980 / Are there any situations where a foreign entity that would gain PFIC status can avoid this PFIC treatment based on its ownership of passive assets?

Corporations are most likely to hold passive assets (1) in a start-up year when investors may have recently invested significant amounts of cash or (2) in a year when the corporation sells an active trade or business and holds the proceeds while it looks for new business opportunities.

Two safe harbor rules allow a corporation to escape PFIC status under these circumstances. In its first year of operation, a corporation is not treated as a PFIC it can demonstrate to the IRS that it will not be a PFIC in the two years following its initial year of operations.¹ Further, a corporation that ceases an active business and then resumes another active business will not be treated as a PFIC during the interim period, so long as it was not a PFIC in any prior year and it demonstrates that it will not be a PFIC in the following two years. These safe harbors apply only if the corporation does not actually attain PFIC status in the relevant two-year period.

An exception also exists if a foreign corporation is in transition from one active business to another active business. This change-of-business exception applies for the foreign corporation’s tax year if:

(i)      neither the foreign corporation nor a predecessor of the foreign corporation was a PFIC in a prior tax year;

(ii)     the foreign corporation can demonstrate that (A) substantially all of the passive income of the foreign corporation for the tax year is attributable to proceeds from the disposition of one or more active trades or businesses, and (B) the foreign corporation will not be a PFIC in either of the following two tax years following; and

(iii)    the foreign corporation is not, in fact, a PFIC for either of the following two tax years.²

In other words, a foreign corporation may qualify for the change-of-business exception even if it does not engage in an active business after a disposition.

If, however, the activity attribution rules would cause the activities of another entity to be taken into account, those activities are considered for purposes of determining whether the change-of-business exception is available.³ Also, income attributable to proceeds from the disposition of an active trade or business means income earned on investment of the proceeds, but excludes the actual proceeds themselves.⁴ The change-of-business exception may apply in either a tax year when the active trade or business is disposed of, or the year that immediately follows, but can apply in only one year in the case of a disposition.⁵ In other words, a foreign corporation that receives proceeds from a disposition in more than one year may only apply the change-of-business exception in a single year. If the exception could apply in multiple years, the foreign corporation can choose which year it applies.

Post-2017 Insurance Exception

For tax years beginning after December 31, 2017, the 2017 tax reform legislation created a new insurance exception. Under the PFIC insurance exception, a foreign corporation’s income attributable to an insurance business will not be considered passive income unless the corporation’s insurance liabilities equal more than 25 percent of the corporation’s total assets.⁶ Asset value, for this purpose, means asset value as reported on an applicable financial statement ending with or within the taxable year.⁷