PFIC look-through rules disregard domestic-group items

Plain-English summary

A publicly traded foreign pharmaceutical corporation owned a first-tier U.S. subsidiary, which in turn owned another U.S. corporation. The foreign parent irrevocably waived treaty protection against the accumulated earnings tax so that the special domestic-corporation look-through rule could apply. The IRS ruled that the second-tier corporation’s shares and dividends would be treated as nonpassive for the foreign parent’s PFIC tests. It also ruled that the first-tier subsidiary’s stock and dividends, and an intercompany loan and its interest, would be disregarded under the general look-through rule. The IRS did not rule on how the provisions would interact if the parent otherwise independently met a PFIC test.

Ruling snapshot

• Question: How do the PFIC look-through rules apply to shares, dividends, a loan, and interest within the foreign parent’s wholly owned U.S. corporate group?
• Outcome: Approved as requested, following the parent’s treaty-benefit waiver.
• Key authorities: IRC §§ 1297(c) and 1298(b)(7), with accumulated-earnings-tax rules under §§ 531–535.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201515006 Third Party Communication: None
Release Date: 4/10/2015 Date of Communication: Not Applicable
Index Number: 1297.00-00
Person To Contact:
---------------------------------------------------------- ------------------------, ID No. ------------------
----------------------- ----------------------------------------------------
------------------------------------------ Telephone Number:
---------------------------------- --------------------
------------ Refer Reply To:
CC:INTL:BR:2
PLR-119133-14
Date:
November 21, 2014

              TY:-------

Legend

Corp X = -----------------------
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Country M = ------------

a = ----

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

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

Year 1 = -------

Year 2 = -------

Year 3 = -------

Year 4 = -------

Year 5 = -------

Dear ---------------:
PLR-119133-14 2

This is in response to a letter received in this office dated May 6, 2014, 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 (“PFIC”) 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

Corp X is a publicly traded Country M corporation that was founded in Year 1.
Approximately a% of its shares are currently held by United States persons. Corp X is
not a controlled foreign corporation within the meaning of section 957(a). Corp X has
requested a determination regarding the application of sections 1298(b)(7) and 1297(c)
for purposes of determining whether Corp X is a PFIC.

Corp X directly owns all of the outstanding shares of US Corp Y, a domestic corporation
that was formed in Year 2. US Corp Y formed US Corp Z, a domestic corporation, in
Year 3 with a capital contribution, and has directly owned all of the outstanding shares
of US Corp Z since its formation.

Corp X is engaged in a business involving the research, development,
commercialization, and marketing of certain pharmaceutical treatments. US Corp Y
conducts operations related to Corp X’s pharmaceutical, research, and development
business.

Corp X holds an obligation of US Corp Y, which requires US Corp Y to pay or accrue
U.S.-source interest expense in Year 5 and subsequent taxable years.

Corp X does not currently own any PFIC stock. Taking into account only income
earned and assets owned directly by Corp X and income earned and assets owned by
US Corp Y other than dividends from and stock of US Corp Z, Corp X would not
currently be a PFIC within the meaning of section 1297.

The treaty between the United States and Country M includes a provision that would
prevent the United States from taxing (including under the accumulated earnings tax
described in section 531) undistributed profits of a corporation that is a resident of
Country M. However, the board of directors of Corp X has passed a resolution to
formally and irrevocably waive any protection under the U.S.-Country M treaty against
PLR-119133-14 3

the imposition of the accumulated earnings tax, effective for the tax year ending
December 31 of Year 4 and all future taxable years.

LAW

Section 1297(a) provides that a foreign corporation is a 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 (“income test”), 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 (“passive assets”) is at least 50 percent
(“asset test”).

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(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 (by value) of the stock of a domestic corporation
(“first-tier domestic corporation”), and if the foreign corporation is either subject to the
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 not treated as a passive asset; and (2) any amount included in
the gross income of the first-tier domestic corporation with respect to the shares of such
second-tier domestic corporation is not treated as 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 accumulated earnings tax for a particular taxable year only if 50% or more
PLR-119133-14 4

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. For purposes of satisfying the requirement in section
1298(b)(7)(A)(i), a corporation may waive any benefit under a treaty that otherwise
would prevent the imposition of the accumulated earnings tax.

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 available to 25-percent
   owned corporations, will be treated as owning non-passive 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 1988 (H.R. 4333 and S. 2238), 294 (JCS-10-88 March 31, 1988).

RULINGS

For purposes of determining whether Corp X is a PFIC:

(1) Pursuant to sections 1298(b)(7) and 1297(c), shares of US Corp Z are treated as
an asset held directly by Corp X that does not produce passive income (and is
not held for the production of passive income) for purposes of applying the asset
test to Corp X.
PLR-119133-14 5

(2) Pursuant to sections 1298(b)(7) and 1297(c), dividends paid by US Corp Z to US
Corp Y are treated as received directly by Corp X and are not treated as passive
income for purposes of applying the income test to Corp X.
(3) Pursuant to section 1297(c), the stock of US Corp Y and dividends paid by US
Corp Y to Corp X and otherwise includible in Corp X’s income are disregarded for
purposes of applying the asset test and the income test, respectively, to Corp X.
(4) Pursuant to section 1297(c), the loan from Corp X to US Corp Y and interest paid
or accrued pursuant to that loan are disregarded for purposes of applying the
asset test and income test, respectively, to Corp X.

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. No opinion is expressed or implied concerning the interaction of sections
1297(c) and 1298(b)(7) if Corp X would be a PFIC under section 1297 as a result of
income earned and assets owned directly by Corp X and income earned and assets
owned by US Corp Y other than dividends from, or stock of, US Corp Z.

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 Corp X’s representatives.

                               Sincerely,




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