Since FATCA’s implementation in 2010, investing in a Passive Foreign Investment Company (PFIC) is a questionable decision. PFICs are reportable investments and their tax regime is punitive. Under FATCA, US Taxpayers’ undisclosed foreign financial holdings are available to IRS through its receipt of reports provided by Foreign Financial Institutions (FFI).
US Taxpayers ought to consider the Internal Revenue Code Passive Foreign Investment Company punitive tax consequences before investing in a PFIC. A Passive Foreign Investment Company is a “pooled investment” that is registered outside of the US. It can include a mutual fund (including a money market fund), hedge fund, insurance product and a non-U.S. pension plan.
Many professional tax preparers are not aware of how a PFIC may be embedded in a Taxpayer’s investment portfolio, and often fail to ask the question: “do you own any foreign investments or do you have any shares in an investment vehicle registered outside of the US”?
Also, US Taxpayers and their professional tax preparers may not be aware that Taxpayers have PFICs in their investment portfolios when they are “wrapped” in an investment vehicle. As a result, there are certain US Taxpayers that could be subject to the PFIC tax regime if they have an ownership interest in a foreign corporation that generates passive income.
With FFI FATCA and associated Taxpayer FBAR compliance, the risks of having investments offshore in a PFIC may outweigh its benefits. There are reporting requirements that are associated with a PFIC such as IRS Form 8621, FBARs and Form 8938.
According to IRS, a foreign corporation is a PFIC if it meets either the income or asset test:
- Income test: whereby 75% or more of the corporation’s gross income for its taxable year is passive income.
- Asset test: whereby at least 50% of the average percentage of assets held by the foreign corporation during the taxable year are assets that produce passive income or that are held for the production of passive income.
Furthermore, there is often confusion when PFICs are held inside of a Controlled Foreign Corporation (CFC). According to the Internal Revenue Code, a CFC itself is NOT a PFIC. However, PFIC assets held by a CFC could potentially cause the CFC to be Disregarded for purposes of PFIC calculations and reporting.
Don’t be a victim of your own making. PFIC calculations are complex. There are different reporting requirements for PFICs and CFCs with potential tax form overlaps. US Taxpayers with a risk appetite for cross-border investments ought to examine the tax cost and reporting implications and requirements as well as penalties for the failure to submit required forms. Taxpayers that have PFICs or CFCs containing PFIC assets and have not reported their holdings to IRS should consult a specialized Tax Professional.