Tax News

CCH (cch.taxgroup.com) reports:

The IRS has finalized regulations providing guidance for taxpayers that continue to be subject to the passive foreign investment company (PFIC) excess distribution regime of Code Sec. 1291, even though the foreign corporation in which they own stock is no longer treated as a PFIC under Code Sec. 1297(a) or (e). The final regulations generally adopt the temporary regulations that were effective and applied on December 8, 2005, with one modification (T.D. 9232; NPRM REG-133446-03). The final regulations clarify that multiple late purging elections are allowed to the same extent that multiple purging elections could have been made if the elections were timely filed. The regulations are effective on September 27, 2007, and apply as of December 8, 2005.
A shareholder of a foreign corporation may purge the stock of PFIC taint by making a deemed sale or deemed dividend election under Code Sec. 1298(b)(1), provided Code Sec. 1297(e) applies to a portion of the holding period. These rules also provide that such shareholders (or shareholders of foreign corporations that no longer meet the income or asset tests of Code Sec. 1297(a)) may make late deemed sale or deemed dividend elections. The deemed sale and deemed dividend election rules generally conform to the provisions under the Code Sec. 1291 regulations that apply to shareholders making a purging election in connection with a qualified electing fund (QEF) election, except for the following differences:
--The deemed dividend or gain recognized on the deemed sale of QEF stock is taxed as an excess distribution received by the shareholder on the qualification date. This qualification date is defined as the first day of the PFIC's first taxable year as a QEF. The final regulations provide, however, that the deemed dividend or gain recognized on the deemed sale, is taxed as an excess distribution received on the "controlled foreign corporation (CFC) qualification date." The CFC qualification date is defined as the first day on which the qualified portion of the shareholder's holding period in the Code Sec. 1297(e) PFIC begins, as determined under Code Sec. 1297(e)(3).
--The Code Sec. 1291 regulations define the term "post-1986 earnings and profits" as certain undistributed earnings and profits as of the day before the qualification date. The final regulations contain a similar rule, whereby post-1986 earnings and profits means certain undistributed earnings as of the day before the CFC qualification date, which may be a day after the first day of the tax year. Thus, when the CFC qualification date is a day after the first day of the tax year, undistributed earnings and profits will be determined at the close of the tax year that includes the CFC qualification date.
--Since the "once a PFIC, always a PFIC" rule of Code Sec. 1298(b)(1) often leaves a shareholder no way of removing the PFIC taint, the final regulations include late election relief provisions. Shareholders of a Code Sec. 1297(e) PFIC or a former PFIC are allowed to make a late deemed dividend or deemed sale election with the consent of the IRS, provided certain requirements are met. If the purging election is made for a closed tax year, the taxpayer must enter into a closing agreement to eliminate any prejudice to the U.S. government's interests as a consequence of the taxpayer's inability to file an amended return. Multiple late purging elections are permitted with IRS consent.
Time for Making the Deemed Sale or Deemed Dividend Elections
A shareholder must make the deemed sale or deemed dividend election on an original or amended return for the tax year that includes the CFC qualification date. If the election is made on an amended return, the return must be filed within three years of the due date of the original return, as extended under Code Sec. 6081.
A shareholder may request the consent of IRS to make a late deemed sale or deemed dividend election for his tax year that includes the CFC qualification date if he requests consent prior to the PFIC status being raised on audit, he agrees in an IRS closing agreement to eliminate any prejudice to U.S. government interests as a result of his inability to file amended returns for the tax year in which the CFC qualification date falls or an earlier closed tax year in which he took an inconsistent position with the treatment of the foreign corporation as a PFIC, and he follows the procedural rules stated below.
Manner of Making the Deemed Sale or Deemed Dividend Election
The deemed sale or deemed dividend election is made by filing Form 8621, Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund, with the shareholder's return for the election year. The gain or deemed dividend is reported as an excess distribution, and the associated tax and interest must be paid with the return. Where a shareholder makes the election after the return's due date, without regard to extensions, it must pay additional interest, as required by Code Sec. 6601, on the amount of the underpayment. Any realized loss is reported on Form 8621, although it is not recognized. The shareholder must attach a schedule to Form 8621 that demonstrates the calculation of the shareholder's pro rata share of the post-1986 earnings and profits of the PFIC that is treated as distributed on the CFC qualification date. If the shareholder claims an exclusion for amounts previously included in its income, the shareholder must include supporting information.
A late purging election is made by filing a completed Form 8621-A, Return by a Shareholder Making Certain Late Elections to End Treatment as a Passive Foreign Investment Company, and filing the form with the IRS, DP 8621-A, Ogden, UT 84201. In addition to the tax on the excess distribution, the shareholder is also liable for interest for the period beginning on the due date (without extensions) of his return for the year in which the CFC qualification date falls and ending on the date the late purging election is filed with the IRS.
Effect of Deemed Sale or Deemed Dividend Election
A shareholder making the deemed sale election is treated as having sold all of its PFIC stock for its fair market value on the CFC qualification date, which is subject to tax under Code Sec. 1291 as an excess distribution received on that date. A shareholder making the deemed dividend election must include in income as a dividend its pro rata share of the post-1986 earnings and profits of the PFIC attributable to all of the stock it held, directly or indirectly, on the termination date. Likewise, the deemed dividend is also taxed under Code Sec. 1291 as an excess distribution received on the termination date. Where a deemed sale election is made by an indirect shareholder, the amount of gain recognized and taxed is the amount of gain that the direct owner of the PFIC stock would have realized on an actual sale or disposition of the PFIC stock indirectly owned by the shareholder. Any loss realized on the deemed sale is not recognized. After the election, the shareholder's stock is no longer treated as PFIC stock. The shareholder is no longer subject to tax under Code Sec. 1291, unless the qualified portion of the shareholder's holding period ends under Code Sec. 1297(e)(2), and the foreign corporation later qualifies as a PFIC under Code Sec. 1297(a). A shareholder increases its basis of the PFIC stock owned directly by the amount of gain recognized on the deemed sale and by the amount of the deemed dividend. If it is an indirect shareholder, its adjusted basis is increased by the amount of the deemed dividend or gain recognized by the shareholder.
T.D. 9360, 2007FED ¶47,068
Other References:
Code Sec. 1291
CCH Reference - 2007FED ¶31,541K
Code Sec. 1297
CCH Reference - 2007FED ¶31,620F
CCH Reference - 2007FED ¶31,620J
Code Sec. 1298
CCH Reference - 2007FED ¶31,641D
CCH Reference - 2007FED ¶31,641J
Tax Research Consultant
CCH Reference - TRC INTLOUT: 18,200
CCH Reference - TRC INTLOUT: 18,202.20
CCH Reference - TRC INTLOUT: 18,202.25