 temporary regulations in relation to when a US person is considered an indirect shareholder as a result of attribution through a domestic corporation. However, to understand this nuanced revision and clarification requires us to take a step back in time. In 1992, the US Treasury and the IRS issued proposed PFIC regulations that, among other things, included rules for determining when a US person is treated as indirectly owning stock of a PFIC. One of these rules provided that a US person who directly or indirectly owned 50% or more (in value) of a foreign corporation that is not a PFIC was considered to own a proportionate amount (by value) of any PFIC stock owned directly or indirectly by such foreign corporation. Since this rule applied to US persons owning a foreign non-PFIC corporation, the US Treasury and the IRS were concerned that a US person could arguably interpose a domestic C corporation into an ownership structure to avoid shareholder status of PFIC stock that the US person indirectly owned through one or more foreign non-PFIC corporations, absent the following old rule relating to attribution through a domestic corporation. The old rule provided that if PFIC stock was not treated as owned indirectly by a US person under any other PFIC attribution rules, but would be treated as owned by a US person if the above foreign non-PFIC corporation attribution rule applied to domestic corporations, then the stock of the PFIC stock would be considered as owned by such US person.

The scenario that the US Treasury and the IRS sought to combat with the above two rules is where, for example, Albert, a US citizen, owns 49% of the stock in ForeignCo, a foreign corporation that is not a PFIC, and separately owns all the stock of USCo, a domestic corporation that is not an S corporation. USCo, in turn, owns the remaining 51% of the stock in ForeignCo, and ForeignCo owns 100 shares of PFIC stock. In this scenario, USCo is treated as an indirect shareholder with respect to 51% of the PFIC stock held by ForeignCo under the above foreign non-PFIC corporation attribution rule. However, because Albert directly owns less than 50% of the value of ForeignCo, Albert might not be treated as an indirect shareholder with respect to any of the PFIC stock held by ForeignCo absent the domestic corporation attribution rule.

On the other hand, the US Treasury and the IRS recognized that a literal reading of the domestic corporation attribution rule could be interpreted to create overlapping ownership by two or more US persons in the same PFIC stock. For instance, under the above rules, Albert (a US person) may be considered as indirectly owning 100% of the underlying PFIC stock, even though 51% of those shares are considered owned indirectly by USCo, which is a second, separately taxable, US person. In response to this duplicative result, the Final Regulations include a non-duplication rule, which provides that a US person will not be treated, as a result of the domestic corporation attribution rule, as owning PFIC stock that is directly or indirectly owned by another US person. So, in Albert’s case, he should only be treated as indirectly owning 49% of the underlying PFIC stock under this new non-duplication rule because USCo, a separate US taxpayer, is treated as indirectly owning the remaining 51% of the PFIC stock.

Lastly, the Final Regulations made two additional clarifications with respect to the above rules. One clarifies that the above attribution rules does not apply to stock owned directly or indirectly through an S corporation, and the other clarifies that the domestic corporation attribution rule applies for all PFIC purposes, not just PFICs taxable under Section 1291.

Who is Required to Report Their Ownership of a PFIC?

General rules

Direct shareholders of a PFIC are required to file Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, unless an exception applies.

The reporting rules for indirect shareholders depend on whether the shareholder owns the PFIC through foreign entities or domestic entities. The regulations then provide several exceptions to reporting followed by specifics for filing the Form 8621.

Attribution through foreign (non-US) entities

US persons have a Form 8621 filing obligation if they are indirect shareholders of PFICs through a foreign entity or if they are treated as the owner of any portion of a grantor trust that directly or indirectly through a foreign entity is treated as having any interest in a PFIC. Therefore, a US-person beneficiary of a foreign nongrantor trust (i.e., foreign entity) that is treated as a direct or indirect shareholder of a PFIC generally must file a Form 8621. Furthermore, a US-person grantor of a grantor trust that is treated as a direct or indirect shareholder of a PFIC generally must file a Form 8621.

Exceptions to filing

The regulations provide an exception from filing for certain US-person beneficiaries of foreign trusts. If the foreign trust owns a PFIC and has not made either a Qualified Electing Fund (QEF) election or Mark to Market (MTM) election with respect to the PFIC the US-person beneficiary is not required to report the PFIC unless the beneficiary is treated as receiving an excess distribution or is treated as recognizing gain that is treated as an excess distribution.

US persons have a Form 8621 filing obligation if they are indirect shareholders of PFICs through a domestic entity only if they (i) are treated as receiving an excess distribution, (ii) are treated as recognizing gain that is treated as an excess distribution as a result of a disposition, (iii) have a QEF inclusion, (iv) have a MTM inclusion, or (v) are required to report the status of a Section 1294 election.1 Therefore, a US-person beneficiary of a US nongrantor trust is required to file a Form 8621 only if one of (i) through (v) above is applicable. Outside of these circumstances, the US nongrantor trust should be filing the Form 8621.

The regulations provide eight general categories of exceptions from the requirement to file Form 8621: (i) if a shareholder is a tax-exempt entity, (ii) if the aggregate value of the shareholder’s PFIC stock is $ 25,000 or less, or value of the shareholder’s indirect PFIC stock is $5,000 or less, (iii) for PFIC stock marked to market under a provision other than Section 1296, (iv) for PFIC stock held through certain foreign pension funds, (v) for certain shareholders who are dual resident taxpayers, (vi) for certain domestic partnerships, (vii) for certain short-term ownership of PFIC stock, and (viii) for certain bona fide residents of certain US territories. We discuss several of these exceptions below.

$ 25,000/$ 5,000 Exception

A shareholder is not required to file Form 8621 for a PFIC if (i) they have not made a QEF election, (ii) they have not received an excess distribution or recognized gain treated as an excess distribution during the year, and (iii) as of the last day of the year (a) the value of all their PFIC stock is $25,000 or less, or (b) the value of their indirect PFIC stock is $5,000 or less.

When determining the $ 25,000 threshold, the shareholder does not have to include the value of PFIC stock (i) owned through another US person, (ii) owned through a PFIC, or (iii) marked to market under a provision other than Section 1296 (with some exceptions). The $ 25,000 threshold is raised to $ 50,000 in the aggregate for spouses filing jointly.

Because each beneficiary of a nongrantor trust is considered to own a proportionate amount of any PFIC stock owned directly or indirectly by the trust, the value of the PFIC stock should be divided among the beneficiaries when determining whether they meet the exception threshold.

PFIC stock held through certain foreign (non-US) pension funds

A shareholder is not required to file Form 8621 if they are a beneficiary of a foreign pension fund (or equivalent) under a relevant US income tax treaty that holds PFICs and pursuant to the applicable income tax treaty, the income earned by the foreign pension fund may be taxed as the income of the shareholder only when and to the extent the income is paid to, or for the benefit of, the shareholder.

Dual resident taxpayers

A shareholder is not required to file Form 8621 if they are a considered a dual resident taxpayer under a relevant US income tax treaty and take a treaty position that they are a nonresident alien for purposes of computing their US income tax liability filing all the required forms.

Certain domestic (US) partnerships

A domestic partnership is not required to file a Form 8621 if each partner (i) is not a shareholder of the PFIC (e.g., a tax exempt shareholder), (ii) a tax-exempt entity not required to file Form 8621, (iii) dual resident taxpayer not required to file Form 8621, or (iv) a domestic partnership not required to file Form 8621.

Short-term ownership

A shareholder is not required to file Form 8621 if they held the stock of a PFIC for 30 days or less and is not treated as receiving an excess distribution or recognizing gain that is treated as an excess distribution.

Specifics regarding filing Form 8621

If required, a Form 8621 must be filed whether or not the shareholder files a US federal income tax return. In the case of a failure to file Form 8621, the statute of limitations to assess additional tax does not begin running. In the case where the taxpayer is unsure or unable to determine whether the company is a PFIC, a protectively filed Form 8621 does not start the statute of limitations to assess additional tax. Instead, the US Treasury decided to rely on reasonable cause statements in those instances to provide relief.

In the event a shareholder holds multiple interests in PFICs such shareholder is not allowed to consolidate filing, instead a separate Form 8621 must be filed for each PFIC.