Year-End US Regulations
Originally published in Canadian Tax Highlights, Volume 25, Number 2, February 2017. Reprinted with permission.
At the end of 2016, the Treasury and the IRS published various regulations that may affect both a
US person that invests in a Canadian company and a Canadian person that owns a US entity that is
disregarded for US income tax purposes (typically, a single-member limited liability company).
New passive foreign investment company (PFIC) regulations affect a US shareholder of a
PFIC; new disregarded entity (DRE) regulations require the filing of an annual form with the IRS by
a Canadian (or another non-US person) that owns at least 25 percent of a US entity that is
disregarded for US income tax purposes.
New PFIC regulations. The new PFIC regulations provide
(1) some clarifications to the definitions of “shareholder” and “indirect shareholder” in the PFIC
context, and (2) clarification of and additional exceptions to form 8621 (“Information Re- turn by
a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund”)
reporting.
(1) Definitions.
The final regulations adopt the 2013 temporary regulations’ definition of “shareholder,” and
they revise and clarify the term “indirect shareholder.” First, they provide that a US person
is not treated as a PFIC shareholder to the extent that such a person owns PFIC stock through a
tax-exempt organization or account.
Second, the new regulations include a non-duplication rule to ensure that the prior regulations are
not interpreted so as to create overlapping ownership in a PFIC (which is taxable under section
1291) by two or more US persons. Thus, solely for the purposes of determining whether a
person owns at least 50 percent of the stock value of a foreign corporation that is not a PFIC, a
person that directly or indirectly owns at least 50 percent in value of a domestic corporation’s
stock is considered to own a proportionate amount (by value) of any stock owned directly or
indirectly by the domestic corporation. However, the non-duplication rule states that a US person
is not treated as owning the stock of a PFIC that is directly owned or considered owned indirectly
by another US person.
Third, the new PFIC regulations revise the prior regulations in relation to when a US
person is considered to be an indirect shareholder as a result of attribution through a domestic
corporation.
Finally, the new PFIC regulations make two additional clarifications with respect to the
rules discussed above. One clarification is that the attribution rules do not apply to stock
owned directly or indirectly through an S corporation; the second clarification is that the domestic-corporation attribution rule applies for all PFIC purposes, not just to a PFIC that is taxable under section 1291.
(2) Reporting (filing) requirements.
Unless an exception applies, a direct PFIC shareholder must file form 8621, “Information Return
by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.” The
reporting rules for an indirect shareholder depend on whether the shareholder owns the PFIC through
foreign or domestic entities.
The new regulations provide several exceptions to reporting, followed by specifics for filing form
8621. Eight general categories of exceptions exist: (1) if a shareholder is a tax-exempt entity;
(2) if the aggregate value of the shareholder’s PFIC stock is no more than US$25,000 or if the
value of the shareholder’s indirect PFIC stock is no more than US$5,000; (3) for PFIC stock
marked to market other than under section 1296; (4) for PFIC stock held through certain foreign
pension funds; (5) for certain shareholders who are dual-resident taxpayers; (6) for
certain domestic partnerships; (7) for certain short-term ownership of PFIC stock (30 days or
less); and (8) for certain bona fide residents of certain US territories.
Form 8621 must be filed whether or not the shareholder files a US federal income tax return. The
statute of limitation period to assess additional tax does not begin to run on the failure to file
the form. Importantly, a protectively filed form 8621 does not trigger the beginning of the
limitation period to assess additional tax. The Treasury relies instead on reasonable- cause
statements to provide relief. Moreover, if a shareholder holds interests in multiple PFICs, the
shareholder must file a separate form 8621 for each PFIC and cannot consolidate the forms for
filing purposes.
New DRE regulations. An entity, such as a US LLC, that has a single owner and is not classified as
a corporation is generally a DRE and disregarded as separate from its owner under other
regulations. A DRE is generally not subject to US tax-filing requirements and thus generally does
not need to obtain an employer identification number (EIN) unless it files an entity
classification election. If an entity must obtain an EIN, it should file form SS-4, “Application
for Employer Identification Number,” and therein identify a responsible party (generally,
the individual with control over, or entitlement to, the entity’s assets); this method applies
unless the sole reason for applying for an EIN is to make an entity classification election and
the entity is foreign-owned.
A domestic corporation, a domestic partnership, and a foreign corporation engaged in a trade or
business in the United States must—unlike a DRE—file an annual income tax return. A domestic corporation that is at least 25 percent foreign-owned has additional
information-reporting and record-maintenance requirements, including the filing of an annual
return on form 5472, “Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign
Corporation Engaged in a U.S. Trade or Business,” for each related party with which it had
any “reportable transactions.” These corporations must also keep records sufficient to establish
the accuracy of the return, including any relevant information regarding related parties.
Generally, a foreign-owned US DRE does not have US reporting obligations unless it is engaged in
a US trade or business or has certain types of US-source income. However, solely for the purposes
of the reporting requirements, a US DRE that is wholly owned by one foreign person is treated under
the new DRE regulations as a domestic corporation separate from its owner: thus, such a DRE is
subject to the reporting and record- keeping requirements currently applicable to a 25
percent foreign-owned US corporation.
For the purposes of the new DRE regulations, a foreign person is considered to wholly
own a domestic DRE if the foreign person has direct or indirect sole ownership of the
entity. To that end, indirect sole ownership means “ownership by one person entirely through one or
more other [DREs] or through one or more grantor trusts, regardless of whether any such [DRE] or
grantor trust is domestic or foreign.”
The new DRE regulations do not affect an entity’s classification for other purposes.
Consequently, the DRE must file IRS form 5472 and maintain related records for reportable trans-
actions with the entity’s foreign owners or other foreign related parties. To complete
this filing, an entity must also obtain an EIN by filing a form SS-4 with
responsible-party information, including the responsible party’s social security number, and the
party’s individual taxpayer identification number (ITIN) or EIN.