“A significant number of Offshore Voluntary Disclosure Practice (VDP) cases involve Passive Foreign Investment Company (PFIC) investments.”
IRS, Offshore Voluntary Disclosure Initiative: Passive Foreign Income Company Investment Computations

Do you own shares in a foreign mutual fund?  Do you own shares in an overseas investment company?  If so, you may be subject to the Passive Foreign Investment Company (PFIC) rules.

These rules aim to place investors in offshore funds on the same footing as investors in US investment funds.  Unfortunately, US taxpayers who invest in foreign companies are usually unaware of these rules.  Investments in PFICs are subject to complicated and onerous tax regimes with reporting requirements and tax obligations distinctly different from investments in US companies. Identifying an overseas investment as a PFIC is a challenge.

Any foreign corporation that meets certain income or asset-based criteria is deemed a PFIC.  If 75% or more of its gross income is passive income, e.g., from interest, dividends, rents, royalties, annuities and some types of property gains, or if 50% or more of the corporation’s assets produce passive income, then the corporation will be considered a PFIC.

R owns shares in ABC, a foreign corporation, whose gross income for 2012 consists entirely of interest income.  Since interest income is a form of passive income, and 75% or more ABC’s gross income is passive, ABC is considered to be a PFIC.

S owns shares of RRR, a foreign corporation. RRR ’s assets are entirely bank fixed deposits.  Since over 50% of RRR ’s assets are passive assets, RRR  is deemed a PFIC.

All investors in a PFIC are subject to the PFIC rules.  There is no minimum ownership requirement.

A owns 1 share in XYZ, a foreign corporation.  A’s ownership interest in XYZ is very small, i.e., less than 1% of total issued shares of XYZ. However, if XYZ is deemed a PFIC then A must follow special tax rules that apply to such investments.

Identifying whether an investment is a PFIC is important to enable a US taxpayer to report and pay taxes on income and gains on dispositions.  A discussion on the various tax regimes applicable to PFIC is beyond the scope of this article.

Small investments in foreign companies, particularly mutual funds, can lead to expensive and complicated tax return filings.  Investors with overseas investments should discuss with their tax advisor the possibility of being subject to the PFIC tax regimes.

Asha Dixit, CPA, MBA, MS is a partner with Shah, Dixit & Associates P.C. in Burlington, MA. For further information, contact Ms. Dixit at asha@shahdixit.com

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