Hi from Debra Rudd.

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Taxation of distributions from PFICs in multi-tiered structures

For this week’s newsletter I will discuss the following scenario:

You, a US citizen, and your friend, a non-US person, form a foreign corporation in 2005. You each own 50% of it. Let’s call your corporation Investment Corp.

In 2005, Investment Corp forms a 100% owned subsidiary called Holding Corp. Holding Corp in turn purchases 100% of the shares of an active business called Manufacturing Corp.

Holding Corp sells Manufacturing Corp in 2013. Two years after the sale, Holding Corp distributes the proceeds from the sale to Investment Corp. Investment Corp then uses the money to make other investments.

You never received a distribution from Investment Corp, but you would like to know if any of these events create a US tax liability for you.

The answer is “yes”. Even though you did not receive any money from any of these transactions, there will be tax to pay. And it will be a somewhat painful tax. Let’s take a look at why.

Multi-tiered structure analysis in general — the blueprint

The way we tend to approach these types of situations is by asking the following questions:

  1. Did you actually receive any money from any foreign corporation you own directly? If you did, it could be a taxable distribution.
  1. Is the foreign corporation you own directly a “controlled foreign corporation”? If so, there may be tax that arises from that company’s earnings even if nothing is distributed to you. This happens when the company has a type of income called “Subpart F” income.
  1. Is the top level corporation (Investment Corp) a PFIC by virtue of the IRC §1297(c) look through rules? If so, you will be subject to the PFIC rules for that entity.
  1. Do you own enough of the top level corporation that the PFIC attribution rules under IRC §1298(a) would apply to you? If you do, and if any of the underlying companies are PFICs, there may be tax that arises from any distributions made from an indirectly held company to its parent, or from the sale of an indirectly held company by its parent, even if you never receive a dollar of the distribution or proceeds.

Multi-tiered structure analysis for this particular scenario

Let’s look at the questions one by one as they apply to our fact pattern:

1. No money was received, so no tax

Investment Corp did not distribute anything to its shareholders – no dividends, no return of capital. Therefore, no tax liability will arise as a result of a distribution from Investment Corp.

2. Investment Corp is not a controlled foreign corporation

A controlled foreign corporation is a foreign corporation where more than 50% of its value or voting power is owned by “US shareholders”. IRC §957(a). A “US shareholder” is defined under IRC §951(b) to be a United States person who owns 10% or more of the voting power of a foreign corporation.

You are a US shareholder of Investment Corp, because you are a United States person, and you own 10% or more of its voting power – you own 50% of its voting stock.

Investment Corp is not a controlled foreign corporation, however, because you are its only US shareholder, and you only own 50% its stock. You would need to ownmore than 50% for Investment Corp to be a controlled foreign corporation.

Because Investment Corp is not a controlled foreign corporation, you do not need to be concerned with Subpart F income. By definition Subpart F income only occurs when there is a controlled foreign corporation.

3. Investment Corp is not a PFIC

Investment Corp owns nothing but 100% of Holding Corp, and Holding Corp owns nothing but 100% of Manufacturing Corp. I will assume that Manufacturing Corp is not a PFIC by virtue of the income test or asset test of IRC §1297(a).

IRC §1297(c) states:

If a foreign corporation owns (directly or indirectly) at least 25 percent (by value) of the stock of another corporation, for purposes of determining whether such foreign corporation is a passive foreign investment company, such foreign corporation shall be treated as if it—

(1) held its proportionate share of the assets of such other corporation, and

(2) received directly its proportionate share of the income of such other corporation.

Because of this look through rule, Holding Corp is attributed all the assets and income of Manufacturing Corp (and it has no other assets or income of its own). Investment Corp is in turn attributed all the assets and income of Holding Corp (and it has no other assets or income of its own).

Manufacturing Corp is not a PFIC, so Holding Corp is not a PFIC. Holding Corp is not a PFIC, so Investment Corp is not a PFIC.

4. Tax liability arises from the PFIC attribution rule

We have already established that Investment Corp, Holding Corp, and Manufacturing Corp are not PFICs. But what happens when Holding Corp sells Manufacturing Corp in 2013? Because its only asset at that point is cash, and because cash is a passive asset for purposes of the asset test, Holding Corp will surely satisfy the asset test under IRC §1297(a) and become a PFIC.

As the owner of Investment Corp, you may think you do not need to worry about that. After all, you do not own the PFIC stock directly. You own the stock of a company (Investment Corp) that owns the stock of a PFIC (Holding Corp).

The PFIC attribution rule of IRC §1298(a)(2) says that you are treated as owning directly the stock of any PFIC that you hold indirectly through another corporation, if you own 50% or more of the stock of that other corporation.

You own 50% of the stock of Investment Corp, so IRC §1298(b)(2) applies to you and you are treated as owning directly the stock of its subsidiaries.

Holding Corp becomes a PFIC after the sale of Manufacturing Corp. When it finally distributes the proceeds of the sale to Investment Corp two years later, that distribution is taxable to you under the PFIC rules as if you had owned the stock directly and received the distribution yourself because of the IRC §1298 attribution rule. This is true even though Investment Corp never distributed any money to you and used the funds to invest in other businesses.

Assuming no elections were ever made for Holding Corp, the cash distribution from Holding Corp to Investment Corp will be taxed under the excess distribution rules of IRC §1291, the default tax treatment for PFICs.

The excess distribution rules require an allocation of the distribution over the entire holding period, an application of maximum tax rates and an interest charge to the prior years’ allocated distributions, and an application of ordinary tax rates for the current year’s allocated distribution.

Because you have to go back to 2005 for the beginning of the holding period, the total PFIC tax you pay will be quite high once you factor in the interest charges.

Change of business exception does not apply

Those of you who are very, very familiar with the PFIC rules may be wondering at this point about the “change of business” exception: Under IRC §1298(b)(3), a corporation that becomes a PFIC because it sold an active business and now has a lot of cash and little else will not be treated as a PFIC.

That rule only applies if the corporation is not a PFIC for either of the two years after the year for which the change in business exception is being claimed. IRC §1298(b)(3)(C). I chose to write the fact pattern for our discussion such that the cash is held within Holding Corp for two years so that Holding Corp does not benefit from the change of business exception and is a PFIC. I did this to illustrate some of the issues that I frequently see in these types of structures.

How to restructure your foreign holding structure

In many cases, this type of holding structure is necessary for business purposes. So how would the US investor avoid the PFIC problem without having to immediately distribute profits from Holding Corp?

Regulation section 301.7701-3 allows a foreign corporation that is not a “per se” corporation listed under section 301.7701-2(b)(8) to elect tax treatment between a flow through entity and a corporation. By making the flow through election, Holding Corp becomes a disregarded entity under US tax law, because its sole owner is Investment Corp. Only entities taxed as corporations can be PFICs. Holding Corp, if it makes the disregarded entity election, can hold onto its cash for as long as it wishes to without becoming a PFIC.

There will be US filing requirements for the disregarded entity (think Form 8858), but there will be no PFIC tax to pay.


The PFIC look through and attribution rules of IRC §§1297(c) and 1298(a) can create situations where, in multi-tiered structures, the ultimate human owners of those structures may be paying tax on transactions that happen several layers down in the holding structure.

The human owner never receives any money from these transactions, as long as the top level corporation is not sold and does not make any distributions to the owner, but has a tax liability to pay nonetheless. Under the excess distribution rules, it could be quite a hefty tax.

If you have this kind of structure, or if you are planning to set one up, you will need to plan carefully to avoid getting caught in these traps.


Thanks for reading. This stuff is really, really complicated, so you should seek some competent professional advice if you’re facing these types of questions — this newsletter is not advice to you. I am, however, happy to talk about PFICs with you if you’d like. Just hit “reply” to this message.