US Investors in Foreign Companies That Turn Into PFICs
Many of our clients are sophisticated investors and are familiar with the concept of a PFIC. A PFIC occurs where US exposed investors in overseas entities / assets incur unfavorable tax and reporting treatment on their US returns. I explain this in more detail here - https://htj.tax/?s=pfic
Recently we have had clients who invested in foreign entities which were not initially PFICs but as the working capital of the company (such as cash) grew, it became a PFIC. What happens then?
Notice 88-22, which for many years contained the only guidance on the application of the Income Test and the Asset Test, provides that cash and other current assets readily convertible into cash, including assets that may be characterized as the working capital of an active business, are treated as passive assets for purposes of the Passive Asset Test. Obviously this is nonsense and we (tax professionals) were expecting that recent proposed regs would have addressed this oversight. Unfortunately the response published earlier in 2021 was as follows -
“The Treasury Department and the IRS continue to study the appropriate treatment of working capital.”
Some professionals stand by the view that if the cash is held in a non-interest bearing account then it won't qualify as a passive asset for the purposes of the passive asset test.
So this may be (depending on the fact pattern) a work around to avoid PFIC classification.
Obviously this is bad for the company (to forgo earning interest because of PFIC concerns). In certain cases we may recommend that the US exposed investor consider alternative holding / investment structures.
Another option to consider is this. The pfic rules (section 1297(e)) sometimes request a valuation be done and this is where IP (or other intangibles) may be formally valued which may help companies with the passive asset test.
Got questions? Get advice from a US qualified professional