Article Title

PFICs Gone Wild!


Monica Gianni


This Article begins in Part II with a discussion of what constitutes a passive foreign investment company ("PFIC") and follows in Part III with the tax rules applicable to PFICs. Part IV begins with a general explanation of the goal of tax deferral, with discussion of several anti-deferral tax regimes enacted prior to the PFIC provisions, i.e., Personal Holding Companies ("PHCs"), Foreign Personal Holding Companies ("FPHCs"), Subpart F income of CFCs, Foreign Investment Companies ("FICs"), and Regulated Investment Companies ("RICs"). An understanding of these regimes is necessary to appreciate the genesis of the PFIC rules. Part V analyzes the policy behind Congress enacting the PFIC provisions as part of the Tax Reform Act of 1986,9 i.e., preventing U.S. investors in foreign investment companies from having more favorable tax treatment than U.S. investors in domestic investment companies. Congress wanted to correct the perceived abuses of U.S. taxpayers investing in foreign investment companies to obtain U.S. tax deferral on their investments and close the gap in previously enacted legislation.

After a crash course in the basic PFIC rules and other anti-deferral regimes, and an understanding of why the rules exist, Part VI examines unexpected consequences of the PFIC rules. PFIC treatment, although targeted to stop abuses with foreign investment companies, can reach start-up and operating companies. In addition, otherwise nontaxable transfers can be subject to tax, such as an exchange of PFIC stock in a tax-deferred reorganization, a gift of PFIC stock during life and upon death, and taxation to immigrants and expatriates who own PFIC stock. Transfers of PFIC stock can result in disastrous consequences to the unsuspecting (or even the suspecting) investor, a result that seems to go beyond what Congress intended when it enacted the PFIC legislation. Part VI additionally addresses specific solutions for these problems. The simple purpose of not allowing tax deferral on investments in foreign investment companies has resulted unfortunately in "PFICs Gone Wild!"

Part VII questions whether the legislative purpose of the PFIC legislation is even valid, asking why PFICs should be subject to such punitive tax consequences when other types of investments allow for deferral of U.S. tax without punishment. The Article concludes in Part VIII that the policy behind the PFIC legislation does not justify the far-reaching and burdensome treatment to PFIC shareholders. Even if the PFIC rules are limited to a defined set of foreign investment companies and issues with transfers of PFIC stock are solved, the overriding question remains whether the basic premise of the legislation should stand. The PFIC rules must either be eliminated entirely, or at least limited to the purpose for which they were enacted-to prevent more favorable tax treatment to an investor in a foreign investment company than an investor in a U.S. investment company.

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