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Year-End US Regulations

Canadian Tax Highlights
February 2017

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”)
(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

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.