PLR 1322009: IRS applies PFIC look-through rules to a foreign holding company structure

Plain-English summary

The IRS clarified how the passive foreign investment company, or PFIC, look-through rules applied to a foreign holding company that owned a domestic software company, which in turn owned a domestic finance company. The foreign company had waived treaty protection against the U.S. accumulated earnings tax. For PFIC testing, the IRS ruled that the foreign company would not be treated as receiving the lower-tier finance company’s income or owning its assets under section 1298(b)(7). Income and assets of the first-tier domestic subsidiary, including its interests in the lower-tier company, would instead be treated as directly received or owned by the foreign company under section 1297(c), with specified dividends and stock treated as nonpassive under section 1298(b)(7). The ruling addresses only the PFIC consequences stated in the letter.

Ruling snapshot

• Question: How should the section 1297 and 1298 look-through rules apply to the foreign company’s domestic subsidiaries when determining PFIC status?
• Outcome: Approved
• Key authorities: IRC §§ 1297, 1298, and 532; Treas. Reg. §§ 1.532-1(c) and 1.535-1(b); IRC § 6110(k)(3).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201322009 Third Party Communication: None
Release Date: 5/31/2013 Date of Communication: Not Applicable
Index Number: 1297.00-00
Person To Contact:
---------------------------------- ---------------------, ID No. --------------
-------------------------------- Telephone Number:
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Refer Reply To:
CC:INTL:B02
PLR-133095-12
Date:
January 31, 2013

LEGEND

Taxpayers = -----------------------
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-----------------------
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Corp X = --------------------------------
-----------------

Country M = ------------

US Corp Y = --------------------------------------
-----------------

US Corp Z = --------------------------------
-----------------

Year 1 = -------

Year 2 = -------

Year 3 = -------

Year 4 = -------

Dear ----------------------------:
PLR-133095-12 2

This is in response to a letter received in this office dated July 25, 2012, in which a
ruling is requested to clarify the proper application of certain look-through rules for
purposes of determining whether Corp X is a passive foreign investment company
within the meaning of section 1297.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

FACTS

Taxpayers are a married couple who own shares in Corp X and have filed joint federal
income tax returns for all taxable years beginning after Year 2. Corp X is a Country M
corporation that was founded in Year 2, and is a passive foreign investment company
(PFIC) within the meaning of section 1297. Since its formation in Year 2, Corp X has
owned all of the outstanding shares of US Corp Y, a domestic corporation. US Corp Y
has owned all the outstanding shares of US Corp Z since the formation of US Corp Z in
Year 4.

Corp X has always been a holding company and has never been engaged directly in the
conduct of business activities. Since its formation in Year 1, US Corp Y has been
engaged in a business involving the development, marketing, and support of certain
application software for businesses. US Corp Z has been engaged in the conduct of a
financing business since its formation.

Nearly all of the income of US Corp Z has consisted of interest earned on receivables
purchased in the course of US Corp Z’s financing business. The amount of income
earned by US Corp Y in the conduct of its business is less than --% of the total income
of Corp X, US Corp Y, and US Corp Z combined. In Year 3 and each subsequent
taxable year, the gross amount of interest income earned by US Corp Y has been less
than the amount of gross income earned by US Corp Y in the course of its business.

The income of Corp X has consisted almost exclusively of dividends received from US
Corp Y. Nearly all of these dividends have been immediately re-distributed by Corp X
as dividends to its shareholders. In Year 3 and each subsequent taxable year, the
gross amount of interest income earned by Corp X (when aggregated with the gross
amount of interest income earned by US Corp Y) has been less than the amount of
gross income earned by US Corp Y in the course of its business from the sales and
support of software applications.

US Corp Y and US Corp Z have historically earned significant amounts of taxable
income, all of which has been subject to U.S. federal income tax.
PLR-133095-12 3

The portion of the outstanding shares of Corp X owned, directly or indirectly, by
individuals who are citizens or residents of the United States for federal income tax
purposes has been greater than ----% at all times since the beginning of Year 3.

The board of directors of Corp X has adopted a resolution confirming that Corp X has
irrevocably waived any protection under the U.S.-Country M treaty against the
imposition of the U.S. accumulated earnings tax, effective for all prior, current, and
future taxable years.

LAW

Section 1297(a) provides that a foreign corporation is a passive foreign investment
company (PFIC) with respect to a taxable year if either (1) 75 percent or more of the
gross income of the corporation for the taxable year is passive income, or (2) the
average percentage of assets held by the corporation during the taxable year which
produce passive income or which are held for the production of passive income is at
least 50 percent.

Section 1297(b)(1) provides that, for purposes of section 1297(a), the term “passive
income” means any income (other than income qualifying under the exceptions set forth
in section 1297(b)(2)) which is of a kind which would be foreign personal holding
company income as defined in section 954(c).

Section 1297(b)(2)(C) contains a look-through rule under which a dividend, interest, or
royalty payment that is received by a foreign corporation from a related person is not
treated as passive income to the extent that the payment is allocable to income of the
payor that is not passive income.

Section 1297(c) contains a look-through rule that provides that if a foreign corporation
owns, directly or indirectly, at least 25 percent of the value of the stock of another
corporation, then the foreign corporation is treated (for purposes of section 1297(a)) as
holding its proportionate share of the assets, and as receiving directly its proportionate
share of the income of, the 25-percent owned subsidiary.

Section 1298(b)(7) contains a look-through rule that provides that if a foreign
corporation owns 25 percent or more of the shares of a domestic corporation (first-tier
domestic corporation), and if the foreign corporation is either subject to the U.S.
accumulated earnings tax or waives any benefit under any treaty which otherwise would
prevent the imposition of the accumulated earnings tax, then for purposes of
determining whether the foreign corporation is a PFIC: (1) any shares of another
domestic corporation, other than a regulated investment company or real estate
investment trust (second-tier domestic corporation), that are held by the first-tier
domestic corporation are treated as not being a passive asset; and (2) any amount
included in the gross income of the first-tier domestic corporation with respect to the
PLR-133095-12 4

shares of such second-tier domestic corporation are treated as not being passive
income.

Unless an income tax treaty provides otherwise, a foreign corporation (other than a
PFIC) that has any shareholder who is a U.S. citizen or resident is subject to the
accumulated earnings tax with respect to the corporation’s U.S.-source income
(including U.S.-source dividend and interest income that is not effectively connected
with a trade or business conducted within the United States by the foreign corporation).
See section 532; Treas. Reg. §§ 1.532-1(c) and 1.535-1(b).

An article of the U.S.-Country M treaty provides that a Country M corporation may be
subject to the U.S. accumulated earnings tax for a particular taxable year if 50% or
more in value of the outstanding voting shares of the corporation is owned, directly or
indirectly, throughout the last half of the taxable year by citizens or residents of the
United States (other than certain citizens of Country M) or by residents of a country
other than the U.S. or Country M.

The legislative history of section 1298(b)(7) states:

   The bill further treats stock of certain U.S. corporations owned by another
   U.S. corporation which is at least 25-percent owned by a foreign
   corporation as a non-passive asset. Under this rule, in determining
   whether a foreign corporation is a PFIC, stock of a regular domestic C
   corporation owned by a 25-percent owned domestic corporation is treated
   as an asset which does not produce passive income (and is not held for
   the production of passive income), and income derived from that stock is
   treated as income which is not passive income. Thus, a foreign
   corporation, in applying the look-through rule applicable to 25-percent
   owned corporations, will be treated as owning nonpassive assets in these
   cases. This rule does not apply, however, if, under a treaty obligation of
   the United States, the foreign corporation is not subject to the
   accumulated earnings tax, unless the corporation agrees to waive the
   benefit under the treaty. This rule is designed to mitigate the potential
   disparate tax treatment between U.S. individual shareholders who hold
   U.S. stock investments through a U.S. holding company and those who
   hold those investments through a foreign holding company. If a foreign
   investment company attempts to use this rule to avoid the PFIC
   provisions, it will be subject to the accumulated earnings tax and, thus, the
   shareholders of that company will be subject to tax treatment essentially
   equivalent to that of the shareholders of PFICs.

H.R. Rep. No. 795, 100th Cong., 2d Sess., 273 (1988); S. Rep. No. 445, 100th Cong.,
2d Sess., 286-87 (1988); Joint Committee on Taxation, Description of the Technical
Corrections Act of 1987 (H.R. 2636 and S. 1350), 213 (JCS-15-87 June 15, 1987).
PLR-133095-12 5

RULING

For purposes of determining whether Corp X is a PFIC:

(1) Pursuant to section 1298(b)(7), Corp X is treated as not receiving any portion of
the income earned by US Corp Z, and Corp X is treated as not owning the assets
held by US Corp Z.
(2) Any dividend received by US Corp Y from US Corp Z, and any other income
received by US Corp Y, is treated under section 1297(c) as being received
directly by Corp X.
(3) The shares of US Corp Z that are held by US Corp Y, and any other assets held
by US Corp Y, are treated under section 1297(c) as being owned directly by Corp
X.
(4) Pursuant to section 1298(b)(7), any dividend received by US Corp Y from US
Corp Z is treated as not being passive income, and the shares of US Corp Z that
are held by US Corp Y are treated as not producing passive income and as not
being held for the production of passive income.

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.

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 must be attached to any 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, copies of this letter are
being sent to Taxpayer's representatives.

                                   Sincerely,



                                   Jeffery G. Mitchell
                                   Chief, Branch 2
                                   Office of the Associate Chief Counsel
                                   (International)