Passive Foreign Investment Companies

The second section of the tax code that may apply to a foreign corporation is the passive foreign investment company (PFIC). A PFIC is a foreign-based corporation that has one of the following attributes:

  1. At least 75% of the corporation's income is considered "passive", which is based on investments rather than standard operating business.
  2. At least 50% of the company's assets are investments that produce interest, dividends and/or capital gains.

If a foreign company meets the requirements of the PFIC income or asset test, the company will be considered a PFIC with respect to each US shareholder in the company. The PFIC regime is essentially a penalty provision. No favorable outcomes or planning opportunities arise once a shareholder falls within these rules.

The general penalty imposed for owning PFIC stock is that certain "excess distributions" from a PFIC, including gains from the sale of PFIC stock, are thrown back ratably over the shareholder's holding period for the stock and subject to tax at the shareholder's highest ordinary income tax rate in each throwback year, rather than the 15% preferential tax rate on qualified dividends and long-term capital gains. In general, the excess distribution rules are designed to prevent the accumulation of passive income in a foreign corporation in a manner that defers current US taxation on the US investor's portion of such income.

An actual distribution is an excess distribution only to the extent that the total of actual distributions during a tax year received by the investor exceeds 125% of the average of actual distributions received in the three preceding tax years. Once the total amount of the excess distribution has been determined, it is allocated ratably to all days in the investor's holding period for the stock and taxed at the taxpayer’s highest ordinary tax rate.

The PFIC regime applies to U.S. taxpayers that directly or indirectly own shares of a PFIC. There is no U.S. shareholder control requirement under the PFIC regime; if a US person holds even a de minimis amount of PFIC shares, it may be subject to tax under the PFIC rules.

Please note that the above is a general outline of the CFC rules and is by no means comprehensive. We hope this outline is helpful to provide our readers with a general understanding of this complex area of the tax code. Again, we look forward to providing the reader with tax consulting and compliance services with relation to specific facts and circumstances.

Tax regulations for foreign bank accounts