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Tax Notes Today Quotes Kirsten Burmester: Toward a Solution to the PFIC Problem

April 14, 2014, Tax Notes Today

Kirsten Burmester spoke with Marie Sapirie of Tax Notes Today concerning international tax reform and the passive foreign investment company (PFIC) regime. The PFIC rules, created by the Tax Reform Act of 1986, were established to level the playing field between U.S. investors who invest in passive assets through offshore mutual funds and those who invest in the same assets through domestic mutual funds. However, the current rules lack guidance and many areas need further clarification. For the complete article, please visit Tax Notes Today's website (subscription required).

Excerpt taken from the article "News Analysis: Toward a Solution to the PFIC Problem" by Marie Sapirie for Tax Notes Today.

"There are a lot of areas that need clarification," said Kirsten Burmester of Caplin & Drysdale. The proposed regulations issued in 1992 are not only still in proposed form, but they are not comprehensive. Subsequent guidance has chipped away at some of the uncertainty, but a lot of work remains to be done.

Burmester said that one area that needs regulatory attention is the look-through rule under section 1297(c), which treats a pro rata share of the income and assets of a subsidiary as owned by the parent if the parent owns more than 25 percent of the value of the subsidiary. "There have not been any regs promulgated under that rule, and it is a pretty important one because it prevents holding companies with active operating subsidiaries from qualifying as PFICs," she said.

Guidance on whether the activities of the employees of a subsidiary, in addition to the subsidiary's income and assets, can be attributed to the parent for purposes of determining whether income is active or passive would also be helpful, said Burmester. For example, the IRS could answer whether a foreign parent company with one foreign subsidiary that holds rental property income and another foreign subsidiary that manages the rental property qualify for the exception for active rental income on the basis of the activities of the subsidiaries.

When non-grantor trusts collide with the PFIC rules, taxpayers run into trouble, because a 2007 technical advice memorandum (TAM 200733024 ) from the IRS told taxpayers to use a reasonable method to determine how much of a PFIC owned by a trust should be attributed to the indirect owners of the trust. This guidance was reiterated in the preamble to recently enacted temporary regulations, but no further guidance has been issued. Providing certainty in this area would be helpful, said Burmester. Further, there is no guidance to coordinate the application of the PFIC rules and the undistributed net income regime for foreign trusts, she said.

How the foreign tax credit rules work regarding PFICs is particularly unfair to U.S. citizens living abroad, said Burmester. Under the PFIC rules, only withholding taxes are creditable against the U.S. tax on excess distributions received from a PFIC, not other taxes that might be paid to a foreign jurisdiction because the taxpayer is a resident there. "This is an area where legislation could be helpful for U.S. citizens who are subject to residence-based taxation in a foreign country," she said.

Moreover, said Burmester, "the rules require an unreasonable amount of vigilance on the part of minority shareholders of foreign corporations." Should Congress revisit the PFIC regime, it should consider whether requiring minority shareholders to do the detailed analysis of the company's income and assets is worth it, or even possible for some shareholders. How passive income and assets are defined in the PFIC rules is "somewhat overbroad," Burmester said. "If the definitions were narrowed, you might not have to do so much due diligence to figure out if you own a PFIC or not," she said.

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