Application of sec. 1297(d) overlap rule to PFIC shares held by a U.S. partnership.

• Author: Asher, Nita
• Position: Passive foreign investment company

In Letter Ruling 200943004, the IRS ruled that a controlled foreign corporation (CFC) will not be treated as a passive foreign investment company (PFIC) with respect to a domestic partnership that wholly owns the CFC or with respect to U.S. persons that indirectly own less than 10% of the voting power of the CFC (through the domestic partnership) under the subpart F/PFIC overlap rule of Sec. 1297(d) during the portion of the U.S. partnership's holding period that it actually owns the CFC stock.

Background

Congress enacted the PFIC regime in 1986 to address concerns about a U.S. person's ability to defer U.S. federal income tax by investing in foreign corporations and to convert the ordinary income of those foreign investments to capital gain on disposition of the shares of such foreign corporations (H.R. Conf. Rep't No. 841, 99th Cong., 2d Sess. II-641 (1986)). The PFIC rules are intended to address both the anti-deferral and character-conversion concerns expressed by Congress.

In 1997, Congress recognized that the PFIC rules and the CFC rules could apply simultaneously to a single U.S. person. To avoid unnecessary complexity, Congress added the overlap rule under Sec. 1297(d) (formerly Sec. 1297(e)). That rule provides that if a PFIC also is a CFC, U.S. shareholders (as defined in Sec. 951(b)) of the CFC generally will not be subject to the PFIC rules.

Notwithstanding the policy underlying the overlap rule, certain U.S. persons that indirectly invest in a PFIC through a U.S. partnership arguably could be subject to both the CFC rules and the excess distribution rules under Sec. 1291. Although Sec. 1298(a) states that PFIC ownership generally is not reattributed from one U.S. person to another U.S. person, the legislative history of Sec. 1298(a), the PFIC ownership attribution rules under Prop. Regs. Sec. 1.1291-1(b)(8), and certain other provisions in the regulations suggest that the IRS may view U.S. persons that indirectly invest in a PFIC through a U.S. partnership as owners of the PFIC stock for purposes of the PFIC rules.

The overlap rule could be viewed as exempting from the PFIC rules only U.S. persons that qualify as U.S. shareholders within the meaning of Sec. 951(b). Under that view, any U.S. person that does not qualify as a U.S. shareholder with respect to such PFIC (such as a U.S. partner in a U.S. partnership that indirectly owns a minority interest in the PFIC--i.e., less than 10% voting power) might be subject to the PFIC...