4582 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[REG–111950–20] 

RIN 1545–BP91 

Guidance on Passive Foreign 

Investment Companies and the 

Treatment of Qualified Improvement 

Property Under the Alternative 

Depreciation System for Purposes of 

Sections 250(b) and 951A(d) 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Withdrawal of notice of 

proposed rulemaking; notice of 

proposed rulemaking. 

SUMMARY: This document contains 

proposed regulations regarding the 

determination of whether a foreign 

corporation is treated as a passive 

foreign investment company (‘‘PFIC’’) 

for purposes of the Internal Revenue 

Code (‘‘Code’’). The proposed 

regulations also provide guidance 

regarding the treatment of income and 

assets of a qualifying insurance 

corporation (‘‘QIC’’) that is engaged in 

the active conduct of an insurance 

business (‘‘PFIC insurance exception’’). 

This document also contains proposed 

regulations addressing the treatment of 

qualified improvement property (‘‘QIP’’) 

under the alternative depreciation 

system (‘‘ADS’’) for purposes of 

calculating qualified business asset 

investment (‘‘QBAI’’) for purposes of the 

global intangible low-taxed income 

(‘‘GILTI’’) and the foreign-derived 

intangible income (‘‘FDII’’) provisions, 

which were added to the Code in the 

Tax Cuts and Jobs Act. The proposed 

regulations affect United States persons 

with direct or indirect ownership 

interests in certain foreign corporations, 

United States shareholders of controlled 

foreign corporations, and domestic 

corporations eligible for the deduction 

for FDII. 

DATES: Written or electronic comments 

and requests for a public hearing must 

be received by April 14, 2021. Requests 

for a public hearing must be submitted 

as prescribed in the ‘‘Comments and 

Requests for a Public Hearing’’ section. 

ADDRESSES: Commenters are strongly 

encouraged to submit public comments 

electronically. Submit electronic 

submissions via the Federal 

eRulemaking Portal at 

www.regulations.gov (indicate IRS and 

REG–111950–20) by following the 

online instructions for submitting 

comments. Once submitted to the 

Federal eRulemaking Portal, comments 

cannot be edited or withdrawn. The IRS 

expects to have limited personnel 

available to process public comments 

that are submitted on paper through 

mail. Until further notice, any 

comments submitted on paper will be 

considered to the extent practicable. 

The Department of the Treasury 

(Treasury Department) and the IRS will 

publish for public availability any 

comment submitted electronically, and 

to the extent practicable on paper, to its 

public docket. 

Send paper submissions to: 

CC:PA:LPD:PR (REG–111950–20), Room 

5203, Internal Revenue Service, P.O. 

Box 7604, Ben Franklin Station, 

Washington, DC 20044. 

FOR FURTHER INFORMATION CONTACT: 

Concerning proposed regulations 

§§ 1.250(b)–1(b)(2) and 1.250(b)–2(e)(2), 

Lorraine Rodriguez, (202) 317–6726; 

concerning proposed regulations 

§ 1.951A–3(e)(2), Jorge M. Oben and 

Larry R. Pounders, (202) 317–6934; 

concerning proposed regulations 

§§ 1.1297–0 through 1.1297–2, 1.1298–0 

and 1.1298–4, Christina G. Daniels at 

(202) 317–6934; concerning proposed 

regulations §§ 1.1297–4 through 1.1297– 

6 (the PFIC insurance exception), 

Josephine Firehock at (202) 317–4932; 

concerning submissions of comments 

and requests for a public hearing, 

Regina L. Johnson at (202) 317–6901 

(not toll-free numbers) or by sending an 

email to publichearings@irs.gov 

(preferred). 

SUPPLEMENTARY INFORMATION: 

Background 

I. Passive Foreign Investment 

Companies 

A. In General 

This document contains proposed 

amendments to 26 CFR part 1 under 

sections 1297 and 1298. Under section 

1297(a), a foreign corporation (‘‘tested 

foreign corporation’’) qualifies as a PFIC 

if it satisfies either of the following tests: 

(i) 75 percent or more of the tested 

foreign corporation’s gross income for a 

taxable year is passive (‘‘Income Test’’); 

or (ii) the average percentage of assets 

held by the tested foreign corporation 

during a taxable year that produce (or 

that are held for the production of) 

passive income is at least 50 percent 

(‘‘Asset Test’’). Section 1297(b)(1) 

generally defines passive income as any 

income of a kind that would constitute 

foreign personal holding company 

income (‘‘FPHCI’’) under section 954(c), 

and section 1297(b)(2) provides 

exceptions to this general definition. In 

addition, section 1297(c) provides a 

look-through rule that applies when 

determining the PFIC status of a tested 

foreign corporation that directly or 

indirectly owns at least 25 percent of 

the stock (determined by value) of 

another corporation. Section 1298(b)(7) 

provides that certain stock (‘‘qualified 

stock’’) in a domestic C corporation 

owned by a tested foreign corporation 

through a 25-percent-owned domestic 

corporation is treated as an asset 

generating non-passive income for 

purposes of section 1297(a), provided 

that the tested foreign corporation is 

subject to the accumulated earnings tax 

or waives any treaty protections against 

the imposition of the accumulated 

earnings tax. 

B. PFIC Insurance Exception 

Before its amendment by section 

14501 of the Tax Cuts and Jobs Act, 

Public Law 115–97, 131 Stat. 2234 

(2017) (the ‘‘Act’’), former section 

1297(b)(2)(B) provided that passive 

income generally did not include 

investment income derived in the active 

conduct of an insurance business by a 

corporation that is predominantly 

engaged in an insurance business and 

that would be subject to tax under 

subchapter L if it were a domestic 

corporation. Congress was concerned 

about a lack of clarity and precision in 

the PFIC insurance exception, and in 

particular about the lack of precision 

regarding how much insurance or 

reinsurance business a company must 

do to qualify under the exception, 

which made the exception difficult to 

enforce. H.R. Report 115–409 at 409–10. 

To address these concerns, the Act 

modified the PFIC insurance exception 

to provide that passive income does not 

include investment income derived in 

the active conduct of an insurance 

business by a QIC. 

Thus, for taxable years beginning after 

December 31, 2017, the PFIC insurance 

exception provides that a foreign 

corporation’s income attributable to an 

insurance business will not be passive 

income if three requirements are met. 

First, the foreign corporation must be a 

QIC as defined in section 1297(f). 

Second, the foreign corporation must be 

engaged in an ‘‘insurance business.’’ 

Third, the income must be derived from 

the ‘‘active conduct’’ of that insurance 

business. 

C. Prior Proposed Regulations 

On April 24, 2015, the Federal 

Register published a notice of proposed 

rulemaking (REG–108214–15) at 80 FR 

22954 (the ‘‘2015 proposed 

regulations’’) under former sections 

1297(b)(2)(B) and 1298(g). The 2015 

proposed regulations addressed the 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4583 

1As enacted, section 951A(d) contains two 

paragraphs designated as paragraph (3). The section 

951A(d)(3) discussed in this preamble relates to the 

determination of the adjusted basis in property for 

purposes of calculating QBAI. 

2Although the applicable convention for 

nonresidential real property under section 

168(d)(2)(A) is the mid-month convention, 

§ 1.951A–3(e)(1) provides that for the purpose of 

determining QBAI, the period in the CFC inclusion 

year to which such depreciation relates is 

determined without regard to the applicable 

convention under section 168(d). 

3Section 168(g)(2)(C)(ii) and (iii) refer to personal 

property with no class life and residential rental 

property, respectively. 

4The phrase ‘‘made by a taxpayer’’ was added by 

section 2307(a)(2) of Public Law 116–136, discussed 

below. 

PFIC insurance exception and provided 

guidance regarding the extent to which 

a foreign corporation’s investment 

income and the assets producing that 

income are excluded from passive 

income and passive assets for purposes 

of the passive income and passive asset 

tests in section 1297(a). Comments were 

received on the previously proposed 

regulations. A public hearing was 

requested and was held on September 

18, 2015. 

On July 11, 2019, the Federal Register 

published a notice of proposed 

rulemaking (REG–105474–18) at 84 FR 

33120 (the ‘‘2019 proposed 

regulations’’) under sections 1291, 1297, 

and 1298. The 2019 proposed 

regulations provided guidance with 

respect to the application of the Income 

Test and the Asset Test under section 

1297(a), the look-through rule under 

section 1297(c), and indirect ownership 

rules under section 1291. The 2019 

proposed regulations also addressed the 

PFIC insurance exception under section 

1297(b)(2)(B), including the definition 

of a QIC under section 1297(f) and the 

requirements for a foreign corporation to 

be engaged in the active conduct of an 

insurance business. 

A public hearing on the 2019 

proposed regulations was scheduled for 

December 9, 2019, but it was not held 

because there were no requests to speak. 

The Treasury Department and the IRS 

received written comments with respect 

to the 2019 proposed regulations. 

Concurrently with the publication of 

these proposed regulations, the Treasury 

Department and the IRS are publishing 

in the Rules and Regulations section of 

this edition of the Federal Register (RIN 

1545–BO59) final regulations under 

sections 1291, 1297, and 1298 (the 

‘‘final regulations’’). In response to 

certain comments, the Treasury 

Department and the IRS are publishing 

this notice of proposed rulemaking to 

provide additional proposed regulations 

under sections 1297 and 1298. 

II. QBAI Rules for GILTI and FDII 

A. GILTI and FDII—In General 

Section 951A(a) requires a United 

States shareholder (as defined in section 

951(b)) (‘‘U.S. shareholder’’) of any 

controlled foreign corporation (as 

defined in section 957) (‘‘CFC’’) for any 

taxable year to include in gross income 

the U.S. shareholder’s GILTI for such 

taxable year (‘‘GILTI inclusion 

amount’’). The U.S. shareholder’s GILTI 

inclusion amount is calculated based on 

its pro rata share of certain items—such 

as tested income, tested loss, and 

QBAI—of each CFC owned by the U.S. 

shareholder. See § 1.951A–1(c). Section 

951A(d)(3) 1 requires a taxpayer to 

calculate QBAI by determining the 

adjusted basis of property using the 

ADS under section 168(g) 

‘‘notwithstanding any provision of this 

title (or any other provision of law) 

which is enacted after the date of the 

enactment of [section 951A].’’ Section 

1.951A–3(e)(2) states that ‘‘[t]he 

adjusted basis in specified tangible 

property is determined without regard 

to any provision of law enacted after 

December 22, 2017, unless such later 

enacted law specifically and directly 

amends the definition of qualified 

business asset investment under section 

951A.’’ The GILTI provisions in section 

951A apply to taxable years of foreign 

corporations beginning after December 

31, 2017, and to taxable years of U.S. 

shareholders in which or with which 

such taxable years of foreign 

corporations end. See section 14201(d) 

of the Act. 

The definition of QBAI in section 

951A(d) also applies for purposes of 

determining deemed tangible income 

return under section 250. See section 

250(b)(2)(B) and § 1.250(b)–2(b). Section 

250 generally allows a domestic 

corporation a deduction equal to 37.5 

percent (21.875 percent for taxable years 

after 2025) of its FDII (as defined in 

section 250(b)(1) and § 1.250(b)–1(b)). 

For purposes of FDII, QBAI is used to 

determine the deemed tangible income 

return of a corporation, which in turn 

reduces the amount of FDII of a 

corporation. See section 250(b)(1) and 

(2). Section 250(b)(2)(B) and § 1.250(b)– 

2 incorporate the definition of QBAI in 

section 951A(d)(3), with some 

modifications. Similar to the GILTI rule 

provided in § 1.951A–3(e)(2), 

§ 1.250(b)–2(e)(2) provides that ‘‘[t]he 

adjusted basis in specified tangible 

property is determined without regard 

to any provision of law enacted after 

December 22, 2017, unless such later 

enacted law specifically and directly 

amends the definition of QBAI under 

section 250 or section 951A.’’ The FDII 

provisions in section 250 apply to 

taxable years beginning after December 

31, 2017. See section 14202(a) of the 

Act. 

B. ADS Depreciation 

ADS depreciation under section 

168(g) is determined by using the 

straight-line method (without regard to 

salvage value), the applicable 

convention determined under section 

168(d), and the applicable recovery 

period as determined under section 

168(g)(2)(C).2 On December 22, 2017, 

the date the Act was enacted, section 

168(g)(2)(C)(iv) provided that the 

recovery period for purposes of ADS 

depreciation for nonresidential real 

property under section 168(e)(2)(B) was 

40 years. Nonresidential real property is 

defined under section 168(e)(2)(B) as 

section 1250 property (that is, real 

property not described in section 1245) 

that is not residential rental property or 

property with a class life of less than 

27.5 years. 

Section 168(g)(2)(C)(i) provided that 

the recovery period for property not 

described in section 168(g)(2)(C)(ii) or 

(iii) 3 is the property’s class life. Class 

life is generally determined under 

section 168 or Rev. Proc. 87–56; 1987– 

42 I.R.B. 4; however, section 168(g)(3) 

specifies class lives for certain types of 

property for ADS purposes. 

C. Qualified Improvement Property 

1. The Act 

Effective for property placed in 

service after December 31, 2017, section 

13204 of the Act amended section 

168(e) by removing references to 

qualified leasehold improvement 

property, qualified restaurant 

improvement property, and qualified 

retail improvement property, and 

instead referring only to QIP. Under 

section 168(e)(6), QIP includes certain 

improvements made by a taxpayer 4 to 

the interior of a nonresidential building 

that are placed in service after the 

building was first placed in service. The 

conference report under the Act states 

that Congress intended QIP to be 

classified as 15-year property under the 

general depreciation system and be 

assigned a 20-year ADS recovery period. 

See Conference Report to Accompany 

H.R. 1 at 366–367. 

2. The CARES Act 

The Coronavirus Aid, Relief, and 

Economic Security Act, Public Law 

116–136 (the ‘‘CARES Act’’) was 

enacted on March 27, 2020. According 

to the Description of the Tax Provisions 

of Public Law 116–136, the Coronavirus 

Aid, Relief, and Economic Security 

4584 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

5Rev. Proc. 2020–25, 2020–19 I.R.B. 785, 

generally allows a taxpayer to change its 

depreciation method under section 168 for QIP 

placed in service by the taxpayer after December 31, 

2017, by amending the applicable tax returns or 

requesting an accounting method change. The 

determination of a taxpayer’s adjusted basis for 

purposes of determining QBAI is not addressed in 

the revenue procedure and is not treated as a 

method of accounting. T.D. 9866, 84 FR 29288, 

29304 (2019). 

(‘‘CARES’’) Act, prepared by the Staff of 

the Joint Committee on Taxation, when 

Congress added the definition of QIP in 

section 168(e)(6) of the Code, it 

intended for QIP to be classified as 15- 

year property under section 168(e)(3)(E) 

of the Code, with a 15-year recovery 

period under the general depreciation 

system in section 168(a) of the Code and 

a 20-year ADS recovery period but 

inadvertently omitted from the statute 

such language. See Joint Committee on 

Taxation, Description of the Tax 

Provisions of Public Law 116–136, The 

Coronavirus, Relief, and Economic 

Security (‘‘CARES’’) Act (JCX–12R–20) 

at 69–70 (Apr. 23, 2020) (‘‘JCT CARES 

Act Report’’). Section 2307(a)(2) of the 

CARES Act amended section 168(e) by 

adding clause (vii) to paragraph (E)(3), 

providing that QIP is classified as 15- 

year property, and amending the table 

in section 168(g)(3)(B) to provide a 

recovery period of 20 years for QIP for 

purposes of the ADS (the ‘‘technical 

amendment’’). The technical 

amendment is effective as if it had been 

included in the Act.5

D. Notice 2020–69 

Notice 2020–69, 2020–30 I.R.B. 604, 

announced that the Treasury 

Department and the IRS intend to issue 

regulations addressing the treatment of 

QIP under the ADS depreciation 

provisions in section 168(g) for 

purposes of calculating QBAI under the 

FDII and GILTI provisions. The notice 

provided that the Treasury Department 

and the IRS expect the regulations 

under sections 250 and 951A to clarify 

that the technical amendment to section 

168 enacted in section 2307(a) of the 

CARES Act applies to determine the 

adjusted basis of property under section 

951A(d)(3) as if it had originally been 

part of section 13204 of the Act. 

Explanation of Provisions 

The proposed regulations provide 

guidance on the valuation of assets and 

on the treatment of working capital for 

purposes of the Asset Test. They modify 

the treatment of dividends paid out of 

earnings and profits not previously 

taken into account, such as dividends 

paid out of pre-acquisition earnings, and 

provide safe harbors for application of 

the principal purpose anti-abuse test 

that may prohibit the use of the 

qualified stock rules of section 

1298(b)(7). The proposed regulations 

also provide guidance regarding 

whether the income of a foreign 

corporation is excluded from passive 

income pursuant to section 

1297(b)(2)(B) because the income is 

derived in the active conduct of an 

insurance business by a QIC. 

Part I.A of this Explanation of 

Provisions describes rules for income 

derived in the active conduct of a 

banking business, asset valuation, and 

working capital in proposed § 1.1297–1; 

the special dividend rules in proposed 

§ 1.1297–2; and the proposed safe 

harbors for the qualified stock principal 

purpose anti-abuse test in proposed 

§ 1.1298–4(e). Part I.B of this 

Explanation of Provisions describes the 

rules in proposed § 1.1297–4 for 

determining whether a foreign 

corporation is a QIC. Part I.C of this 

Explanation of Provisions describes the 

rules in proposed § 1.1297–5 for 

determining whether a foreign 

corporation is engaged in the active 

conduct of an insurance business. Part 

I.D of this Explanation of Provisions 

describes the rules in proposed 

§ 1.1297–6 regarding the treatment of 

income and assets of a qualifying 

domestic insurance company. 

The proposed regulations also provide 

guidance on the treatment of QIP under 

the ADS for purposes of calculating 

QBAI under the GILTI and FDII 

provisions. See Part II of this 

Explanation of Provisions. 

I. Passive Foreign Investment 

Companies 

A. General PFIC Rules 

1. Income Derived in the Active 

Conduct of a Banking Business 

a. Active Banking Business Exception 

Section 1297(b)(1) generally defines 

the term passive income to mean any 

income which is of a kind which would 

be FPHCI as defined in section 954(c). 

Section 1297(b)(2) provides exceptions 

to this general definition. Section 

1297(b)(2)(A) provides that passive 

income does not include any income 

derived in the active conduct of a 

banking business by an institution 

licensed to do business as a bank in the 

United States (or, to the extent provided 

in regulations, by any other corporation) 

(the ‘‘section 1297(b)(2)(A) banking 

exception’’), and section 1297(b)(2)(B) 

provides a similar exception for income 

derived in the active conduct of an 

insurance business. The Treasury 

Department and the IRS have 

determined that in light of this statutory 

framework, qualifying banking income 

should be treated as non-passive under 

the section 1297(b)(2)(A) banking 

exception (and qualifying insurance 

income should be treated as non-passive 

under the similar rule in section 

1297(b)(2)(B)) and not under the general 

rule of section 1297(b)(1). Otherwise, an 

exception for active banking and 

insurance income of a tested foreign 

corporation would apply indirectly 

under section 1297(b)(1) and also 

directly under sections 1297(b)(2)(A) 

and (B), which would be duplicative 

and would effectively narrow the scope 

of the statutory exceptions in section 

1297(b)(2). Accordingly, the Treasury 

Department and the IRS have 

determined that section 954(h)(1), 

which provides that for purposes of 

section 954(c)(1) FPHCI does not 

include qualified banking or financing 

income of an eligible controlled foreign 

corporation, does not apply for purposes 

of section 1297(b)(1). See Part III.B.1 of 

the preamble to the final regulations. 

Notice 88–22, 1988–1 C.B. 489, states 

that assets held by foreign corporations 

described in section 1297(b)(2)(A) (then 

section 1296(b)(2)(A)) that are utilized 

to produce income in the active conduct 

of a banking business will be treated as 

non-passive assets. Notice 89–81, 1989– 

2 C.B. 399, provides guidance 

addressing the characterization of 

income derived in a banking business 

by a foreign corporation that is not 

licensed to do business as a bank in the 

United States for purposes of the 

definitional tests of the PFIC provisions, 

and states that the rules contained in 

Notice 89–81 will be incorporated into 

future regulations. In 1995, regulations 

were proposed to implement the section 

1297(b)(2)(A) banking exception. See 

proposed § 1.1296–4, 60 FR 20922, 

April 28, 1995. In light of the fact that 

the 1995 proposed regulations have not 

been finalized, the Treasury Department 

and the IRS are aware that taxpayers 

need guidance on how to properly apply 

section 1297(b)(2)(A). 

Section 1297(b)(2)(A) requires that 

income be derived in the active conduct 

of a banking business, and grants 

authority for regulations to expand the 

scope of entities that are eligible for the 

section 1297(b)(2)(A) exception beyond 

U.S.-licensed banks. The preamble to 

the 1995 proposed regulations states 

that the Treasury Department and the 

IRS believe that Congress intended to 

grant the banking exception only to 

corporations that conform to a 

traditional U.S. banking model. 1995–1 

C.B. 978. The Treasury Department and 

IRS continue to believe that the section 

1297(b)(2)(A) banking exception should 

apply to foreign banks and not to other 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4585 

6See Joint Committee on Taxation, General 

Explanation of the Tax Reform Act of 1986, at 1025 

(JCS–10–87) (May 4, 1987) (‘‘The Act provides 

regulatory authority to expand the exception to 

passive income for income derived by a foreign 

bank licensed to do business in the United States 

to any other foreign corporation engaged in the 

active conduct of a banking business, as well.’’) 

(emphasis added); cf. H.R. Rep. No. 99–841, at II– 

644 (1986) (Conf. Rep.) (providing that ‘‘the 

Secretary has regulatory authority to apply the PFIC 

provisions to any ‘bank’ where necessary to prevent 

U.S. individuals from earning what is essentially 

portfolio investment income in a tax deferred 

entity’’) (emphasis added). 

7See H.R. Conf. Rep. No. 103–213, Omnibus 

Budget Reconciliation Act of 1993, at 641 (Aug. 4, 

1993) (‘‘These rules [the banking exception and the 

securities dealer exception], however, do not apply 

to income derived in the conduct of financing and 

credit services businesses’’). 

8H.R. Rep. No. 817, 105th Cong. 2d Sess. 37 (Oct. 

12, 1988) (‘‘It generally is intended that these 

requirements for the active conduct of a banking or 

securities business be interpreted in the same 

manner provided in the regulations proposed under 

prior law section 1296(b) . . . See Prop. Treas. Reg. 

secs. 1.1296–4 and 1.1296–6. Specifically, it is 

intended that these requirements include the 

requirements for foreign banks under Prop. Treas. 

Reg. sec. 1.1296–4 as currently drafted.’’); see also 

H.R. Rep. No. 220, 105th Cong. 1st Sess. 642 (July 

30, 1997) (similar language); Joint Committee on 

Taxation, General Explanation of Tax Legislation 

Enacted in 1997, at 330 (JCS–23–97) (Dec. 17, 1997) 

(‘‘The Congress generally intended that the income 

of a corporation engaged in the active conduct of 

a banking or securities business that would have 

been eligible for this exception would have been the 

income that is treated as nonpassive under the 

regulations proposed under prior law section 

1296(b). See Prop. Treas. Reg. secs. 1.1296–4 and 

1.1296–6.’’). 

types of financial institutions, based on 

both the statutory framework and the 

history of section 1297(b).6

In the Tax Reform Act of 1986, 

Congress repealed broad FPHCI 

exceptions under section 954, including 

an exception for active banks, while 

simultaneously enacting PFIC rules, 

including current section 1297(b)(2)(A) 

(as subsequently renumbered in 1997). 

Thus, when the PFIC rules were 

enacted, section 1297(b)(2)(A) was the 

exclusive means by which an active 

bank could avail itself of a passive 

income exception to the PFIC rules. 

Since 1986, Congress has repeatedly 

amended section 1297(b) to add, repeal, 

and modify the exceptions therein as 

they apply to financial institutions. For 

example, in 1993 a new paragraph (3) 

was added to section 1297(b) (then 

section 1296(b)) providing that income 

earned in the active conduct of a 

securities business by a CFC was not 

treated as passive for PFIC purposes for 

a United States shareholder (‘‘U.S. 

shareholder’’) as defined in section 

951(b). Public Law 103–66, Omnibus 

Budget Reconciliation Act of 1993, 

section 13231(d)(3). In 1997, that 

paragraph was repealed, in connection 

with the enactment of section 1297(d) 

(then section 1297(e)), which eliminated 

the need for rules relating to CFCs in 

section 1297 with respect to US 

shareholders. Public Law 105–34, 

Taxpayer Relief Act of 1997, section 

1122(d)(4). In 2017, TCJA amended 

section 1297(b)(2)(B), relating to income 

earned in the active conduct of an 

insurance business, and added section 

1297(f). Congress has thus expressly 

addressed when income of a kind 

earned by various active financial 

institutions should be treated as nonpassive. Because section 1297(b)(2)(A) 

applies to income derived in the active 

conduct of a banking business, the 

relevant class of foreign financial 

institutions is foreign banks. 

The Treasury Department and the IRS 

have considered alternatives to the 

analysis set forth above. In particular, 

because the PFIC rules when enacted in 

1986 provided broader exclusions for 

income of active foreign financial 

institutions than the subpart F rules did, 

and because broader exclusions for 

active financial businesses for PFIC 

purposes may be appropriate in light of 

the fact that U.S. investors in a PFIC do 

not control the PFIC, the Treasury 

Department and the IRS have 

considered whether a wholesale 

incorporation of section 954(h) into 

either section 1297(b)(1) or section 

1297(b)(2)(A) would be appropriate as 

an exercise of regulatory discretion. A 

broader approach of that kind could be 

of particular relevance to finance 

companies whose income is eligible for 

the section 954(h) exception. 

The Treasury Department and the IRS 

concluded that such a broader approach 

is not warranted by the statutory 

language or history, as described in Part 

I.A.1.a of this Explanation of Provisions. 

Furthermore, the 1993 legislative 

history to the expansion of section 

1297(b)’s passive income exceptions 

makes clear that the PFIC rules as in 

effect at that time did not apply to 

finance companies, that is, entities that 

did not engage in the deposit-taking 

activities characteristic of banks.7

Consequently, if all of section 954(h) 

were permitted to apply for purposes of 

section 1297(b)(2)(A), finance 

companies, which can qualify for the 

section 954(h) exception, would obtain 

a privileged treatment for PFIC purposes 

that Congress intended to deny in 1993 

and has not expressly approved in the 

interim. 

However, section 954(h) provides 

some useful guideposts that can be 

applied to interpret section 

1297(b)(2)(A) in the absence of final 

regulations, because the two provisions 

have similar and complementary 

purposes. Sections 954(h)(2)(B)(ii) and 

1297(b)(2)(A) construe the same 

statutory phrase: Income ‘‘derived in the 

active conduct of a banking business.’’ 

And they both are limited to banks 

licensed to do business as a bank in the 

United States or any other corporation 

as prescribed by the Secretary. 

Moreover, the legislative history to 

section 954(h) explicitly states that the 

phrase ‘‘active conduct of a banking 

business’’ under section 954(h) is 

intended to have the same meaning as 

under the 1995 proposed regulations 

issued under section 1297(b)(2)(A).8

Finally, section 954(h) is a more recent 

expression of Congressional intent as to 

the conditions under which banking 

income of a foreign entity should be 

treated as non-passive than section 

1297(b)(2)(A). 

Accordingly, in order to provide 

guidance to foreign banks and in light 

of the close connection between section 

1297(b)(2)(A) and section 

954(h)(2)(B)(ii), the Treasury 

Department and the IRS propose to 

apply certain principles of section 

954(h) for purposes of section 

1297(b)(2)(A), under section 

1297(b)(2)(A)’s specific grant of 

regulatory authority. See proposed 

§ 1.1297–1(c)(2). Alternatively, 

taxpayers also may rely upon Notice 89– 

81 or proposed § 1.1296–4 (relating to 

banking income of active banks) to 

determine whether income of a foreign 

entity may be treated as non-passive 

under section 1297(b)(2)(A). 

b. Proposed Exception for Active 

Banking Income of Foreign Banks 

Proposed § 1.1297–1(c)(2) provides 

that income of a tested foreign 

corporation will not be treated as 

passive if the income would be eligible 

for section 954(h) if the tested foreign 

corporation were a CFC, and the income 

is derived in the active conduct of a 

banking business by a foreign bank. The 

term active conduct of a banking 

business has the meaning given to it by 

section 954(h)(2)(B)(ii). See proposed 

§ 1.1297–1(c)(2)(i)(B). The term foreign 

bank is defined in a manner similar to 

the definition of active bank under 

proposed § 1.1296–4, and is intended to 

have the same meaning, except where 

the proposed regulations provide a 

different rule. For example, a foreign 

bank must engage in one or more of the 

list of relevant banking activities 

provided by section 954(h)(4) rather 

than being required to make loans. See 

proposed § 1.1297–1(c)(2)(ii). Some 

clarifying changes have been made to 

the definition to ensure that it applies 

only to entities that are banks as that 

4586 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

9The legislative history of section 954(h) states 

that the active banking test is not intended to apply 

to affiliates that do not independently satisfy the 

test. H.R. Rep. No. 817, 105th Cong. 2d Sess. 37 

(Oct. 12, 1988) (‘‘[I]t is not intended that these 

requirements be considered to be satisfied by a CFC 

merely because it is a qualified bank affiliate . . . 

within the meaning of the proposed regulations 

under former section 1296(b).’’) 

term is ordinarily understood, and not, 

for example, to payment service 

providers or money transmitters. As is 

the case under section 954(h), the 

exception is intended to apply to the 

income of qualified business units of a 

foreign bank. 

As proposed, the exception does not 

apply to affiliates of a foreign bank that 

do not independently qualify for the 

exception, in light of the fact that 

section 954(h) takes affiliates into 

account only for purposes of treating the 

activities of same-country related 

persons that are CFCs as activities that 

are conducted directly by an eligible 

CFC if certain conditions are satisfied. 

See section 954(h)(3)(E). Proposed 

§ 1.1297–1(c)(2)(i)(A) permits such 

related persons to be treated as if they 

were CFCs so that section 954(h)(3)(E) 

may apply for purposes of proposed 

§ 1.1297–1(c)(2). 

A comment on the 2019 proposed 

regulations suggested that the 

attribution of activities of look-through 

subsidiaries to other affiliates that is 

permitted by § 1.1297–2(e) for purposes 

of specified provisions of section 954(c) 

be extended to apply for purposes of 

section 954(h). The comment indicated 

that such treatment would be proper 

because financial businesses generally 

segregate assets and operations that are 

part of an integrated business into 

different entities for non-tax reasons. 

Because section 954(h)(3)(E) operates to 

attribute activities among entities for 

purposes of determining whether 

income constitutes qualified banking 

income, the Treasury Department and 

the IRS have determined that it would 

be inappropriate to adopt additional 

rules for attribution of activities for 

purposes of the incorporation of section 

954(h) into section 1297(b)(2)(A) and 

did not adopt this comment in the final 

regulations. However, as an alternative 

to proposed § 1.1297–1(c)(2), taxpayers 

may rely upon Notice 89–81 or 

proposed § 1.1296–4, which provide 

rules treating banking income of 

qualified bank affiliates as non-passive. 

If a foreign bank is a look-through 

subsidiary of a tested foreign 

corporation, then under section 1297(c) 

and § 1.1297–2(b)(2) the income and 

assets of the foreign bank are treated as 

passive or non-passive at the level of the 

tested foreign corporation to the extent 

they are treated as passive or nonpassive at the level of the foreign bank. 

If that foreign bank itself owns a lookthrough subsidiary, then under section 

1297(c) and § 1.1297–2(b)(2) the income 

and assets of the look-through 

subsidiary are treated as passive or nonpassive at the level of the foreign bank 

to the extent they are treated as passive 

or non-passive at the level of the lookthrough subsidiary. 

Another comment noted that, in the 

case of tested foreign corporations with 

look-through subsidiaries that are 

domestic corporations, section 

954(h)(3)(A)(ii)(I) would result in the 

section 954(h) exception being 

inapplicable to active financing income 

earned by these subsidiaries from 

transactions with local customers, even 

though it would otherwise be of a type 

that would not be passive. The comment 

suggested that section 954(h) should be 

applied in the PFIC context by treating 

income as qualified banking or 

financing income even if the income is 

derived from transactions with 

customers in the United States. 

Section 1298(b)(7) provides an 

exception for income derived from 

certain 25-percent owned domestic 

subsidiaries that treats such income as 

non-passive. The Treasury Department 

and the IRS do not agree that an 

additional rule should be provided to 

treat income of a domestic subsidiary 

that is not eligible for section 1298(b)(7) 

as non-passive, and accordingly these 

proposed regulations do not adopt this 

recommendation.9

The preamble to the 2019 proposed 

regulations requested comments 

addressing the question of whether the 

section 954(h) exception, if adopted as 

proposed in the 2019 proposed 

regulations, should continue to apply if 

final regulations implementing section 

1297(b)(2)(A), for example final 

regulations similar to proposed 

§ 1.1296–4, are adopted. Several 

comments recommended that the 

section 954(h) exception continue to 

apply in the PFIC context under section 

1297(b)(1) in such a case. In light of the 

different approach taken by these 

proposed regulations compared to the 

2019 proposed regulations, the Treasury 

Department and the IRS request 

comments on whether proposed 

§ 1.1297–1(c)(2) provides sufficient 

guidance to foreign banks, such that 

Notice 89–81 and proposed § 1.1296–4 

can be withdrawn, whether alternatively 

proposed § 1.1296–4 should be finalized 

rather than proposed § 1.1297–1(c)(2), 

whether both proposed § 1.1296–4 and 

proposed § 1.1297–1(c)(2) should be 

finalized, or whether a single 

harmonized set of rules should be 

provided. Until Notice 89–81 and 

proposed § 1.1296–4 are withdrawn, 

taxpayers may rely upon them as 

alternatives to proposed § 1.1297– 

1(c)(2). 

The Treasury Department and the IRS 

also request comments on the general 

approach taken by proposed § 1.1297– 

1(c)(2), on whether further guidance is 

needed to address when income is 

derived in the active conduct of a 

banking business, on whether the 

definition of foreign bank is drafted in 

a manner that does not exclude bona 

fide foreign banks and does not include 

other types of financial institutions, and 

on how income of affiliates of foreign 

banks should be taken into account. 

2. Valuation of Assets for Purposes of 

the Asset Test 

Under section 1297(e), the 

determination of whether a tested 

foreign corporation satisfies the Asset 

Test either must or may be made on the 

basis of the value of the assets of the 

tested foreign corporation, unless the 

tested foreign corporation is a controlled 

foreign corporation the shares of which 

are not publicly traded. Accordingly, it 

is typically necessary to determine the 

relative value of a tested foreign 

corporation’s passive and non-passive 

assets in order to determine whether the 

tested foreign corporation satisfies the 

Asset Test. 

The value of individual assets of an 

operating company may not be readily 

determinable. However, financial 

accounting standards generally provide 

rules that are intended to provide 

stakeholders with an economically 

realistic understanding of a company’s 

financial position, including the cost or 

value of its assets. Financial statement 

information also often is accessible by 

tested foreign corporations and their 

shareholders, and is prepared for nontax purposes. The Treasury Department 

and the IRS understand that, for these 

reasons, taxpayers often utilize financial 

statements in order to determine the 

value of a tested foreign corporation’s 

assets. Section 1297(f)(4) specifically 

requires the use of information from 

financial statements prepared under 

U.S. generally accepted accounting 

principles (‘‘GAAP’’) or international 

financial reporting standards (‘‘IFRS’’) 

for purposes of the QIC rules, indicating 

that Congress believes that such 

information is appropriate in some 

circumstances as a basis for determining 

whether a tested foreign corporation 

qualifies as a PFIC. 

Accordingly, proposed § 1.1297– 

1(d)(1)(v)(D) generally permits a 

taxpayer to rely upon the information in 

a tested foreign corporation’s financial 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4587 

statements in order to determine the 

value of the corporation’s assets. The 

Treasury Department and the IRS 

request comments on whether ordering 

rules similar to those of section 

1297(f)(4) and proposed § 1.1297–4(f)(1) 

should apply, and whether other 

safeguards such as requiring that 

financial statements be audited should 

be required. 

The Treasury Department and the IRS 

are aware that financial statements do 

not include values for some types of 

assets that are important to companies 

in certain industries, for example selfcreated intangibles. Accordingly, 

proposed § 1.1297–1(d)(1)(v)(D) 

provides that if a shareholder has 

reliable information about the value of 

an asset that differs from its financial 

statement valuation, that information 

must be used to determine the value of 

the asset. Whether valuation 

information is more reliable than 

financial statement valuation is based 

on the facts and circumstances, 

including the experience and 

knowledge of the source of the 

information, whether the information is 

recent and whether there have been 

intervening developments that would 

affect the accuracy of the information, 

and whether the information 

specifically addresses the value of the 

asset in question. Another fact pattern 

that may raise questions as to whether 

divergence from a financial statement 

valuation is warranted is when a tested 

foreign corporation or look-through 

entity owns property that is subject to 

a lease or license that is disregarded 

under the rules for intercompany 

obligations between a tested foreign 

corporation and a look-through entity, 

and similar fact patterns. See § 1.1297– 

2(c)(1)(ii). The Treasury Department and 

the IRS request comments on whether 

the Asset Test should take into account 

the value of the property subject to the 

lease or license and the value of the 

lease or license, or whether instead the 

Asset Test should take into account the 

value of the property disregarding the 

lease or license. The Treasury 

Department and the IRS request 

comments on additional considerations 

that may be relevant to determining 

when shareholders may use information 

other than financial statement 

valuations for purposes of the Asset 

Test. 

3. Treatment of Working Capital and 

Goodwill for Purposes of the Asset Test, 

and Other Asset Test Rules Provided by 

Notice 88–22 

Notice 88–22, 1988–1 C.B. 489 

(‘‘Notice 88–22’’), provides guidance on 

the application of the Asset Test 

pending the issuance of regulations. The 

Treasury Department and the IRS 

propose to adopt final regulations that 

will address the portions of Notice 88– 

22 that have not already been addressed 

by regulations, for example the guidance 

relating to depreciable property used in 

a trade or business, trade or service 

receivables, intangible property, 

working capital, and tax-exempt assets. 

After the issuance of those regulations 

Notice 88–22 would be obsoleted. 

Except as described in the remainder of 

this Part I.A.3 of this Explanation of 

Provisions section, the rules provided in 

Notice 88–22 are proposed to be 

adopted in final form as set forth in 

Notice 88–22. The Treasury Department 

and the IRS request comments on 

whether any changes should be made to 

those rules when they are adopted in 

final regulations. 

Notice 88–22 provides that cash and 

other current assets readily convertible 

into cash, including assets that may be 

characterized as the working capital of 

an active business, are treated as passive 

assets for purposes of the Asset Test. 

Notice 88–22 indicated that passive 

treatment is warranted because working 

capital produces passive income (that is, 

interest income). 

Comments have noted that the 

approach taken in Notice 88–22 with 

respect to working capital may be 

inconsistent with the intent of the PFIC 

regime to distinguish between 

investments in passive assets and 

investments in active businesses. It has 

been asserted that the working capital 

rule in Notice 88–22 causes many 

foreign corporations otherwise engaged 

in active operating businesses to be 

classified as PFICs because Notice 88– 

22 treats working capital as a passive 

asset even though it is an asset used in 

the active conduct of business 

operations. Critics of Notice 88–22’s 

working capital rule have also noted 

that, for some purposes of the Code, 

cash is treated as a business (nonpassive) asset to the extent it is held as 

working capital for use in a trade or 

business. See generally section 

1202(e)(6) and §§ 1.864–4(c)(2) and 

1.897–1(f)(1)(iii). 

The Treasury Department and the IRS 

recognize that, because any active 

operating company must have some 

cash or cash equivalents on hand to pay 

operating expenses, Notice 88–22’s 

working capital rule, which treats all 

working capital as a passive asset, does 

not reflect the manner in which bona 

fide businesses operate. The Treasury 

Department and the IRS also are aware 

that some foreign companies engaged in 

active businesses hold cash or liquid 

securities in amounts that substantially 

exceed the present needs of the business 

for extended periods. Therefore, the 

proposed regulations provide a limited 

exception to the treatment of working 

capital as passive. Under proposed 

§ 1.1297–1(d)(2), an amount of cash held 

in a non-interest bearing account that is 

held for the present needs of an active 

trade or business and is no greater than 

the amount reasonably expected to 

cover 90 days of operating expenses 

incurred in the ordinary course of the 

trade or business of the tested foreign 

corporation (for example, accounts 

payable for ordinary operating expenses 

or employee compensation) is not 

treated as a passive asset. 

The Treasury Department and the IRS 

understand that this definition is 

narrower than the ordinary business 

meaning of working capital and the 

definitions used in some other Treasury 

regulations. Because the PFIC rules are 

based on numeric formulas, it is 

important that taxpayers and the IRS 

can determine what the amount treated 

as working capital is for purposes of the 

PFIC asset test with some level of 

precision. Moreover, because the 

statutory PFIC rules (and FPHCI rules) 

generally treat an asset held to produce 

interest as passive, it may not be 

appropriate to treat an interest-bearing 

instrument held by an operating 

company as working capital other than 

as an asset that produces passive 

income. Those rules permit interestbearing assets to be treated as active 

assets for limited classes of taxpayers 

like banks, insurance companies and 

securities dealers, and also permit 

interest from related persons to be 

treated in whole or part as active, but in 

those cases there are specific statutory 

exceptions from passive treatment. See 

sections 1297(b)(2)(A) (banks), 

1297(b)(2)(B) and (f) (insurance 

companies), 1297(b)(2)(C) (interest from 

related persons) and 954(c)(2)(C) 

(securities dealers). The Treasury 

Department and the IRS request 

comments on this exception to the 

general rule of Notice 88–22 that cash is 

a passive asset, including the scope of 

statutory authority to treat interestbearing accounts or instruments held as 

working capital as an active asset and 

the ways in which the exception might 

be broadened while maintaining 

appropriate safeguards to avoid 

uncertainty as to how to determine the 

amounts and types of instruments 

properly treated as held for the present 

needs of a business and to ensure that 

a business’s investments and capital 

held for future needs continue to be 

characterized as passive assets. 

Like working capital, goodwill was 

not addressed by the 2019 proposed 

4588 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

regulations. Notice 88–22 provides that, 

for purposes of the Asset Test, goodwill 

or going concern value must be 

identified with a specific incomeproducing activity of the corporation 

and characterized as a passive or nonpassive asset based on the income 

derived from the activity. The Treasury 

Department and the IRS understand that 

some taxpayers believe that Notice 88– 

22 takes an improper approach with 

respect to the treatment and 

characterization of goodwill for 

purposes of the Asset Test and argue 

that goodwill related to an active trade 

or business should be treated in its 

entirety as a non-passive asset or, in the 

alternative, that the dual-character asset 

rule in the proposed regulations should 

be read to apply to goodwill. 

The Treasury Department and the IRS 

agree that goodwill should be allocated 

to business activities but do not agree 

that goodwill should always be treated 

entirely as a non-passive asset because 

the PFIC rules may treat certain 

business assets as passive and it is 

therefore possible that goodwill would 

be associated with those assets. Because 

companies in different lines of business 

may be valued as an economic matter 

under different valuation models, some 

of which may give more weight to 

income and others to assets or to other 

aspects of a business like customer 

relationships, there is no single basis for 

allocating goodwill that is likely to be 

best suited to every company as an 

economic matter. The Treasury 

Department and the IRS believe that the 

approach provided by Notice 88–22 for 

determining the character of goodwill 

for purposes of the Asset Test is a 

reasonable approach although other 

approaches may be more economically 

accurate for a particular tested foreign 

corporation. In light of the complex 

nature of goodwill as an economic and 

accounting matter, and developments in 

tax law since 1988 with respect to the 

treatment of goodwill and similar assets, 

the Treasury Department and the IRS 

request comments on alternative 

approaches to addressing the treatment 

of goodwill for purposes of the Asset 

Test. 

4. Elimination of Intercompany 

Dividends for Purposes of the Income 

Test and Related Adjustments 

Proposed § 1.1297–2(c)(2) provided 

that, for purposes of applying the 

Income Test, intercompany payments of 

dividends between a look-through 

subsidiary and a tested foreign 

corporation are eliminated to the extent 

the payment is attributable to income of 

a look-through subsidiary that was 

included in gross income by the tested 

foreign corporation for purposes of 

determining its PFIC status. The 

preamble to the proposed regulations 

indicated that the Treasury Department 

and the IRS intended for the elimination 

of such items to prevent double 

counting of intercompany income and 

assets. 

A comment expressed concern that 

the proposed regulation did not 

eliminate a payment of a dividend by a 

look-through subsidiary to a tested 

foreign corporation that is made out of 

earnings and profits not attributable to 

income of the subsidiary previously 

included in the gross income of the 

tested foreign corporation for purposes 

of determining its PFIC status 

(‘‘dividends from non-accounted-for 

earnings’’), for example a dividend paid 

out of earnings and profits accumulated 

before the tested foreign corporation’s 

acquisition of the look-through 

subsidiary. The comment recommended 

that final regulations provide for the 

elimination of all dividends from lookthrough subsidiaries and made a 

number of alternative suggestions 

intended to reduce or eliminate the 

likelihood that a dividend from a lookthrough subsidiary would be treated as 

a dividend from non-accounted-for 

earnings. The final regulations did not 

adopt these recommendations, because 

treating a distribution from a lookthrough subsidiary as not giving rise to 

gross income to the tested foreign 

corporation for purposes of the Income 

Test could reduce gain on a future sale 

of the stock of the look-through 

subsidiary unless a basis or other 

adjustment were made to the stock or 

gain. 

The final regulations indicate that for 

purposes of applying the Income Test, a 

tested foreign corporation must take into 

account its gain on the disposition of 

stock in a look-through subsidiary. See 

§ 1.1297–2(f)(2). In the final regulations, 

the amount of gain derived from a tested 

foreign corporation’s direct disposition 

of stock of a look-through subsidiary, or 

an indirect disposition resulting from 

the disposition of stock of a lookthrough subsidiary by other lookthrough subsidiaries or by look-through 

partnerships, that is taken into account 

by the tested foreign corporation for 

purposes of section 1297(a)(1), section 

1298(b)(3), and § 1.1298–2 is the 

residual gain. See § 1.1297–2(f)(2). The 

residual gain equals the total gain 

recognized by the tested foreign 

corporation from the disposition of the 

stock of the look-through subsidiary 

reduced (but not below zero) by 

unremitted earnings. Id. Unremitted 

earnings are the excess of the aggregate 

income taken into account by the tested 

foreign corporation pursuant to section 

1297(c) with respect to the stock of the 

disposed-of look-through subsidiary 

over the aggregate dividends received by 

the tested foreign corporation from the 

disposed-of look-through subsidiary 

with respect to the stock. Id. 

Reducing unremitted earnings to take 

dividends into account as provided by 

the final regulations does not fully 

account for the effect of dividends from 

non-accounted-for earnings, for example 

where there are no unremitted earnings 

after taking into account distributions of 

earnings and profits previously 

included in the gross income of the 

tested foreign corporation for purposes 

of determining its PFIC status but the 

stock of the look-through subsidiary is 

sold at a gain. Consequently, either such 

dividends should be treated as giving 

rise to income to the recipient, as 

provided by the final regulations, or 

some other adjustment such as to basis 

should be made in order to prevent the 

disappearance of potential gain. See Part 

IV.D.1 of the Summary of Comments 

and Explanation of Revisions for the 

final regulations. 

The PFIC regulations do not provide 

rules for determining or adjusting the 

basis of the stock of a look-through 

subsidiary. In addition to the fact 

pattern described above, many other fact 

patterns could raise questions about 

how the basis of stock of a look-through 

subsidiary should be adjusted. 

Examples of such transactions include 

unremitted earnings, certain 

reorganizations the parties to which are 

look-through subsidiaries, in-kind 

dividend distributions that could give 

rise to gain at the level of the 

distributing subsidiary but the 

elimination of dividends from the 

income of the dividend recipient, and 

other transactions governed by 

subchapter C. Additional questions arise 

if a subsidiary becomes, or ceases to be, 

a look-through subsidiary while its 

shares continue to be held by the same 

shareholder, and with respect to 

transactions that shift property between 

a look-through entity and a tested 

foreign corporation that owns the lookthrough entity (or between two lookthrough entities) in light of the fact that 

the transaction may give rise to gain or 

loss if it is regarded but the tested 

foreign corporation is treated as owning 

the asset for Asset Test purposes both 

before and after the transaction. 

Rules addressing similar issues exist 

for members of a consolidated group, 

which might provide a possible model 

for rules addressing ‘‘corporate’’ 

transactions between a look-through 

subsidiary and its owner(s). However, 

the consolidated return regulations are 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4589 

highly complex and may not be suitable 

for foreign corporations that do not 

follow U.S. tax principles. The 

consolidated return regulations are also 

based on a single-entity paradigm that 

may not be relevant for section 1297(c) 

given that the stock ownership 

threshold for treating a subsidiary as a 

look-through subsidiary is 25 percent 

rather than 80 percent. Accordingly, 

those rules may not be an appropriate 

model for basis and related rules for 

look-through subsidiaries. 

Proposed § 1.1297–2(c)(2) and (f) 

provide rules that would—for purposes 

of determining a tested foreign 

corporation’s PFIC status—eliminate 

from the gross income of the corporation 

a dividend it receives from a lookthrough subsidiary that is made out of 

earnings and profits not attributable to 

income of the subsidiary previously 

included in the gross income of the 

tested foreign corporation. The rules 

also would make corresponding 

adjustments to the basis of a lookthrough subsidiary’s stock for purposes 

of determining gain upon the 

disposition of such stock in applying 

the Income Test. For the reasons already 

described, these rules may or may not 

be a desirable approach to addressing 

the issues with respect to earnings and 

distributions of look-through 

subsidiaries. For example, the basis 

reduction rule could apply if a 

subsidiary paid a dividend when it was 

not a look-through subsidiary but later 

became one. The Treasury Department 

and the IRS invite comments addressing 

these issues—in particular, comments 

are requested on the treatment of preacquisition earnings and profits. 

5. Safe Harbors for the Domestic 

Subsidiary Anti-Abuse Rule 

Section 1298(b)(7) provides a special 

characterization rule that applies when 

(i) a tested foreign corporation owns at 

least 25 percent of the value of the stock 

of a domestic corporation (‘‘25-percentowned domestic corporation’’), (ii) the 

25-percent-owned domestic corporation 

owns stock in another domestic 

corporation (‘‘the second-tier domestic 

corporation), and (iii) the tested foreign 

corporation is subject to the 

accumulated earnings tax under section 

531 (or waives any benefit under a 

treaty that would otherwise prevent 

imposition of such tax). In that case, 

section 1298(b)(7) treats the stock of the 

second-tier domestic corporation held 

by the 25-percent-owned domestic 

corporation (‘‘qualified stock’’) as a nonpassive asset, and the related income as 

non-passive income. 

The 2019 proposed regulations 

provided that section 1298(b)(7) did not 

apply if, among other matters, a 

principal purpose for the tested foreign 

corporation’s formation or acquisition of 

the 25-percent-owned domestic 

corporation was to avoid classification 

of the tested foreign corporation as a 

PFIC (‘‘principal purpose anti-abuse 

rule’’). See proposed § 1.1298–4(f)(2). A 

modified version of the principal 

purpose anti-abuse rule is adopted in 

the final regulations. See § 1.1298– 

4(e)(1). 

The proposed regulations provide two 

safe harbors from the principal purpose 

anti-abuse rule in § 1.1298–4(e)(1). The 

Treasury Department and the IRS 

request comments on the application of 

the safe harbors discussed in this Part 

I.A.5 of the Explanation of Provisions. 

Under the first safe harbor, the antiabuse rule will not apply if more than 

80 percent of the assets of the secondtier domestic corporation are used in an 

active U.S. trade or business, as 

determined under modified section 367 

rules. See proposed § 1.1298–4(e)(2)(i). 

For purposes of the safe harbor, the 

assets of the domestic subsidiary 

qualified affiliates (as defined in 

proposed § 1.1298–4(e)(2)(i)(B)) are also 

taken into account in determining 

whether the assets of the second-tier 

domestic corporation are used in a U.S. 

trade or business. See proposed 

§ 1.1298–4(e)(2)(i)(A). 

The proposed regulations provide a 

second safe harbor for active companies 

undergoing transition and start-up 

companies. See proposed § 1.1298– 

4(e)(2)(ii). Under this safe harbor, the 

anti-abuse rule will not apply if the 

second-tier domestic corporation 

engages in an active U.S. trade or 

business that satisfies the first safe 

harbor by the end of the transition 

period following the testing date. See 

proposed § 1.1298–4(e)(2)(ii). Proposed 

§ 1.1298–4(e)(2)(ii)(B) defines testing 

date as the last day of the month in 

which either (i) the second-tier domestic 

corporation is created, organized, or 

acquired (‘‘start-up testing date’’) or (ii) 

a second-tier domestic corporation that 

previously satisfied the first safe harbor 

disposes of substantially all its active 

U.S. trade or business (‘‘change-ofbusiness testing date’’). Proposed 

§ 1.1298–4(e)(2)(ii)(C) provides that the 

transition period is thirty-six months 

after a testing date. If the requirements 

of the business transition and start-up 

safe harbor are not satisfied within the 

transition period, the benefit of the safe 

harbor is lost retroactively for the entire 

period in which the safe harbor was 

claimed. See proposed § 1.1298– 

4(e)(2)(ii)(D). In these instances, the 

general anti-abuse rule in § 1.1298– 

4(e)(1) will be applied to the tested 

foreign corporation to determine 

whether a principal purpose to avoid 

PFIC classification existed for the 

preceding years, which would be within 

the normal statute of limitations on 

assessments under section 6501. 

B. Proposed Revisions to § 1.1297–4— 

Qualifying Insurance Corporation 

Section 1297(f) provides that a QIC is 

a foreign corporation that (1) would be 

subject to tax under subchapter L if it 

were a domestic corporation, and (2) 

either (A) has applicable insurance 

liabilities (‘‘AIL’’) constituting more 

than 25 percent of its total assets on its 

applicable financial statement (‘‘AFS’’) 

(‘‘the 25 percent test’’), or (B) meets an 

elective alternative facts and 

circumstances test which lowers the 

required AIL-to-total assets ratio to 10 

percent (‘‘alternative facts and 

circumstances test’’). 

Most of the rules for determining 

whether a foreign corporation is a QIC 

under section 1297(f) are provided in 

the final regulations under § 1.1297–4. 

Proposed § 1.1297–4 contains additional 

rules relating to the definition of an 

applicable financial statement, the 

definition of applicable insurance 

liabilities, and an optional adjustment to 

total assets. 

1. Definition of Applicable Financial 

Statement 

Proposed § 1.1297–4(f)(1) defines the 

term applicable financial statement 

(‘‘AFS’’) in a manner that provides 

ordering rules for how to prioritize 

between multiple financial statements 

prepared at the same level of priority, 

for example multiple financial 

statements prepared on the basis of 

GAAP or multiple financial statements 

prepared on the basis of IFRS, and 

between multiple financial statements 

prepared taking into account the assets 

and liabilities of different legal entities. 

The definition is modeled on similar 

definitions elsewhere in the Code and 

Treasury regulations, such as 

regulations under section 451, but has 

been adapted to the QIC context. 

The term financial statement is 

defined to mean a complete balance 

sheet, income statement, and cash flow 

statement, or the equivalent statements 

under the relevant accounting standard, 

and ancillary documents typically 

provided together with such statements. 

As regards an AFS, in addition to the 

general levels of priority set forth in 

section 1297(f)(4)(A) (GAAP, IFRS, and 

insurance regulatory (statutory) 

statements), ordering rules provide subpriority levels (based on the purpose for 

which the statement is prepared), with 

higher priority being accorded to 

4590 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

accounting statements viewed as more 

reliable. Since the AFS is the financial 

statement of a non-U.S. entity, financial 

statements provided to foreign 

regulatory bodies generally are treated 

as having the same priority as if 

provided to an equivalent U.S. 

regulatory body. The requirement that a 

non-U.S. regulatory agency have 

standards not less stringent than those 

of the U.S. Securities & Exchange 

Commission is intended to provide a 

standard similar to the definition of a 

qualified exchange or other market for 

purposes of section 1296, with respect 

to reporting standards. Because audited 

financial statements have been reviewed 

by independent auditors, and it is 

anticipated that insurance regulators 

will require audited financial 

statements, only audited statements can 

qualify as AFS. 

If a tested foreign corporation has 

multiple financial statements, the order 

of priority described above is 

determinative. However, if there are 

multiple financial statements within a 

single level of priority and sub-priority 

(for example, multiple GAAP financial 

statements provided to creditors), 

additional ordering rules are provided 

to assign priority first to a financial 

statement that is not prepared on a 

consolidated basis (and that accounts 

for investments in the tested foreign 

corporation’s subsidiaries (if any) on a 

cost or equity basis), and then to a 

consolidated financial statement that 

has the tested foreign corporation as the 

parent of the consolidated group. These 

rules are intended to make it more likely 

that the AFS reflects the same or similar 

assets and liabilities as the financial 

statement used to determine whether 

the section 1297(f)(3)(B) limitation on 

the amount of applicable insurance 

liabilities applies. 

A financial statement prepared on a 

consolidated basis that takes into 

account affiliates that are not owned by 

the tested foreign corporation (for 

example, sister companies) is not 

treated as the AFS unless it is the only 

financial statement of the tested foreign 

corporation and is provided to an 

insurance regulator. It is anticipated that 

the only financial statement likely to fall 

within that category is a financial 

statement that includes the tested 

foreign corporation and subsidiaries if 

any, and a parent corporation. 

Accordingly, if there are multiple 

financial statements with the same level 

of priority, non-consolidated financial 

statements take priority over 

consolidated financial statements. 

However, a consolidated financial 

statement prepared on the basis of 

GAAP that has the tested foreign 

corporation as the parent of the 

consolidated group has priority over a 

non-consolidated statement prepared on 

the basis of statutory accounting 

standards, because financial statements 

prepared on the basis of GAAP are 

higher priority than financial statements 

prepared on the basis of statutory 

accounting standards. Similarly, a 

consolidated statement prepared on the 

basis of IFRS would have priority over 

a non-consolidated statement prepared 

on the basis of statutory accounting 

standards. 

The Treasury Department and IRS 

request comments on the expanded 

definition of an AFS and the priority 

rules provided, including whether 

special rules are needed to properly 

apply the limitation under § 1.1297– 

4(e)(2) if the statutory accounting 

statement covers a different period than 

the AFS, and whether other more 

detailed rules are necessary in order to 

identify the AFS when a foreign 

corporation operates in multiple 

jurisdictions and is subject to the 

authority of more than one insurance 

regulatory body. 

2. Definition of Applicable Insurance 

Liabilities 

As described in Part V.A.2 of the 

Summary of Comments and Explanation 

of Revisions to the final regulations, 

section 1297(f)(4) contemplates that a 

foreign corporation can use GAAP, 

IFRS, or the accounting standard used 

for the annual statement required to be 

filed with the local regulator (if a 

statement prepared for financial 

reporting purposes using GAAP or IFRS 

is not available) as the starting point to 

determine AIL. The preamble to the 

final regulations notes, however, that 

AIL is defined more specifically so that 

only those liabilities that meet the 

requirements of section 1297(f)(3) and 

the related regulatory definitions in 

§ 1.1297–4(f)(2) are included in AIL, 

irrespective of differences in 

nomenclature and methods that may be 

used by different financial reporting 

standards. 

Proposed § 1.1297–4(f)(2)(i)(D)(3) 

clarifies that, in determining AIL, 

liabilities are reduced by an amount 

equal to the assets reported on the 

corporation’s financial statement that 

represent amounts relating to those 

liabilities that may be recoverable from 

other parties through reinsurance. The 

rule is necessary because GAAP and the 

newest IFRS accounting standard for 

insurance contracts, IFRS 17, (and 

possibly local statutory accounting 

depending on the laws of the foreign 

jurisdiction) record amounts recoverable 

from other parties as reinsurance with 

respect to unpaid insurance losses and 

other reserves on the asset side of the 

balance sheet, rather than reducing 

balance sheet liabilities. In contrast, 

insurance regulatory accounting rules 

(including those in the United States) 

often reduce a ceding company’s 

insurance liabilities by those amounts 

instead of including them as assets on 

the balance sheet. Both methods result 

in the same amount of shareholder 

equity for a foreign corporation but 

create different ratios of AIL to total 

assets and, thus, can potentially 

produce a difference in a foreign 

corporation’s QIC status. 

The Treasury Department and IRS 

have determined that AIL should 

exclude amounts that have been 

reinsured because the ratio test would 

otherwise be subject to manipulation, 

and because the Treasury Department 

and IRS believe that a uniform approach 

is appropriate for the treatment of 

reinsured risk regardless of the 

particular accounting standard that may 

apply. In addition, proposed § 1.1297– 

4(f)(2)(i)(D)(3) clarifies that, if a tested 

foreign corporation’s financial statement 

is prepared on a consolidated basis, 

liabilities of the tested corporation must 

be reduced (to the extent not reduced 

under other provisions) by an amount 

equal to the assets relating to those 

liabilities that may be recoverable 

through reinsurance from another entity 

included in the consolidated financial 

statement, regardless of whether the 

reinsurance transaction is eliminated in 

the preparation of the consolidated 

financial statement. This proposed rule 

is consistent with the rules of § 1.1297– 

4(f)(2)(i)(D)(1) and (2), which provide 

that no item may be taken into account 

more than once and that AIL include 

only the liabilities of the foreign 

corporation whose QIC status is being 

tested, and not liabilities of other 

entities within a consolidated group. 

The Treasury Department and IRS are 

aware that certain arrangements permit 

a ceding company to continue to hold 

the reserves and assets required to 

support the insurance liabilities for the 

reinsured contracts during the policy 

term (so-called modified coinsurance or 

modco). It has been held that life 

insurance reserves on policies reinsured 

under a modco arrangement are 

attributed to the ceding company, and 

not the assuming company. See Rev. 

Rul. 70–508, 1970–2 C.B. 136 (1970). 

See generally Colonial Am. Life Ins. v. 

United States, 491 U.S. 244, 248, n.2 

(1989); Anchor National Life Ins. v. 

Commissioner, 93 T.C. 382, 423 (1989). 

Proposed § 1.1297–4(f)(2)(i)(D)(3) is not 

intended to apply to modco 

arrangements where the ceding 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4591 

company retains the assets supporting 

the insured risks (because they do not 

create an amount recoverable from 

another party), but the Treasury 

Department and IRS request comments 

as to whether the rule appropriately 

addresses modco arrangements and 

whether additional rules may be 

necessary in the final regulations. The 

Treasury Department and IRS also 

request comments as to whether to more 

specifically define amounts recoverable 

from another party through reinsurance 

and whether there are other special 

circumstances in which modification of 

the definition of AIL is appropriate. 

3. Optional Asset Adjustment 

Due to the manner in which AIL are 

defined under § 1.1297–4(f)(2), it may be 

necessary to adjust the amount of a 

foreign corporation’s total assets to 

avoid distortions in applying the 25 

percent test and the 10 percent test. 

First, if a foreign corporation’s AFS is 

prepared on a consolidated basis, total 

assets may be reduced by the amount 

equal to the amount of insurance 

liabilities of affiliated entities that are 

reported on the AFS and would be 

included in AIL if its definition did not 

limit AIL to the AIL of the subject 

foreign corporation. See proposed 

§ 1.1297–4(e)(4)(i). This adjustment is 

appropriate because insurance liabilities 

of an affiliate, though excluded from the 

definition of AIL, can have the effect of 

reducing the assets available to satisfy 

the foreign corporation’s insurance 

liabilities. 

Second, if a foreign corporation 

reports amounts recoverable from other 

parties through reinsurance as assets on 

its AFS, proposed § 1.1297–4(e)(4)(ii) 

provides that total assets may be 

reduced by the amount by which AIL 

are reduced under proposed § 1.1297– 

4(f)(2)(i)(D)(3). As explained in Part 

I.B.2 of this Explanation of Provisions, 

proposed § 1.1297–4(f)(2)(i)(D)(3) 

requires a foreign corporation’s AIL to 

be reduced to reflect those amounts. 

Without a corresponding adjustment to 

total assets, the same reinsurance 

contract could have the effect of 

reducing a foreign corporation’s AIL 

while also increasing its total assets. 

The Treasury Department and IRS 

request comments as to whether there 

are other situations that warrant an 

adjustment to total assets. 

C. Proposed § 1.1297–5: Active Conduct 

of an Insurance Business 

Section 1297(b)(2)(B) provides an 

exclusion from the definition of passive 

income for income derived in the active 

conduct of an insurance business by a 

QIC. As described in Part VI.A of the 

Summary of Comments and Explanation 

of Revisions to the final regulations, 

proposed § 1.1297–5 revises previously 

proposed rules for determining whether 

a QIC is engaged in the active conduct 

of an insurance business. 

1. Overview 

As explained in Part VI.A of the 

Summary of Comments and Explanation 

of Revisions to the final regulations, the 

Treasury Department and the IRS have 

determined that the active conduct of an 

insurance business is a requirement 

mandated by the statute in addition to 

(and separate from) the requirements of 

subchapter L and section 1297(f), but 

that in response to comments, the active 

conduct test should be amended to 

provide more flexibility in determining 

whether a QIC is engaged in the active 

conduct of an insurance business. 

Proposed § 1.1297–5(b)(1) provides that 

a QIC is treated as engaged in the active 

conduct of an insurance business if it 

satisfies either the factual requirements 

test under proposed § 1.1297–5(c) or the 

active conduct percentage test under 

proposed § 1.1297–5(d). The Treasury 

Department and IRS request comments 

on the active conduct test, including the 

addition of the new factual 

requirements test and revisions to the 

active conduct percentage test. 

2. Exclusions From Active Conduct 

Under § 1.1297–5(b)(2), two categories 

of insurance companies are precluded 

from meeting the active conduct test. 

First, a QIC is not engaged in the active 

conduct of an insurance business if it 

has no employees (or a nominal number 

of employees) and relies exclusively (or 

almost exclusively) on independent 

contractors to perform its core 

functions. Second, the active conduct 

test excludes securitization vehicles 

(such as vehicles used to issue 

catastrophe bonds, sidecars, or 

collateralized reinsurance vehicles) and 

insurance linked securities funds that 

invest in securitization vehicles. These 

vehicles are excluded because they are 

designed to provide a passive 

investment return tied to insurance risk 

rather than participation in the earnings 

of an active insurance business. 

3. Factual Requirements Test 

As noted in Part VI.A of the Summary 

of Comments and Explanation of 

Revisions to the final regulations, 

several comments requested the 

addition of a facts and circumstances 

test; other comments recommended that 

the active conduct test focus on the 

assumption of insurance risk; and a 

comment specifically identified 

underwriting as a core insurance 

function that must be performed by an 

insurance company’s officers and 

employees. The factual requirements 

test has been added in response to these 

comments. The active conduct 

percentage test has been retained (in 

modified form) as an alternative means 

of satisfying the active conduct 

requirement. 

Proposed § 1.1297–5(c) provides that 

the factual requirements test is satisfied 

if the QIC’s officers and employees carry 

out substantial managerial and 

operational activities on a regular and 

continuous basis with respect to all of 

its core functions and perform virtually 

all of the active decision-making 

functions relevant to underwriting. A 

QIC’s core functions are generally 

defined to include underwriting, 

investment, contract and claim 

management, and sales activities. See 

proposed § 1.1297–5(f) for definitions of 

these terms. See Part I.C.5 of this 

Explanation of Provisions for rules 

concerning officers and employees of 

related entities. 

A QIC’s officers and employees are 

considered to carry out substantial 

managerial and operational activities 

relevant to its core functions only if they 

are involved in all levels of planning 

and implementation related to the QIC’s 

core functions as described in proposed 

§ 1.1297–5(c)(2). The required activities 

must be conducted by officers or senior 

employees with appropriate experience 

who devote all (or virtually all) of their 

work to those activities and similar 

activities for related entities. 

The active decision-making functions 

relevant to a QIC’s underwriting 

activities are those underwriting 

activities most important to decisions of 

the QIC relating to the assumption of 

specific insurance risks. See proposed 

§ 1.1297–5(c)(3). To meet this 

requirement, officers and employees of 

the QIC must carry out virtually all of 

the activities related to a QIC’s decision 

to assume an insurance risk and must 

conduct virtually all of the decisionmaking with respect to the execution of 

an insurance contract on a contract-bycontract basis. Development of 

underwriting policies and parameters 

that are changed infrequently is not an 

active decision-making function in the 

absence of further ongoing involvement 

by the QIC’s officers and employees. See 

proposed § 1.1297–5(c)(3)(iii)(A). 

4. Active Conduct Percentage Test 

The active conduct percentage test is 

provided in proposed § 1.1297–5(d). To 

meet this test, two requirements must be 

satisfied. First, the total costs incurred 

by a QIC with respect to its officers and 

employees for services rendered with 

4592 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

respect to its core functions (other than 

investment activities) must equal at 

least 50 percent of the total costs 

incurred for all services rendered with 

respect to the QIC’s core functions 

(other than investment activities). In 

response to comments to the 2019 

proposed regulations, investment 

activities have been excluded from both 

the numerator and denominator of the 

percentage calculation. Second, if any 

part of a QIC’s core functions (including 

investment management) is outsourced 

to an unrelated entity, the QIC’s officers 

and employees must conduct robust 

oversight with respect to the outsourced 

activities. See proposed § 1.1297– 

5(d)(2). 

The proposed regulations provide a 

definition of total costs that is used to 

apply the active conduct percentage 

test. See § 1.1297–5(f)(8). With respect 

to a QIC’s own officers and employees, 

total costs are defined as compensation 

costs plus other expenses reasonably 

allocable to the services provided 

(determined in accordance with section 

482 and taking into account all expenses 

that would be included in the total 

services costs under § 1.482–9(j) and 

§ 1.482–9(k)(2)). With respect to services 

performed by employees of another 

entity (whether related or unrelated), 

total costs are equal to the amount paid 

or accrued by the QIC to the other entity 

for the relevant services. Ceding 

commissions paid with respect to 

reinsurance contracts and commissions 

paid to brokers or sales agents to 

procure reinsurance contracts are 

excluded from the definition of total 

costs. 

5. Officers and Employees of Related 

Entities 

For purposes of applying the factual 

requirements test and the active conduct 

percentage test, a QIC’s officers and 

employees are considered to include the 

officers and employees of related 

entities, where such entities are 

qualified affiliates of the QIC within the 

meaning of § 1.1297–2(e)(2), except that 

the 50 percent ownership standard is 

based on both value and voting power. 

See proposed § 1.1297–5(e). A qualified 

affiliate is a corporation or a partnership 

that is included in an affiliated group 

that includes the QIC. Affiliated group 

has the meaning provided in section 

1504(a), determined without regard to 

section 1504(b)(2) and (3) (which would 

otherwise exclude foreign corporations 

and life insurance companies from 

membership) and substituting ‘‘more 

than 50 percent’’ ownership for ‘‘at least 

80 percent’’. In addition, consistent with 

the rules of § 1.1297–2(e)(2), the 

common parent of the group must be a 

foreign corporation or foreign 

partnership, and a corporation or a 

partnership is included in the affiliated 

group only if it is a look-through 

subsidiary or look-through partnership, 

as applicable, of the common parent. 

Also, a partnership is included in the 

affiliated group only if more than 50 

percent of the value of its capital 

interests, profits interests and any other 

partnership interests is owned by one or 

more corporations that are included in 

the affiliated group. The related entity 

rule applies only if the QIC bears the 

compensation costs on an arm’s length 

basis and exercises oversight and 

supervision with respect to the services 

provided by affiliated officers and 

employees. See proposed § 1.1297– 

5(e)(3). 

As noted in Part VI.A of the Summary 

of Comments and Explanation of 

Revisions to the final regulations, 

comments requested broader attribution 

rules that would cover employees of 

entities that are related to the QIC 

within the meaning of section 954(d)(3) 

or are under common practical control 

with the QIC. These comments have not 

been adopted. Because the active 

conduct test is designed to assess the 

activities of a QIC on a separate entity 

basis (rather than the activities 

conducted by an insurance group as a 

whole), services performed by officers 

and employees of other entities cannot 

be attributed to a QIC except in the 

circumstances described in proposed 

§ 1.1297–5(e). However, the Treasury 

Department and the IRS determined that 

it was appropriate to align the common 

ownership requirements for purposes of 

the insurance active conduct rule with 

the ownership requirements used in 

§ 1.1297–2(e)(2) for look-through 

subsidiary activity attribution purposes, 

except including a vote as well as value 

requirement to ensure a heightened 

level of common control of the related 

entity officers and employees. 

D. Proposed § 1.1297–6(e)(2): Qualifying 

Domestic Insurance Corporation NonPassive Income and Asset Limitations 

1. Qualifying Domestic Insurance 

Corporation Rule 

Sections 1.1297–6(b)(2) and (c)(2) of 

the final regulations provide that 

income and assets, respectively, of a 

qualifying domestic insurance 

corporation (‘‘QDIC’’) are non-passive 

for purposes of determining whether a 

non-U.S. corporation is treated as a PFIC 

(the ‘‘QDIC Rule’’). Section 1.1297– 

6(e)(1) of the final regulations defines a 

QDIC as a domestic corporation that is 

subject to tax as an insurance company 

under subchapter L, is subject to Federal 

income tax on its net income, and is a 

look-through subsidiary of a tested 

foreign corporation. The QDIC Rule is 

intended to address situations where a 

tested foreign corporation owns a 25 

percent or greater interest in a domestic 

insurance corporation through a 

structure to which section 1298(b)(7) 

does not apply, such that the income 

and assets of the QDIC are taken into 

account in determining whether the 

tested foreign corporation is a PFIC. 

The previous 2019 proposed 

regulations also provided that the QDIC 

Rule did not apply for purposes of 

section 1298(a)(2) and determining if a 

U.S. person indirectly owns stock in a 

lower tier PFIC (‘‘Proposed QDIC 

Attribution Exception’’). Consequently, 

for attribution purposes, the 2019 

proposed regulations required a tested 

foreign corporation to apply the Income 

Test and Asset Test without applying 

the QDIC Rule. 

Several comments on the 2019 

proposed regulations requested that the 

Proposed QDIC Attribution Exception 

be removed because U.S. shareholders 

of a tested foreign corporation that 

would not otherwise be a PFIC but owns 

a PFIC and a U.S. insurance subsidiary 

that is a QDIC could become indirect 

owners of a PFIC as a result of the 

section 1298(a)(2) attribution rule. 

Comments asserted that turning off the 

QDIC Rule when testing for lower-tier 

PFIC ownership attribution would 

undermine the purpose of the rule and 

create significant burden for U.S. 

minority shareholders of the tested 

foreign corporation, who would have to 

separately evaluate the PFIC status of all 

of the tested foreign corporation’s 

foreign subsidiaries. 

2. Proposed § 1.1297–6(e)(2) QDIC 

Limitation Rule 

The Treasury Department and IRS 

agree that the Proposed QDIC 

Attribution Exception was overbroad 

and removed it from the final 

regulations. However, the Treasury 

Department and IRS believe that limits 

on the amount of a QDIC’s assets and 

income that are treated as non-passive 

may be appropriate in cases where a 

QDIC holds substantially more passive 

assets than necessary to support its 

insurance and annuity obligations. 

Thus, proposed § 1.1297–6(e)(2) 

provides that the amount of a QDIC’s 

otherwise passive income and assets 

that may be treated as non-passive is 

subject to a maximum based on an 

applicable percentage of the QDIC’s 

total insurance liabilities (‘‘QDIC 

Limitation Rule’’). 

Proposed § 1.1297–6(e)(2)(i) provides 

that the amount of a QDIC’s passive 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4593 

assets that are treated as non-passive 

under the QDIC Rule may not exceed an 

applicable percentage of the 

corporation’s total insurance liabilities. 

This amount is the QDIC’s non-passive 

asset limitation. Proposed § 1.1297– 

6(e)(2)(ii) provides that the amount of a 

QDIC’s passive income that is treated as 

non-passive under the QDIC Rule may 

not exceed the corporation’s passive 

income multiplied by the proportion 

that the QDIC’s non-passive asset 

limitation bears to its total passive 

assets (determined without the 

application of the rules under § 1.1297– 

6(c)(2)). 

Under proposed § 1.1297–6(e)(2)(iii), 

the applicable percentage is 200 percent 

for a life insurance company and 400 

percent for a nonlife insurance 

company. Proposed § 1.1297– 

6(e)(2)(iv)(A) provides that, for a QDIC 

taxable under Part I of Subchapter L 

(that is, a life insurance company), total 

insurance liabilities means the sum of 

the company’s total reserves (as defined 

in section 816(c)) plus (to the extent not 

included in total reserves) the reserve 

items referred to in paragraphs (3), (4), 

(5), and (6) of section 807(c). For a 

company taxable under Part II of 

Subchapter L (that is, a nonlife 

insurance company), the term total 

insurance liabilities means the sum of 

unearned premiums and unpaid losses. 

See proposed § 1.1297–6(e)(2)(iv)(B). 

Because a QDIC will be subject to tax 

under Subchapter L, it is appropriate to 

determine the amount of its insurance 

liabilities for purposes of the QDIC 

Limitation Rule in accordance with 

Subchapter L rules governing insurance 

liabilities because the QDIC will already 

be determining these amounts for U.S. 

income tax purposes. See proposed 

§ 1.1297–6(e)(3) for an example 

illustrating the application of these 

rules. 

The Treasury Department and the IRS 

request comments on the QDIC 

Limitation Rule and in particular on 

whether the specified applicable 

percentages are reasonable based on 

industry data. The Treasury Department 

and IRS expect most QDICs to not 

exceed the passive asset and income 

limitations based on the applicable 

percentages. In addition, a tested foreign 

corporation may hold less than 50 

percent passive assets and receive less 

than 75 percent passive income without 

being classified as a PFIC. Thus, the 

QDIC Limitation Rule provides a 

disincentive for a foreign corporation to 

shift excessive passive assets into its 

U.S. insurance subsidiary in order not to 

qualify as a PFIC and is likely to affect 

the PFIC classification of only a very 

small number of companies. Comments 

are also requested on whether final 

regulations should specifically allow for 

the applicable percentages to be 

adjusted or supplemented in 

subregulatory guidance (for example, to 

reflect possible future changes in 

industry practice). 

E. Life Insurance and Annuity Contract 

Status 

Section 1297(f)(1)(A) provides that a 

QIC must be a foreign corporation that 

would be subject to tax under 

subchapter L if it were a domestic 

corporation. An insurance company is 

defined in sections 816(a) and 831(c), 

which limit insurance company status 

to a company more than half the 

business of which during the taxable 

year is the issuing of insurance or 

annuity contracts or the reinsurance of 

risks underwritten by insurance 

companies. Thus, the status of a 

company as an insurance company 

under subchapter L depends upon the 

characterization of the contracts that a 

company issues or reinsures. In 

addition, section 816(a) provides that if 

more than half of the company’s total 

reserves (as defined in section 816(c)) 

are life insurance reserves (as defined in 

section 816(b)) or unearned premiums 

and unpaid losses on non-cancellable 

life, accident, or health contracts, then 

the company is a life insurance 

company taxable under part 1 of 

subchapter L; otherwise, an insurance 

company is taxable under part II of 

subchapter L. 

Life insurance contracts and annuity 

contracts must meet certain statutory 

requirements to be treated as contracts 

giving rise to life insurance reserves for 

subchapter L purposes. Section 7702(a) 

defines a life insurance contract for 

purposes of the Code as a life insurance 

contract under applicable law (which 

includes foreign law) that satisfies one 

of two actuarial tests set forth in section 

7702. Similarly, section 72(s) sets forth 

distribution on death requirements that 

an annuity contract must satisfy in order 

to be considered an annuity contract for 

purposes of the Code. In addition, if a 

contract is a variable contract within the 

definition of section 817(d), it must 

satisfy the diversification requirements 

for variable contracts under section 

817(h) to be treated as a life insurance 

or annuity contract for purposes of 

subchapter L. These statutory 

requirements reflect Congress’s concern 

that the tax-favored treatment generally 

accorded to life insurance and annuity 

contracts under the Code should not be 

available to contracts that are too 

investment oriented or provide for 

undue tax deferral. 

A taxpayer request (and follow-up 

submission) was received by the 

Treasury Department and the IRS 

regarding promulgating regulations that 

would provide that these statutory 

requirements do not apply for purposes 

of determining whether a foreign 

corporation satisfies the section 

1297(f)(1)(A) requirement that the 

corporation would be subject to tax 

under subchapter L if it were a domestic 

corporation (as well as for other PFIC 

purposes), if certain requirements are 

met. The request suggested an approach 

to the statutory requirements analogous 

to the approach Congress took in section 

953(e)(5). Section 953(e)(5) waives the 

statutory requirements for purposes of 

the subpart F insurance and foreign base 

company income rules if a contract is 

regulated as a life insurance or annuity 

contract in the issuer’s home country 

and no policyholder, insured, annuitant, 

or beneficiary with respect to the 

contract is a U.S. person. The request 

asserts that such a waiver is warranted 

for PFIC purposes because contracts 

issued by non-U.S. insurance companies 

are unlikely to satisfy the statutory 

requirements, since non-U.S. insurance 

companies that do not target sales to the 

U.S. market typically do not take the 

statutory requirements into account 

when setting the terms of their life 

insurance and annuity contracts. The 

request also states that local law 

requirements may in some cases conflict 

with the statutory requirements. The 

follow-up submission suggested that 

additional qualification rules could be 

imposed that restrict the rule to cases in 

which the issuing company meets 

substantial home country requirements 

(such as deriving more than 50 percent 

of its aggregate net written premiums 

from insuring or reinsuring home 

country risks of unrelated persons). 

The proposed regulations do not 

address the request as it is beyond the 

scope of the current rulemaking. The 

Treasury Department and the IRS are 

evaluating whether further guidance is 

necessary or appropriate regarding the 

application of these provisions in the 

context of PFICs and request comments 

on this issue. 

II. QIP’s 20-Year ADS Recovery Period 

Applies To Determine QBAI for FDII 

and GILTI 

The proposed regulations contain 

certain rules announced in Notice 2020– 

69. Proposed § 1.250(b)–2(e)(2) and 

proposed § 1.951A–3(e)(2) clarify that 

the technical amendment to section 168 

enacted in section 2307(a) of the CARES 

Act applies to determine the adjusted 

basis of property under section 

951A(d)(3) as if it had originally been 

4594 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

10The Treasury Department and the IRS 

requested comments on the need for a transition 

rule in Notice 2020–69. The Treasury Department 

and the IRS will consider comments that are timely 

submitted in response to the request for comments 

in Notice 2020–69, along with any comments 

received in response to this notice of proposed 

rulemaking, when finalizing proposed § 1.250(b)– 

2(e)(2) and proposed § 1.951A–3(e)(2). 

11The rule in proposed § 1.250(b)–2(e)(2) in this 

notice of proposed rulemaking applies to taxable 

years beginning after December 31, 2017 and before 

January 1, 2021 regardless of whether the taxpayer 

has relied on proposed §§ 1.250(a)–1 through 

1.250(b)–6 (as proposed in REG–104464–18, 84 FR 

8188), the final regulations under §§ 1.250(a)–1 

through 1.250(b)–6 under § 1.250–1(b) (T.D. 9901, 

85 FR 43042), or neither. 

part of section 13204 of the Act. The 

Treasury Department and the IRS have 

determined that this clarification is 

consistent with congressional intent. 

See JCT CARES Act Report at 69–70. 

The Treasury Department and the IRS 

request comments on whether a 

transition rule should be provided that 

would allow a corrective adjustment in 

the first taxable year ending after the 

date of publication in the Federal 

Register of the Treasury Decision 

adopting proposed § 1.250(b)–2(e)(2) 

and proposed § 1.951A–3(e)(2) as final 

regulations for taxpayers that took a 

position that is inconsistent with 

proposed § 1.250(b)–2(e)(2) and 

proposed § 1.951A–3(e)(2) on a return 

filed before September 1, 2020 and that 

do not file an amended return with 

respect to such year.10

Applicability Dates 

I. Applicability Dates Relating to the 

General PFIC Rules 

These regulations are proposed to 

apply to taxable years of United States 

persons that are shareholders in certain 

foreign corporations beginning on or 

after the date of filing of the Treasury 

Decision adopting these rules as final 

regulations in the Federal Register. 

However, until these regulations are 

finalized, taxpayers may rely on one or 

more of the following proposed rules 

with respect to a tested foreign 

corporation for any open taxable year 

beginning before the date of publication 

of the Treasury decision adopting these 

rules as final regulations in the Federal 

Register, provided they consistently 

follow each such rule for each 

subsequent taxable year beginning 

before the date of filing of the Treasury 

decision adopting these rules as final 

regulations in the Federal Register: 

Proposed § 1.1297–1(c)(1)(i)(B) 

(exceptions to section 954 not taken into 

account); proposed § 1.1297–1(c)(2) 

(exception for active banking income of 

certain foreign banks); proposed 

§ 1.1297–1(d)(1)(v)(D) (valuation of 

assets); proposed § 1.1297–1(d)(2) 

(regarding working capital); proposed 

§ 1.1297–2(b)(2)(ii)(A), (b)(3)(ii)(A), and 

(e)(4) (regarding application of 

exception for active banking income of 

certain foreign banks); proposed 

§ 1.1297–2(c)(2)(i) and (4)(ii)(A) 

(regarding not taking into account 

certain dividends); proposed § 1.1297– 

2(f)(1) and (2) (regarding gain on 

disposition of stock in a look-through 

subsidiary), and proposed § 1.1298–4(e) 

(regarding safe harbors to the domestic 

subsidiary anti-abuse rule). For a taxable 

year ending on or before December 31, 

2020, a taxpayer may rely on proposed 

§ 1.1297–1(c)(1)(A) of the 2019 proposed 

regulations concerning the application 

of section 954(h) rather than proposed 

§ 1.1297–1(c)(2) with respect to a tested 

foreign corporation, without regard to 

whether the taxpayer consistently 

applies all of the provisions of these 

proposed regulations or the 2019 

proposed regulations with respect to the 

tested foreign corporation. As discussed 

in greater detail in the preamble to the 

final regulations published in the Rules 

and Regulations section of this edition 

of the Federal Register (RIN 1545– 

BO59), when a tested foreign 

corporation no longer qualifies as a PFIC 

(due to a change in facts or law), the 

foreign corporation nonetheless retains 

its PFIC status with respect to a 

shareholder unless and until the 

shareholder makes an election under 

section 1298(b)(1) and § 1.1298–3 

(‘‘purging election’’) on Form 8621 

attached to the shareholder’s tax return 

(including an amended return), or 

requests the consent of the 

Commissioner to make a late election 

under section 1298(b)(1) and § 1.1298– 

3(e) (‘‘late purging election’’) on Form 

8621–A. 

II. Applicability Dates Relating to the 

Insurance Exception 

For a taxable year beginning after 

December 31, 2017 and before the date 

of filing of the Treasury Decision 

adopting these rules as final regulations 

in the Federal Register, taxpayers may 

rely on §§ 1.1297–4, 1.1297–5, and 

1.1297–6 of the proposed regulations 

with respect to a tested foreign 

corporation, provided they consistently 

follow the rules of §§ 1.1297–4, 1.1297– 

5, and 1.1297–6 of the proposed 

regulations with respect to such tested 

foreign corporation for such taxable year 

and for each subsequent taxable year 

beginning before the date of filing of the 

Treasury decision adopting these rules 

as final regulations in the Federal 

Register. In addition, taxpayers may rely 

on proposed § 1.1297–4(e)(4), provided 

they consistently apply § 1.1297–4 of 

the final regulations for the same taxable 

year. 

Alternatively, for a taxable year 

beginning after December 31, 2017 and 

before January 14, 2021, taxpayers may 

rely on proposed §§ 1.1297–4 and 

1.1297–5 of the 2019 proposed 

regulations with respect to a tested 

foreign corporation, provided they 

consistently apply the rules of proposed 

§§ 1.1297–4 and 1.1297–5 of the 2019 

proposed regulations with respect to 

such tested foreign corporation for such 

taxable year. 

III. Applicability Dates Relating to 

Regulations Under Sections 250 and 

951A 

Consistent with section 2307(b) of the 

CARES Act, the proposed regulations 

addressing QIP are proposed to apply 

retroactively. The modification to 

proposed § 1.951A–3(e)(2) is proposed 

to apply to taxable years of foreign 

corporations beginning after December 

31, 2017, and to taxable years of U.S. 

shareholders in which or with which 

such taxable years of foreign 

corporations end. The modification to 

proposed § 1.250(b)–2(e)(2) is proposed 

to apply to taxable years beginning after 

December 31, 2017.11 See section 

7805(b)(2). U.S. shareholders and 

domestic corporations (including any 

individuals that elect to apply section 

962) may, before the date of publication 

of the Treasury Decision adopting these 

rules as final regulations in the Federal 

Register, rely on proposed §§ 1.951A– 

3(e)(2) and 1.250(b)–2(e)(2) for any 

taxable year beginning after December 

31, 2017, provided they consistently 

apply those rules for purposes of FDII 

and GILTI under sections 250 and 951A 

to such taxable year and all subsequent 

taxable years. 

Special Analyses 

I. Regulatory Planning and Review— 

Economic Analysis 

Executive Orders 13771, 13563, and 

12866 direct agencies to assess costs and 

benefits of available regulatory 

alternatives and, if regulation is 

necessary, to select regulatory 

approaches that maximize net benefits, 

including potential economic, 

environmental, public health and safety 

effects, distributive impacts, and equity. 

Executive Order 13563 emphasizes the 

importance of quantifying both costs 

and benefits, reducing costs, 

harmonizing rules, and promoting 

flexibility. The Executive Order 13771 

designation for any final rule resulting 

from the final regulations will be 

informed by comments received. 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4595 

This proposed regulation has been 

designated by the Office of Information 

and Regulatory Affairs (OIRA) as subject 

to review under Executive Order 12866 

pursuant to the Memorandum of 

Agreement (MOA, April 11, 2018) 

between the Treasury Department and 

the Office of Management and Budget 

regarding review of tax regulations. 

OIRA has determined that the final 

rulemaking is significant and subject to 

review under Executive Order 12866 

and section 1(b) of the Memorandum of 

Agreement. Accordingly, the final 

regulations have been reviewed by 

OMB. 

A. Background 

The passive foreign investment 

company (PFIC) rules of the Internal 

Revenue Code address situations in 

which taxable U.S. persons indirectly 

hold assets that earn ‘‘passive income’’ 

(generally, interest, dividends, capital 

gains, and similar types of income) 

through a foreign corporation. If not 

subject to the PFIC rules, the income 

earned on these assets would be subject 

to U.S. tax only when that income is 

distributed as dividends by the foreign 

corporation or when shares of the 

foreign corporate stock are sold for a 

gain by the U.S. shareholder. If the 

income were subject to a low or zero 

rate of foreign tax, the U.S. investor 

would have a tax incentive to hold 

passive assets in this manner rather than 

hold the securities directly. By creating 

tax-deferral opportunities, these types of 

investment arrangements could 

significantly lower the effective tax rate 

on passive income ultimately received 

by participating U.S. investors. This 

potential result would decrease U.S. tax 

revenues and possibly lower the cost of 

capital faced by foreign and domestic 

corporations whose securities were held 

in this manner. 

A foreign corporation is considered a 

PFIC if at least 75 percent of the 

corporation’s gross income for a given 

taxable year is passive income or if 

assets that produce passive income, or 

that are held for the production of 

passive income, comprise at least 50 

percent of the corporation’s total assets. 

A PFIC is not subject to U.S. tax under 

the PFIC regime; rather, U.S. 

shareholders of a PFIC are subject to tax 

on a current, or current-equivalent, basis 

in proportion to their ownership share 

in the PFIC’s income. 

Passive income generally consists of 

dividends, interest, rents, royalties, 

annuities, gains on the sale of property 

that is not inventory or property used in 

an active business, and similar forms of 

income. Passive income is distinguished 

generally from non-passive income in 

that it is not earned in the active 

conduct of a trade or business by the 

foreign corporation, by a party closely 

affiliated with the foreign corporation, 

or by other corporations or partnerships 

that can be assumed to be controlled by 

the foreign corporation. 

The ‘‘subpart F’’ rules in the Code 

also address the taxation of passive 

income earned by foreign corporations 

but only in the context of U.S. 

controlled foreign corporations (CFCs), 

defined as being more than 50 percent 

owned by U.S. shareholders (where a 

U.S. shareholder of a CFC is a U.S. 

person owning at least ten percent of the 

vote or value of the foreign corporation’s 

shares). There is no such minimum 

ownership requirement for a U.S. 

shareholder of a PFIC. A PFIC that is 

also a CFC during a portion of a U.S. 

PFIC shareholder’s holding period is not 

treated as a PFIC with respect to a U.S. 

shareholder of a CFC during that portion 

of the holding period. 

A U.S. shareholder of a PFIC is 

responsible for determining its 

proportionate share of ownership in the 

PFIC and the appropriate amount of 

PFIC income to include on the 

shareholder’s tax return. The Code and 

regulations provide ownership 

attribution rules for determining 

indirect ownership of PFICs by U.S. 

persons and rules for determining 

amounts of a corporation’s annual total 

and passive income and the amounts of 

total and passive assets on each of 

several measuring periods (generally 

quarterly) throughout the year. 

Compliance with the PFIC regime 

requires an ability to negotiate its oftencomplicated rules and generally means 

that those willing to invest in potential 

PFICs are relatively sophisticated 

taxpayers that have access to 

professional tax advice in order to 

navigate the tax complexities presented 

by the PFIC regime. It is also possible 

that a less sophisticated taxpayer could 

invest in a PFIC without a full 

understanding of the tax treatment of 

that investment. 

The PFIC definition of passive income 

refers to the passive income definition 

of ‘‘foreign personal holding company 

income’’ (FPHCI) used for purposes of 

the CFC rules. That definition contains 

exceptions from passive income that 

involve certain income derived by a 

CFC in the active conduct of a banking 

or financing business and certain 

income derived by a CFC in the active 

conduct of an insurance business. 

However, the PFIC statutory rules have 

separate exceptions from the definition 

of passive income that include any 

income ‘‘derived in the active conduct 

of a banking business by an institution 

licensed to do business as a bank in the 

United States (or, to the extent provided 

in regulations, by any other 

corporation)’’ and any income ‘‘derived 

in the active conduct of an insurance 

business by a qualifying insurance 

corporation.’’ Regulations under the 

PFIC banking exception were proposed 

in 1995 (the ‘‘1995 proposed 

regulations’’) to provide greater clarity 

and additional specification of this 

exception to passive income. These 

1995 proposed regulations have not 

been finalized. Regulations under the 

PFIC insurance exception were 

proposed in 2015 to clarify further the 

meaning of ‘‘active conduct’’ in this 

context, but these regulations have not 

been finalized. More recently, the Tax 

Cuts and Jobs Act (TCJA) of 2017 

amended the statutory provision by 

requiring that the PFIC insurance 

exception applies only to an insurance 

business conducted by a qualifying 

insurance corporation (QIC) and 

provided a statutory definition of a QIC. 

The Treasury Department and the IRS 

previously published proposed 

regulations pertaining to sections 1291, 

1297, and 1298 of the Code (the ‘‘2019 

proposed regulations’’). See 84 FR 

33120. These regulations dealt with 

several general PFIC implementation 

issues and with the new requirement 

(beginning in 2018) that a foreign 

corporation must be a QIC for its 

insurance-related income to qualify as 

non-passive under the insurance 

business exception. Regulations to 

finalize these proposed regulations (the 

‘‘2020 final regulations’’) are being 

published contemporaneously with 

these newly proposed regulations 

(‘‘these regulations’’ or the ‘‘2020 

proposed regulations’’). See TD 9936. 

Upon further reflection on certain 

issues, and in response to public 

comments received with respect to the 

2019 proposed regulations, certain 

revised rules and additional 

specifications are being re-proposed. 

B. Need for the Proposed Regulations 

These regulations are needed because 

a number of the details behind the 

relevant terms and necessary 

calculations required for the 

determination of PFIC status would 

benefit from greater specificity beyond 

that provided by the 2020 final 

regulations. In particular, these 2020 

proposed regulations further clarify the 

determination of the banking and 

insurance ‘‘active conduct’’ statutory 

exceptions to the definition of passive 

income. 

4596 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

C. Economic Analysis 

This economic analysis provides a 

summary of the economic effects of the 

regulations relative to the no-action 

baseline. It further analyzes, first, 

proposed regulations under the general 

rules that implement the exception from 

passive income for income derived in 

the active conduct of a banking business 

and, second, proposed regulations 

under the passive income exception for 

income earned in the active conduct of 

an insurance business by a qualifying 

insurance corporation (QIC). This latter 

analysis covers, in particular, elements 

of these proposed regulations as they 

relate to the primary test ratio that must 

be satisfied by a QIC. This test requires 

measurement of certain applicable 

insurance liabilities (AIL) and total 

assets of a tested corporation. 

1. Baseline 

In this analysis, the Treasury 

Department and the IRS assess the 

benefits and costs of these regulations 

relative to a no-action baseline reflecting 

anticipated Federal income tax-related 

behavior in the absence of these 

proposed regulations. 

2. Summary of Economic Effects 

These 2020 proposed regulations will 

provide improved certainty and 

consistency in the application of 

sections 1297 and 1298 of the Internal 

Revenue Code with respect to passive 

foreign investment companies (PFICs) 

and qualified insurance corporations 

(QICs) by providing definitions and 

clarifications regarding application of 

the statute’s terms and rules. Efficient 

investment requires planning, and good 

planning requires knowledge of the 

proper and consistent application of tax 

rules. Furthermore, uncertainty 

regarding the applicability of tax rules 

invites aggressive taxpayer 

interpretations and increased 

enforcement costs, including increased 

litigation. 

Divergence in taxpayers’ 

interpretations of the statute can cause 

similarly situated U.S. persons to 

allocate investment funds differently. If 

economic investment is not guided by 

uniform tax incentives, the resulting 

pattern of investment may be inefficient, 

leading to relatively lower incomes. By 

providing clarity to the law and greater 

uniformity in its application, the 2020 

proposed regulations, when finalized, 

will help to ensure that similar 

economic activities are taxed similarly. 

Thus, the Treasury Department and the 

IRS expect that the definitions and 

guidance provided in the proposed 

regulations will lead to an improved 

allocation of investment among U.S. 

taxpayers as well as more equitable 

treatment of those taxpayers. 

To the extent that certain regulatory 

provisions provide greater opportunities 

for foreign corporations to avoid PFIC 

status relative to the no-action baseline, 

they provide U.S. investors with 

additional tax deferral opportunities 

relative to a no-action baseline. An 

increased use of these tax deferral 

opportunities would decrease effective 

shareholder taxes and generally lower 

the cost of real investment by both 

domestic businesses and foreign 

corporations for which U.S. investors 

are investment funding sources. This 

would likely increase such investment 

and thereby increase U.S. GNP relative 

to the no-action baseline. However, such 

actions would reduce U.S. tax revenues, 

although this effect could be offset to a 

degree by increased taxable capital gains 

due to a resultant increase in the 

valuation of corporate equities. 

To the extent that other provisions of 

the regulations reduce the opportunities 

for foreign corporations to avoid PFIC 

status, they would eliminate deferral by 

U.S. persons and thereby increase U.S. 

shareholder tax burdens. This may 

dissuade U.S. persons from pursuing 

profitable investment opportunities in 

active foreign corporations that would 

be sought under a no-action baseline. 

Such provisions also could cause some 

active foreign corporations to incur 

additional economic costs in order to 

avoid designations as PFICs, resulting in 

lower investment returns and less 

investment in such corporations. The 

avoidance of otherwise profitable 

foreign investment opportunities by 

U.S. persons can result in a loss of U.S. 

GNP. 

It is unclear whether these proposed 

regulations have a net effect of 

increasing or decreasing the ability of 

foreign corporations to avoid PFIC 

status relative to the no-action baseline. 

The Treasury Department and the IRS 

have not estimated the differences in 

economic activity that might result from 

implementation of these proposed 

regulations relative to alternative 

regulatory approaches, including the noaction baseline. They do not have 

readily available data or models that 

capture in sufficient detail the economic 

activities that taxpayers might 

undertake under each of these 

regulatory approaches. The Treasury 

Department and the IRS have similarly 

not estimated the differences in 

compliance costs of U.S. persons or IRS 

administrative burden that would arise 

under each of the alternative regulatory 

approaches because they do not have 

readily available data or models that 

capture these aspects in sufficient 

detail. 

The Treasury Department and the IRS 

solicit comments on this economic 

analysis and particularly solicit data, 

models, or other evidence that could be 

used to enhance the rigor with which 

the final regulations are developed. 

3. Economic Analysis of Specific 

Provisions 

a. Income Derived in the Active 

Conduct of a Banking Business 

The PFIC provisions define passive 

income as income which is of a kind 

that would be foreign personal holding 

company income (FPHCI) as defined in 

section 954(c), which is part of the 

subpart F rules of the Internal Revenue 

Code. A related provision, section 

954(h), excludes from FPHCI for subpart 

F purposes the ‘‘qualified banking or 

financing income’’ of an ‘‘eligible 

controlled foreign corporation,’’ that is, 

a CFC that is predominantly engaged in 

the active conduct of a banking, 

financing, or similar business and that 

conducts substantial activity with 

respect to such business. A banking, 

financing or similar business includes 

(i) a lending or finance business, (ii) a 

banking business conducted by an 

institution that is licensed to do 

business as a bank in the United States 

or is a corporation specified in 

regulations, and (iii) a securities 

business conducted by a corporation 

that is either registered with the SEC as 

a securities broker or dealer or is 

otherwise specified in regulations. 

The 2019 PFIC proposed regulations 

would have incorporated this section 

954(h) exception to FPHCI into the 

definition of passive income for the 

purpose of the PFIC rules. However, the 

Treasury Department and the IRS 

subsequently determined that this 

exception does not apply for purposes 

of the PFIC definition of passive income 

absent regulations and that any such 

regulations should be issued under the 

separate PFIC statutory rule described in 

the next paragraph. Accordingly, these 

2020 proposed regulations specify that 

the FPHCI exception for active banking 

income of CFCs is not to be taken into 

account in the general definition of 

passive income for the purpose of the 

PFIC regime. 

The Treasury Department and the IRS 

considered two options for the 

implementation of an active banking 

exception under the PFIC tax regime. 

The first alternative would re-propose 

the 1995 proposed regulations. The 

second alternative would adopt the 

statutory rules of the FPHCI exception 

for CFCs, with modifications (such as 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4597 

not limiting the rule to CFCs). Each 

alternative is discussed in turn. 

i. 1995 Proposed Regulations 

The 1995 proposed regulations treat 

‘‘banking income’’ of ‘‘active banks’’ and 

‘‘qualified bank affiliates’’ as nonpassive. An active bank is either a 

domestic or foreign corporation that is 

licensed by federal or state regulators to 

do business as a bank in the United 

States or a foreign corporation that 

satisfies the following requirements: 

1. It must be licensed or authorized to 

accept deposits from its home country 

residents and must actively conduct a 

banking business; 

2. It must regularly accept such 

deposits in the ordinary course of 

business; in addition, the amount of 

deposits shown on the corporation’s 

balance sheet must be substantial; and 

3. It must regularly make loans to 

customers in the ordinary course of 

business. 

Banking income is defined as gross 

income that is derived from the active 

conduct of a specified banking activity. 

The regulations list 14 banking activities 

(plus a provision that allows the IRS 

Commissioner to specify additional 

banking activities). The major activities 

listed include lending activities, the 

purchasing or selling of notes or other 

debt instruments for customers, issuing 

of letters of credit, performing trust 

services, arranging foreign exchange 

transactions, interest rate or currency 

futures, etc., underwriting issues of 

securities for customers, engaging in 

finance leases, and providing credit card 

services. 

The 1995 proposed regulations also 

extend the banking income definition to 

certain affiliates of active banks that are 

not themselves active banks. To be a 

qualified bank affiliate, at least 60 

percent of a foreign corporation’s gross 

income must be income that qualifies as 

non-passive income under the PFIC 

active conduct exceptions. In addition, 

a qualified bank affiliate must be a 

member of an affiliated group (based on 

an affiliation ownership standard of 

more than 50 percent voting power), 

and at least 30 percent of the group’s 

‘‘aggregate gross financial services 

income’’ (defined in foreign tax credit 

regulations) must be banking income 

earned by active banks that are group 

affiliates. Also, at least 70 percent of 

such group income must be income 

excepted under the PFIC active conduct 

rules. 

ii. FPHCI Exception for Banking, 

Finance, or Similar Income of CFCs 

The FPHCI exception, while limited 

to eligible CFCs, applies to a broader 

group of eligible corporations and 

qualified financial activities than the 

1995 proposed regulations for banking 

income. The FPHCI rules for CFCs 

define an eligible business as including 

a banking business, a securities 

business, and a ‘‘lending or finance’’ 

business. While the FPHCI statutory 

rules include identical language 

regarding banks as does the PFIC 

statutory exception; neither set of 

statutory rules specifically define 

eligible banks, leaving the definition to 

regulations. 

The FPHCI exception for CFCs applies 

to qualified banking or financing 

income. A CFC that is not engaged in a 

banking or securities business must 

derive more than 70 percent of its gross 

income from a lending or finance 

business with unrelated customers. A 

‘‘lending or finance’’ business includes 

a business that is making loans, 

purchasing or discounting accounts 

receivable or certain other assets, 

engaging in leasing, issuing letters of 

credit or providing guarantees, 

providing credit card services, and 

rendering services related to the other 

listed activities. This list is similar to, 

but not the same as, the list of banking 

activities provided in the 1995 proposed 

regulations. 

Qualified banking or other financing 

income can be derived in the active 

conduct of a branch or other ‘‘qualified 

business unit’’ (QBU) of an eligible CFC. 

A QBU is a separate and clearly 

identified unit that maintains its own 

separate books and records. Qualified 

banking or financing income must be 

derived from transactions with 

customers located in a country other 

than the United States. Substantially all 

of the activities of the business must be 

conducted directly by the corporation in 

its home country, or by its QBU in the 

home country of the QBU. There are no 

similar requirements in the 1995 

proposed regulations. Under the FPHCI 

exception for CFCs, business activity 

may include the activity of the 

employees of a related CFC located in 

the same home country as that of the 

corporation or QBU, provided the 

activity is conducted in the home 

country of the related person. Unlike the 

1995 proposed regulations, the FPHCI 

exception for CFCs does not treat 

income of affiliates of an eligible CFC 

that are not themselves eligible CFCs as 

non-passive income. 

iii. 2020 Proposed Regulations— 

Definition of a Foreign Bank 

The 2020 proposed regulations 

generally adopt the approach taken 

under the FPHCI statutory language but 

substitute a tested foreign corporation 

(TFC) (or a related person of the TFC) 

for a CFC. As in the case of the PFIC 

banking exception adopted in the 1995 

proposed regulations, the 2020 

proposed regulations apply only to 

foreign banks. 

Similar to the ‘‘active bank’’ 

definition of the 1995 regulations, the 

2020 proposed regulations require a 

‘‘foreign bank’’ to be either licensed as 

a bank in the United States or as a bank 

in the country in which it is chartered 

or incorporated (its ‘‘home country’’). 

The 2020 proposed regulations also 

require that a foreign bank accept bank 

deposits from home country residents, 

and indirectly incorporate the 

‘‘substantial deposits’’ requirement of 

the 1995 proposed regulations. Unlike 

the 1995 proposed regulations, the 2020 

proposed regulations do not require a 

foreign bank to regularly make loans to 

customers in the ordinary course of its 

business. Instead, the bank must carry 

out with unrelated customers one or 

more of the activities listed in the 

FPHCI statute that constitute a lending 

or finance business. One of those 

activities is the making of loans, but a 

foreign bank can have as its business 

activity any of the other listed finance 

business activities in order to qualify for 

the PFIC banking exception. This 

change in the definition of a qualifying 

foreign bank may be a significant 

difference from the 1995 proposed 

regulations, depending on what 

activities are required of and permitted 

to be carried out by a bank under bank 

regulatory rules. If bank regulatory rules 

do not require a bank to make loans to 

customers as part of a banking business, 

the definition of foreign bank may 

represent a broadening of the type of 

institutions that may qualify for an 

exception under the PFIC active 

conduct exception for banking 

compared to the 1995 proposed 

regulations. 

In contrast to the 1995 proposed 

regulations, the 2020 proposed 

regulations provide that the banking 

exception applies separately to the 

income and activities of a qualified 

branch (i.e., a QBU) of a foreign bank. 

Depending on the activities of a branch, 

this may either increase or decrease the 

likelihood that income of a foreign bank 

is treated as non-passive. 

iv. 2020 Proposed Regulations—Banking 

Income 

While it may be easier to qualify as a 

foreign bank under the 2020 proposed 

regulations than as an active bank under 

the 1995 proposed regulations, the 

conditions that must be satisfied in 

order to treat income as qualified 

banking or financing income eligible for 

4598 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

the FPHCI exception are more stringent 

than the requirements for treating 

income as banking income under the 

1995 proposed regulations. The 2020 

proposed regulations require that 

substantially all activities that produce 

active banking income must be 

performed by the TFC or its QBU in the 

home country of the bank or that of the 

QBU, respectively. However, an 

affiliated entity can provide employees 

to perform the requisite activity, but 

only if the affiliate is created or 

organized in the relevant home country 

and the activity is performed in the 

home country of the related person. No 

such requirement exists under the 1995 

proposed regulations. This home 

country activity requirement limits the 

variety of organizational structures that 

foreign banks may use in order to 

qualify for the new PFIC banking 

exception. If a bank must restructure its 

operations in order to satisfy the homecountry requirement, this might be 

considered a significant PFIC 

compliance cost by foreign banks and 

therefore it may impact the investment 

choices of U.S. persons. 

In addition, under the FPHCI 

exception, eligible income must be 

derived in transactions with customers 

located in a country other than the 

United States. Relative to the 1995 

regulations, this rule imposes an 

additional compliance burden on 

foreign corporations that desire to 

access the U.S. investment community. 

It requires them to distinguish income 

derived from U.S.-based customers from 

income derived from other customers. 

v. 2020 Proposed Regulations— 

Affiliates 

Under the 2020 final regulations, a 

tested foreign corporation (TFC) that 

owns at least 25 percent (by value) of a 

corporation or partnership may be 

treated as if it held its proportionate 

share of the assets of the look-through 

subsidiary (LTS) or look-through 

partnership (LTP) and received its 

proportionate share of the income of the 

LTS or LTP. The income and assets of 

the subsidiary entity are treated as 

passive or non-passive in the hands of 

the TFC in the same manner as such 

items are treated in the hands of the LTS 

or LTP. In general, an exception to the 

passive income rules applies to income 

of an LTS or LTP only if the exception 

would have applied to exclude the 

income from passive income in the 

hands of the LTS or LTP. For this 

purpose, the activities of a specified 

affiliated group of entities that includes 

the TFC may be taken into account to 

judge the active conduct nature of the 

LTS’s or LTP’s income. 

Under certain conditions, the 1995 

proposed regulations permit the banking 

income of a qualified bank affiliate to be 

treated as non-passive income for the 

purpose of determining the PFIC status 

of its affiliated companies. No similar 

rule applies under the 2020 proposed 

regulations for bank affiliates. Thus, for 

banking income of an LTS to be treated 

as excepted income, the LTS must itself 

be an eligible foreign bank. 

The income of an LTS that is a U.S. 

bank conducting business with U.S. 

residents does not qualify as having 

excepted income under the 2020 

proposed regulations. Such a bank 

would likely qualify as an active bank 

under the 1995 proposed regulations 

and, under the look-through rules, that 

income would be considered nonpassive in the hands of the TFC. In this 

respect the 2020 proposed regulations 

make it more difficult for certain foreign 

corporations to avoid PFIC status 

relative to the 1995 proposed 

regulations. 

vi. Summary of Economic Effects 

The Treasury Department and the IRS 

expect that the 2020 proposed 

regulations may produce different 

outcomes relative to the no-action 

baseline. However, whether ‘‘on net’’ 

these different outcomes make it more 

difficult for income of certain foreign 

corporations to qualify as non-passive 

under the banking active conduct 

exception or make it more likely that 

income of foreign banking institutions 

will be treated as non-passive depends 

heavily on the individual facts and 

circumstances of the TFC and its 

affiliates, so that no general conclusion 

can be drawn in that regard. 

b. Applicable Financial Statement and 

Applicable Insurance Liabilities 

For PFIC purposes, passive income 

does not include income derived in the 

active conduct of an insurance business 

by a qualifying insurance corporation 

(QIC). Under the statute, a QIC must 

have ‘‘applicable insurance liabilities’’ 

(AIL) that constitute more than 25 

percent of its total assets (the ‘‘QIC 

test’’). AIL generally include amounts 

shown on a financial statement for 

unpaid loss reserves (including unpaid 

loss adjustment expenses) of insurance 

and reinsurance contracts and certain 

life and health insurance reserves and 

unpaid claims with respect to contracts 

providing coverage for mortality or 

morbidity risks. 

i. Definition of an AFS 

For the purpose of the QIC test, AIL 

are based on insurance liabilities as they 

are accounted for on the taxpayer’s 

applicable financial statement (AFS). 

Under the statute and the 2020 final 

regulations, an AFS is a financial 

statement prepared for financial 

reporting purposes that is based on U.S. 

generally accepted accounting 

principles (GAAP), or international 

financial reporting standards (IFRS) if 

there is no statement based on GAAP. If 

neither of these statements exist, then 

an AFS can be an annual statement that 

is required to be filed with an applicable 

insurance regulatory body. Such a 

statement would be one that is prepared 

on the basis of a local regulatory 

accounting standard. Thus, the statute 

has a preference for financial statements 

prepared on the basis of GAAP or IFRS, 

which are rigorous and widelyrespected accounting standards, but will 

permit a foreign corporation to have an 

AFS that is prepared on the basis of a 

local regulatory accounting standard if 

the foreign corporation does not do 

financial reporting based on GAAP or 

IFRS. 

This definition of an AFS does not 

necessarily produce a single financial 

statement that can be deemed ‘‘the’’ 

AFS of a foreign insurance company. 

GAAP and IFRS statements may be 

prepared for several financial reporting 

purposes, and there may be differences 

in the value of assets or in the 

presentation of results, depending on 

the purpose and jurisdiction for which 

it is prepared. This may be particularly 

true in the case of a financial statement 

filed with local regulatory bodies. For 

example, a company that operates 

branches in more than one jurisdiction 

may be filing multiple regulatory 

financial statements, each based on a 

separate local accounting standard. This 

variability may be tempered, however, if 

the local regulatory authorities require 

their regulatory statements to be filed on 

a GAAP or IFRS basis. 

The Treasury Department and the IRS 

determined that it was appropriate to 

modify the definition of AFS in order to 

impose greater structure on the 

identification of the AFS used for 

purposes of the QIC test. These 2020 

proposed regulations refine the 

definition of a financial statement to 

ensure that an AFS includes a complete 

balance sheet, statement of income, a 

statement of cash flows and related 

exhibits, schedules, forms, and 

footnotes that are normal components of 

such a filing. A complete financial 

statement is more likely to present an 

accurate picture of a company’s 

financial position. These 2020 proposed 

regulations also require that an AFS be 

an audited financial statement. While an 

audit requirement may impose 

additional accounting costs on the 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4599 

foreign corporation (and, therefore, on 

its shareholders), a financial statement 

reviewed by independent auditors 

insures adherence to the relevant 

accounting standard. The Treasury 

Department and the IRS have 

determined that local jurisdictions 

generally will require audited financial 

statements to be filed with insurance 

regulatory bodies, so that this 

requirement should not impose a 

significant additional compliance 

burden on foreign corporations. 

The 2020 proposed regulations 

impose a new set of sub-priorities on 

financial statements prepared under 

GAAP and a similar set of sub-priorities 

on statements prepared under IFRS. 

These sub-priorities have been used in 

other regulatory contexts. They are 

based on the purpose for which a 

financial statement is being released or 

filed. In the opinion of the Treasury 

Department and the IRS, these different 

priorities represent the reliability of the 

statement. Thus, a GAAP statement filed 

by publicly regulated corporations with 

the Securities and Exchange 

Commission or with an equivalent 

foreign agency is deemed highly reliable 

and is preferred to a statement that is 

used, say, for credit purposes or for 

reporting in shareholder reports. 

The new rule narrows the potential 

number of financial statements that 

might be considered as AFSs relative to 

the no-action baseline and should 

thereby reduce compliance and tax 

administrative costs, while bringing 

taxpayer behavior closer in line with the 

intent and purpose of the statute. 

If an AFS is a consolidated financial 

statement in which the tested 

corporation is not the parent, such 

statement could include AIL and assets 

of the parent, as well as AIL and assets 

of other sibling corporations. 

Nevertheless, under the 2020 final 

regulations, the amount of AIL on an 

AFS that can be AIL for the purpose of 

the QIC test includes only the AIL of the 

corporation being tested. Consequently, 

the 2020 proposed regulations stipulate 

that a financial statement that includes 

parent and sibling assets and liabilities 

cannot be an AFS unless it is a financial 

statement filed with a local regulator 

and is the only such financial statement 

available, in which case the AIL as 

reported on the statement would have to 

be adjusted to remove the double 

counted parental and sibling AIL. This 

rule is expected to reduce the likelihood 

that the AIL shown on an AFS would 

have to be adjusted prior to the 

application of the QIC test and thereby 

reduce compliance costs relative to 

alternative regulatory approaches. The 

Treasury Department and the IRS have 

not estimated this reduction in 

compliance costs because they do not 

have data or models with this level of 

specificity. 

If more than one financial statement 

exists for an AFS subcategory and that 

subcategory is the highest priority 

subcategory of AFS for which an AFS is 

available, then the 2020 proposed 

regulations dictate that any financial 

statement prepared on a nonconsolidated basis has priority over a 

statement prepared on a consolidated 

basis. In most cases, a non-consolidated 

AFS will be preferred by the tested 

corporation because assets of the tested 

corporation will generally include the 

corporation’s net equity share of its 

subsidiaries and not the full value of its 

assets. A consolidated statement will 

include all assets and liabilities of 

lower-tiered subsidiaries (whether fully 

or partially owned) other than 

eliminated items that represent intracorporate transactions when viewed 

from a consolidated perspective. 

Nevertheless, AIL eligible to be taken 

into account for purposes of the QIC test 

includes only AIL of the tested 

corporation. Therefore, use of a 

consolidated AFS requires that any AIL 

of entities other than the tested 

corporation (such as subsidiaries) that 

are recorded on the consolidated 

statement must be eliminated for the 

purpose of the QIC test. Because this 

would bias downward the QIC test 

statistic (because the subsidiary assets 

supporting these eliminated AIL remain 

on the AFS), the 2020 proposed 

regulations allow a tested corporation to 

reduce its assets by the amount of AIL 

that are eliminated for this reason. 

Any AIL of the tested corporation that 

have been eliminated because of the 

preparation of a consolidated statement 

(for example, if the tested corporation 

had insured or reinsured a subsidiary) 

are not added back to the AIL reported 

on the AFS. The corresponding 

subsidiary assets have also been 

eliminated in the preparation of the 

consolidated AFS, so that the reverse 

process of that described in the previous 

paragraph is accomplished 

automatically. 

ii. Limitations on Applicable Insurance 

Liabilities 

Pursuant to statutory mandate and 

explicitly granted regulatory authority, 

the 2020 final regulations specify that 

any amount of AIL used in the QIC test 

cannot exceed the smallest of following 

three amounts: 

(1) The amount of AIL of the tested 

corporation shown on any financial 

statement that is filed or required to be 

filed with the corporation’s applicable 

insurance regulatory body; 

(2) The amount of AIL determined on 

an AFS that is prepared on the basis of 

GAAP or IFRS, whether or not such 

statement is filed by the tested 

corporation with its applicable 

insurance regulatory body; 

(3) The amount of AIL required by 

law or regulation to be held by the 

tested corporation (or a lesser amount, 

if the corporation is holding a lesser 

amount as a permitted practice of the 

applicable insurance regulatory body). 

These limitation amounts may induce 

local regulators to require the filing of 

financial statements based on GAAP or 

IFRS instead of filing statements based 

on a local regulatory accounting 

standard. Such actions would eliminate 

limitation amount 1) above, and 

assuming that limitation amount 3) does 

not apply, would leave the amount of 

AIL reported on a GAAP- or IFRSprepared statement as the relevant AIL. 

This approach will improve the 

application of the QIC test, relative to 

the no-action baseline, by increasing the 

likelihood that AIL and total assets are 

both derived from consistent accounting 

principles by the tested corporations 

affected by the PFIC insurance rules. 

A tested corporation that has an AFS 

based on GAAP or IFRS may be required 

to file a financial statement with its 

home country regulator using local 

statutory accounting rules, where the 

AIL on the latter statement are less than 

those shown on the AFS. The difference 

in AIL could perhaps be due to the use 

of dissimilar accounting rules, the use of 

different discounting assumptions or 

other assumptions regarding the 

measurement of liabilities, or disparate 

methods of valuing assets. Under the 

2020 proposed regulations, such 

accounting differences are not 

accounted for by prescribed asset 

adjustments or by other means. 

As a regulatory alternative, the 

Treasury Department and the IRS 

considered whether to require asset or 

liability adjustments based on certain 

identified differences between an AFS 

based on GAAP or IFRS and a financial 

statement based on local accounting 

standards, where the differences were 

due solely to different accounting 

standard requirements. For example, in 

preparing the 2020 final regulations, the 

Treasury Department and the IRS 

considered imposing the discounting 

rules specified by the Code for 

measuring property and casualty unpaid 

losses for domestic tax purposes on 

losses measured on a non-GAAP or nonIFRS basis. Such an option was rejected 

due partly to its anticipated heavy 

compliance costs (and thus the 

4600 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

possibility that the foreign corporation 

may not take the steps necessary to 

attract U.S. investors) without any 

accompanying, identifiable general 

economic benefit. The Treasury 

Department and the IRS determined that 

prescribing other requirements or 

adjustments could have similar 

compliance costs and that the impacts 

of such accounting discrepancies on the 

QIC test ratio are generally either 

unknown or without a consistent bias. 

In this regard, the Treasury Department 

and the IRS further determined that they 

did not have and could not practically 

obtain sufficient information regarding 

the differences among GAAP, IFRS, and 

the various local accounting standard 

requirements that might apply to tested 

corporations in different foreign 

jurisdictions to formulate additional 

appropriate rules. 

iii. Reinsurance Recoverable 

In the context of reinsurance, 

however, the differences in the 

measurement of AIL and assets under 

different accounting standards are in 

some cases due merely to a different 

presentation of the accounting results 

with respect to reinsurance, rather than 

more fundamental differences in 

measurement or accounting methods. 

Companies that have ceded business to 

another insurer under a contract of 

reinsurance will have amounts 

recoverable from those reinsurers that 

could represent a reimbursement of AIL. 

These amounts may be related to claims 

that have been paid or unpaid. 

Generally, if the insurer has paid a 

claim, the reinsurance recoverable is 

shown as a receivable (that is, an asset) 

on its balance sheet. However, the 

treatment of amounts recoverable with 

respect to unpaid losses and unpaid loss 

adjustment expenses can differ amongst 

different accounting standards. For 

example, under current GAAP, 

reinsurance recoverable with respect to 

unpaid claims is reported as an asset. 

The same is true under IFRS 17 (an 

insurance accounting standard that will 

be effective generally beginning in 

2023), where a single reinsurance asset 

may be reported with respect to both 

paid and unpaid claims. The situation is 

different under U.S. statutory 

accounting rules as specified by the 

National Association of Insurance 

Commissioners and implemented by the 

various states. Under U.S. statutory 

accounting, reinsurance recoverable for 

unpaid losses and loss adjustment 

expenses is treated as an offset to the 

unpaid loss reserves and would thus 

reduce AIL. It is likely that some nonU.S. local statutory accounting 

standards similarly reduce unpaid loss 

reserves (and thus AIL) by amounts 

recoverable through reinsurance. 

Measuring AIL on a ‘‘gross’’ basis, as 

under GAAP and IFRS 17, necessarily 

increases the QIC test ratio relative to a 

‘‘net’’ AIL measure. However, if the 

local accounting standard governing the 

financial statement filed with an 

applicable regulatory body requires a 

‘‘net’’ measure of AIL, then the AIL of 

the GAAP- or IFRS-based AFS will 

generally be limited for the purpose of 

the QIC test. 

Reporting AIL on a ‘‘gross’’ basis 

could enable a foreign insurer to raise 

its QIC test ratio to almost any desired 

level simply by being a reinsurance 

conduit (that is by reinsuring business 

and then retroceding all, or virtually all, 

of that business to other reinsurers). 

Such a possibility could allow 

corporations that might otherwise be 

designated as PFICs instead to qualify as 

QICs and thereby avoid PFIC status. 

For these reasons the 2020 proposed 

regulations specify that amounts 

recoverable from reinsurance and 

related to AIL, if reported as assets on 

a financial statement of the tested 

corporation, must be subtracted from 

the reported AIL. That is, all AIL are to 

be determined on a ‘‘net’’ basis with 

respect to reinsurance recoverable. 

Furthermore, if such reinsurance 

amounts are recoverable from an 

insurance subsidiary of the tested 

corporation, and such amounts of 

reinsurance recoverable are eliminated 

in the preparation of a consolidated 

financial statement, the AIL of the tested 

corporation nevertheless must be 

reduced by the recoverable amount. 

Under the 2020 proposed regulations, 

total assets reported on the AFS of the 

tested corporation may be reduced by 

amounts equal to the reductions in AIL 

for the purpose of the QIC test. 

4. Number of Potentially Affected 

Taxpayers 

An entity must file a separate Form 

8621 for each PFIC for which it has an 

ownership interest. The accompanying 

table indicates how many entities have 

filed at least one form 8621 between 

2016 and 2018. These data are based on 

IRS master files of tax return filings and 

do not encompass late filings that have 

not yet been received. For 2018, nearly 

62,000 Forms 8621 were filed. Over 70 

percent of the entities filing a Form 

8621 are individuals, although certain 

individuals are exempt from filing a 

Form 8621 if their aggregate holdings 

are less than $25,000 ($50,000 if filing 

a joint return) and they do not have 

PFIC income to report. Another 27 

percent are pass-through entities, the 

overwhelming number of which are 

partnerships, but which also include S 

corporations, estates, and non-grantor 

trusts. These pass-through entities 

primarily have individuals as partners, 

shareholders, or beneficiaries. It is 

possible there is some double counting 

whereby both partnerships and partners 

are filing a Form 8621 for the same 

PFIC. C corporations comprise just over 

one percent of total entities, while 

another nearly two percent of Forms 

8621 do not identify on the form the 

filing status of the filer. 

In general, only the taxpayer that is 

the lowest tier U.S. entity owning a 

PFIC needs to file a Form 8621. Thus, 

an individual that is a PFIC shareholder 

because he or she owns an interest in a 

U.S. partnership that holds shares of a 

PFIC does not need to file a Form 8621 

if the individual is not required to 

report PFIC-related income on the Form 

8621. This may happen if, for example, 

the individual and the partnership have 

made a Qualifying Electing Fund (QEF) 

election with respect to the PFIC. In that 

case, only the partnership files the Form 

8621. The partnership records the QEF 

income for the year, and that taxable 

income is reported to the taxpayer as 

part of his or her distributive share of 

partnership income. 

TABLE

Number of entities filing Form 8621 

2016 2017 2018 

Individuals .................................................................................................................................... 36,978 40,891 43,406 

Passthrough Entities .................................................................................................................... 15,326 16,133 16,607 

C Corporations ............................................................................................................................. 713 733 739 

Unreported Filer Type .................................................................................................................. 1,114 1,053 1,084 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4601 

TABLE—Continued 

Number of entities filing Form 8621 

2016 2017 2018 

All Entities ............................................................................................................................. 54,131 58,810 61,836 

In 2018, each reporting taxpaying 

entity filed an average of 12 Forms 8621. 

This average was 11 forms per entity for 

individuals, 16 forms per entity for 

partnerships and other pass-through 

entities, and 28 forms per entity for C 

corporations. 

The Treasury Department and the IRS 

do not have information in current tax 

filings regarding how many 

shareholders own shares in qualifying 

insurance companies or qualifying 

banks. 

5. Regulatory Flexibility Act 

It is hereby certified that these 

proposed regulations will not have a 

significant economic impact on a 

substantial number of small entities 

within the meaning of section 601(6) of 

the Regulatory Flexibility Act (5 U.S.C. 

chapter 6). The proposed regulations 

provide guidance with respect to the 

statutory provisions in sections 1291 

through 1298 (the ‘‘PFIC regime’’), 

which generally affect U.S. taxpayers 

that have ownership interests in foreign 

corporations that are not CFCs. The 

proposed regulations do not impose any 

new costs on taxpayers. Consequently, 

the Treasury Department and the IRS 

have determined that the proposed 

regulations will not have a significant 

economic impact on a substantial 

number of small entities. 

Notwithstanding this certification, the 

Treasury Department and the IRS invite 

comments on the impact of these rules 

on small entities. 

Pursuant to section 7805(f), this 

notice of proposed rulemaking has been 

submitted to the Chief Counsel for 

Advocacy of the Small Business 

Administration for comment on its 

impact on small business. The Treasury 

Department and the IRS request 

comments on the impact of these 

proposed regulations on small business 

entities. 

II. Unfunded Mandates Reform Act 

Section 202 of the Unfunded 

Mandates Reform Act of 1995 (UMRA) 

requires that agencies assess anticipated 

costs and benefits and take certain other 

actions before issuing a final rule that 

includes any Federal mandate that may 

result in expenditures in any one year 

by a state, local, or tribal government, in 

the aggregate, or by the private sector, of 

$100 million in 1995 dollars, updated 

annually for inflation. This rule does 

not include any Federal mandate that 

may result in expenditures by state, 

local, or tribal governments, or by the 

private sector in excess of that 

threshold. 

III. Executive Order 13132: Federalism 

Executive Order 13132 (entitled 

‘‘Federalism’’) prohibits an agency from 

publishing any rule that has federalism 

implications if the rule either imposes 

substantial, direct compliance costs on 

state and local governments, and is not 

required by statute, or preempts state 

law, unless the agency meets the 

consultation and funding requirements 

of section 6 of the Executive Order. This 

proposed rule does not have federalism 

implications and does not impose 

substantial direct compliance costs on 

state and local governments or preempt 

state law within the meaning of the 

Executive Order. 

Comments and Requests for a Public 

Hearing 

Before these proposed amendments to 

the regulations are adopted as final 

regulations, consideration will be given 

to comments that are submitted timely 

to the IRS as prescribed in the preamble 

under the ADDRESSES section. The 

Treasury Department and the IRS 

request comments on all aspects of the 

proposed regulations. See also the 

specific requests for comments in the 

following Parts of the Explanation of 

Provisions: I.A.1 (concerning rules for 

foreign banks and the ongoing 

application of Notice 89–81 and 

proposed § 1.1296–4), I.A.2 (regarding 

financial statement valuation), I.A.3 (on 

the treatment of working capital in 

applying the Asset Test), I.A.4 

(concerning the elimination of 

intercompany dividends and the 

treatment of pre-acquisition earnings 

and profits), I.A.5 (on the safe harbor for 

the anti-abuse rule for section 

1298(b)(7)), I.B.1 (on the expanded 

definition of an AFS and the priority 

rules provided), I.B.2 (concerning 

modco arrangements and other special 

circumstances in which modification of 

the definition of AIL is appropriate), 

I.B.3 (on situations that may warrant an 

adjustment to total assets), I.C.1 

(concerning the active conduct test), 

I.D.2 (on the QDIC Limitation Rule), I.E 

(concerning the application of statutory 

requirements relating to life insurance 

contracts and annuity contracts), and II 

(concerning a transition rule). Any 

electronic comments submitted, and to 

the extent practicable any paper 

comments submitted, will be made 

available at www.regulations.gov or 

upon request. 

A public hearing will be scheduled if 

requested in writing by any person who 

timely submits electronic or written 

comments. Requests for a public hearing 

are also encouraged to be made 

electronically by sending an email to 

publichearings@irs.gov. If a public 

hearing is scheduled, notice of the date 

and time for the public hearing will be 

published in the Federal Register. 

Announcement 2020–4, 2020–17 I.R.B. 

667 (April 20, 2020), provides that until 

further notice, public hearings 

conducted by the IRS will be held 

telephonically. Any telephonic hearing 

will be made accessible to people with 

disabilities. 

Statement of Availability of IRS 

Documents 

IRS Revenue Procedures, Revenue 

Rulings, notices, and other guidance 

cited in this document are published in 

the Internal Revenue Bulletin (or 

Cumulative Bulletin) and are available 

from the Superintendent of Documents, 

U.S. Government Publishing Office, 

Washington, DC 20402, or by visiting 

the IRS website at www.irs.gov. 

Drafting Information 

The principal drafters of these 

regulations are Christina G. Daniels, 

Josephine Firehock, Jorge M. Oben, and 

Larry R. Pounders of the Office of 

Associate Chief Counsel (International). 

Other personnel from the Treasury 

Department and the IRS also 

participated in the development of these 

regulations. 

List of Subjects in 26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

Proposed Amendments to the 

Regulations 

Accordingly, 26 CFR part 1 is 

proposed to be amended as follows: 

4602 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

PART 1—INCOME TAXES 

■ Paragraph 1. The authority citation 

for part 1 continues to read in part as 

follows: 

Authority: 26 U.S.C. 7805 * * * 

■ Par. 2. In § 1.250–1 amend paragraph 

(b) by revising the first sentence and 

adding a sentence at the end of the 

paragraph to read as follows: 

§ 1.250–1 Introduction. 

* * * * * 

(b) * * * Except as otherwise 

provided in this paragraph (b)(2), 

§§ 1.250(a)–1 and 1.250(b)–1 through 

1.250(b)–6 apply to taxable years 

beginning on or after January 1, 2021. 

* * * The last sentence in § 1.250(b)– 

2(e)(2) applies to taxable years 

beginning after December 31, 2017. 

* * * * * 

■ Par. 3. Section 1.250(b)–2 is amended 

by adding a sentence at the end of 

paragraph (e)(2) to read as follows: 

§ 1.250(b)–2 Qualified business asset 

investment (QBAI). 

* * * * * 

(e) * * * 

(2) * * * For purposes of applying 

section 250(b)(2)(B) and this paragraph 

(e), the technical amendment to section 

168(g) enacted in section 2307(a) of the 

Coronavirus Aid, Relief, and Economic 

Security Act, Public Law 116–136 

(2020) is treated as enacted on 

December 22, 2017. 

■ Par. 4. Section 1.951A–3 is amended 

by adding a sentence at the end of 

paragraph (e)(2) to read as follows: 

§ 1.951A–3 Qualified business asset 

investment. 

* * * * * 

(e) * * * 

(2) * * * For purposes of applying 

section 951A(d)(3) and this paragraph 

(e), the technical amendment to section 

168(g) enacted in section 2307(a) of the 

Coronavirus Aid, Relief, and Economic 

Security Act, Public Law 116–136 

(2020) is treated as enacted on 

December 22, 2017. 

* * * * * 

■ Par. 5. Section 1.1297–0 is amended 

by: 

■ 1. Revising the entries for § 1.1297– 

2(f)(1) and (2). 

■ 2. Revising the entries for § 1.1297– 

4(e)(4) and (5), (f)(1)(iv), (f)(6)(i), (ii), 

and (iii), and (g)(1) and (2). 

■ 3. Adding an entry for § 1.1297–5. 

■ 4. Revising the entries for § 1.1297– 

6(e)(2) and (3) and (f)(1) and (2). 

The revisions and additions read as 

follows: 

§ 1.1297–0 Table of contents. 

* * * * * 

§ 1.1297–1 Definition of passive foreign 

investment company. 

* * * * * 

(c) * * * 

(2) Exception for certain income derived in 

the active conduct of a banking businesses by 

a foreign bank. 

(i) In general. 

(ii) Foreign bank determination. 

* * * * * 

(d) * * * 

(1) * * * 

(v) * * * 

(D) Valuation. 

* * * * * 

(2) Working capital. 

* * * * * 

(g) * * * 

(3) Paragraphs (c)(1)(i)(B), (c)(2), 

(d)(1)(v)(D), and (d)(2) of this section. 

§ 1.1297–2 Special rules regarding lookthrough subsidiaries and look-through 

partnerships. 

* * * * * 

(e) * * * 

(4) Active banking business. 

(f) * * * 

(1) Stock basis adjustment. 

(2) Amount of gain taken into account. 

* * * * * 

§ 1.1297–4 Qualifying insurance 

corporation. 

* * * * * 

(e) * * * 

(4) Corresponding adjustment to total 

assets. 

(i) Consolidated applicable financial 

statement 

(ii) Insurance risk transferred through 

reinsurance. 

(5) Example. 

(i) Facts. 

(ii) Results. 

(A) AIL reduction. 

(B) Asset reduction. 

* * * * * 

(f) * * * 

(1) * * * 

(iv) Priority of financial statements. 

* * * * * 

(6) * * * 

(i) In general. 

(ii) Consolidated and non-consolidated 

financial statement. 

(iii) Audited financial statement. 

* * * * * 

(g) * * * 

(1) General applicability date. 

(2) Exception. 

(3) Early application. 

§ 1.1297–5 Active conduct of an insurance 

business. 

(a) Scope. 

(b) Active conduct of an insurance 

business. 

(1) In general. 

(2) Exceptions. 

(c) Factual requirements test. 

(1) In general. 

(2) Substantial managerial and operational 

activities with respect to core functions. 

(i) Substantial managerial and operational 

activities. 

(ii) Regular and continuous basis. 

(3) Performance of virtually all of the active 

decision-making functions relevant to a QIC’s 

underwriting activities. 

(i) Active decision-making functions. 

(ii) Performance requirements. 

(iii) Exclusions. 

(4) Number of officers and employees. 

(d) Active conduct percentage test. 

(1) Percentage test. 

(2) Outsourcing. 

(e) Related officers and employees. 

(1) Modified qualified affiliate 

requirement. 

(2) Oversight and supervision requirement. 

(3) Compensation requirement. 

(f) Definitions. 

(1) Applicable reporting period. 

(2) Compensation costs. 

(3) Contract and claims management 

activities. 

(4) Core functions. 

(5) Investment activities. 

(6) Qualifying insurance corporation or 

QIC. 

(7) Sales activities. 

(8) Total costs. 

(9) Underwriting activities. 

(10) Virtually all. 

(g) Applicability date. 

§ 1.1297–6 Exception from the definition of 

passive income for active insurance 

income. 

* * * * * 

(e) * * * 

(2) Qualifying domestic insurance 

corporation non-passive asset and income 

limitations. 

(i) Qualifying domestic insurance 

corporation’s non-passive assets. 

(ii) Qualifying domestic insurance 

corporation’s non-passive income. 

(iii) Non-passive asset limitation. 

(iv) Total insurance liabilities. 

(A) Companies taxable under Part I of 

Subchapter L. 

(B) Companies taxable under Part II of 

Subchapter L. 

(3) Example. 

(i) Facts. 

(ii) Result. 

(A) Non-passive asset limitation. 

(B) Non-passive income limitation. 

(f) * * * 

(1) General applicability date. 

(2) Exception. 

(3) Early application. 

■ Par. 6. Section 1.1297–1 is amended 

by: 

■ 1. Revising paragraphs (c)(1)(i)(B), 

(c)(2), (d)(1)(v)(D), and (d)(2). 

■ 2. Revising the first sentence of 

paragraph (g)(1). 

■ 3. Adding paragraph (g)(3). 

The revisions and addition read as 

follows: 

§ 1.1297–1 Definition of passive foreign 

investment company. 

* * * * * 

(c) * * * 

(1) * * * 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4603 

(i) * * * 

(B) The exceptions in sections 

954(c)(3) (relating to certain income 

received from related persons), 954(c)(6) 

(relating to certain amounts received 

from related controlled foreign 

corporations), 954(h) (relating to entities 

engaged in the active conduct of a 

banking, financing, or similar business), 

and 954(i) (relating to entities engaged 

in the active conduct of an insurance 

business) are not taken into account; 

* * * 

* * * * * 

(2) Exception for certain income 

derived in the active conduct of a 

banking business by a foreign bank—(i) 

In general. For purposes of section 

1297(b)(2)(A), income of a tested foreign 

corporation is treated as non-passive 

if— 

(A) The income would not be treated 

as foreign personal holding company 

income under section 954(h) (relating to 

entities engaged in the active conduct of 

a banking, financing, or similar 

business) if the tested foreign 

corporation (and, to the extent relevant, 

any related person as defined by section 

954(d)(3)) were a controlled foreign 

corporation within the meaning of 

section 957(a); and 

(B) The tested foreign corporation is a 

foreign bank that is engaged in the 

active conduct of a banking business 

(within the meaning of section 

954(h)(2)(B)(ii)) and the income is 

derived in the conduct of that banking 

business. 

(ii) Foreign bank determination. A 

tested foreign corporation will be 

treated as a foreign bank only if it— 

(A) is licensed by federal or state bank 

regulatory authorities to do business as 

a bank in the United States, or is 

licensed or authorized by a bank 

regulatory authority in the country in 

which it is chartered or incorporated 

(or, in the case of a qualified business 

unit, in the country in which the unit 

maintains its principal office) to do 

business as a bank in that country, 

including to— 

(I) Accept bank deposits from 

residents of that country; and 

(II) Carry out one or more of the 

activities listed in section 954(h)(4), and 

(B) regularly receives bank deposits 

from and carries out one or more of the 

activities listed in section 954(h)(4) with 

unrelated customers in the ordinary 

course of a banking business. 

* * * * * 

(d) * * * 

(1) * * * 

(v) * * * 

(D) Valuation. For purposes of 

determining the value of assets during a 

measuring period when the shares of a 

tested foreign corporation are not 

publicly traded, valuation may be 

determined on the basis of periodic 

financial accounting statements 

provided at least annually. If the tested 

foreign corporation or one or more 

shareholders has actual knowledge or 

reason to know based on readily 

accessible information that the financial 

accounting statements do not reflect a 

reasonable estimate of an asset’s value 

and the information provides a more 

reasonable estimate of the asset’s value, 

then the information must be used to 

determine the value of the assets to 

which it relates. 

* * * * * 

(2) Working capital. For purposes of 

section 1297(a)(2), an amount of 

currency denominated in functional 

currency (as defined in section 985(b)) 

held in a non-interest bearing financial 

account that is held for the present 

needs of an active trade or business and 

is no greater than the amount necessary 

to cover operating expenses incurred in 

the ordinary course of the trade or 

business of the tested foreign 

corporation (for example, accounts 

payable for ordinary operating 

expenses) and reasonably expected to be 

paid within 90 days is not treated as a 

passive asset. For purposes of the 

preceding sentence, cash equivalents are 

not treated as currency, and amounts 

held for purposes other than to meet the 

ordinary course operating expenses of 

the trade or business, including for the 

purpose of providing for (i) future 

diversification into a new trade or 

business, (ii) expansion of trade or 

business activities, (iii) future plant 

replacement, or (iv) future business 

contingencies, are treated as passive 

assets. 

* * * * * 

(g) * * * 

(1) In general. Except as otherwise 

provided, the rules of this section apply 

to taxable years of shareholders 

beginning on or after January 14, 2021. 

* * * 

* * * * * 

(3) Paragraphs (c)(1)(i)(B), (c)(2), 

(d)(1)(v)(D), and (d)(2) of this section. 

Paragraphs (c)(1)(i)(B), (c)(2), 

(d)(1)(v)(D), and (d)(2) of this section 

apply to taxable years of shareholders 

beginning on or after [the date these 

regulations are filed as final regulations 

in the Federal Register]. A shareholder 

may choose to apply the paragraphs in 

the preceding sentence for any open 

taxable year beginning before [the date 

these regulations are filed as final 

regulations in the Federal Register] 

without regard to whether the rules of 

this section are applied consistently, 

provided that once applied, each rule 

must be applied for each subsequent 

taxable year beginning before [the date 

these regulations are filed as final 

regulations in the Federal Register]. 

■ Par. 7. Section 1.1297–2 is amended 

by: 

■ 1. Revising the third sentence in 

paragraph (b)(2)(ii)(A), the second 

sentence in paragraph (b)(3)(ii)(A), the 

first sentence in paragraph (c)(2)(i), and 

the second sentence in (c)(4)(ii)(A). 

■ 2. Adding subparagraph (e)(4). 

■ 3. Revising the first sentence and 

adding two sentences to the end of 

paragraph (h). 

The revisions and additions read as 

follows: 

§ 1.1297–2 Special rules regarding lookthrough subsidiaries and look-through 

partnerships. 

* * * * * 

(b) * * * 

(2) * * * 

(ii) * * * 

(A) * * * The exceptions to passive 

income in section 1297(b)(2) and the 

relevant exceptions to foreign personal 

holding company income in sections 

954(c) and (h) that are based on whether 

income is derived in the active conduct 

of a business or whether a corporation 

is engaged in the active conduct of a 

business apply to such income only if 

the exception would have applied to 

exclude the income from passive 

income or foreign personal holding 

company income in the hands of the 

subsidiary, determined by taking into 

account only the activities of the 

subsidiary except as provided in 

paragraph (e) of this section. * * * 

* * * * * 

(3) * * * 

(ii) * * * 

(A) * * * The exceptions to passive 

income in section 1297(b)(2) and the 

relevant exceptions to foreign personal 

holding company income in sections 

954(c) and (h) that are based on whether 

income is derived in the active conduct 

of a business or whether a corporation 

is engaged in the active conduct of a 

business apply to such income only if 

the exception would have applied to 

exclude the income from passive 

income or foreign personal holding 

company income in the hands of the 

partnership, determined by taking into 

account only the activities of the 

partnership except as provided in 

paragraph (e) of this section. * * * 

* * * * * 

(c) * * * 

(2) * * * 

(i) LTS stock. For purposes of section 

1297, a tested foreign corporation does 

4604 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

not take into account dividends derived 

with respect to LTS stock, including 

dividends that the tested foreign 

corporation is treated as receiving on a 

measurement date pursuant to section 

1297(c) and paragraphs (b)(2) or (b)(3) of 

this section. * * * 

* * * * * 

(4) * * * 

(ii) * * * 

(A) * * * During the first quarter of 

the taxable year, TFC received $20x of 

dividends from LTS1 and $30x of 

interest on the loan, both of which were 

paid in cash. 

* * * * * 

(e) * * * 

(4) Active banking business. For 

purposes of § 1.1297–1(c)(2), the 

activities of the employees of a person 

that is a related person with respect to 

a look-through subsidiary or partnership 

are taken into account to the extent 

provided in section 954(h)(3)(E). 

* * * * * 

(f) Gain on disposition of a lookthrough subsidiary or look-through 

partnership—(1) Stock basis 

adjustment. For purposes of 

determining gain in paragraph (2) of this 

paragraph (f), a tested foreign 

corporation’s basis in the stock of a 

look-through subsidiary is decreased, 

but not below zero, by the aggregate 

amount of distributions made by the 

look-through subsidiary with respect to 

the look-through subsidiary’s stock that 

are attributable to income of the lookthrough subsidiary not treated as 

received directly by the tested foreign 

corporation pursuant to paragraph (b)(2) 

of this section. 

(2) Amount of gain taken into 

account. The amount of gain derived 

from a tested foreign corporation’s 

direct disposition of stock of a lookthrough subsidiary, or an indirect 

disposition resulting from the 

disposition of stock of a look-through 

subsidiary by other look-through 

subsidiaries or by look-through 

partnerships, that is taken into account 

by the tested foreign corporation for 

purposes of section 1297(a)(1), section 

1298(b)(3), and § 1.1298–2 is the 

residual gain. The residual gain equals 

the total gain recognized by the tested 

foreign corporation (including gain 

treated as recognized by the tested 

foreign corporation pursuant to section 

1297(c) and paragraph (b)(2) of this 

section or § 1.1297–1(c)(2)) from the 

disposition of the stock of the lookthrough subsidiary reduced (but not 

below zero) by unremitted earnings. 

Unremitted earnings are the excess (if 

any) of the aggregate income (if any) 

taken into account by the tested foreign 

corporation pursuant to section 1297(c) 

and paragraph (b)(2) of this section or 

§ 1.1297–1(c)(2) with respect to the 

stock of the disposed-of look-through 

subsidiary (including with respect to 

any other look-through subsidiary, to 

the extent it is owned by the tested 

foreign corporation indirectly through 

the disposed-of look-through subsidiary) 

over the aggregate dividends (if any) 

received by the tested foreign 

corporation from the disposed-of lookthrough subsidiary with respect to the 

stock other than dividends described in 

paragraph (f)(1) of this section. For 

purposes of this paragraph (f)(2), the 

amount of gain derived from the 

disposition of stock of a look-through 

subsidiary and income of and dividends 

received from the look-through 

subsidiary is determined on a share-byshare basis, determined under a 

reasonable method. 

* * * * * 

(h) Applicability date. Except as 

otherwise provided, the rules of this 

section apply to taxable years of 

shareholders beginning on or after 

January 14, 2021. * * * Paragraphs 

(b)(2)(ii)(A), (b)(3)(ii)(A), (c)(2)(i), 

(c)(4)(ii)(A), (e)(4), (f)(1), and (f)(2) of 

this section apply to taxable years of 

shareholders beginning on or after [the 

date these regulations are filed as final 

regulations in the Federal Register]. A 

shareholder may choose to apply the 

paragraphs in the preceding sentence for 

any open taxable year beginning before 

[the date these regulations are filed as 

final regulations in the Federal Register] 

without regard to whether the rules of 

this section are applied consistently, 

provided that once applied, each rule 

must be applied for each subsequent 

taxable year beginning before [the date 

these regulations are filed as final 

regulations in the Federal Register]. 

■ Par. 8. Section 1.1297–4 is amended 

by revising paragraphs (e)(4), (e)(5), 

(f)(1), (f)(2)(i)(D)(3), (f)(6)(i), (ii), and 

(iii), and (g) to read as follows: 

§ 1.1297–4 Qualifying insurance 

corporation. 

* * * * * 

(e) * * * 

(4) Corresponding adjustment to total 

assets. For purposes of determining 

whether a foreign corporation satisfies 

the 25 percent test or the 10 percent test, 

the amount of total assets reported on 

the foreign corporation’s applicable 

financial statement may be reduced as 

described in paragraphs (e)(4)(i) through 

(iii) of this section. 

(i) Consolidated applicable financial 

statement. If a foreign corporation’s 

applicable financial statement is 

prepared on a consolidated basis, the 

amount of total assets may be reduced 

by the amount of liabilities of another 

entity that are reported on the 

applicable financial statement and 

would be treated as applicable 

insurance liabilities but for the 

application of paragraphs (e)(2) or 

(f)(2)(i)(D)(2) of this section. 

(ii) Insurance risk transferred through 

reinsurance. If the applicable financial 

statement is prepared on the basis of an 

accounting method that measures 

insurance liabilities without a reduction 

for amounts that may be recovered from 

other parties through reinsurance and 

the amount that may be recovered 

through reinsurance is reported as an 

asset on the applicable financial 

statement (rather than as a reduction in 

the amount of an insurance liability), 

the foreign corporation’s total assets 

may be reduced by the amount of the 

corporation’s insurance liabilities that 

are reinsured to another party and are 

excluded from the definition of 

applicable insurance liabilities under 

paragraph (f)(2)(i)(D)(3) of this section. 

(iii) No amount may be used more 

than once to reduce total assets under 

paragraphs (e)(4)(i) and (ii) of this 

section. 

(5) Example. The following example 

illustrates the application of paragraph 

(e)(4) of this section. 

(i) Facts. P, a foreign corporation, 

issues property and casualty insurance 

contracts and has a consolidated 

applicable financial statement (AFS) 

constructed using IFRS accounting 

principles, including those of IFRS 17, 

for the applicable reporting period. The 

AFS reports insurance contract 

liabilities for incurred claims that meet 

the requirements of paragraphs 

(f)(2)(i)(A) and (f)(2)(i)(B) of this section 

in an amount equal to 1,100x, 200x of 

which are liabilities under contracts 

issued by S, a wholly owned insurance 

subsidiary, and 900x of which are 

liabilities under contracts issued by P. 

The AFS also reports 2,500x of total 

assets, including 250x of assets related 

to P’s insurance contract liabilities for 

incurred claims that are recoverable 

from unrelated parties through 

reinsurance. 

(ii) Results—(A) Reduction to 

applicable insurance liabilities (AIL). 

Under paragraph (f)(2)(i)(D)(2) of this 

section, only AIL of the foreign 

corporation whose QIC status is being 

determined may be included in AIL. 

Thus, P’s AIL do not include the 200x 

of insurance contract liabilities on P’s 

consolidated AFS that are liabilities 

under contracts issued by S. Under 

paragraph (f)(2)(i)(D)(3) of this section, 

the amount of insurance liabilities 

determined under paragraphs (f)(2)(i)(A) 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4605 

through (C) and (D)(1) and (2) of this 

section are reduced by an amount equal 

to the assets reported on P’s AFS that 

represent amounts relating to those 

liabilities that may be recoverable from 

other parties through reinsurance. Thus, 

P’s AIL are reduced by an amount equal 

to the 250x of assets for incurred claims 

related to the insurance liabilities of P 

that are recoverable from another party 

through reinsurance. Assuming no other 

limitation applies (such as those 

contained in paragraph (e) of this 

section), P’s AIL equals 650x 

(1,100x¥200x¥250x). 

(B) Reduction to total assets. Pursuant 

to paragraph (e)(4)(i) of this section, P 

may reduce its total assets by amounts 

of liabilities of another entity that are 

excluded from P’s AIL because of 

paragraphs (e)(2) or (f)(2)(i)(D)(2) of this 

section. Under paragraph (f)(2)(i)(D)(2) 

of this section, P’s AIL may include only 

the liabilities of P, the entity whose QIC 

status is being determined. Therefore, P 

may reduce its total assets by 200x, the 

amount of liabilities under contracts 

issued by S that are included on P’s AFS 

but excluded from P’s AIL. Pursuant to 

paragraph (e)(4)(ii) of this section, P 

may also reduce its total assets by 250x, 

the amount of P’s liabilities that are 

reinsured by another party and 

excluded from the definition of AIL 

under paragraph (f)(2)(i)(D)(3) of this 

section. After these adjustments, P has 

total assets of 2,050x 

(2,500x¥200x¥250x). 

(C) AIL to total assets tests. 

Accordingly, for purposes of the 25 

percent and 10 percent tests, P has AIL 

of 650x and total assets of 2,050x, for a 

test ratio of 650x/2,050x, or 31.7%. 

(f) Definitions. * * * 

(1) Applicable financial statement. 

The term applicable financial statement 

means the foreign corporation’s 

financial statement prepared for the 

financial reporting purposes listed in 

paragraphs (f)(1)(i) through (iii) of this 

section that has the highest priority, 

including priority within paragraphs 

(f)(1)(i)(B) and (f)(1)(ii) of this section. 

Subject to paragraph (f)(1)(iv) of this 

section, the financial statements are, in 

order of descending priority— 

(i) GAAP statements. A financial 

statement that is prepared in accordance 

with GAAP and is: 

(A) A Form 10–K (or successor form), 

or annual statement to shareholders, 

filed with the United States Securities 

and Exchange Commission (SEC), or 

filed by the taxpayer with an agency of 

a foreign government that is equivalent 

to the SEC, and has reporting standards 

not less stringent than the standards 

required by the SEC; 

(B) An audited financial statement of 

the taxpayer that is used for: 

(1) Credit purposes; 

(2) Reporting to shareholders, 

partners, or other proprietors, or to 

beneficiaries; 

(3) Filing with the Federal 

government or any Federal agency, 

other than the SEC or the Internal 

Revenue Service or an applicable 

insurance regulatory body, or filing with 

a state or foreign government or an 

agency of a state or foreign government, 

other than an agency that is equivalent 

to the SEC or the Internal Revenue 

Service or is an applicable insurance 

regulatory body; or 

(4) Any other substantial non-tax 

purpose, including filing with the 

applicable insurance regulatory body; or 

(ii) IFRS statements. A financial 

statement that is prepared in accordance 

with IFRS and is described in 

paragraphs (f)(1)(i)(A) or (B) of this 

section, in the order of priority set forth 

in those paragraphs; or 

(iii) Regulatory annual statement. An 

audited financial statement required to 

be filed with the applicable insurance 

regulatory body that is not prepared in 

accordance with GAAP or IFRS. 

(iv) Priority of financial statements. 

(A) A financial statement that takes 

into account assets and liabilities of 

affiliates of the foreign corporation that 

are not owned in whole or part by the 

foreign corporation is not treated as an 

applicable financial statement for 

purposes of paragraphs (f)(1)(i) and (ii) 

of this section, and is not treated as an 

applicable financial statement for 

purposes of paragraph (f)(1)(iii) of this 

section unless it is the only financial 

statement described in paragraph 

(f)(1)(iii) of this section. 

(B) A financial statement that is 

described in more than one clause listed 

in paragraphs (f)(1)(i) through (iii) of 

this section is treated for purposes of 

this paragraph (f)(1) as described solely 

in the highest priority clause. If a 

foreign corporation has more than one 

financial statement with equal priority 

under paragraphs (f)(1)(i) through (iii) of 

this section, a non-consolidated 

financial statement has priority over 

other financial statements. 

(2) Applicable insurance liabilities. 

* * * 

(i) * * * 

(D) * * * 

(3) Amounts of liabilities determined 

under paragraphs (f)(2)(i)(A) through (C) 

and (D)(1) and (2) are reduced by an 

amount equal to the assets reported on 

the corporation’s financial statement as 

of the financial statement end date that 

represent amounts relating to those 

liabilities that may be recoverable from 

other parties through reinsurance. If a 

foreign corporation’s financial statement 

is prepared on a consolidated basis, to 

the extent not reduced already under 

paragraphs (f)(2)(i)(A) through (C) and 

(D)(1) and (2), liabilities are reduced by 

an amount equal to the assets relating to 

those liabilities that may be recoverable 

through reinsurance from another entity 

included in the consolidated financial 

statement, regardless of whether the 

reinsurance transaction is eliminated in 

the preparation of the consolidated 

financial statement. 

* * * * * 

(6) Financial statements—(i) In 

general. The term financial statement 

means a statement prepared for a legal 

entity for a reporting period in 

accordance with the rules of a financial 

accounting or statutory accounting 

standard that includes a complete 

balance sheet, statement of income, a 

statement of cash flows (or equivalent 

statements under the applicable 

reporting standard), and related 

exhibits, schedules, forms, and 

footnotes that usually accompany the 

balance sheet, income statement and 

cash flow statement. 

(ii) Consolidated and nonconsolidated financial statement. The 

term consolidated financial statement 

means a financial statement of a 

consolidated group of entities that 

includes a parent and its subsidiaries 

presented as those of a single economic 

entity, prepared in accordance with 

GAAP, IFRS or another financial or 

statutory accounting standard. A nonconsolidated financial statement means 

a financial statement that is not 

prepared on a consolidated basis and 

that accounts for investments in 

subsidiaries on a cost or equity basis. 

(iii) Audited financial statement. The 

term audited financial statement means 

a financial statement that has been 

examined by an independent auditor 

that has provided an opinion that the 

financial statement presents fairly in all 

material respects the financial position 

of the audited company (and its 

subsidiaries and controlled entities, if 

relevant) and the results of their 

operations and cash flows in accordance 

with GAAP or IFRS, or an equivalent 

opinion under GAAP, IFRS or another 

financial accounting or statutory 

accounting standard. 

* * * * * 

(g) Applicability date—(1) General 

applicability date. Except as provided in 

paragraph (g)(2) of this section, this 

section applies to taxable years of 

shareholders beginning on or after 

January 14, 2021. 

4606 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

(2) Exception. Paragraphs (e)(4), (e)(5), 

(f)(1), (f)(2)(i)(D)(3), and (f)(6) of this 

section apply to taxable years of United 

States persons that are shareholders in 

foreign corporations beginning on or 

after [the date these regulations are filed 

as final regulations in the Federal 

Register]. 

(3) Early application—(i) A 

shareholder may choose to apply the 

rules of this section (other than 

paragraphs (f)(1), (f)(2)(i)(D)(3), and 

(f)(6) of this section) for any open 

taxable year beginning after December 

31, 2017 and before the applicability 

dates described in paragraphs (g)(1) and 

(2) of this section, provided that, with 

respect to a tested foreign corporation, 

it consistently applies those rules and 

the rules described in § 1.1297–6(f)(3) 

for such year and all subsequent years. 

(ii) A shareholder may choose to 

apply paragraphs (f)(1), (f)(2)(i)(D)(3), 

and (f)(6) of this section for any open 

taxable year beginning after December 

31, 2017 and before [the date these 

regulations are filed as final regulations 

in the Federal Register], provided that, 

with respect to a tested foreign 

corporation, it consistently applies the 

rules of this section, § 1.1297–5, and 

§ 1.1297–6 for such year and all 

subsequent years. 

■ Par. 9. Section 1.1297–5 is revised to 

read as follows: 

§ 1.1297–5 Active conduct of an insurance 

business. 

(a) Scope. This section provides rules 

pertaining to the exception from passive 

income under section 1297(b)(2)(B) for 

income derived in the active conduct of 

an insurance business. Paragraph (b) of 

this section sets forth the options for a 

qualifying insurance company (QIC) to 

qualify as engaged in the active conduct 

of an insurance business and describes 

circumstances under which a QIC will 

not be engaged in the active conduct of 

an insurance business. Paragraph (c) of 

this section describes the factual 

requirements that are sufficient to show 

that a QIC is engaged in the active 

conduct of an insurance business for 

purposes of section 1297(b)(2)(B). 

Paragraph (d) of this section describes 

an alternative active conduct percentage 

test, pursuant to which a QIC may be 

deemed to be engaged in the active 

conduct of an insurance business for 

purposes of section 1297(b)(2)(B). 

Paragraph (e) of this section describes 

the circumstances under which officers 

and employees of certain entities related 

to a QIC may be treated as if they were 

employees of the QIC. Paragraph (f) of 

this section provides definitions 

applicable to this section. Paragraph (g) 

of this section provides the applicability 

date of this section. 

(b) Active conduct of an insurance 

business—(1) In general. A QIC is 

engaged in the active conduct of an 

insurance business only if it satisfies— 

(i) the factual requirements test in 

paragraph (c) of this section; or 

(ii) the active conduct percentage test 

in paragraph (d) of this section. 

(2) Exceptions. Notwithstanding 

paragraph (b)(1) of this section, a QIC is 

not engaged in the active conduct of an 

insurance business if either of the 

following circumstances apply— 

(i) It has no employees or only a 

nominal number of employees and 

relies exclusively or almost exclusively 

upon independent contractors 

(disregarding for this purpose any 

related entity that has entered into a 

contract designating its status as an 

independent contractor with respect to 

the QIC) to perform its core functions; 

(ii) It is a vehicle that has the effect 

of securitizing or collateralizing 

insurance risks underwritten by other 

insurance or reinsurance companies or 

is an insurance linked securities fund 

that invests in securitization vehicles, 

and its stock (or a financial instrument, 

note, or security that is treated as equity 

for U.S. tax purposes) is designed to 

provide an investment return that is tied 

to the occurrence of a fixed or predetermined portfolio of insured risks, 

events, or indices related to insured 

risks. 

(c) Factual Requirements Test—(1) In 

general. A QIC satisfies the factual 

requirements test of paragraph (b)(1)(i) 

of this section if all the following are 

met— 

(i) The officers and employees of the 

QIC carry out substantial managerial 

and operational activities on a regular 

and continuous basis with respect to its 

core functions as described in paragraph 

(c)(2) of this section; and 

(ii) The officers and employees of the 

QIC perform virtually all of the active 

decision-making functions relevant to 

underwriting functions as described in 

paragraph (c)(3) of this section. 

(2) Substantial managerial and 

operational activities with respect to 

core functions—(i) Substantial 

managerial and operational activities. 

Substantial managerial and operational 

activities with respect to a QIC’s core 

functions requires all of the following— 

(A) Establishing the strategic, overall 

parameters with respect to each core 

function; 

(B) Establishing, or reviewing and 

approving, detailed plans to implement 

the strategic, overall parameters for each 

of the QIC’s core functions; 

(C) Managing, controlling and 

supervising the execution of the 

detailed plans to carry out each of the 

QIC’s core functions; 

(D) Establishing criteria for the hiring 

of employees or independent 

contractors to execute the detailed plans 

to carry out each of the QIC’s core 

functions, and if independent 

contractors are hired, prescribing the 

goals and objectives of the engagement, 

the scope of work, evaluation criteria for 

contractor eligibility and for 

submissions by prospective contractors, 

and criteria and budget for the work to 

be performed; 

(E) Reviewing the conduct of the work 

performed by employees or independent 

contractors to ensure that it meets the 

goals, standards, criteria, timeline and 

budget specified by the QIC, and taking 

appropriate action if it does not; and 

(F) Conducting each of the 

requirements above by officers or senior 

employees of the QIC, which officers or 

employees are experienced in the 

conduct of those activities and devote 

all or virtually all of their work to those 

activities and similar activities for 

related entities. 

(ii) Regular and continuous basis. 

Carrying out managerial and operational 

activities on a regular and continuous 

basis requires that the parameters and 

plans described in paragraphs 

(c)(2)(i)(A) and (B) of this section are 

regularly reviewed and updated and 

that the activities described in 

paragraphs (c)(2)(i)(C) and (E) of this 

section are carried out on a daily or 

other frequent basis as part of the 

ordinary course of the QIC’s operations. 

(3) Performance of virtually all of the 

active decision-making functions 

relevant to a QIC’s underwriting 

activities—(i) Active decision-making 

functions. Active decision-making 

functions are the underwriting activities 

that are most important to decisions of 

the QIC relating to the assumption of 

specific insurance risks. 

(ii) Performance requirements. 

Performance of virtually all of the active 

decision-making functions relating to 

underwriting activities requires all of 

the following— 

(A) Carrying out virtually all of the 

activities related to a QIC’s decision to 

assume an insurance risk, as set forth in 

the definition of underwriting activities, 

by employees and not by independent 

contractors; and 

(B) Evaluating, analyzing, and 

conducting virtually all of the decisionmaking with respect to executing an 

insurance contract on a contract-bycontract basis, including determining 

whether the contract meets the QIC’s 

criteria with respect to the risks to be 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4607 

undertaken and pricing and is otherwise 

sound and appropriate. 

(iii) Exclusions. The following 

activities are not active decision-making 

functions relevant to a QIC’s core 

functions— 

(A) Development of underwriting 

policies or parameters that are changed 

infrequently without further ongoing, 

active involvement in the day-to-day 

decision-making related to these 

functions; and 

(B) Clerical or ministerial functions 

with respect to underwriting that do not 

involve the exercise of discretion or 

business judgment. 

(4) Number of officers and employees. 

The number of officers and employees 

actively engaged in each core function 

is a relevant factor in determining 

whether the factual requirements in 

paragraph (c)(1) of this section have 

been satisfied. 

(d) Active conduct percentage test. A 

QIC satisfies the active conduct 

percentage test of paragraph (b)(1)(ii) 

and will be deemed to be engaged in an 

active insurance business for the 

applicable reporting period only if it 

satisfies the percentage requirement in 

paragraph (d)(1) of this section and, to 

the extent core functions are 

outsourced, the oversight requirement 

in paragraph (d)(2) of this section. 

(1) Percentage test. For the applicable 

reporting period covered by the 

applicable financial statement, total 

costs incurred by the QIC with respect 

to the QIC’s officers and employees for 

services rendered with respect to its 

core functions (other than investment 

activities) equals or exceeds 50 percent 

of total costs incurred by the QIC with 

respect to the QIC’s officers and 

employees and any other person or 

entities for services rendered with 

respect to its core functions (other than 

investment activities). 

(2) Outsourcing. To the extent the QIC 

outsources any part of its core functions 

to unrelated entities, officers and 

employees of the QIC with experience 

and relevant expertise must select and 

supervise the person that performs the 

outsourced functions, establish 

objectives for performance of the 

outsourced functions, and prescribe 

rigorous guidelines relating to the 

outsourced functions which are 

routinely evaluated and updated. 

(e) Related officers and employees. 

For purposes of this section, a QIC’s 

officers and employees are considered 

to include the officers and employees of 

a related entity if the requirements of 

this paragraph (e) are satisfied. In 

determining whether an activity is 

carried out by employees, the activities 

of persons that are independent 

contractors and that are not related 

entities are disregarded. An entity may 

be a related entity regardless of whether 

it has entered into a contract designating 

its status as an independent contractor 

with respect to the QIC. An entity is 

treated as a related entity only if the 

requirements of this paragraph (e) are 

satisfied. 

(1) Modified qualified affiliate 

requirement. The entity is a qualified 

affiliate of the QIC within the meaning 

of § 1.1297–2(e)(2) (determined by 

treating the QIC as the tested foreign 

corporation) except that, for purposes of 

this section, section 1504(a)(2)(A) (with 

‘‘more than 50 percent’’ substituted for 

‘‘at least 80 percent’’) also applies for 

purposes of determining qualified 

affiliate status. 

(2) Oversight and supervision 

requirement. The QIC exercises regular 

oversight and supervision over the 

services performed by the related 

entity’s officers and employees for the 

QIC. 

(3) Compensation requirement. The 

QIC either— 

(i) Pays directly all the compensation 

costs of the related entity’s officers and 

employees attributable to core functions 

performed by those officers and 

employees on behalf of the QIC; 

(ii) Reimburses the related entity for 

the portion of its expenses, including 

compensation costs and related 

expenses (determined in accordance 

with section 482 and taking into 

account all expenses that would be 

included in the total services costs 

under § 1.482–9(j) and § 1.482–9(k)(2)) 

for the performance by its officers and 

employees of core functions on behalf of 

the QIC; or 

(iii) Otherwise pays arm’s length 

compensation in accordance with 

section 482 on a fee-related basis to the 

related entity for services related to core 

functions. 

(f) Definitions. The following 

definitions apply solely for purposes of 

this section. 

(1) Applicable reporting period. The 

term applicable reporting period has the 

meaning set forth in § 1.1297–4(f)(4). 

(2) Compensation costs. The term 

compensation costs means all amounts 

incurred by the QIC during the 

applicable reporting period with respect 

to an officer and employee (including, 

for example, wages, salaries, deferred 

compensation, employee benefits, and 

employer payroll taxes). 

(3) Contract and claims management 

activities. The term contract and claims 

management activities means 

performing the following activities with 

respect to an insurance or annuity 

contract: Monitoring a contract (or 

group of contracts) over its life cycle 

(that is, maintaining the information on 

contractual developments, insured risk 

and occurrences, and maintaining 

accounts on premiums, claims reserves 

and commissions); performing loss and 

claim reporting (establishing and 

maintaining loss reporting systems, 

developing reliable claims statistics, 

defining and adjusting claims 

provisions and introducing measures to 

protect and reduce claims in future); 

and all the activities related to a 

policyholder’s claim, including 

processing the claims report, examining 

coverage, handling the claim (working 

out the level of the claim, clarifying 

causes, claims reduction measures, legal 

analysis) and seeking recovery of funds 

due to the QIC. 

(4) Core functions. The term core 

functions means the QIC ‘s 

underwriting, investment, contract and 

claims management and sales activities; 

however, contract and claims 

management activities will not be 

considered to be a core function of a 

reinsurance company with respect to 

indemnity reinsurance contracts to the 

extent that the ceding company has 

agreed to retain this core function under 

a reinsurance contract. 

(5) Investment activities. The term 

investment activities means investment 

in equity and debt instruments and 

related hedging transactions and other 

assets of a kind typically held for 

investment, for the purpose of 

producing income to meet obligations 

under the insurance, annuity or 

reinsurance contracts. 

(6) Qualifying insurance corporation 

or QIC. The term qualifying insurance 

corporation or QIC has the meaning 

described in § 1.1297–4(b). 

(7) Sales activities. The term sales 

activities means sales, marketing and 

customer relations with respect to 

insurance or reinsurance policies. 

(8) Total costs. With respect to the 

QIC’s own officers and employees (and 

without regard to related officers and 

employees described in paragraph (e) of 

this section), the term total costs means 

the compensation costs of those officers 

and employees and related expenses 

(determined in accordance with section 

482 and taking into account all expenses 

that would be included in the total 

services costs under § 1.482–9(j) and 

§ 1.482–9(k)(2)) for services performed 

related to core functions. With respect 

to services performed by related officers 

and employees and unrelated persons or 

entities, the term total costs means the 

amount paid or accrued to the related or 

unrelated persons or entities for the 

services related to core functions. For 

purposes of this section, total costs, 

4608 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

however, do not include any ceding 

commissions paid or accrued with 

respect to reinsurance contracts or 

commissions or fees paid or accrued to 

brokers or sales agents to procure 

reinsurance contracts. 

(9) Underwriting activities. The term 

underwriting activities means the 

performance of activities related to a 

QIC’s decision to assume an insurance 

risk (for example, the decision to enter 

into an insurance or reinsurance 

contract, setting underwriting policy, 

risk classification and selection, 

designing or tailoring insurance or 

reinsurance products to meet market or 

customer requirements, performing 

actuarial analysis with respect to 

insurance products, and performing 

analysis for purposes of setting 

premium rates or calculating reserves, 

and risk retention). 

(10) Virtually all. The term virtually 

all means all, other than a de minimis 

portion, measured on any reasonable 

basis. 

(g) Applicability date. This section 

applies to taxable years of shareholders 

beginning on or after [the date these 

regulations are filed as final regulations 

in the Federal Register]. A shareholder 

may choose to apply the rules of this 

section for any open taxable year 

beginning after December 31, 2017 and 

before [the date these regulations are 

filed as final regulations in the Federal 

Register], provided that, with respect to 

a tested foreign corporation, it 

consistently applies the rules of this 

section, § 1.1297–4, and § 1.1297–6 for 

such year and all subsequent years. 

■ Par. 10. Section 1.1297–6 is amended 

by adding a sentence to the end of 

paragraph (b)(2), adding a sentence to 

the end of paragraph (c)(2), and revising 

paragraphs (e)(2), (e)(3), and (f), to read 

as follows: 

§ 1.1297–6 Exception from the definition of 

passive income for active insurance 

income. 

* * * * * 

(b) Exclusion from passive income of 

active insurance income. * * * 

(2) * * * See paragraph (e)(2)(i) of 

this section for additional rules 

regarding the amount of income of a 

qualifying domestic insurance 

corporation that is treated as nonpassive. 

* * * * * 

(c) Exclusion of assets for purposes of 

the passive asset test under section 

1297(a)(2). * * * 

(2) * * * See paragraph (e)(2)(ii) of 

this section for additional rules 

regarding the amount of assets of a 

qualifying domestic insurance 

corporation that are treated as nonpassive. 

* * * * * 

(e) Qualifying domestic insurance 

corporation. * * * 

(2) Qualifying domestic insurance 

corporation non-passive asset and 

income limitations. For purposes of 

section 1297 and § 1.1297–1— 

(i) Qualifying domestic insurance 

corporation’s non-passive assets. The 

amount of passive assets of a qualifying 

domestic insurance corporation that 

may be treated as non-passive is equal 

to the lesser of the passive assets of the 

corporation (determined without 

application of paragraph (c)(2) of this 

section) or the corporation’s non-passive 

asset limitation (as defined in paragraph 

(e)(2)(iii) of this section). 

(ii) Qualifying domestic insurance 

corporation’s non-passive income. The 

amount of passive income of a 

qualifying domestic insurance 

corporation that may be treated as nonpassive is equal to the lesser of the 

passive income of the corporation 

(determined without application of 

paragraph (b)(2) of this section) or the 

corporation’s passive income multiplied 

by the proportion that its non-passive 

asset limitation (as defined in paragraph 

(e)(2)(iii) of this section) bears to its total 

passive assets (determined without 

application of paragraph (c)(2) of this 

section). 

(iii) Non-passive asset limitation. For 

purposes of paragraph (e) of this section, 

the non-passive asset limitation equals 

the corporation’s total insurance 

liabilities multiplied by the applicable 

percentage. The applicable percentage 

is— 

(A) 400 percent of total insurance 

liabilities, for a company taxable under 

Part II of Subchapter L; and 

(B) 200 percent of total insurance 

liabilities, for a company taxable under 

Part I of Subchapter L. 

(iv) Total insurance liabilities. For 

purposes of paragraph (e) of this 

section— 

(A) Companies taxable under Part I of 

Subchapter L. In the case of a company 

taxable under part I of Subchapter L, the 

term total insurance liabilities means 

the sum of the total reserves (as defined 

in section 816(c)) plus (to the extent not 

included in total reserves) the items 

referred to in paragraphs (3), (4), (5), and 

(6) of section 807(c). 

(B) Companies taxable under Part II of 

Subchapter L. In the case of a company 

taxable under part II of Subchapter L, 

the term total insurance liabilities 

means the sum of unearned premiums 

(determined under § 1.832–4(a)(8)) and 

unpaid losses. 

(3) Example. The following example 

illustrates the application of this 

section. 

(i) Facts. X, a qualifying domestic 

insurance corporation within the 

meaning of paragraph (e)(1) of this 

section, is a nonlife insurance company 

taxable under part II of Subchapter L. X 

has passive assets of $1000x, total 

insurance liabilities of $200x, and 

passive income of $100x. 

(ii) Result—(A) Non-passive asset 

limitation. The applicable percentage 

for nonlife insurance companies is 

400%. Pursuant to paragraph (e)(2)(iii) 

of this section, X has a non-passive asset 

limitation of $800x, which is equal to its 

total insurance liabilities of $200x 

multiplied by 400%. Under paragraph 

(e)(2)(i) of this section, $800x of X’s 

passive assets (equal to the lesser of the 

non-passive asset limitation ($800x) or 

passive assets ($1000x)) are treated as 

non-passive, and $200x remains 

passive. 

(B) Non-passive income limitation. X 

has a non-passive asset limitation of 

$800x. The proportion of its non-passive 

asset limitation ($800x) to its total 

passive assets ($1000x) is 80%. 

Pursuant to paragraph (e)(2)(ii) of this 

section, X has $80x of passive income 

treated as non-passive (equal to the 

lesser of passive income ($100x) or 80% 

times $100x) and $20x remains passive. 

(f) Applicability date—(1) General 

applicability date. Except as provided in 

paragraph (f)(2) of this section, this 

section applies to taxable years of 

shareholders beginning on or after 

January 14, 2021. 

(2) Exception. Paragraphs (e)(2) and 

(e)(3) of this section apply to taxable 

years of shareholders beginning on or 

after [the date these regulations are filed 

as final regulations in the Federal 

Register]. 

(3) Early application. A shareholder 

may choose to apply the rules of this 

section (other than paragraphs (e)(2) and 

(e)(3) of this section) for any open 

taxable year beginning after December 

31, 2017 and before January 14, 2021, 

provided that, with respect to a tested 

foreign corporation, it consistently 

applies those rules and the rules 

described in § 1.1297–4(g)(3)(i) for such 

year and all subsequent years. 

■ Par. 11. Section 1.1298–0 is amended 

by adding entries for § 1.1298–4(e)(2)(i) 

and (ii); § 1.1298–4(e)(2)(ii)(A), (B), (C), 

and (D); § 1.1298–4(e)(3); § 1.1298– 

4(e)(3)(i), (ii), (iii), and (iv); § 1.1298– 

4(e)(3)(i)(A) and (B); § 1.1298– 

4(e)(3)(ii)(A) and (B); § 1.1298– 

4(e)(3)(iii)(A) and (B); and § 1.1298– 

4(e)(3)(iv)(A) and (B) to read as follows: 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 4609 

§ 1.1298–0 Table of contents. 

§ 1.1298–4 Rules for certain foreign 

corporations owning stock in 25-percentowned domestic corporations. 

* * * * * 

(e) * * * 

(2) Safe harbor. 

(i) Active business within Unites States. 

(ii) Businesses undergoing change and new 

businesses. 

(A) In general. 

(B) Testing date. 

(C) Transition period. 

(D) Inapplicability. 

(3) Examples. 

(i) Example 1. 

(A) Facts. 

(B) Results. 

(ii) Example 2. 

(A) Facts. 

(B) Results. 

(iii) Example 3. 

(A) Facts. 

(B) Results. 

(iv) Example 4. 

(A) Facts. 

(B) Results. 

* * * * * 

■ Par. 12. Section 1.1298–4 is amended 

by: 

■ 1. Revising paragraphs (e)(2) and (3). 

■ 2. Revising the first sentence and 

adding two sentences to the end of 

paragraph (f). 

The additions and revisions read as 

follows: 

§ 1.1298–4 Rules for certain foreign 

corporations owning stock in 25-percentowned domestic corporations. 

* * * * * 

(e) * * * 

(2) Safe harbor. Paragraph (e)(1) of 

this section will not apply if paragraph 

(e)(2)(i) or (e)(2)(ii) of this section 

applies. 

(i) Active business within United 

States. The value of the assets of the 

second-tier domestic corporation used 

or held for use in an active trade or 

business within the U.S. is more than 80 

percent of the fair market value of the 

gross assets of such corporation. For 

purposes of this paragraph (e)(2)— 

(A) The value of the assets of the 

second-tier domestic corporation takes 

into account its pro-rata share of the 

value of the assets of its domestic 

subsidiary qualified affiliates and does 

not take into account the stock of such 

affiliates; 

(B) The term domestic subsidiary 

qualified affiliate means each member 

of the affiliated group (as defined in 

section 1504(a) applied by substituting 

‘‘more than 50 percent’’ for ‘‘at least 80 

percent’’ each place it appears), treating 

the second-tier domestic corporation as 

the common parent of such affiliated 

group; and 

(C) For purposes of this paragraph 

(e)(2), the determination of the existence 

of an active trade or business and 

whether assets are used in an active 

trade or business is made under 

§ 1.367(a)–2(d)(2), (3), and (5) except 

that officers and employees of related 

entities as provided in § 1.367(a)–2(d)(3) 

include only the officers and employees 

of related domestic entities within the 

meaning of section 267(b) or 707(b)(1). 

(ii) Businesses undergoing change and 

new businesses—(A) In general. The 

second-tier domestic corporation 

engages in an active U.S. trade or 

business that satisfies paragraph (e)(2)(i) 

of this section by the end of the 

transition period following the testing 

date. 

(B) Testing date. For purposes of this 

paragraph (e)(2)(ii), the term ‘‘testing 

date’’ means the last day of the month 

in which either— 

(1) The second-tier domestic 

corporation is created or organized or is 

acquired, directly or indirectly, by the 

tested foreign corporation; or 

(2) A second-tier domestic 

corporation that previously satisfied 

(e)(2)(i) of this paragraph (e) disposes of, 

to a person that is not related within the 

meaning of section 267(b) or 707(b)(1), 

substantially all of the assets used or 

held for use in its active U.S. trade or 

business. 

(C) Transition period. For purposes of 

this paragraph (e)(2)(ii), the term 

‘‘transition period’’ means thirty-six 

months after the testing date as defined 

in paragraph (e)(2)(ii)(B)(1) or (2) of this 

section. 

(D) Inapplicability. This paragraph 

(e)(2)(ii) does not apply for any taxable 

year (including previous taxable years) 

of the tested foreign corporation if the 

second-tier domestic corporation does 

not engage in an active U.S. trade or 

business that satisfies paragraph (e)(2)(i) 

of this section by the end of the 

transition period following a testing 

date. 

(3) Examples. The following examples 

illustrate the rules of this paragraph (e). 

For purposes of these examples, TFC is 

a foreign corporation that is not a 

controlled foreign corporation (within 

the meaning of section 957(a)) and that 

is subject to the section 531 tax, USS1 

and USS2 are domestic corporations for 

TFC’s entire taxable year, TFC owns 

100% of the single class of stock of 

USS1, and USS1 owns 100% of the 

single class of stock of USS2. 

(i) Example 1—(A) Facts. USS2 

operates an active trade or business 

within the United States within the 

meaning of § 1.367(a)–2(d)(2), (3), and 

(5). Throughout TFC’s Year 1, the value 

of USS2’s assets is $100x, and the value 

of USS2’s assets that are used or held for 

use in its active trade or business within 

the United States is $20x. USS2 was not 

created, organized, or acquired within 

the preceding thirty-six months and has 

not disposed of an active trade or 

business within the United States 

within the preceding thirty-six months. 

(B) Results. Paragraph (e)(2)(i) of this 

section does not apply in Year 1 even 

though USS2 is engaged in an active 

trade or business within the United 

States because only 20% ($20x/$100x) 

of its assets are used or held for use in 

an active U.S. trade or business within 

the meaning of § 1.367(a)–2(d)(2), (3), 

and (5), an amount that is not more than 

80% of the fair market value of the total 

gross assets of USS2. Accordingly, the 

general rule in paragraph (e)(1) of this 

section will apply if there is a principal 

purpose to hold passive assets through 

USS2, the second-tier domestic 

corporation, to avoid classification of 

TFC, the tested foreign corporation, as a 

PFIC. 

(ii) Example 2—(A) Facts. The facts 

are the same as in as in paragraph 

(e)(4)(i)(A) of this section (the facts in 

Example 1), except that USS2 also has 

an investment in USS3, a wholly owned 

domestic subsidiary of USS2. 

Throughout TFC’s taxable Year 1, the 

value of USS3’s assets is $400x and 

USS3 uses 100% of its assets in an 

active trade or business within the 

United States within the meaning of 

§ 1.367(a)–2(d)(2), (3), and (5). 

(B) Results. Because USS3 is a 

domestic subsidiary qualified affiliate of 

USS2, USS2’s pro-rata share of the 

assets of USS3 is taken into account to 

determine whether USS2 satisfies 

paragraph (e)(2)(i) of this section. 

Accordingly, USS2 takes into account 

$400x (its pro-rata share) of USS3’s 

assets in addition to the $100x of its 

own assets and, thus, is treated for 

purposes of paragraph (e)(2)(i) of this 

section as owning $500x of assets, with 

84% ($420x/$500x) of such assets being 

used or held for use in an active trade 

or business within the United States 

within the meaning of § 1.367(a)– 

2(d)(2), (3), and (5). Therefore, 

paragraph (e)(2)(i) of this section applies 

in Year 1 and the general rule in 

paragraph (e)(1) of this section does not 

apply. 

(iii) Example 3—(A) Facts. 

Throughout Year 1, USS2 uses 100% of 

its assets in an active trade or business 

within the United States within the 

meaning of § 1.367(a)–2(d)(2), (3), and 

(5), and thus satisfied paragraph (e)(2)(i) 

of this section in Year 1. On the first day 

of Year 2, USS2 disposes of all of those 

assets for cash. On the seventh day of 

Year 5 (before the end of the first month 

4610 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Proposed Rules 

in Year 5), USS2 invests the cash in 

assets that it immediately begins to use 

in an active trade or business in the 

United States. 

(B) Results. Because USS2, the 

second-tier domestic corporation, 

engages in an active U.S. trade or 

business that satisfies paragraph (e)(2)(i) 

of this section by the end of thirty-six 

months after the last day of the month 

in which it disposed of its entire active 

U.S. trade or business that previously 

satisfied paragraph (e)(2)(i) of this 

section, paragraph (e)(2)(ii) of this 

section applies in Year 2, Year 3, and 

Year 4, and the general rule in 

paragraph (e)(1) of this section does not 

apply. 

(iv) Example 4—(A) Facts. The facts 

are the same as in paragraph 

(e)(4)(iii)(A) of this section (the facts in 

Example 3), except that at the end of the 

first month of Year 5, USS2 is still in 

negotiations to purchase assets to be 

used in an active trade or business in 

the United States within the meaning of 

§ 1.367(a)–2(d)(2), (3), and (5), and USS2 

does not complete the purchase of such 

assets until the third month of Year 5. 

(B) Results. The safe harbor in 

paragraph (e)(2)(ii) of this section does 

not apply for Year 2, Year 3, or Year 4, 

because USS2, the second-tier domestic 

corporation, did not engage in an active 

U.S. trade or business that satisfied 

paragraph (e)(2)(i) of this section by the 

end of the thirty-six month transition 

period after the end of the month in 

which it sold its prior active trade or 

business. Accordingly, the general rule 

in paragraph (e)(1) of this section will 

apply if there is a principal purpose to 

hold passive assets through USS2, the 

second-tier domestic corporation, to 

avoid classification of TFC, the tested 

foreign corporation, as a PFIC. 

(f) Applicability date. Except as 

otherwise provided, the rules of this 

section apply to taxable years of 

shareholders beginning on or after 

January 14, 2021 * * * Paragraphs 

(e)(2) and (3) of this section apply to 

taxable years of shareholders beginning 

on or after [DATE OF FILING OF FINAL 

RULE IN THE FEDERAL REGISTER]. A 

shareholder may choose to apply the 

paragraphs in the preceding sentence for 

any open taxable year beginning before 

[DATE OF FILING OF FINAL RULE IN 

THE FEDERAL REGISTER] without 

regard to whether the rules of this 

section are applied consistently, 

provided that once applied, each rule 

must be applied for each subsequent 

taxable year beginning before [DATE OF 

FILING OF FINAL RULE IN THE 

Federal Register]. 

Sunita Lough, 

Deputy Commissioner for Services and 

Enforcement. 

[FR Doc. 2020–27003 Filed 1–14–21; 8:45 am] 

BILLING CODE 4830–01–P