This is a question we get frequently through email:
I have a pension fund. Is that a PFIC?
Unfortunately, there is no easy answer to this question, because every country has a different pension system, and they can be classified wildly differently depending on how the country’s pension works.
For this post, I will pick on the retail Australian super fund again, because I happen to see a lot of them. This post merely illustrates one process I use to determine if there is a PFIC problem.
It is a retirement savings schemes. A super fund can contain up to 3 components:
It is organized as a trust in Australia. The account balance is locked in until the owner is old enough, though there are some early distribution rules such as for extreme hardship.
I will assume that we are talking about a retail fund, meaning a super fund that an established financial institution offers to many clients. This post does not discuss self-managed super fund.
Passive foreign investment company (PFIC) is a specific classification under US tax law. When a US person owns shares in a PFIC, the US person is subject to extremely punitive tax and reporting rules.
An important element of a PFIC is that it must be a foreign corporation. IRC §1297(a). If you have a foreign arrangement that is something other than a corporation, then you do not have a PFIC, regardless of whether you are receiving the benefits of passive foreign investments or not.
I wrote about this in some detail here, but the basic idea is this.
US tax law has its own classification system that relates to how an entity is classified under local law, but the result is not necessarily the same as under local law. Reg. §301.7701-1(a).
Some trusts are business trusts organized for the purpose of conducting a business; some trusts are investment trusts where the trustee has the power to change the investments; these trusts are business entities rather than trusts. Reg. §301.7701-4(b), (c).
A foreign business entity that provides limited liability for all members is by default a corporation. Reg. §301.7701-3(b)(2)(i)(B).
Based on these rules, foreign investment vehicles such as unit trusts and mutual fund trusts are often (though not always) foreign corporations for US tax purposes.
Now let us look at the retail super fund and see whether it is a foreign corporation.
A business trust is organized for the purpose of conducting a profit-making business. Reg. §301.7701-4(b). This refers to activities such as retail, providing services, manufacturing, and the like. This is in contrast to making investments. Reg. §301.7701-4(c).
A retail super fund usually makes passive investments, so it is not a business trust.
The regulations do not define what an investment trust means, but they appear to refer to a trust organized for holding investments. Commissioner vs North American Bond Trust, 122 F.2d 545 (2nd Cir. 1941). A super fund certainly holds investments.
A retail super fund is organized for the purpose of providing for retirement. It does so by making investments to grow the super fund. But a normal trust also makes investments so it can grow its assets for the beneficiaries. In fact, the trustee is normally required to make prudent investments with the trust funds. Restat. 3d Trusts, §§90-92. So the mere fact that a trust makes investments does not mean it is an investment trust.
We should contrast an investment trust with the definition of an ordinary trust, which is “an arrangement created either by a will or by an inter-vivos declaration whereby trustees take title to property for the purpose of protecting or conserving it for the beneficiaries…” Reg. §301.7701-4(a).
If the employee selects a conservative (and possibly balanced) investment plan for the retail fund, then we can be fairly certain that the purpose of the trust is to protect or conserve trust assets for retirement. Thus, the super fund is an ordinary trust rather than an investment trust.
If the employee selects an aggressive investment plan, then the result is not quite so clear. But here is my thought: Australia has a comprehensive set of rules about what a super fund can do. They are similar to US retirement fund rules and trust rules. They are (supposedly) intended to protect the retiree’s retirement funds. If a trust can take an action under these rules, then they should fit under the purpose of protecting or conserving property for retirement. Thus, I would still classify the super fund as an ordinary trust rather than an investment trust.
A corporation is a type of business entity. A business entity is not a trust. Reg. §301.7701-2(a). The super fund is probably a trust, so it cannot be a business entity. Thus, the super fund is not a PFIC.
A very common practice for these retirement fund is to buy only shares of “pension provider conservative fund”, “pension provider balanced fund”, or “pension provider growth fund”, depending on the employee’s selected investment strategy.
These funds represent separate investment funds that the pension provider organized. They are separate from the retirement fund itself. These very likely are PFICs. So it is quite possible that even though the retirement fund itself is not a PFIC, its assets consist of nothing except shares in a PFIC.
And these PFICs often invest in exchange traded funds, so they own PFICs.
This post looked at a retail Australian superannuation fund, because I happen to see them fairly often. It might not be suitable for self-managed super funds. It should not be generalized to all foreign pensions, because each country has a different pension system. Other pensions might be PFICs, investment accounts, saving accounts, or annuities, depending on how they are operated and what rules apply to them, and they might not hold PFICs.