Offshore Voluntary Disclosure Initiative: Passive Foreign Income Company Investment Computations
A significant number of Offshore Voluntary Disclosure Practice (VDP) cases involve Passive Foreign Investment Company (PFIC) investments. A lack of historical information on the cost basis and holding period of many PFIC investments makes it difficult for taxpayers to prepare statutory PFIC computations and for the Service to verify them. As a result, resolution of many VDP cases is being unduly delayed. Therefore, for purposes of this initiative, the Service is offering taxpayers an alternative to the statutory PFIC computation that will resolve PFIC issues on a basis that is consistent with the Mark to Market (MTM) methodology authorized in Internal Revenue Code section 1296 but will not require complete reconstruction of historical data.
The terms of this alternative resolution are as follows:
- If elected, the alternative resolution will apply to all PFIC investments in cases that have been accepted into the VDP and that qualify for the special civil penalty framework announced by the IRS on March 23, 2009. The initial MTM computation of gain or loss under this methodology will be for the first year of the VDP application but could be made after 2003 depending on when the first PFIC investment was made. Generally, under the terms of the March 23, 2009 framework, the first year of the VDP application will be for the calendar year ending December 31, 2003. This will require a determination of the basis for every PFIC investment, which should be agreed between the taxpayer and the Service based on the best available evidence.
- A tax rate of 20% will be applied to the MTM gain(s), MTM net gain(s) and gains from all PFIC dispositions during the VDP period, in lieu of the rate contained in section 1291(a)(1)(B) for the amount allocable to the current year and section 1291(c)(2) for the deferred tax amount(s) allocable to any other taxable year.
- A rate of 7% of the tax computed for PFIC investments marked to market in the first year of the VDP application will be added to the tax for that year, in lieu of the interest charge mechanism described in sections 1291(c) and 1296(j).
- MTM losses will be limited to unreversed inclusions (generally, previously reported MTM gains less allowed MTM losses) on an investment-by-investment basis in the same manner as section 1296. During the VDP period, these MTM losses will be treated as ordinary losses (IRC 1296[c][B]) and the tax benefit is limited to the tax rate applicable to the MTM gains derived during the VDP period (20%). This limitation is accomplished by multiplying the MTM loss by 20% and applying the result as a credit against the tax liability for the year.
- Regular and Alternative Minimum Tax are both to be computed without the PFIC dispositions or MTM gains and losses. The tax from the PFIC transactions (20% plus the 7% for 2003, if applicable) is added to (or subtracted from) the applicable total tax (either regular or AMT, whichever is higher). The tax and interest (i.e., the 7% for the first year of the VDP) computed under the VDP alternative MTM can be added to the applicable total tax (either regular or AMT, whichever is higher) and placed on the amended return in the margin, with a supporting schedule.
- Underpayment interest and penalties on the deficiency are computed in accordance with the Internal Revenue Code and the terms of the VDP.
- For any PFIC investment retained beyond 12/31/2008, the taxpayer must continue using the MTM method, but will apply the normal statutory rules of section 1296 as well as the provisions of sections 1291-1298, as applicable.
Taxpayers should direct questions regarding PFICs and how the alternative resolution will affect their cases to the examiners assigned to their cases. Before electing the alternative PFIC resolution, taxpayers with PFIC investments should consult their tax advisors to ensure that the issue is material in their cases and that the alternative is in fact preferable to the statutory computation in their situation. If the taxpayer does not elect to use the alternative PFIC computation, then the PFIC provisions of section 1291-1298 apply.