This article will look at PFICs for UK residents. For questions and advice — firstname.lastname@example.org.
‘Passive Foreign Investment Company’ also known by the name ‘PFIC’. A Company is said to be a PFIC if it follows two conditions. They are:
- Depending on the income of the company, a minimum of 75% of the gross income of the company should be a passive type of income. It should not be generated from the company’s active and regular business methods.
- Depending on the company’s assets, a minimum of 50% of the company’s assets should be investments that generate income in the form of Capital Gains, Dividends or Earned Interest.
By satisfying any of the above-mentioned two conditions, a company can be declared as a PFIC. PFICs were first recognized in the tax reforms passed in 1986.
These were designed in such a way that they create a tax loophole by which some of the U.S. investors/taxpayers were able to avoid taxation of offshore investments.
Afterward, the tax reforms removed this tax loophole by bringing them under the U.S. taxation and introduced higher tax rates for such practices in order to make investors/taxpayers less likely to invest in such types of investments.
‘IRS and the PFICs’ — IRS (Internal revenue Service) has subjected the PFICs to an extreme set of complicated tax guidelines. These can be referred by a person under sections 1291 through 1297 in the U.S. income tax code.
It is mandatory for the PFICs as well as the shareholders to keep an exact record and details of the transactions such as share costs, details of the dividends earned, undistributed income that a PFIC might be able to earn, etc.
While dealing with the PFICs, the guidelines related to the cost basis present an example of the strict taxes that are applicable to the shares in a PFIC.
A person inheriting the shares from a PFIC is allowed by the IRS to set up a cost basis according to the fair market value at the time of inheritance. This is applicable to any other marketable security and assets virtually.
Although the cost basis can be set up, the boost in the cost basis is not usually allowed in case of shares in a PFIC. It is also considered a very confusing process to declare the acceptable cost basis for shares in a PFIC.
‘Taxation for the PFICs’ — People from the United States who own shares in a PFIC should file an ‘IRS Form 8621’. This is the form that generally reports the actual distributions and profits along with the income earned and the increases in the ‘QEF Elections’.
Form 8621 is very complicated that a person can take up to 40 hours to fill this form. Hence, it is advised to let a tax-related professional fill this form in order to avoid any mistakes or hassles.
There is an exception for the U.S. shareholders (approximately 10% or more) in terms of tax and interests, who have bought the shares of a PFIC before the year 1997. Investors of this kind won’t be charged with any kind of taxes or interests. However, they might be subjected to the ‘CFC (Controlled Foreign Corporation)’ rules.
There is an availability of some options for the investors in PFIC for reducing the tax rate of their respective shares. One of the famously available options is that the individual has to seek a PFIC investment which has been recognized as a ‘QEF (Qualified Electing Fund)’.
This type of process might reduce some taxes but may cause problems related to other taxes for the investors. It is better to take the help of a financial advisor and do some actual research in order to avoid such tax-related problems for the investors.
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