Retroactive qualified electing fund election approved

Plain-English summary

A U.S. taxpayer invested through a foreign employee co-investment company whose only asset was a minority interest in an active financial-services business. Because the investment company owned less than 25 percent of that business, it could not look through to the business's income and assets and was itself a passive foreign investment company. The taxpayer's return preparers did not identify that status, and the issue was discovered later during a restructuring review. The taxpayer supplied affidavits explaining reasonable reliance on qualified tax professionals, and the PFIC issue had not been raised on audit. The IRS allowed a retroactive qualified electing fund election for the first investment year, provided the taxpayer followed the required filing rules.

Ruling snapshot

• Question: Could the taxpayer make a retroactive QEF election after reasonably relying on tax professionals who did not identify the PFIC?
• Outcome: Approved.
• Key authorities: IRC §§ 1295, 1297(c); Treas. Reg. § 1.1295-3(f), (g).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201445006 Third Party Communication: None
Release Date: 11/7/2014 Date of Communication: Not Applicable
Index Number: 1295.02-02
Person To Contact:
--------------------------- --------------------------, ID No. ----------------
-------------------------- -----------------
-------------------------------- Telephone Number:
----------------------
Refer Reply To:
CC:INTL:B02
PLR-119735-14
Date: July 23, 2014

              TY: -------

Legend:

Taxpayer = ----------------------
--------------------
Firm = -----------------------------------------
Stock Exchange = --------------------------------------
Merchant Bank = -----------------------------
Central Bank = ----------------------------------
Investment Bank = -------------
Company 1 = ----------------------------
Company 2 = -----------------
FC1 = -----------------------
FC2 = --------------------------
Accountant 1 = -------------------------
Accountant 2 = ---------------------------
Accounting Firm = -----------------------------------
Year 1 = -------
Year 2 = -------
Year 3 = -------
Year 4 = -------
Year 5 = -------
Year 6 = -------
Country X = ------------
Country Y = -----------------------
x = ----
y = ----
z = --

Dear ------------------:
PLR-119735-14 2

This is in response to a letter dated May 7, 2014, submitted by Taxpayer’s 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 FC1.

The ruling contained in this letter is based upon information and representations
submitted on behalf of Taxpayer by his authorized representative, 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
material is subject to verification on examination. The information submitted in the
request is substantially as set forth below.

FACTS

Taxpayer is a U.S. citizen and a key employee of Firm, an investment banking firm
in Country X. Firm is an active financial services business and is not a passive foreign
investment company (PFIC).

In Year 1, Merchant Bank in Country Y and Firm’s employees took over Firm. In Year 2,
Firm was listed on Stock Exchange, and Merchant Bank and Firm’s employees sold
down their ownership interests. Following a financial crisis in Year 3, Firm was delisted,
underwent a recapitalization, and was put up for sale. In Year 4, Company 1 and
Company 2 acquired Firm at book value.

In order to retain Firm employees, Company 1 and Company 2 structured a retention
program in which key employees were offered the opportunity to co-invest in Firm. For
administrative purposes, Company 1 established two Country X companies, FC1 and
FC2, as investment vehicles to raise capital from key employees to co-invest in Firm
simultaneously and at the same terms as Company 1 and Company 2. In Year 4 and
Year 5, Taxpayer invested in FC1. In Year 5, Firm acquired Investment Bank. In Year 6,
Company 2 sold its entire holding in Firm to Company 1. As a result of the restructuring,
FC1 and FC2 together owned x percent (less than 25 percent) of Firm, Company 1
owned y percent, and the former Investment Bank owners held z percent. The
promoters of the transaction did not seek U.S. tax advice because most of the investors
in FC1 are foreign taxpayers.

FC1’s only asset was its less than 25 percent by value ownership interest in Firm. It
was therefore ineligible to look through to Firm’s underlying income and assets pursuant
to section 1297(c) in determining whether FC1 was a PFIC. Because FC1’s only asset
was its passive investment in Firm, FC1 held only passive assets from Year 4 to Year 5.
PLR-119735-14 3

For Year 4, Taxpayer engaged Accountant 1 for preparation of his individual U.S. tax
return. For Year 5, Taxpayer engaged Accountant 2 for preparation of his individual
U.S. tax return. Accountant 1 and Accountant 2 have significant experience advising on
U.S. federal income tax matters, including advising U.S. persons on U.S. federal income
tax matters relating to owning stock in foreign corporations. Taxpayer made available to
Accountant 1 and Accountant 2 all information each requested to provide tax advice and
to prepare Taxpayer’s tax returns.

In Year 6, Firm retained Accounting Firm in Country X as an external advisor. During a
review of the tax consequences of the potential restructuring, a senior officer of
Accounting Firm raised the question of whether FC1 could be considered a PFIC for
U.S. tax purposes. Upon further review, Accounting Firm informed Taxpayer that FC1
is a PFIC.

Taxpayer has submitted an affidavit, under penalties of perjury, describing the events
that led to the failure to make a QEF election by the election due date, including the
roles of Accounting Firm, Accountant 1 and Accountant 2. Accountant 2 has submitted
an affidavit corroborating the representations made by Taxpayer with respect to the
failure to identify FC1 as a PFIC.

Taxpayer represents that, as of the date of the request for ruling, the PFIC status of
FC1 has not been raised by the IRS on audit for any of the taxable years at issue.

RULING REQUESTED

Taxpayer requests the consent of the Commissioner to make a retroactive QEF election
with respect to FC1 under Treas. Reg. §1.1295-3(f), retroactive to Year 4.

LAW

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 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 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.
PLR-119735-14 4

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 FC1 for Year 4, provided that Taxpayer complies with the rules under Treas.
Reg. §1.1295-3(g) regarding the time and manner for making the retroactive QEF
election.

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

This private letter ruling is directed only to the taxpayer who requested it. 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
PLR-119735-14 5

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
                                               Chief, Branch 2
                                               Office of Associate Chief Counsel
                                               (International)