PLR 1025011: IRS allowed a retroactive QEF election for a PFIC investment

Plain-English summary

The IRS consented to a corporation's retroactive qualified electing fund (QEF) election for an investment in a passive foreign investment company (PFIC). A service provider failed to identify the foreign company as a PFIC and did not advise the taxpayer about the possible election. The IRS found that the taxpayer reasonably relied on qualified tax professionals, that the PFIC status had not been raised in an IRS audit, and that the regulatory requirements for retroactive consent were satisfied. The taxpayer may make the election for the specified year if it follows the time and manner rules in Treas. Reg. § 1.1295-3(g).

Ruling snapshot

• Question: Could the taxpayer make a retroactive QEF election for its investment in the PFIC?
• Outcome: Approved
• Key authorities: IRC § 1295; Treas. Reg. § 1.1295-3(f) and (g)

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201025011 Third Party Communication: None
Release Date: 6/25/2010 Date of Communication: Not Applicable
Index Number: 1295.02-02
Person To Contact:
--------------------------- -----------------------, ID No. ------------
----------------------------- Telephone Number:
----------------------------- --------------------
-------------------------- Refer Reply To:
------------------------------------- CC:INTL:B02
PLR-115130-09
Date:
March 15, 2010

              ------------

Legend

Taxpayer = -----------------------------
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QSub1 = --------------------------------------
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QSub2 = --------------------------------
-----------------------
QSub3 = -----------------------------
----------------------
QSub4 = -----------------------------
-----------------------
QSub5 = ------------------------
-----------------------
QSub6 = ---------------------------
-----------------------

FC1 = ---------------------------------------------
FC2 = --------------------------------------------
FC3 = -------------------------------------------
FC4 = -------------------
FC5 = ----------------------
FC6 = --------------------
FC7 = ------------------------------------------
FC8 = -----------------------------
FC9 = ---------------------------------------------------------
FC10 = -----------------------------
FC11 = -----------------------------------
FC12 = ----------------------------------
PLR-115130-09 2

FC13 = -----------------
FC14 = ----------------------------
FC15 = -------------------

FP = ----------------------------

State V = -----------------

Country W = --------------------------
Country X = ----------------
Country Y = ---------
Country Z = ---------------------

b = ------
c = ------
d = -------
e = -------

Date1 = ------------------
Date2 = -------------------

Year1 = -------
Year2 = -------
Year3 = -------
Year4 = -------

Service Provider1 = ---------------------------------------------
Service Provider2 = -----------------------------------------------------
Accounting Firm = ----------------------------------------

Dear -------------------:

This is in response to a letter dated September 15, 2008, submitted by your authorized
representative that requested the consent of the Commissioner of the Internal Revenue
Service (“Commissioner”) for Taxpayer to make a retroactive qualified electing fund
(“QEF”) election under section 1295(b) of the Internal Revenue Code (“Code”) and
Treas. Reg. §1.1295-3(f) with respect to Taxpayer’s investment in FC7.

The ruling contained in this letter is based upon information and representations
submitted on behalf of Taxpayer by its authorized representatives, and accompanied by
a penalties of perjury statement executed by an appropriate party. While this office has
not verified any of the material submitted in support of this request for ruling, such
PLR-115130-09 3

material is subject to verification on examination. The information submitted in the
request is substantially as set forth below.

FACTS

Taxpayer is a corporation organized under the laws of State V that is a subchapter S
corporation within the meaning of Code section 1361(a). Taxpayer owns, directly and
indirectly, six corporations that are each a qualified subchapter S subsidiary within the
meaning of Code section 1361(b)(3)(B), and that are disregarded as separate from
Taxpayer for U.S. tax purposes. Specifically, Taxpayer wholly owns QSub1, which, in
turn, wholly owns QSub2. QSub2 wholly owns each of QSub3 and QSub4. In turn,
QSub3 wholly owns QSub5, and QSub4 wholly owns QSub6.

During Year1, through QSub5, Taxpayer acquired a b percent interest in FP, a
partnership formed under the laws of Country W. Also during Year1, FP and other
investors, including Taxpayer through QSub6, formed FC1, a company formed under
the laws of Country X. Taxpayer’s total ownership interest in FC1, taking into account
its interest through both FP and QSub6, was approximately c percent.

FC1 owned d percent of FC2, a company formed under the laws of Country X. FC2
wholly owned FC3, a company formed under the laws of Country X, which, in turn,
wholly owned FC4, a company formed under the laws of Country Y. On Date1, FC3
fully liquidated into FC2. Subsequently, FC2 was the sole owner of FC4.

FC4, directly and indirectly, wholly owned the following subsidiaries: (i) FC5, a company
formed under the laws of Country Y; (ii) FC6, a company formed under the laws of
Country Y; (iii) FC7, a company formed under the laws of Country Y; (iv) FC8, a
company formed under the laws of Country Y; (v) FC9, a company formed under the
laws of Country Y; (vi) FC10, a company formed under the laws of Country Y; (vii)
FC11, a company formed under the laws of Country Y; (viii) FC12, a company formed
under the laws of Country Z; (ix) FC13, a company formed under the laws of Country Y;
(x) FC14, a company formed under the laws of Country Y; and (xi) FC15, a company
formed under the laws of Country Y (collectively, “Subsidiaries”). Each of the
Subsidiaries owned real property, which it leased to unrelated persons and upon which
it collected rental income. The majority of leases entered into by the Subsidiaries were
so-called “triple-net leases” whereby the lessee generally was responsible for the
maintenance and operation of the property. No Subsidiary held any assets other than
real property, nor earned any income other than rental income.

In Year1, FC2’s ownership of FC4 was diluted by e percent as part of an initial public
offering. On Date2, FP and QSub6 sold the remaining portion of their interests in FC4
(and, indirectly, the Subsidiaries) to an unrelated party.
PLR-115130-09 4

In accordance with its partnership agreement, FP was required to provide sufficient
detail to its U.S. investors to enable such investors to prepare their U.S. tax returns,
including any information required with respect to a foreign corporation that was a
passive foreign investment company within the meaning of Code section 1297 (“PFIC”).
To do this, FP retained Service Provider1 to provide tax and administrative services,
including the preparation of U.S. tax-related documents. Service Provider1 was known
to be a leader in providing such services to the private equity industry. Following the
takeover of Service Provider1 by Service Provider2 in Year2, FP retained Service
Provider2 as a tax and administrative service provider. FP retained Service Provider2
on the basis that Service Provider2 employed experienced tax specialists who were
qualified tax professionals. Such qualified tax professionals were responsible for
preparing and distributing information regarding the U.S. tax consequences of an
investment in FP, and indirectly, in FC1, FC2, FC3, FC4 and the Subsidiaries
(collectively, “FCs”).

Service Provider2 prepared K-1 equivalents for FP’s investors for the Year1 and Year2
tax years. During the time that Service Provider2 prepared FP’s K-1 equivalents,
Service Provider2 had access to both income statement and balance sheet information
relating to the FCs. However, Service Provider2 failed to identify FC7 as a PFIC, and
failed to advise FP (or, consequently, Taxpayer) of the PFIC status of FC7 and the
possibility of making a QEF election with respect to FC7.

It was not until Year4, when FP retained Accounting Firm to prepare its K-1 equivalents
and provide relevant U.S. tax information to its U.S. investors with respect to its Year3
tax year, that it was discovered that FC7 was a PFIC.

Taxpayer has submitted an affidavit, under penalties of perjury, describing the events
that led to the failure to make the QEF election with respect to FC7 by the election due
date, including the role of Service Provider2. Taxpayer represents that Service
Provider2 prepared and distributed FP’s K-1 equivalents, which contained the U.S. tax
consequences of an investment in FP, and, indirectly, FC7. Taxpayer also submitted an
affidavit from an advisor to FP that was responsible for engaging Service Provider2,
corroborating the representations made by Taxpayer.

Taxpayer represents that the PFIC status of FC7 has not been raised by the IRS on
audit for any of the taxable years.

RULING REQUESTED

Taxpayer requests the consent of the Commissioner to make a retroactive QEF election
with respect to FC7 for Year1 under Treas. Reg. §1.1295-3(f).

LAW
PLR-115130-09 5

Code Section 1295(a) provides that a PFIC will be treated as a QEF with respect to a
taxpayer if (1) an election by the taxpayer under Code section 1295(b) applies to such
PFIC for the taxable year; and (2) the PFIC complies with such requirements as the
Secretary may prescribe for purposes of determining the ordinary earnings and net
capital gains of such company.

Under Code section 1295(b)(2), a QEF election may be made for any taxable year at
any time on or before the due date (determined with regard to extensions) for filing the
return for such taxable year. To the extent provided in regulations, such an election
may be made after such due date if the taxpayer failed to make an election by the due
date because the taxpayer reasonably believed the company was not a PFIC.

Under Treas. Reg. §1.1295-3(f), a shareholder may request the consent of the
Commissioner to make a retroactive QEF election for a taxable year if:

   1. the shareholder reasonably relied on a qualified tax professional, within the
      meaning of Treas. Reg. §1.1295-3(f)(2);
   2. granting consent will not prejudice the interests of the United States
      government, as provided in Treas. Reg. §1.1295-3(f)(3);
   3. the request is made before a representative of the Internal Revenue Service
      raises upon audit the PFIC status of the corporation for any taxable year of
      the shareholder; and
   4. the shareholder satisfies the procedural requirements of Treas. Reg. §1.1295-
      3(f)(4).

The procedural requirements include filing a request for consent to make a retroactive
election with, and submitting a user fee to, the Office of the Associate Chief Counsel
(International). Treas. Reg. §1.1295-3(f)(4)(i). Additionally, affidavits signed under
penalties of perjury must be submitted that describe:

   1. the events that led to the failure to make a QEF election by the election due
      date;
   2. the discovery of such failure;
   3. the engagement and responsibilities of the qualified tax professional; and
   4. the extent to which the shareholder relied on such professional.

Treas. Reg. §§1.1295-3(f)(4)(ii) and (iii).

CONCLUSION

Based on the information submitted and representations made with Taxpayer’s ruling
request, we conclude that Taxpayer has satisfied Treas. Reg. §1.1295-3(f).
Accordingly, consent is granted to Taxpayer to make a retroactive QEF election with
respect to FC7 for Year1, provided that Taxpayer complies with the rules under Treas.
PLR-115130-09 6

Reg. §1.1295-3(g) regarding the time and manner for making the retroactive QEF
election.

Except as specifically set forth above, no opinion is expressed or implied concerning the
U.S. tax consequences of the facts described above under any other provision of the
Code.

This private letter ruling is directed only to the taxpayer who requested it. Code section
6110(k)(3) provides that it may not be used or cited as precedent.

A copy of this letter ruling must be attached to any federal income tax return to which it
is relevant. Alternatively, taxpayers filing their returns electronically may satisfy this
requirement by attaching a statement to their return that provides the date and control
number of the letter ruling.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.

                                   Sincerely,



                                   Jeffery G. Mitchell
                                   Special Counsel (International)