Final and proposed PFIC regulations: Additional analysis

Overview

Treasury and the IRS on December 4 released Final Regulations (which finalize with modifications the 2019 Proposed Regulations published on July 11, 2019) under Sections 1291, 1297, and 1298, and Proposed Regulations under Sections 250, 951A, 1291, 1297, and 1298.  The Final Regulations retain the basic approach and structure of the 2019 Proposed Regulations.  The New Proposed Regulations provide additional guidance with respect to certain definitional and mechanical issues under the passive foreign investment company (PFIC) rules, including the application of the Section 1297(b)(2)(A) active banking exception.

The PFIC rules, which were modified by the 2017 tax reform legislation (the 2017 act) (enacted on December 22, 2017), generally aim to remove the economic benefit of deferral that otherwise may be available to US investors in foreign investment funds.  Broadly, the Final Regulations and the Proposed Regulations address the attribution of PFIC stock to US investors, the determination of a foreign corporation’s PFIC status, and the application of the PFIC insurance and banking exceptions.

The Final Regulations generally apply to tax years of shareholders beginning on or after the date the regulations are filed with the Federal Register.  The Proposed Regulations generally are effective for tax years of shareholders beginning on or after the date of the filing of those rules as final in the Federal Register. See further discussion of applicability dates below.

This Insight covers the key provisions of the Final Regulations and the Proposed Regulations. 

The takeaway

The Final Regulations generally retain the basic approach and structure of the 2019 Proposed Regulations while addressing a number of open, broadly relevant issues.  Specifically, this guidance provides needed clarity with respect to the application of the ownership attribution rules, the PFIC Income and Asset Tests, the PFIC look-through rules, and the PFIC active banking and insurance exceptions. The 2020 Proposed Regulations provide additional guidance on certain definitional and mechanical issues. 

Some of this guidance is not taxpayer-favorable.  For example, under the Final Regulations, the Section 954(h) active financing exception no longer explicitly applies to determine whether a foreign corporation is a PFIC (although the 2020 Proposed Regulations introduce a narrower exception for active banks that incorporates certain principles of Section 954(h)).  Additionally, the Final Regulations retain, with certain modifications, an anti-abuse rule for the domestic subsidiary look-through rule provided in the 2019 Proposed Regulations. 

Taxpayers should review carefully the Final and Proposed Regulations with respect to their direct and indirect foreign investments to determine whether and how this latest guidance might impact the PFIC status of any such investment.  The Proposed Regulations invite comments on a number of issues, and businesses affected by the new rules should consider providing comments during the comment period, which ends 90 days after publication in the Federal Register.