4516 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

1The other portions of the section 958 proposed 

regulations were finalized at 85 FR 59428. 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 1 

[TD 9936] 

RIN 1545–BO59 

Guidance on Passive Foreign 

Investment Companies 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Final regulations. 

SUMMARY: This document contains final 

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’’), and 

the application and scope of certain 

rules that determine whether a United 

States person that indirectly holds stock 

in a PFIC is treated as a shareholder of 

the PFIC. The regulations affect United 

States persons with direct or indirect 

ownership interests in certain foreign 

corporations. 

DATES: 

Effective date: These regulations are 

effective on January 14, 2021. 

Applicability dates: For dates of 

applicability see §§ 1.1291–1(j), 1.1297– 

1(g), 1.1297–2(h), 1.1297–4(g), 1.1297– 

6(f), 1.1298–2(g), and 1.1298–4(f). 

FOR FURTHER INFORMATION CONTACT: 

Concerning the regulations §§ 1.1291–0 

and 1.1291–1, 1.1297–0 through 1.1297– 

2, 1.1298–0, 1.1298–2, and 1.1298–4, 

Christina G. Daniels at (202) 317–6934; 

concerning the regulations §§ 1.1297–4 

and 1.1297–6, Josephine Firehock at 

(202) 317–4932 (not toll-free numbers). 

SUPPLEMENTARY INFORMATION: 

Background 

On July 11, 2019, the Department of 

the Treasury (‘‘Treasury Department’’) 

and the IRS published proposed 

regulations (REG–105474–18) under 

sections 1291, 1297, and 1298 in the 

Federal Register (84 FR 33120) (the 

‘‘proposed regulations’’ or ‘‘2019 

proposed regulations’’). All written 

comments received in response to the 

proposed regulations are available at 

www.regulations.gov or upon request. A 

public hearing on the proposed 

regulations was scheduled for December 

9, 2019, but it was not held because 

there were no requests to speak. Terms 

used but not defined in this preamble 

have the meaning provided in these 

final regulations. 

In addition, on October 2, 2019, the 

Treasury Department and the IRS 

published proposed regulations (REG– 

104223–18) relating to the repeal of 

section 958(b)(4) by the Tax Cuts and 

Jobs Act, Public Law 115–97, 131 Stat. 

2054 (2017) (the ‘‘Act’’) in the Federal 

Register (84 FR 52398) (the ‘‘section 958 

proposed regulations’’). As in effect 

before its repeal, section 958(b)(4) 

provided that section 318(a)(3)(A), (B), 

and (C) (providing for downward 

attribution) was not to be applied so as 

to consider a United States person (as 

defined in section 7701(a)(30)) as 

owning stock owned by a person who is 

not a United States person (a ‘‘foreign 

person’’). After the Act repealed section 

958(b)(4), stock of a foreign corporation 

owned by a foreign person could be 

attributed to a United States person 

under section 318(a)(3) for various 

purposes, including for purposes of 

determining whether the foreign 

corporation is a controlled foreign 

corporation within the meaning of 

section 957 (‘‘CFC’’). The section 958 

proposed regulations generally made 

modifications to ensure that the 

operation of certain rules outside of 

subpart F of part III of subchapter N of 

chapter 1 of subtitle A of the Code 

(‘‘subpart F’’) are consistent with their 

application before the Act’s repeal of 

section 958(b)(4). A public hearing on 

these regulations was not held because 

there were no requests to speak. This 

rulemaking finalizes the portion of the 

section 958 proposed regulations under 

section 1297 regarding the treatment of 

foreign corporations for purposes of 

section 1297(e).1 See Part III.D.1 of the 

Summary of Comments and Explanation 

of Revisions section. 

A notice of proposed rulemaking 

published in the Proposed Rules section 

of this issue of the Federal Register 

(REG–111950–20) (the ‘‘2020 NPRM’’) 

provides additional guidance on the 

treatment of income and assets of a 

foreign corporation for purposes of the 

PFIC rules and on the exception from 

passive income under section 

1297(b)(2)(B) (‘‘PFIC insurance 

exception’’). 

Summary of Comments and 

Explanation of Revisions 

I. Overview 

The final regulations retain the basic 

approach and structure of the proposed 

regulations, with certain revisions. This 

Summary of Comments and Explanation 

of Revisions section discusses those 

revisions as well as comments received 

in response to the solicitation of 

comments in the notice of proposed 

rulemaking. Comments outside the 

scope of this rulemaking are generally 

not addressed but may be considered in 

connection with the potential issuance 

of future guidance. 

II. Comments and Revisions to 

Proposed § 1.1291–1—Taxation of U.S. 

Persons That Are Shareholders of 

Section 1291 Funds 

Section 1298(a) provides attribution 

rules that apply to the extent the effect 

is to treat stock of a PFIC as owned by 

a United States person. These rules 

apply when a United States person 

directly or indirectly owns an interest in 

a PFIC, a partnership, an estate or a 

trust, or when a United States person 

directly or indirectly owns 50 percent or 

more in value of the stock of a 

corporation that is not a PFIC. In such 

cases, the attribution rules of section 

1298(a) may apply to treat the United 

States person as owning shares of a PFIC 

owned directly or indirectly by such an 

entity. Stock considered to be owned by 

a person by reason of any of the 

foregoing rules is treated as actually 

owned by that person for purposes of 

the further application of those rules 

(the ‘‘successive application rule’’). 

Except as provided in regulations, the 

attribution rules do not apply to treat 

stock owned or treated as owned by a 

United States person as owned by any 

other person. The current rules in 

§ 1.1291–1(b)(8) are consistent with 

these statutory provisions. 

A. Attribution of Ownership Through a 

Partnership, S Corporation, Estate or 

Trust 

Proposed § 1.1291–1(b)(8)(iii) 

provided that an owner of an interest in 

a partnership, S corporation, estate or 

trust (a ‘‘pass-through entity’’) would be 

treated as owning stock owned by the 

pass-through entity only if the passthrough owner owns 50 percent or more 

of the pass-through entity. Examples in 

the proposed regulations illustrated the 

operation of this rule in cases where a 

United States person owns 50 percent, 

in one case, or 40 percent, in another 

case, of a foreign partnership. The 

preamble to the proposed regulations 

indicated that the proposed rule was 

intended to ensure that the attribution 

rules apply consistently whether a 

United States person owns stock of a 

non-PFIC foreign corporation indirectly 

through a partnership or directly. 

The only comment received on this 

proposed rule agreed with the results of 

the first example but recommended that 

a different approach be taken with 

respect to attribution through 

partnerships. The comment responded 

to the statement in the preamble that the 

proposed regulations would have results 

consistent with an aggregate approach to 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4517 

partnerships by noting that in certain 

circumstances the proposed rule would 

deviate from a true aggregation 

approach. It posited an example in 

which application of the rule in the 

proposed regulations would prevent a 

United States person from being treated 

as owning stock of a PFIC owned by a 

non-PFIC corporation, even though the 

United States person directly and 

indirectly owned, in the aggregate, more 

than 50 percent of the stock of the nonPFIC corporation and argued that this 

result was inappropriate. Accordingly, 

the comment suggested that the final 

regulations, instead of adopting the rule 

included in the proposed regulations, 

adopt a rule that uses an aggregation 

approach to attribution through 

partnerships. 

The Treasury Department and the IRS 

agree with the comment that the rule in 

the proposed regulations could have 

inappropriate results, and that a partner 

in a partnership should be treated as 

indirectly owning the same number of 

shares of a non-PFIC corporation owned 

by the partnership as if the partner held 

those shares directly. Accordingly, the 

final regulations do not adopt the rules 

in the proposed regulations to amend 

the rules of § 1.1291–1(b)(8)(iii), relating 

to pass-through entities (partnerships, S 

corporations, estates and nongrantor 

trusts). 

B. Application of ‘‘top-down’’ Approach 

The preamble to the proposed 

regulations indicated that proposed 

§ 1.1291–1(b)(8)(iii) was intended to 

apply the attribution rules to a tiered 

ownership structure involving a passthrough entity on a ‘‘top-down’’ basis, 

by starting with a United States person 

and determining what stock is 

considered owned at each successive 

lower tier on a proportionate basis. The 

preamble requested comments as to 

whether the ‘‘top-down’’ approach 

should be extended to attribution 

through corporations. 

The only comment received on the 

issue indicated that the ‘‘top-down’’ 

approach should not be so extended, on 

the grounds that the successive 

application rule of section 1298(a)(5) 

requires a ‘‘bottom-up’’ approach (that 

is, applying the attribution rules to a 

tiered ownership structure by starting 

with the lowest-tier entity and 

determining which persons are treated 

as owning stock of that entity at each 

successive higher tier on a proportionate 

basis) for corporate structures. The 

comment acknowledged that this would 

result in inconsistency in attribution of 

ownership between stock of a PFIC held 

through a partnership (which, in many 

cases, may be a foreign corporate entity 

treated as a partnership for U.S. federal 

income tax purposes as the result of a 

check-the-box election) and stock of a 

PFIC held through a corporation. 

The Treasury Department and the IRS 

have determined that the same approach 

should apply to attribution through a 

pass-through entity, a PFIC or a 50 

percent-owned non-PFIC corporation. In 

each case, the statutory language 

provides that an owner of an interest in 

such an entity is treated as owning its 

proportionate share of stock owned by 

the entity. The same approach to 

attribution therefore should apply 

regardless of which entity a United 

States person holds an interest in. 

The successive application rule of 

section 1298(a)(5) can be applied either 

under a ‘‘top-down’’ or ‘‘bottom-up’’ 

approach. While both approaches to 

attribution may treat a United States 

person as owning an amount of stock of 

a PFIC that is less than that person’s 

economic interest in the PFIC, a ‘‘topdown’’ approach takes into account both 

the direct and indirect ownership of 

stock of a corporation by the same 

person while the bottom-up approach 

may not do so. For example, assume 

that U.S. individual A owns 49 percent 

of the partnership interests in a 

partnership that owns 95 percent of the 

stock of a tested foreign corporation. 

The tested foreign corporation is not a 

PFIC but owns all of the single class of 

stock of a PFIC. Individual A also owns 

the remaining 5 percent of the tested 

foreign corporation’s stock directly. 

Under a ‘‘top-down’’ approach, 

individual A is deemed to hold 46.55 

percent of the tested foreign 

corporation’s stock through the 

partnership and owns 5 percent of the 

tested foreign corporation’s stock 

directly. Therefore, individual A is 

treated as owning 51.55 percent of the 

tested foreign corporation’s stock and 

51.55 percent of the PFIC stock. Under 

a ‘‘bottom-up’’ approach, the tested 

foreign corporation owns all of the PFIC 

stock; the partnership owns 95 percent 

of the tested foreign corporation’s stock 

and therefore is treated as owning 95 

percent of the PFIC stock; and 

individual A is treated as owning 49 

percent of what the partnership owns, 

or 46.55 percent of the PFIC stock. In 

this example, the ‘‘top-down’’ approach 

treats individual A as owning its 

economic share of the PFIC’s stock, 

while the ‘‘bottom-up’’ approach may 

not take into account the PFIC stock that 

is owned through the 5 percent of the 

tested foreign corporation’s stock that 

individual A owns directly. 

Accordingly, the final regulations apply 

a ‘‘top-down’’ approach to the 

attribution of ownership through all 

tiered ownership structures. 

The final regulations also include a 

new rule addressing the application of 

the successive application rule to tiered 

ownership structures. The new rule 

specifically provides for a top-down 

approach to attribution of ownership. 

See § 1.1291–1(b)(8)(iv). The examples 

in the existing and proposed regulations 

have been revised to clarify how the 

top-down approach applies to those 

examples. See § 1.1291–1(b)(8)(v). A 

new example is added to illustrate the 

operation of the successive application 

rule in a fact pattern in which a United 

States person owns stock of a foreign 

corporation both directly and indirectly 

through a partnership. See § 1.1291– 

1(b)(8)(v)(D). 

C. Ownership Attribution Through 

Nongrantor Trusts 

A comment requested that the final 

regulations provide additional guidance 

on attributing PFIC stock held by a 

nongrantor trust to the beneficiaries of 

the trust, suggesting that determining 

ownership by U.S. beneficiaries of PFIC 

stock held directly or indirectly by a 

nongrantor trust warrants more 

specificity than determining ownership 

in PFIC stock held directly or indirectly 

by other pass-through entities. 

Section 1298(a)(3) and § 1.1291– 

1(b)(8)(iii)(C) provide that each 

beneficiary is considered to own a 

proportionate amount of stock held by 

a foreign or domestic estate or 

nongrantor trust. Section 1.1291– 

1(b)(8)(i) provides that the 

determination of a person’s indirect 

ownership is made on the basis of all 

the facts and circumstances of each case 

and that the substance rather than the 

form of the ownership is controlling, 

taking into account the purposes of 

sections 1291 through 1298. 

On December 31, 2013, the Treasury 

Department and the IRS published final 

and temporary regulations under several 

Code sections including section 1291 

(78 FR 79602, as corrected at 79 FR 

26836) (‘‘2013 temporary and final 

regulations’’). The preamble to those 

regulations provided that pending 

further guidance, beneficiaries of estates 

and nongrantor trusts that hold PFIC 

stock subject to the section 1291 regime 

should use a reasonable method to 

determine their ownership interests in 

the PFIC. The preamble to those 

regulations also provided that section 

1291 and the principles of subchapter J 

must be applied in a reasonable manner 

with respect to estates and trusts, and 

beneficiaries thereof, to preserve or 

trigger the tax and interest charge rules 

under section 1291. Accordingly, the 

4518 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

2As enacted, section 951A(d) contains two 

paragraphs designated as paragraph (3). The section 

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

paragraph on determination of the adjusted basis in 

property for purposes of calculating QBAI. 

preamble provided that the estate or 

trust, or the beneficiary thereof, must 

take excess distributions into account 

under section 1291 in a reasonable 

manner, consistent with the general 

operating rules of subchapter J and that 

it would be unreasonable for the 

shareholders of the section 1291 fund to 

take the position that neither the 

beneficiaries nor the estate or trust are 

subject to the tax and interest charge 

rules under section 1291. 

The Treasury Department and the IRS 

remain aware of the need for guidance 

regarding both the ownership 

attribution rules and the interaction of 

the rules in subchapter J with the PFIC 

rules. The Treasury Department and the 

IRS are also aware that in some cases, 

the application of the PFIC attribution 

rules may impose tax on U.S. 

beneficiaries of foreign trusts that never 

receive the related distributions. The 

Treasury Department and the IRS 

believe that further guidance with 

respect to the identification of indirect 

shareholders in such circumstances 

requires coordination of the PFIC rules 

with the rules of subchapter J, which is 

beyond the scope of this regulation 

project. Pending the issuance of further 

guidance, taxpayers should continue to 

apply these rules in a reasonable 

manner as expressed in the preamble to 

the 2013 temporary and final 

regulations. 

III. Comments and Revisions to 

Proposed § 1.1297–1—Definition of 

Passive Foreign Investment Company 

Proposed § 1.1297–1 provided general 

rules and definitions under section 1297 

including general rules concerning the 

application of the income test of section 

1297(a)(1) (‘‘Income Test’’) and the asset 

test of section 1297(a)(2) (‘‘Asset Test’’), 

clarification on the scope of the section 

1297(b)(1) cross-reference to section 

954(c) for purposes of defining passive 

income, and general rules that address 

certain computational and 

characterization issues that arise in 

applying the Asset Test. 

A. Definition of Passive Income 

1. In General 

Section 1297(b)(1) defines passive 

income, for purposes of the PFIC rules, 

as income of a kind that would be 

foreign personal holding company 

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

and proposed § 1.1297–1(c)(1)(i) 

provided accordingly that passive 

income means income of a kind that 

would be FPHCI under section 

954(c)(1). A comment suggested that the 

cross-reference to section 954(c)(1) 

should incorporate only those 

provisions of section 954(c) (and the 

regulations thereunder) that were in 

effect in 1986 when section 1297 was 

enacted and not, for example, section 

954(c)(1)(H), relating to income from 

personal services contracts, or recent 

revisions to the regulatory rules for 

active rents and royalties under section 

954(c)(2)(C). The Treasury Department 

and the IRS disagree, and believe that, 

in view of the original purpose of 

referencing section 954(c), section 1297 

incorporates the law in respect of the 

referenced provisions—both statutory 

and regulatory—when it is applied. 

Compare section 951A(d)(3).2 Therefore, 

the final regulations do not adopt this 

comment. 

2. PFIC/CFC Overlap Rule and RPII 

Income 

Section 1297(d) provides that, for 

PFIC purposes, a corporation shall not 

be treated as a PFIC with respect to a 

shareholder during the qualified portion 

of such shareholder’s holding period 

with respect to stock in such 

corporation during which time the 

corporation is a CFC (‘‘PFIC/CFC 

overlap rule’’). The qualified portion of 

a shareholder’s holding period generally 

is the period during which the 

shareholder is a United States 

shareholder (‘‘U.S. shareholder’’), as 

defined in section 951(b). Section 951(b) 

defines a U.S. shareholder, for purposes 

of the Code, as a U.S. person that owns 

10 percent or more of the voting power 

or value of a foreign corporation. 

Section 957(a) provides that, for 

purposes of the Code, a CFC means any 

foreign corporation more than 50 

percent owned (by vote or value, taking 

into account section 958(b) constructive 

ownership rules) by U.S. shareholders 

on any day during the taxable year of 

the foreign corporation. 

In certain circumstances, the subpart 

F insurance rules lower the CFC 

ownership threshold requirements used 

to determine CFC status and eliminate 

the 10 percent vote or value test for 

determining U.S. shareholder status that 

are otherwise applicable for purposes of 

the Code. Under section 957(b), a 

special definition of a CFC applies and 

lowers the more than 50 percent 

ownership rule to a more than 25 

percent ownership rule for taking into 

account section 953(a) insurance 

income, but only if the foreign 

corporation’s gross amount of premiums 

or other consideration in respect of 

reinsurance or the issuing of insurance 

or annuity contracts not described in 

section 953(e)(2) exceeds 75 percent of 

the gross amount of all premiums or 

other consideration in respect of all 

risks. Also, under section 953(c)(1)(B), 

for purposes of taking into account 

related party insurance income (‘‘RPII’’) 

as defined in section 953(c)(2), the CFC 

ownership requirement is reduced to a 

‘‘25 percent or more’’ requirement. In 

addition, for purposes of determining 

RPII, the 10 percent of vote or value test 

for determining U.S. shareholder status 

is eliminated. See section 953(c)(1)(A). 

Instead, for RPII purposes, a U.S. 

shareholder means any U.S. person that 

directly or indirectly owns any of the 

stock of the foreign corporation at any 

time during the foreign corporation’s 

taxable year. See section 953(c)(1)(A). 

Constructive ownership under section 

958(b) is not taken into account for this 

purpose. 

A comment requested that the 

proposed regulations be modified to 

provide an exception to the PFIC rules 

for all U.S. shareholders (meaning 

without regard to the 10 percent vote or 

value test in section 951(b)) of all CFCs 

(including those that satisfy the 25 

percent threshold applicable solely for 

the subpart F purposes described 

above). The final regulations do not 

adopt this comment. Consideration of 

the scope of the PFIC/CFC overlap rule, 

including the interaction with the RPII 

rules, is beyond the scope of this 

rulemaking. The Treasury Department 

and the IRS continue to study the 

interaction of these provisions and if 

necessary, will provide guidance in the 

future. 

B. Exceptions From Passive Income 

1. Application of Active Banking and 

Active Insurance Exceptions 

Proposed § 1.1297–1(c)(1)(i)(A) 

provided that section 954(h), which 

excludes from FPHCI income derived by 

a CFC in the active conduct of a banking 

or financing business from customers 

outside of the United States, applied for 

purposes of determining PFIC status. 

The proposed regulations also provided 

that section 954(i), which excludes from 

FPHCI certain income derived in the 

active conduct of an insurance business, 

did not apply for purposes of 

determining PFIC status. See proposed 

§ 1.1297–1(c)(1)(i)(B). Several comments 

approved of the application of section 

954(h) to the determination of whether 

income is treated as passive for 

purposes of section 1297. One 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) 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4519 

3See H.R. Rep. No. 220, 105th Cong. 1st Sess. 

623–28 (July 30, 1997) (discussing adoption of 

section 1297(d) CFC overlap rule and section 1296 

mark-to-market rule; no discussion of 

contemporaneous adoption of section 954(h)); id. at 

639–45 (discussing adoption of active financing 

income (section 954(h)) rule; no suggestion that 

rules apply for PFIC purposes). 

4 Id. at 642; see also H.R. Rep. No. 105–825, at 

1555 (Oct. 19, 1998) (Conf. Rep.) (‘‘[I]n this regard, 

a corporation is considered to be engaged in the 

active conduct of a banking or securities business 

if the corporation would be treated as so engaged 

under the regulations proposed under prior law 

section 1296(b) (as in effect prior to the enactment 

of the Taxpayer Relief Act of 1997)’’). 

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. Several comments 

recommended that the section 954(h) 

exception continue to apply in the PFIC 

context in the event that final 

regulations implementing the active 

banking exception in section 

1297(b)(2)(A) are adopted. Comments 

also requested that the final regulations 

apply the section 954(i) insurance 

exception for purposes of determining 

PFIC status of an insurance company in 

a parallel manner as section 954(h). 

In response to these comments, the 

Treasury Department and the IRS have 

further studied sections 954 and 1297 

and their legislative history. As 

described in more detail in the 

remainder of this Part III.B.1 of this 

Summary of Comments and Explanation 

of Revisions section, the Treasury 

Department and the IRS have 

determined that sections 954(h) and (i) 

do not apply for purposes of section 

1297(b) absent regulations and that the 

appropriate statutory authority for any 

such regulations is section 1297(b)(2) 

rather than section 1297(b)(1). The 

Treasury Department and the IRS have 

further concluded that section 954(i) 

does not apply for purposes of section 

1297(b)(2)(B), and that certain 

principles of section 954(h) should be 

applied for purposes of section 

1297(b)(2)(A) but that a different 

approach is warranted with respect to 

section 954(h) than the approach taken 

in the proposed regulations. 

Accordingly, the 2020 NPRM proposes 

rules that would treat qualifying income 

of certain taxpayers that satisfy the 

requirements of section 954(h) as 

income derived in the active conduct of 

a banking business within the meaning 

of section 1297(b)(2). See proposed 

§ 1.1297–1(c)(2). 

As previously discussed, section 

1297(b)(1) provides that, except as 

otherwise provided in section 

1297(b)(2), passive income means any 

income of a kind that would be FPHCI 

as defined in section 954(c). The 

definitions of the categories of FPHCI 

listed in section 954(c) describe types of 

gross income, for example interest, 

dividends, gains from the sale of 

property and foreign currency gains, as 

well as exceptions to those definitions. 

While these definitions and exceptions 

in some places refer to CFCs, the 

definitions and exceptions themselves 

do not require that a foreign corporation 

be a CFC. By contrast, although sections 

954(h) and (i) apply ‘‘for purposes of 

section 954(c)(1),’’ those provisions 

explicitly require that a foreign 

corporation be a CFC to qualify for an 

exception to FPHCI. Section 954(h) 

applies only to eligible CFCs, as defined 

in section 954(h)(2), and section 954(i) 

applies only to qualifying insurance 

company CFCs, as defined in section 

953(e)(3). Accordingly, sections 954(h) 

and (i) do not apply for purposes of 

section 1297(b)(1) unless a tested 

foreign corporation is treated pursuant 

to regulations as a CFC for that purpose 

or otherwise qualifies as a CFC. See 

proposed § 1.1297–1(c)(1)(i)(D) of the 

2019 proposed regulations (treating a 

tested foreign corporation as a CFC for 

purposes of applying section 954(h)). 

The Treasury Department and the IRS 

have further determined that any 

regulations treating sections 954(h) and 

(i) as applicable for purposes of section 

1297(b) should be issued under section 

1297(b)(2) and not under section 

1297(b)(1). As originally enacted, 

section 1297(b)(1) provided a rule of 

general application, and section 

1297(b)(2) provided a limited set of 

exceptions to section 1297(b)(1). While 

the list of exceptions in section 

1297(b)(2) has changed from time to 

time, that statutory scheme remains 

intact today. Section 1297(b)(2) provides 

exceptions for income derived in the 

active conduct of a banking or insurance 

business, subject to various conditions. 

If section 954(h) or (i) were treated as 

applicable for purposes of section 

1297(b)(1), section 1297(b)(2)(A) and (B) 

would provide duplicative exceptions 

for banking or insurance income, 

respectively. Moreover, interpreting 

section 1297(b)(1) in this manner would 

have the effect of narrowing the scope 

of the exceptions provided by section 

1297(b)(2), because the income of some 

foreign banks or insurance companies 

would already be treated as non-passive 

under section 1297(b)(1). No explicit 

action by Congress authorizes the 

narrowing of section 1297(b)(2) in this 

manner. The legislative history of the 

enactment of section 954(h) (as a 

temporary rule relating to both banking 

and insurance income) in 1997 and the 

enactment of sections 954(h) and (i) in 

1998 are void of any indication that 

Congress intended such an 

interpretation of section 1297(b)(1).3

The legislative history provides further 

evidence that section 954(h) was not 

intended to apply for purposes of 

section 1297(b)(1); the conference report 

states that ‘‘the conferees intend that a 

corporation will be considered to be 

engaged in the active conduct of a 

banking . . . business if the corporation 

would be treated as so engaged under 

the regulations proposed under’’ section 

1297(b)(2).4 Incorporating this standard 

into section 1297(b)(1) would limit the 

scope of section 1297(b)(2). 

Accordingly, given the specialized 

nature of these exceptions within the 

subpart F regime, the Treasury 

Department and the IRS have 

determined that it is inappropriate to 

apply them in defining the types of 

income that are ‘‘of a kind’’ described in 

section 954(c) (that is, FPHCI) for 

purposes of section 1297(b)(1). 

In addition, as explained in the 

preamble to the 2019 proposed 

regulations, the Treasury Department 

and the IRS have determined that 

because the recent changes to section 

1297(b)(2)(B) require that income 

eligible for the exception be earned by 

a qualifying insurance corporation, 

section 954(i) should not apply in 

addition to the newly modified 

exception in section 1297(b)(2)(B). See 

84 FR 33120, at 33123. Therefore, the 

final regulations do not adopt the 

comments requesting that the section 

954(i) exception apply for purposes of 

determining PFIC status. As a result, 

section 954(i) remains listed in 

§ 1.1297–1(c)(1)(i)(B) as one of the 

exceptions in section 954 that is not 

applied in the PFIC context. 

Section 954(h) has been removed from 

the list of exceptions that are applied to 

PFICs with respect to section 1297(b)(1). 

See § 1.1297–1(c)(1)(i)(A). Despite the 

conclusion that it is inappropriate to 

incorporate section 954(h) as an 

exception to the definition of passive 

income under section 1297(b)(1), the 

Treasury Department and the IRS have 

considered whether principles of 

section 954(h) could apply in the 

context of the rules of section 

1297(b)(2)(A). Section 1297(b)(2)(A) 

provides that passive income does not 

include any income derived in the 

4520 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

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). Pursuant to this 

grant of regulatory authority, the 2020 

NPRM proposes an active banking 

exception that incorporates certain 

principles of section 954(h) in defining 

other corporations that are eligible to 

apply this exception in addition to U.S. 

licensed banks. See proposed § 1.1297– 

1(c)(2). The preamble to the 2020 NPRM 

discusses comments that address issues 

relating to the potential application of 

section 954(h) in the PFIC context. 

2. Treatment of Gains From Certain 

Transactions 

Proposed § 1.1297–1(c)(1)(ii) provided 

that for purposes of the Income Test, 

categories of income under section 

954(c) that are determined by netting 

gains against losses are taken into 

account by a corporation on that net 

basis. However, under the proposed 

regulations, the net amount of income in 

each category of FPHCI was calculated 

separately for each relevant corporation, 

such that net gains or losses of a lookthrough subsidiary may not be netted 

against net losses or gains of another 

look-through subsidiary or of a tested 

foreign corporation. See proposed 

§ 1.1297–1(c)(1)(ii). 

One comment recommended that the 

final regulations not adopt the separate 

entity approach in proposed § 1.1297– 

1(c)(1)(ii) and, instead, permit a tested 

foreign corporation to net its gains and 

losses with those of its directly or 

indirectly owned look-through 

subsidiaries and its directly or 

indirectly owned partnerships. The 

comment noted that the separate entity 

approach could result in an 

overstatement of FPHCI of an integrated 

business that is conducted through 

multiple subsidiaries. 

The Treasury Department and the IRS 

have determined that the integrated 

treatment proposed by the comment 

with respect to look-through 

subsidiaries and look-through 

partnerships is consistent with the 

statutory language treating the owner of 

a look-through subsidiary as receiving 

directly its proportionate share of the 

income of the subsidiary, and with the 

policies underlying section 1297(c). 

Accordingly, § 1.1297–1(c)(1)(ii) 

provides that the net gains or income for 

a category of FPHCI that is determined 

by netting gains against losses are 

determined at the level of a tested 

foreign corporation taking into account 

individual items of the tested foreign 

corporation and its look-through 

subsidiaries and look-through 

partnerships. Because these regulations 

do not adopt an overall look-through 

approach with respect to all 

partnerships, netting is not provided 

with respect to gains and losses derived 

from partnerships that are not lookthrough partnerships. For example, 

netting does not apply to gains and 

losses that are part of a tested foreign 

corporation’s distributive share from a 

partnership that is a related person 

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

but not a look-through partnership. 

3. Treatment of Effectively Connected 

Income and Income Attributable to U.S. 

Permanent Establishments 

Section 952(b) excludes from subpart 

F income the U.S. source income of a 

CFC that is effectively connected with 

the conduct by such CFC of a trade or 

business in the United States 

(‘‘effectively connected income’’). 

Comments noted that the proposed 

regulations did not address the 

treatment of effectively connected 

income, or the assets held to produce 

such income, of a foreign corporation or 

the treatment of income that is 

attributable to a U.S. permanent 

establishment, or the assets held to 

produce such income. The comments 

noted that section 952(b) can exclude 

from subpart F income amounts that are 

FPHCI in order to prevent such amounts 

from being double-taxed, once directly 

to the foreign corporation, and a second 

time to United States shareholders of 

the foreign corporation, and stated that 

the PFIC rules should not discriminate 

against income earned through a U.S. 

branch rather than through a domestic 

subsidiary that may qualify for the 

special rules of section 1298(b)(7). 

These comments suggested that the final 

regulations either characterize such 

income, and the assets held to produce 

such income, as non-passive or not 

include such income for purposes of the 

Income and Asset Tests. 

As noted in Part III.B.1 of this 

Summary of Comments and Explanation 

of Revisions, the determination of 

whether amounts should be taken into 

account for purposes of the Income Test 

or the Asset Test is based on whether 

income would be FPHCI under section 

954(c), not whether the income is 

treated as subpart F income. The PFIC 

rules address whether income is 

passive, which is a different question 

from whether it should be treated as 

subpart F income. Section 1298(b)(7) 

does not provide non-passive treatment 

for all income of domestic subsidiaries, 

but rather only for income of domestic 

subsidiaries that meet specified 

requirements, indicating that Congress 

did not consider it appropriate to 

exclude all income of domestic 

subsidiaries that are subject to U.S. net 

income taxation from passive income 

treatment. As a corollary, the limited 

scope of section 1298(b)(7) implies that 

a broad exception for effectively 

connected income is not warranted. 

Furthermore, section 1293(g)(1)(B)(ii) 

provides authority to exclude effectively 

connected income of a PFIC that is 

subject to U.S. net income taxation from 

inclusion in the hands of a shareholder 

of the PFIC that has made a qualified 

electing fund election, indicating that 

effectively connected income is 

otherwise treated as income of a tested 

foreign corporation for PFIC purposes. 

The Treasury Department and the IRS 

have determined that an exclusion of 

effectively connected income (and 

income attributable to a U.S. permanent 

establishment) from passive income 

would be inconsistent with the statutory 

definition of passive income in section 

1297(b)(1), with the limited application 

of section 1298(b)(7) and with the 

exclusion provided by section 

1293(g)(1)(B)(ii), and that the treatment 

of effectively connected income (and 

income attributable to a U.S. permanent 

establishment) is contemplated and 

appropriately addressed by the existing 

PFIC rules. Consequently, the final 

regulations do not adopt the suggestions 

in these comments. 

C. Income Subject to the Related Person 

Look-Through Rule 

Section 1297(b)(2)(C) characterizes 

dividends, interest, rents, and royalties 

received or accrued from a related 

person as non-passive income to the 

extent those amounts are properly 

allocable to income of such related 

person that is not passive. Proposed 

§ 1.1297–1(c)(3) provided additional 

guidance on the application of the 

section 1297(b)(2)(C) related person 

exception for dividends, interest, rents, 

and royalties. In response to comments, 

changes have been made to these 

regulations and additional guidance has 

been provided. 

Under the final regulations, for 

purposes of the Asset Test and Income 

Test, corporations and partnerships 

owned in whole or part by a tested 

foreign corporation are generally 

classified into one or more of three 

categories. Lower-tier entities generally 

are treated as one or more of (i) a lookthrough subsidiary or look-through 

partnership (a ‘‘look-through entity’’), 

(ii) a related person or (iii) an entity that 

is neither a look-through entity nor a 

related person. The rules for lookthrough entities are discussed in Part IV 

of this Summary of Comments and 

Explanation of Revisions. Dividends 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4521 

and the distributive share of income 

from a lower-tier entity that is neither a 

look-through entity nor a related person 

generally are treated as passive income, 

regardless of whether the income of the 

lower-tier entity is active or passive in 

its hands. See § 1.1297–1(c)(3). 

Similarly, ownership interests in such 

entities are treated as passive assets. See 

§ 1.1297–1(d)(4). 

For purposes of section 1297(b)(2)(C), 

the term related person has the meaning 

provided by section 954(d)(3). See 

section 1297(b)(2) and § 1.1297–1(f)(8). 

Because the ownership threshold 

required for an entity to be treated as a 

related person is higher than the 

ownership threshold required for an 

entity to be treated as a look-through 

entity, there may be many entities that 

qualify as both or solely as look-through 

entities. However, because section 

954(d)(3) has broader attribution rules 

than the rules that apply for purposes of 

determining look-through entity 

classification, there may be entities that 

are treated as related persons with 

respect to a tested foreign corporation 

but not as look-through entities with 

respect to that tested foreign 

corporation. 

For purposes of section 1297(b)(2)(C), 

interest, dividends, rents or royalties 

actually received or accrued by a tested 

foreign corporation are considered 

received or accrued from a related 

person only if the payor of the interest, 

dividend, rent or royalty is a related 

person with respect to the tested foreign 

corporation. In the case of income 

received or accrued from a look-through 

entity, the rules that eliminate 

intercompany income described in Part 

IV.D of this Summary of Comments and 

Explanation of Revisions apply before 

the rules applicable to income received 

or accrued from a related person. See 

§ 1.1297–1(c)(4)(ii). Consequently, the 

rules of § 1.1297–1(c)(4) apply to 

dividends, interest, rents, and royalties 

received or accrued from a look-through 

entity only if those amounts are treated 

as regarded after application of the 

intercompany income rules. These rules 

also apply to income from a related 

person that is received or accrued by a 

look-through entity. The determination 

of whether income received or accrued 

by a look-through entity is treated as 

received from a related person is made 

at the level of the look-through entity, 

both for purposes of determining 

whether the look-through entity is a 

PFIC, if relevant, and for purposes of 

determining whether an upper-tier 

tested foreign corporation is a PFIC. See 

§ 1.1297–2(d). 

If a partnership is a related person 

(that is not a look-through entity) with 

respect to a tested foreign corporation or 

look-through entity, and therefore 

subject to these rules, the tested foreign 

corporation’s or look-through entity’s 

distributive share of income from the 

partnership is treated as passive or nonpassive in whole or part based on the 

activities of the partnership, and the 

partnership interest is correspondingly 

treated as passive or non-passive in 

whole or part. See § 1.1297–1(c)(4)(vii), 

(d)(3)(i), and (d)(4). An asset that gives 

rise to income that is treated as in part 

passive and in part non-passive 

pursuant to these rules is subject to the 

rules that apply to dual-character assets. 

See § 1.1297–1(d)(3)(i). 

1. Treatment of Interest 

The proposed regulations provided 

that, for purposes of the section 

1297(b)(2)(C) exception, interest is 

properly allocable to income of the 

related person that is not passive 

income based on the relative portion of 

the related person’s income for its 

taxable year that ends in or with the 

taxable year of the recipient that is not 

passive income. See proposed § 1.1297– 

1(c)(3)(i). Comments generally 

supported the pro rata approach taken 

in the proposed regulations. One 

comment noted that the final 

regulations should clarify that the 

allocation is based on the ratio of gross 

non-passive income to gross total 

income. Another comment that 

supported the pro rata approach in the 

proposed regulations recommended that 

the final regulations address situations 

in which the related person does not 

have income during the taxable year of 

the payment. In such a case, this 

comment suggested that the final 

regulations apply the principles of 

§ 1.861–9T, which provides rules for 

allocating and apportioning interest 

expense, to determine whether the 

interest payments are allocated to 

passive or non-passive income of the 

related person. The comment also 

requested that the approach using the 

principles of § 1.861–9T to allocate 

interest when the related person does 

not have gross income be made 

available as an alternative method at the 

election of the tested foreign 

corporation. 

As suggested by the first comment, 

the final regulations clarify that the ratio 

for allocating interest to income is based 

on gross income. See § 1.1297– 

1(c)(4)(iii). Similar clarifications are 

made for the rule for rents and royalties. 

See § 1.1297–1(c)(4)(v). The Treasury 

Department and the IRS have 

determined that the pro rata approach 

provided in the proposed regulations is 

the most straightforward and consistent 

with the purposes of the section 

1297(b)(2)(C) exception if the related 

person has gross income in the taxable 

year, and accordingly, the final 

regulations do not provide a generally 

applicable election to apply the 

principles of § 1.861–9T in lieu of the 

general rule. See § 1.1297–1(c)(4)(iii). 

It is anticipated that it will rarely be 

the case that a related person will not 

have gross income, because gross 

income for most taxpayers is 

determined without taking expenses 

into account. However, in the case of 

taxpayers that determine gross income 

after taking operating expenses into 

account, it is possible that a taxpayer 

will not have gross income for a taxable 

year. In such a case, the Treasury 

Department and the IRS agree that the 

principles of § 1.861–9T may properly 

apply for a year in which the related 

person does not have gross income, 

because § 1.861–9T is a general rule— 

the default rule in the absence of a more 

specific rule—relating to the allocation 

of interest expense. Alternatively, 

because section 1297(b)(2)(C) 

characterizes interest received or 

accrued from a related person as nonpassive income to the extent it is 

properly allocable to non-passive 

income of the related person, it may also 

be appropriate for interest received or 

accrued by the tested foreign 

corporation to be allocated entirely to 

passive income in such a case, and that 

treatment may be simpler for a tested 

foreign corporation to determine. 

Accordingly, the final regulations 

provide that for a year in which the 

related person does not have gross 

income, a tested foreign corporation 

may use the principles of § 1.861–9 

through –13T, applied in a reasonable 

and consistent manner taking into 

account the general operation of the 

PFIC rules and the purpose of section 

1297(b)(2)(C) in order to allocate interest 

received or accrued from the related 

person between passive and non-passive 

income. Alternatively, at a tested foreign 

corporation’s election, it may treat the 

interest income entirely as passive 

income. 

2. Treatment of Dividends 

The proposed regulations provided 

that, for purposes of the section 

1297(b)(2)(C) exception, dividends are 

treated as properly allocable to income 

of the related person that is not passive 

income based on the portion of the 

related payor’s current earnings and 

profits (‘‘E&P’’) for the taxable year that 

ends in or with the taxable year of the 

recipient that is attributable to nonpassive income. See proposed § 1.1297– 

1(c)(3)(ii). 

4522 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

A comment observed that foreign 

corporations often do not maintain E&P 

based on U.S. tax principles. The 

comment recommended that dividends 

be treated as allocated between passive 

and non-passive amounts based on the 

ratio of passive to non-passive gross 

income. 

Two comments requested that 

proposed § 1.1297–1(c)(3)(ii) be 

modified to allocate dividend income 

based on both current and accumulated 

E&P of the related payor to which the 

dividend income is attributable, in 

accordance with the principles of 

section 316. A third comment observed 

that there are administrative benefits to 

characterizing dividends by reference to 

current E&P, because it may be easier to 

obtain relevant information for current 

E&P and because the nature of a 

company’s activities may change. This 

comment further requested that 

dividends be determined by reference to 

gross income over a reasonable lookback period such as three to five years, 

rather than by reference to E&P under 

section 316 principles, in order to 

reflect the economic reality of the 

corporation’s activities and to avoid 

undue emphasis on the timing of the 

dividends. The comment suggested as 

an alternative that this method might 

apply only if the related payor does not 

maintain E&P using U.S. tax principles, 

while if the related party does maintain 

E&P based on U.S. tax principles, then, 

to the extent of current E&P, dividends 

would be characterized based on the 

portion of the related payor’s currentyear E&P that is attributable to nonpassive income, and the remaining 

amount would be characterized based 

on the relative portion of accumulated 

E&P that is attributable to non-passive 

income. The comment suggested that 

the ratio for accumulated E&P could be 

based on accumulated E&P for the 

period in which the related payor was 

a related person under section 954(d)(3). 

Another comment suggested that the 

difficulty in obtaining information 

necessary to determine the character of 

accumulated E&P with respect to foreign 

corporations could be addressed by 

allowing taxpayers to use reasonable 

methods to determine the character of 

accumulated E&P and proposed that 

characterizing the accumulated E&P 

based on the current year’s E&P be 

considered a reasonable method. 

The Treasury Department and the IRS 

agree that dividends from related parties 

should be allocated between passive 

and non-passive E&P based on the 

principles of section 316, which apply 

generally for purposes of the U.S. 

international tax rules. Accordingly, the 

final regulations adopt the 

recommendation to characterize 

dividends in accordance with first 

current and then accumulated E&P of 

the related payor to which the dividend 

income is attributable. See § 1.1297– 

1(c)(4)(iv)(A). In order to address 

concerns that foreign corporations that 

are not CFCs may not maintain E&P 

based on U.S. tax principles, taxpayers 

are permitted to allocate E&P in 

proportion to the ratio of passive gross 

income to non-passive gross income for 

the relevant period. See § 1.1297– 

1(c)(4)(iv)(B). 

The Treasury Department and the IRS 

also agree with the premise of all of the 

comments that if dividends are paid out 

of E&P other than current E&P, either 

because there is no current E&P or 

because the amount of the dividends 

exceeds the current E&P, it would be 

appropriate to take into account the 

character of the income supporting the 

dividend. The final regulations provide 

that dividends paid out of accumulated 

E&P are allocated between passive and 

non-passive E&P under the same rules 

that apply with respect to dividends 

paid out of current E&P. See § 1.1297– 

1(c)(4)(iv)(C). 

The Treasury Department and the IRS 

understand that it may be difficult for 

shareholders to determine the character 

of accumulated E&P with respect to 

foreign corporations, particularly for 

E&P from pre-acquisition periods. The 

suggestion of referring to a look-back 

period of several years is consistent 

with the rule for characterizing stock, 

discussed in Part III.D.4 of this 

Summary of Comments and Explanation 

of Revisions, which is intended to 

effectively treat stock as, in whole or 

part, held for the production of nonpassive income if dividends received 

with respect to it within a three-year 

period constitute non-passive income 

due to the application of section 

1297(b)(2)(C). Accordingly, the final 

regulations permit taxpayers to use the 

default approach, consistent with 

general U.S. federal income tax 

principles, of allocating dividends paid 

out of accumulated E&P based on the 

ratio of passive to non-passive E&P for 

each prior year (beginning with the most 

recently accumulated), or to use one of 

two administratively simpler 

alternatives. See id. The first alternative 

is to allocate dividends paid out of 

accumulated E&P based on the ratio of 

passive to non-passive E&P that is 

attributable to E&P accumulated in the 

years in which the payor was related to 

the recipient. If the payor has been 

related to the recipient for more than 

three years, a second alternative is 

available, which is to allocate dividends 

paid out of accumulated E&P based on 

the ratio of passive to non-passive E&P 

that is attributable to E&P accumulated 

during a look-back period of the three 

years before the current taxable year. 

See id. 

D. Asset Test 

1. Section 958 Proposed Regulations 

Shareholders of a foreign corporation 

that became a CFC as a result of the 

repeal of section 958(b)(4) would have 

to apply the Asset Test based on the 

adjusted basis of the foreign 

corporation’s assets under section 

1297(e). The section 958 proposed 

regulations modified the definition of a 

CFC for purposes of section 1297(e) to 

disregard downward attribution from 

foreign persons. See proposed § 1.1297– 

1(d)(1)(iii)(A). No comments were 

received with respect to this rule in the 

section 958 proposed regulations. 

Accordingly, the rule is finalized 

without modification. See § 1.1297– 

1(d)(1)(v)(B)(2). 

2. Determination of Average Amount of 

Assets Based on Value or Adjusted Basis 

Section 1297(e) provides that the 

assets of a tested foreign corporation are 

to be measured based on (i) value, 

pursuant to section 1297(e)(1), if it is a 

publicly traded corporation for the 

taxable year, or if section 1297(e)(2) 

does not apply to it for the taxable year; 

or (ii) adjusted basis, pursuant to section 

1297(e)(2), if it is a CFC or elects the 

application of section 1297(e)(2). These 

statutory provisions create a hierarchy 

for determining the method for 

measuring the assets of a tested foreign 

corporation, as follows: (a) First by 

value, if the tested foreign corporation is 

a publicly traded corporation for the 

taxable year; (b) second by adjusted 

basis, if the tested foreign corporation is 

not a publicly traded corporation and is 

a CFC; and (c) third by value, or at the 

election of the tested foreign 

corporation, by adjusted basis, in other 

cases. The Treasury Department and the 

IRS understand that taxpayers typically 

prefer to use value to measure assets of 

a tested foreign corporation. 

The proposed regulations provided 

that, for purposes of the Asset Test, 

companies that were publicly traded for 

only part of the year were required to 

measure assets on the basis of value for 

the entire year if the corporation was 

publicly traded on the majority of days 

during the year or if section 1297(e)(2) 

did not apply to the corporation on the 

majority of days of the year. If the tested 

foreign corporation was not publicly 

traded on the majority of days during 

the year, the tested foreign corporation 

was required to use adjusted basis to 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4523 

measure assets if it was a CFC or if an 

election to use adjusted basis was made 

under section 1297(e)(2)(B). See 

proposed § 1.1297–1(d)(1)(v). The 

majority of days rule in the proposed 

regulations would have required a 

tested foreign corporation that was a 

CFC and whose shares were publicly 

traded for less than the majority of days 

during the year to use adjusted basis to 

measure its assets for that taxable year 

because the corporation would not have 

been treated as a publicly traded 

corporation. The requirement to use 

adjusted basis might apply, for example, 

to a foreign corporation treated as a CFC 

that issues publicly traded shares in an 

initial public offering in the second half 

of the year. 

A comment requested that the 

proposed regulations be modified to 

provide that the Asset Test be applied 

based on value if shares of the tested 

foreign corporation were publicly traded 

at any time during the taxable year. The 

comment asserted that the use of value 

more appropriately reflects the purposes 

of the PFIC rules in general, and that the 

statute requires only non-publicly 

traded CFCs to use basis for purposes of 

the Asset Test and otherwise allows a 

tested foreign corporation to apply the 

Asset Test based on value. The 

comment also noted that, due to the 

repeal of section 958(b)(4), there may be 

more tested foreign corporations that are 

CFCs. In such cases, less-than-10- 

percent shareholders of those tested 

foreign corporations would be required 

to use basis rather than value in 

determining PFIC status. The comment 

requested relief from this result. The 

comment further noted that publicly 

traded corporations required to use 

basis would not be able to take into 

account goodwill and other self-created 

business intangibles for purposes of the 

Asset Test because such items often do 

not have tax basis. 

The Treasury Department and the IRS 

agree with the concerns expressed by 

the comment regarding the effects of the 

repeal of section 958(b)(4). As discussed 

in Part III.D.1 of this Summary of 

Comments and Explanation of 

Revisions, this rulemaking finalizes the 

portion of the section 958 proposed 

regulations concerning the definition of 

the term CFC for purposes of the Asset 

Test, which accordingly allows use of 

the value method of measuring assets to 

the extent permissible under the statute. 

See § 1.1297–1(d)(1)(v)(B)(2) (treating 

foreign corporations that are CFCs solely 

due to the repeal of section 958(b)(4) as 

not CFCs for purposes of section 

1297(e)). The Treasury Department and 

the IRS believe that this change may 

alleviate much of the concern expressed 

about the proposed rule because the 

change makes it less likely that a tested 

foreign corporation will be treated as a 

CFC that is required to use adjusted 

basis to measure its assets. 

The Treasury Department and the IRS 

also agree that section 1297(e) favors the 

use of value as a method to measure 

assets and that the use of value aligns 

with the objective of the PFIC rules. As 

a result, the final regulations expand the 

definition of publicly traded corporation 

for purposes of section 1297(e) to 

include more circumstances in which a 

tested foreign corporation is treated as a 

publicly traded foreign corporation. See 

§ 1.1297–1(f)(7). However, the Treasury 

Department and the IRS believe that it 

would be inappropriate to require a 

corporation to use value for purposes of 

the Asset Test if it was publicly traded 

for a de minimis period during its 

taxable year. Accordingly, the final 

regulations provide that a publicly 

traded corporation, which is defined as 

a corporation that has been publicly 

traded in more than de minimis 

amounts for at least twenty trading days 

(approximately one month) during a 

taxable year, is required to apply the 

Asset Test based on value. See § 1.1297– 

1(d)(1)(v)(A) and (f)(7). Pursuant to 

section 1297(e), a tested foreign 

corporation that does not qualify as a 

publicly traded foreign corporation may 

use value to measure assets as long as 

it is not a non-publicly traded CFC, but 

it is not required to do so. 

The comment also requested 

clarification on the application of 

section 1297(e) in the case of tiers of 

tested foreign corporations. The 

comment recommended the final 

regulations provide that, for purposes of 

applying the Asset Test, a publicly 

traded tested foreign corporation should 

measure all of its assets—including the 

assets of its non-publicly traded lookthrough subsidiaries—based on value. 

The Treasury Department and the IRS 

generally agree with the premise of this 

comment, except in cases where section 

1297(e) requires a different treatment for 

the assets of subsidiaries (as discussed 

in the next paragraph). For the 

avoidance of doubt, the final regulations 

include cross-references to § 1.1297– 

2(b)(2)(i) (which provides the rule that 

a tested foreign corporation is deemed 

to directly own the assets of the lookthrough subsidiary) in the final section 

1297(e) rules. See § 1.1297–1(d)(1)(i) 

and (d)(1)(v)(A). 

The comment also observed that, 

unlike the typical situation where a 

publicly traded tested foreign 

corporation would measure all of its 

assets (including the assets of its nonpublicly traded look-through 

subsidiaries) based on value in 

accordance with section 1297(e)(1)(A), it 

is questionable whether a CFC that is a 

non-publicly traded subsidiary of a 

publicly traded parent corporation 

could also use value, rather than basis, 

for purposes of testing its own PFIC 

status. The comment noted that such a 

subsidiary might be a CFC as a result of 

the repeal of section 958(b)(4). As 

discussed in Part III.D.1 of this 

Summary of Comments and Explanation 

of Revisions, § 1.1297–1(d)(1)(v)(B)(2), 

which provides that foreign 

corporations that are CFCs solely due to 

the repeal of section 958(b)(4) are not 

treated as such for purposes of section 

1297(e), mitigates this concern. Further, 

if a lower-tier tested foreign corporation 

is a CFC that is not publicly traded, 

section 1297(e)(2)(A) requires that 

adjusted basis be used as the method for 

measuring its assets. Therefore, the final 

regulations clarify that a lower-tier 

tested foreign corporation that is a nonpublicly traded CFC must use adjusted 

basis and not value to measure its 

assets, regardless of whether it is owned 

by a publicly traded foreign corporation. 

In order to clarify the application of 

the statutory hierarchy for measuring a 

tested foreign corporation’s assets more 

generally, including with respect to 

lower-tier tested foreign corporations, 

§ 1.1297–1(d)(1)(v) has been revised. 

The regulation provides a hierarchy that 

generally applies to every tested foreign 

corporation, regardless of whether it is 

an upper-tier or lower-tier tested foreign 

corporation. Pursuant to section 1297(e) 

and this hierarchy, (i) a publicly traded 

foreign corporation (as defined in 

§ 1.1297–1(f)(7)) must use value to 

measure its assets, (ii) a non-publicly 

traded CFC must use basis to measure 

its assets, unless the CFC becomes a 

publicly traded foreign corporation (as 

defined in § 1.1297–1(f)(7)) during a 

taxable year, and (iii) any other tested 

foreign corporation would use value to 

measure its assets unless an election is 

made to use adjusted basis, except if it 

is a lower-tier subsidiary in which case 

additional rules apply. See § 1.1297– 

1(d)(1)(v)(A), (B), and (C)(1). Section 

1.1297–1(d)(1)(iii) clarifies that the 

election to use adjusted basis may be 

made by the tested foreign corporation 

or its shareholders. 

Revised § 1.1297–1(d)(1)(v) provides 

specific rules for measuring the assets of 

lower-tier subsidiaries, which in the 

usual case are expected to be lookthrough subsidiaries. These rules follow 

the same hierarchy described in the 

prior paragraph, except that the method 

used to measure the assets of a lowertier subsidiary may be determined either 

by the status of the lower-tier subsidiary 

4524 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

if it is a publicly traded foreign 

corporation or a non-publicly traded 

CFC, or by the status of a tested foreign 

corporation that directly or indirectly 

owns all or part of the shares of the 

lower-tier subsidiary (a parent foreign 

corporation), if the parent foreign 

corporation has one of those statuses. 

See § 1.1297–1(d)(1)(v)(C)(2). 

As a general matter, the method used 

by a parent foreign corporation to 

measure its assets also must be used to 

measure the assets of a lower-tier 

foreign corporation owned in whole or 

part by that parent foreign corporation. 

This rule applies both for purposes of 

determining whether the parent foreign 

corporation is a PFIC and for purposes 

of determining whether the lower-tier 

foreign corporation is a PFIC. If a tested 

foreign corporation indirectly owns a 

lower-tier subsidiary through one or 

more other foreign corporations, the 

status of the parent foreign corporation 

in that chain of corporations that has the 

highest status in the hierarchy described 

above governs. See § 1.1297– 

1(d)(1)(v)(C)(2)(iii). 

This general consistency rule does not 

apply, however, if the lower-tier foreign 

corporation has a status for which 

section 1297(e) mandates a method for 

measuring assets (that is, it is a publicly 

traded foreign corporation or nonpublicly traded CFC). In such a case, the 

statutorily mandated method applies to 

measure the lower-tier foreign 

corporation’s assets, both for purposes 

of determining whether the parent 

foreign corporation is a PFIC and for 

purposes of determining whether the 

lower-tier foreign corporation is a PFIC. 

For example, if a tested foreign 

corporation is a publicly traded foreign 

corporation, then both its assets and the 

assets of its lower-tier subsidiaries must 

be measured on the basis of value, 

unless a lower-tier subsidiary is a nonpublicly traded CFC, in which case the 

assets of that subsidiary must be 

measured using adjusted basis. 

Similarly, if a tested foreign corporation 

is a non-publicly traded CFC, then both 

its assets and the assets of its lower-tier 

subsidiaries must be measured using 

adjusted basis, unless a lower-tier 

subsidiary is a publicly traded foreign 

corporation, in which case the assets of 

that subsidiary must be measured using 

value. See § 1.1297–1(d)(1)(v)(C)(2)(i) 

and (ii). If a lower-tier tested foreign 

corporation does not have a status for 

which section 1297(e) mandates a 

method for measuring assets, and it is a 

subsidiary of more than one parent 

foreign corporation, then U.S. 

shareholders of the two different parent 

corporations may be required to use 

different methods to measure the assets 

of the lower-tier foreign corporation 

based on the method used for each 

respective parent foreign corporation. 

See the last sentence of § 1.1297– 

1(d)(1)(v)(C)(2)(iii) and § 1.1297– 

1(d)(1)(v)(E)(3) (Example 3). 

The Treasury Department and the IRS 

recognize that section 1297(e)(1) 

requires in many cases that a valuation 

must be performed for assets of an 

operating company for which no 

publicly available valuation is available, 

apart from information provided in 

financial statements prepared under 

widely-used financial reporting 

standards, and that ascertaining such a 

valuation creates a compliance burden. 

The Treasury Department and the IRS 

are studying whether to provide rules 

permitting taxpayers to rely on financial 

statement information in appropriate 

cases, and the final regulations reserve 

on this issue. See § 1.1297–1(d)(1)(v)(D). 

The 2020 NPRM proposes a rule to 

address this issue and solicits comments 

on the proposed rule. See proposed 

§ 1.1297–1(d)(1)(v)(D). 

3. Treatment of Working Capital for 

Purposes of Asset Test 

The proposed regulations did not 

address the treatment of working capital 

for purposes of the Asset Test. Notice 

88–22, 1988–1 C.B. 489 (‘‘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 

(interest income). 

A comment on the proposed 

regulations asserted that the approach 

taken in Notice 88–22 with respect to 

working capital undermines the purpose 

of the PFIC regime to distinguish 

between investments in passive assets 

and investments in active businesses. 

The comment requested that the final 

regulations adopt an approach, similar 

to the treatment of dual-character assets, 

pursuant to which working capital 

would be bifurcated between passive 

and non-passive assets in proportion to 

the relative amount of gross income that 

is passive or non-passive. 

The Treasury Department and the IRS 

continue to study the appropriate 

treatment of working capital, and the 

final regulations reserve on this issue. 

See § 1.1297–1(d)(2). The 2020 NPRM 

proposes a limited exception to the 

treatment of working capital to take into 

account the short-term cash needs of 

operating companies. See proposed 

§ 1.1297–1(d)(2). 

4. Assets That Produce Income Subject 

to the Related Person Look-Through 

Rule 

The proposed regulations defined the 

term passive asset, consistent with 

section 1297(a), as an asset that 

produces passive income, or which is 

held for the production of passive 

income, taking into account the rules in 

proposed § 1.1297–1(c), which defined 

passive income, and proposed § 1.1297– 

1(d), which provided rules for the 

application of the Asset Test. See 

proposed § 1.1297–1(f)(6). The proposed 

regulations also provided that an asset 

that produces both passive income and 

non-passive income during a taxable 

year is treated as two assets, one of 

which is passive and one of which is 

non-passive, with the value (or adjusted 

basis) of the asset being allocated 

between the passive asset and nonpassive asset in proportion to the 

relative amounts of passive and nonpassive income produced by the asset 

during the taxable year. See proposed 

§ 1.1297–1(d)(2)(i). 

A number of comments expressed 

concern that the proposed regulations 

did not provide a general rule to 

characterize assets—in particular shares 

of stock—that give rise to income 

subject to the related person lookthrough rule of section 1297(b)(2)(C), 

discussed in Part III.C of this Summary 

of Comments and Explanation of 

Revisions. The comments suggested that 

the final regulations include a rule that 

treats assets that give rise to income 

subject to section 1297(b)(2)(C) as a 

passive or non-passive asset to the 

extent the income that is received with 

respect to such asset is treated as 

passive or non-passive by the tested 

foreign corporation. The Treasury 

Department and the IRS agree that it is 

consistent with the statutory language 

and intent of section 1297(a)(2) to treat 

assets that give rise to both passive and 

non-passive income as partly passive 

and partly non-passive. The Treasury 

Department and the IRS believe that it 

was clear under proposed § 1.1297– 

1(d)(2)(i) and (f)(6) that assets that 

produced income subject to the related 

person look-through rule of section 

1297(b)(2)(C) were treated as nonpassive in proportion to the non-passive 

income produced by the asset, subject to 

the special rules in § 1.1297–1(d). 

However, for the avoidance of doubt, 

the final regulations provide an explicit 

cross-reference to section 1297(b)(2)(C) 

to clarify that assets that produce 

income subject to the related person 

look-through rule are subject to the 

general and special rules with respect to 

treatment of assets under § 1.1297–1(d), 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4525 

for example related party stock, loans, 

leases or licenses that produce 

dividends, interest, rent or royalties that 

are treated as passive and non-passive 

under section 1297(b)(2)(C). See 

§ 1.1297–1(d)(3)(i). Accordingly, assets 

that give rise to income subject to 

section 1297(b)(2)(C) generally are 

treated as a passive or non-passive asset 

to the extent the income that is received 

with respect to such asset is treated as 

passive or non-passive by the tested 

foreign corporation. 

The proposed regulations also 

provided that stock of a related person 

with respect to which no dividends are 

received or accrued during a taxable 

year but that previously generated 

dividends that were characterized as 

non-passive income, in whole or in part, 

under section 1297(b)(2)(C) is 

characterized based on the dividends 

received or accrued with respect thereto 

for the prior two years. See proposed 

§ 1.1297–1(d)(2)(iii). 

Comments noted that there may be 

instances in which the related person 

has not paid dividends in more than 

two years. One comment suggested that, 

in this instance, stock be apportioned in 

proportion to the average percentage of 

the dividends that were characterized as 

passive and non-passive in the last two 

years in which the related person paid 

dividends. If the related person never 

paid a dividend that was excluded 

under section 1297(b)(2)(C), the 

comment recommended that the stock 

be characterized based on the earnings 

during the last two years in which the 

related person generated earnings or, if 

the related person has never generated 

earnings, based on the earnings that are 

reasonably expected to be generated in 

the future. Another comment requested 

that proposed § 1.1297–1(d)(2)(iii) be 

replaced with a general rule with 

respect to stock of a related party that 

would characterize the stock based on 

whether the stock is expected to 

generate passive income. The comment 

asserted that this rule would allow for 

taxpayers to use reasonable methods to 

determine if the stock is expected to 

generate passive income. 

One comment argued that, for 

purposes of characterizing stock that 

does not generate dividends in the 

current year, a look-back period of two 

years would be appropriate if the final 

regulations adopt an approach that 

characterizes the stock based on the 

character of hypothetical dividends and 

uses the proportionate amount of nonpassive gross income over the look-back 

period to determine the character of the 

dividends. If such an approach is not 

adopted, the comment recommended 

that, instead of a look-back period of 

two years, the stock could be 

characterized based on dividends paid 

during the preceding five years or, if 

shorter, the period during which the 

subsidiary was a related person under 

section 954(d)(3). 

Proposed § 1.1297–1(d)(2)(iii) was 

premised on the understanding that 

stock that has recently generated 

dividends that are, in whole or in part, 

non-passive under the related person 

look-through rule can be understood to 

be held for the production of nonpassive income. If, however, the stock 

has not recently generated dividends, it 

is more appropriate to treat the stock as 

held for the production of gains upon 

disposition, which would generally be 

passive income. Accordingly, the 

Treasury Department and the IRS have 

determined that it would not be 

appropriate to allow stock to be treated 

as a non-passive asset on the basis of 

speculation that dividends might be 

received with respect to the stock and 

that such dividends could be nonpassive under section 1297(b)(2)(C) as 

most of the comments’ 

recommendations would provide. 

Moreover, the changes to the rules for 

determining the passive or non-passive 

character of dividends, discussed in Part 

III.C.2 of this Summary of Comments 

and Explanation of Revisions, also take 

into account the actual history of the 

stock and allow taxpayers to treat the 

most recent prior years as most relevant 

in determining the character of the 

stock. Thus, the final regulations do not 

adopt these comments and, instead, the 

final regulations provide that stock that 

did not produce dividends within the 

current taxable year or within either of 

the preceding two taxable years is 

characterized as a passive asset. See 

§ 1.1297–1(d)(3)(iii); but see section 

1297(c) and § 1.1297–2(c)(1)(i) 

(eliminating stock of look-through 

subsidiaries for purposes of the Asset 

Test). 

E. Stapled Entities 

Proposed § 1.1297–1(e) provided that, 

for purposes of determining whether 

any stapled entity (as defined in section 

269B(c)(2)) is a PFIC, all entities that are 

stapled entities with respect to each 

other are treated as one entity. A 

comment suggested that the definition 

of stapled entities provided in section 

269B(c)(2) and § 1.269B–1 could be 

overbroad and thus lead to planning 

opportunities for purposes of PFIC 

testing. Therefore, the comment 

recommended that the final regulations 

provide a more restrictive definition for 

stapled entities so that, for purposes of 

PFIC testing, single-entity treatment 

would be limited to situations in which 

nearly 100 percent of the outstanding 

equity interests in both entities are 

stapled to each other. Alternatively, the 

comment suggested, the Treasury 

Department and the IRS could issue 

rules applicable to the holders of 

stapled interests clarifying the 

application of the anti-abuse rule in 

section 1298(b)(4) (which would treat 

separate classes of stock (or other 

interests) in a corporation as interests in 

separate corporations, pursuant to 

regulations, where necessary to carry 

out the purposes of the PFIC regime) to 

such stapled interests by providing that 

the rule would apply only if unusual 

features exist and the arrangement 

would allow avoidance of the PFIC 

rules. The comment also highlighted the 

inappropriateness of potentially 

applying the rule in proposed § 1.1297– 

1(e) to treat a shareholder of an entity 

that would not be a PFIC, but for the 

rule, as the shareholder of a PFIC. 

Another comment requested 

clarification on the extent to which 

stapled entities that were treated as a 

single entity for purposes of PFIC testing 

would be treated as a single entity with 

respect to other provisions in the PFIC 

regime. In particular, the comment 

requested that the final regulations 

indicate whether the stapled entities are 

treated as one PFIC for purposes of 

including income under the PFIC 

regime and for purposes of making an 

election with respect to income 

inclusions under the PFIC regime. Like 

the first comment, it also requested 

guidance when not all interests are 

stapled. 

The Treasury Department and the IRS 

have determined that it is appropriate to 

apply the single entity treatment of 

proposed § 1.1297–1(e) even when not 

all interests in the stapled entities are 

stapled because section 269B(c)(2) 

applies only when controlling interests 

in the stapled entities are stapled, but 

that the application of the rule should 

be limited to apply only to U.S. persons 

that hold stapled interests and should 

not affect U.S. persons that directly or 

indirectly own only one of the stapled 

entities. Accordingly, the rule in 

proposed § 1.1297–1(e) is modified to 

apply only if a U.S. person that would 

be a shareholder of the stapled entities 

owns stock in all entities that are 

stapled entities with respect to each 

other. In this case, the stapled entities 

are treated as an interest in a single 

entity for all purposes of the PFIC rules, 

which may have the effect of causing a 

stapled entity that would not be a PFIC 

on a stand-alone basis to be treated as 

a PFIC when stapled, or the reverse. See 

§ 1.1297–1(e). Given these modifications 

to the rule and the fact that the 

4526 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

definition of stapled entities in section 

269B(c)(2) already limits stapling to 

situations in which more than 50 

percent in the value of the beneficial 

ownership in each of the entities 

consists of stapled interests, the 

Treasury Department and the IRS have 

determined that it is not necessary at 

this time to provide guidance on the 

application of section 1298(b)(4) or to 

further limit the interests that can be 

stapled. 

IV. Comments and Revisions to 

Proposed § 1.1297–2—Special Rules 

Regarding Look-Through Subsidiaries 

and Look-Through Partnerships 

Proposed § 1.1297–2 provided 

guidance on the application of the lookthrough rule of section 1297(c) for 

purposes of the Income Test and the 

Asset Test. 

A. Overview 

1. Treatment of Income and Assets 

Under the final regulations, a tested 

foreign corporation is treated as directly 

owning the assets of, and directly 

deriving the gross income of, a lookthrough subsidiary or look-through 

partnership. See § 1.1297–2(b)(2) and 

(b)(3). The tested foreign corporation 

disregards the equity interest in the 

look-through entity for purposes of the 

Asset Test. See § 1.1297–2(c)(1)(i) and 

(c)(3). As discussed in more detail in 

Part IV.D of this Summary of Comments 

and Explanation of Revisions, dividends 

from a lower-tier subsidiary and 

distributions and the distributive share 

of income from a lower-tier partnership 

generally are treated as if they did not 

exist (‘‘eliminated’’) for purposes of the 

Income Test. See § 1.1297–2(c)(2)(i) and 

(c)(3). 

For Income Test purposes, the 

proposed regulations provided that the 

disposition of the stock of a lookthrough subsidiary is treated as the 

disposition of stock and provided rules 

for the calculation of gain. See proposed 

§ 1.1297–2(f)(1). The final regulations 

also include rules addressing the 

disposition of partnership interests in a 

look-through partnership, which are 

similar in concept to the rules that 

apply to the disposition of stock of a 

look-through subsidiary, and rules 

addressing the disposition of 

partnership interests in a partnership 

described in section 954(c)(4)(B). See 

§ 1.1297–2(f)(4). Where both rules could 

potentially apply, the disposition is 

subject to the rules of section 954(c)(4). 

See § 1.1297–2(f)(4)(i) and (ii). 

Consequently, it is anticipated that the 

sale of interests in a partnership that a 

tested foreign corporation owns at least 

25 percent of by value generally will be 

subject to section 954(c)(4), and 

therefore will be treated as a disposition 

of assets rather than a disposition of the 

partnership interest, while the sale of 

interests in a partnership that a tested 

foreign corporation owns less than 25 

percent of by value may or may not be 

subject to section 954(c)(4) in light of 

the different 25-percent ownership test 

in that statutory provision. The effect on 

the determination of gain under section 

954(c)(4) of partnership earnings that 

have been included in income by the 

tested foreign corporation but not 

distributed is beyond the scope of these 

regulations. 

Payments of interest, rent and 

royalties, and the related debt 

obligation, lease or license, between the 

tested foreign corporation and the lookthrough entity or between look-through 

entities generally also are eliminated for 

purposes of both the Income and the 

Asset Tests, as discussed in Part IV.D of 

this Summary of Comments and 

Explanation of Revisions. See § 1.1297– 

2(c)(1)(ii), (c)(2)(ii), and (c)(3). If the 

obligation is between look-through 

entities that are not wholly owned by 

the tested foreign corporation, a 

proportionate part of the obligation and 

income from it is eliminated. See id. 

2. Definition of Look-Through 

Subsidiary 

A subsidiary of a tested foreign 

corporation is treated as a look-through 

subsidiary if both an asset test and an 

income test are satisfied. See § 1.1297– 

2(g)(3). If only one test is satisfied, the 

subsidiary is not treated as a lookthrough subsidiary. See generally id. 

The asset test is satisfied for any 

measuring period (for example, one 

quarter of a taxable year) if on the 

relevant measuring date (for example, 

the end of a quarter) the tested foreign 

corporation owns at least 25 percent of 

the value of the stock of the subsidiary. 

See § 1.1297–2(g)(3)(i). The income test 

is satisfied if either (i) the tested foreign 

corporation owns an average of at least 

25 percent of the value of the 

subsidiary’s stock on the measuring 

dates of an entire taxable year, or (ii) the 

tested foreign corporation owns at least 

25 percent of the value of the 

subsidiary’s stock on a measuring date 

and the subsidiary’s gross income for 

the measuring period can be 

determined. See § 1.1297–2(g)(3)(ii). 

Consequently, if a tested foreign 

corporation owns at least 25 percent of 

a subsidiary’s stock for part but not all 

of a taxable year, the subsidiary is 

treated as a look-through subsidiary for 

that part of the taxable year only if the 

tested foreign corporation can determine 

the subsidiary’s gross income on the 

measuring dates within that part of the 

taxable year. These rules are intended to 

ensure that a subsidiary is not treated as 

a look-through subsidiary unless the 

tested foreign corporation can determine 

the proportionate share of the 

subsidiary’s assets and income that it is 

treated as directly owning and deriving. 

B. Look-Through Partnerships 

1. Overview 

The proposed regulations defined a 

look-through partnership as a 

partnership in which the tested foreign 

corporation owned at least 25 percent in 

value. See proposed § 1.1297–1(c)(2)(i), 

(d)(3)(i), and (f)(1). The preamble to the 

proposed regulations indicated that the 

look-through partnership rules were 

drafted to apply look-through treatment 

as provided in section 1297(c) 

consistently to lower-tier partnerships 

and lower-tier corporations. See 84 FR 

33120, at 33124. The preamble stated 

that the difference between the 25 

percent threshold for look-through 

partnerships in the proposed regulations 

and the treatment of partnership income 

for FPHCI purposes is warranted 

because of the flexibility that entities 

have in their characterization under 

§ 301.7701–3 and because of the fact 

that treating a subsidiary as a 

partnership may not have U.S. income 

tax consequences for a tested foreign 

corporation as it could for a CFC. See id. 

The preamble also noted that this rule 

ensured that the tested foreign 

corporation would have significant 

control over the partnership activities, 

such that a partnership interest could 

represent an active business interest. 

See id. The preamble requested 

comments on whether 25 percent was 

the right threshold, whether different 

rules should apply to general 

partnerships and limited partnerships, 

and whether a material participation 

test should apply. 

The definition of look-through 

partnership in the final regulations is 

revised to more closely align with the 

definition of look-through subsidiary. 

Under the final regulations, a lookthrough partnership is a partnership 

that would be a look-through subsidiary 

with respect to the tested foreign 

corporation if the partnership were a 

corporation. See § 1.1297–2(g)(4)(i)(A). 

Accordingly, as noted by one comment, 

the taxpayer-favorable rules of section 

1297(c) will apply to look-through 

partnerships, for example by allowing 

attribution of the activities of other 

affiliates in determining whether rental 

or royalty income of the partnership is 

treated as passive or non-passive. In 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4527 

response to other comments, additional 

changes have been made to the 

definition of look-through partnership 

to allow look-through treatment for 

certain minority interests in 

partnerships. See § 1.1297–2(g)(4)(i)(B). 

These changes are discussed in Part 

IV.B.2 of this Summary of Comments 

and Explanation of Revisions. 

The look-through partnership rules 

were located in proposed § 1.1297–1, 

which provided general rules 

concerning the Income and Asset Tests. 

Because look-through treatment for 

purposes of PFIC testing is provided in 

section 1297(c) and § 1.1297–2 provides 

guidance on the application of section 

1297(c), the rules in the final regulations 

concerning look-through partnerships 

are in § 1.1297–2 along with all of the 

other rules discussing look-through 

treatment. See § 1.1297–2(b)(3) and 

(g)(4). 

2. Definition of Look-Through 

Partnership 

Under the proposed regulations, a 

look-through partnership with respect to 

a tested foreign corporation was defined 

as a partnership if (i) for purposes of 

section 1297(a)(2), the tested foreign 

corporation owned at least 25 percent of 

its value on a measuring date and (ii) for 

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

tested foreign corporation owned at 

least 25 percent of its value on the date 

on which income was received or 

accrued by the partnership. See 

proposed § 1.1297–1(f)(1). The proposed 

regulations also provided that, if a 

tested foreign corporation owns, directly 

or indirectly, less than 25 percent of the 

value of a partnership, the corporation’s 

distributive share of the partnership’s 

income was treated as passive income 

for purposes of the Income Test and the 

corporation’s interest in the partnership 

was treated as a passive asset for 

purposes of the Asset Test. See 

proposed § 1.1297–1(c)(2)(ii) and 

(d)(3)(ii). 

Three comments were received 

addressing these rules. The comments 

supported the proposed regulations’ 

general treatment of look-through 

partnerships and addressed the 

determination of when a partnership is 

treated as a look-through partnership. 

Two comments recommended that the 

25-percent threshold be eliminated so 

that look-through treatment would 

apply to all partnerships regardless of 

the ownership level by the tested 

foreign corporation. A third comment 

stated that the proper approach to 

partnerships in applying look-through 

rules raises difficult issues and made 

several alternative recommendations. 

The two comments recommending 

that all partnerships be treated as lookthrough partnerships noted that 

partnerships are pass-through entities 

that are generally treated as aggregates 

for many purposes throughout the Code 

and asserted that section 1297(c) 

implicitly indicates that aggregate 

treatment was intended to apply to all 

partnerships because it provides a 25- 

percent threshold only for corporations. 

The comments also stated that the 

differences between corporate treatment 

and partnership treatment have 

ramifications for many other parts of the 

Code, such as subpart F, GILTI, and the 

anti-hybrid rules. The comments 

asserted that minority shareholders 

generally cannot compel an upper-tier 

foreign corporation to make an election 

for a lower-tier foreign corporation to be 

treated as a partnership under 

§ 301.7701–3 and that it is unlikely that 

a tested foreign corporation would make 

a non-commercial investment in order 

to benefit minority shareholders. 

The Treasury Department and the IRS 

do not agree with these comments, other 

than the comment that partnerships are 

treated as aggregates for many Code 

purposes. Many of the legal entities 

potentially treated as look-through 

partnerships under section 1297 would 

have been treated as corporations for 

U.S. federal income tax purposes when 

section 1297(c) was enacted, because 

the enactment of section 1297(c) 

preceded the promulgation of 

§ 301.7701–3 by approximately ten 

years and before that time foreign 

corporate entities were generally 

classified as corporations for U.S. 

federal income tax purposes. The 

differences between corporate treatment 

and partnership treatment referred to by 

the comments generally are not relevant 

to foreign corporations that are not 

subject to U.S. net income taxation or to 

U.S. shareholders as to whom a foreign 

corporation is not treated as a CFC. As 

stated in the preamble to the proposed 

regulations, an election under 

§ 301.7701–3 to treat a foreign 

subsidiary of such a foreign corporation 

as a partnership for U.S. federal income 

tax purposes may have no U.S. tax 

consequences other than to affect the 

determination of whether the foreign 

corporation is a PFIC. 

The Treasury Department and the IRS 

recognize that minority shareholders 

may not be able to compel a foreign 

corporation to make a U.S. tax election 

or to make particular investments. 

However, a foreign corporation may 

cause a subsidiary to make an election 

to be treated as a partnership for U.S. 

tax purposes or take other steps in order 

to avoid classification as a PFIC in order 

to retain or attract U.S. investors, since 

there are likely to be no non-tax and no 

foreign tax consequences to the election. 

The two comments indicated that the 

subpart F regime characterizes a 

partner’s distributive share of 

partnership income without regard to 

the partner’s level of control or 

involvement for purposes of 

determining subpart F income and 

recommended that the same approach 

apply in these regulations. The final 

regulations do not adopt this comment. 

The Treasury Department and the IRS 

believe that the difference in treatment 

between these regulations and the 

subpart F regime is warranted in light of 

the fact that Congress imposed a 25- 

percent threshold for look-through 

treatment for subsidiaries in section 

1297 but not in subpart F, and that 

consistency of treatment for lookthrough subsidiaries and look-through 

partnerships in these regulations is 

consistent with Congressional intent. 

One comment recommended, as an 

alternative to automatic passive 

treatment for less than 25-percentowned interests, that the distributive 

share of income from, and the interest 

in, a less than 25-percent-owned 

partnership be characterized as passive 

only if the necessary information cannot 

be obtained for purposes of the Income 

Test and the Asset Test. The Treasury 

Department and the IRS agree that it 

may be difficult for a tested foreign 

corporation to obtain adequate 

information from a subsidiary in which 

a tested foreign corporation holds a lessthan-25-percent investment, and that if 

that is the case, the investment should 

be treated as passive. The Treasury 

Department and the IRS have taken this 

comment into account in the new rules 

described at the end of this Part IV.B.2. 

The Treasury Department and the IRS 

do not agree that a tested foreign 

corporation that has less than a 25- 

percent-interest in an active partnership 

should be able to automatically treat 

such partnership interest as active if 

such information is available, for the 

reasons already stated. 

A third comment stated that the 

approach proposed in the proposed 

regulations has the advantage of 

certainty and ease of administration 

because it provides a relatively clear 

bright-line test and limits the need to 

obtain information about the assets and 

income of a lower-tier partnership that 

may be difficult for small partners to 

obtain. The comment also noted that the 

proposed approach creates greater 

equivalence between lower-tier entities 

that have or have not elected to be 

treated as pass-through entities, but 

observed that the proposed regulations 

4528 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

did not create complete equivalence 

between such entities because the 

distributive share from a related 

partnership was not subject to the same 

rules as dividends from a related 

corporation. The final regulations 

address this concern by providing that 

the distributive share derived by a 

tested foreign corporation from a related 

partnership is subject to rules similar to 

such dividends. See § 1.1297– 

1(c)(4)(vii). 

This comment also stated that a 25- 

percent threshold is not a good proxy 

for an active business interest and is not 

consistent with long-standing market 

practice. The comment recommended 

four alternatives for the threshold for 

partnership look-through treatment. 

Under the first alternative, the comment 

suggested that the final regulations 

adopt a 25 percent threshold similar to 

that of section 954(c)(4). Under a second 

alternative, the comment suggested that 

the final regulations not take into 

account elections under § 301.7701–3 

for purposes of PFIC testing. Under a 

third alternative, the comment proposed 

that the final regulations treat every 

pass-through entity as an aggregate 

without regard to ownership threshold. 

Under the fourth alternative, the 

comment recommended that the final 

regulations adopt a ‘‘material 

participation’’ approach pursuant to 

which look-through with respect to a 

partnership applies if the tested foreign 

corporation materially participates in 

the underlying business of the 

partnership. 

The Treasury Department and the IRS 

recognize that although Congress has 

mandated a 25-percent threshold in 

order to treat a corporate subsidiary as 

a look-through entity, that threshold 

may not be a good proxy for an active 

business interest. The Treasury 

Department and the IRS considered 

whether the alternatives suggested 

would better identify an active 

partnership interest. The final 

regulations do not adopt any of the 

alternatives suggested by the third 

comment but do adopt an approach 

similar in concept to the fourth of the 

alternatives. With respect to the first 

and third alternatives, the Treasury 

Department and the IRS have 

determined that the 25-percent 

threshold should be the same for lowertier entities regardless of whether they 

have elected pass-through treatment for 

the reasons already discussed. With 

respect to the second alternative, the 

Treasury Department and the IRS do not 

believe that it is appropriate in this 

context to draw distinctions between 

entities in the legal form of a 

partnership and other entities treated as 

partnerships for U.S. federal income tax 

purposes. 

In regard to the fourth alternative, the 

Treasury Department and the IRS agree 

that if a tested foreign corporation is 

actively involved in the business of a 

partnership with active business 

operations, look-through treatment may 

be appropriate, even if the tested foreign 

corporation is a minority investor in the 

partnership, so that the tested foreign 

corporation may take into account the 

active assets and income of the 

partnership rather than treating the 

partnership investment as passive. The 

Treasury Department and the IRS 

considered a material participation test 

but determined that the passive activity 

loss rules of section 469 are not 

appropriate for a foreign corporate 

investor in a partnership owned directly 

or indirectly by a tested foreign 

corporation. The section 469 material 

participation rules focus primarily on 

the activities of individuals. See 

§ 1.469–5 and –5T. While section 469 

also provides rules for partners that are 

closely held corporations, those rules 

are likely to be difficult to apply and to 

audit in the PFIC context. 

The Treasury Department and the IRS 

also considered other participation and 

attribution rules of the Code, including 

proposed rules addressing when a 

corporate partner would be attributed 

the trade or business assets and 

activities of a partnership for purposes 

of the active trade or business 

requirement in section 355(b). See 88 FR 

26012 (REG–123365–03) (proposing a 

rule that a partner that owns a 

meaningful interest in a partnership 

would be attributed the trade or 

business assets and activities of the 

partnership if the partner performs 

active and substantial management 

functions for the partnership with 

respect to the trade or business assets or 

activities (for example, by making 

decisions regarding significant business 

issues of the partnership and regularly 

participating in the overall supervision, 

direction, and control of the employees 

performing the operational functions for 

the partnership)). However, the 

Treasury Department and the IRS 

determined that such a rule would not 

be appropriate for purposes of section 

1297. As stated in a comment, the 

disadvantage of participation-based tests 

is that they are factual and potentially 

subjective, and therefore less 

administrable. For example, the 

proposed section 355(b) test described 

above would be difficult for the IRS to 

audit in the case of a foreign corporation 

that is not controlled by U.S. 

shareholders. Moreover, if the 

‘‘meaningful interest’’ requirement 

applied, look-through treatment might 

apply only to a small number of 

partnerships that are not already treated 

as look-through partnerships. The 

Treasury Department and the IRS did 

not consider these approaches to be 

more appropriate than applying the 

rules of section 1297 at the partner level 

as a means of testing whether an 

investment in a partnership is an active 

business interest. Accordingly, the 

definition of look-through partnership is 

further altered to include certain 

partnerships in which the tested foreign 

corporation owns a minority interest if 

the tested foreign corporation has 

sufficient active assets and income as 

determined under the rules of section 

1297 apart from the partnership. See 

§ 1.1297–2(g)(4)(i)(B). 

Under the final regulations, a lookthrough partnership is defined as (i) a 

partnership that would be a lookthrough subsidiary if such partnership 

were a corporation—as discussed in Part 

IV.B.1 of this Summary of Comments 

and Explanation of Revisions—or (ii) 

any other partnership if the tested 

foreign corporation satisfies the active 

partner test. See § 1.1297–2(g)(4)(i). The 

active partner test is satisfied if the 

tested foreign corporation would not be 

a PFIC if both the Income and the Asset 

Test were applied to it without 

including its interest in any partnership 

that would not be a look-through 

subsidiary if such partnership were a 

corporation. See § 1.1297–2(g)(4)(ii). If 

the tested foreign corporation has no 

passive assets or income, even a very 

small active business would allow the 

interest to qualify as a look-through 

partnership under the active partner 

test. On the other hand, qualifying 

under the active partner test can only 

prevent a partnership interest from 

tainting an otherwise non-PFIC 

corporation, rather than be used 

affirmatively. Because the Treasury 

Department and the IRS understand that 

it may be difficult for minority investors 

in partnerships to obtain the 

information necessary to apply the 

Income and Asset Tests taking into 

consideration the income and assets of 

a look-through partnership, the final 

regulations provide an election out of 

the look-through partnership definition 

for partnerships that would not be a 

look-through subsidiary if such 

partnership were a corporation. See 

§ 1.1297–2(g)(4)(iii). The final 

regulations also provide two new 

examples illustrating the active partner 

test. See § 1.1297–2(g)(4)(iv). 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4529 

C. Overlap Between Section 1297(c) and 

Section 1298(b)(7) 

The proposed regulations provided 

that the look-through rule of section 

1297(c) does not apply to a domestic 

corporation if the stock of the domestic 

corporation is characterized under 

section 1298(b)(7) as a non-passive asset 

that produces non-passive income. See 

proposed § 1.1297–2(b)(2)(iii). The 

preamble to the proposed regulations 

noted that the Treasury Department and 

the IRS determined that section 

1298(b)(7) should generally take 

precedence over section 1297(c) when 

both rules would apply simultaneously 

because section 1298(b)(7) contains the 

more specific rule applicable to a tested 

foreign corporation that owns a 

domestic subsidiary. 

Comments asserted that the legislative 

history concerning section 1297(c) and 

section 1298(b)(7) does not support the 

approach taken by proposed § 1.1297– 

2(b)(2)(iii). These comments argued that 

section 1298(b)(7) was intended to 

apply only in circumstances in which 

income and assets would be passive if 

section 1297(c) applied. According to 

the comments, Congress did not intend 

for one section to take precedence over 

the other because the legislative history 

does not discuss whether section 

1298(b)(7) is supposed to take 

precedence over section 1297(c) or 

express any limitations on the 

application of section 1297(c). 

Because section 1298(b)(7) contains 

the more specific rule applicable to a 

tested foreign corporation that owns a 

domestic subsidiary, the Treasury 

Department and the IRS have 

determined that the section 1298(b)(7) 

coordination rule is consistent with the 

relevant statutory provisions and results 

in appropriate treatment with respect to 

look-through subsidiaries. Accordingly, 

the final regulations do not adopt these 

comments. 

D. Elimination of Certain Assets and 

Income for Purposes of Applying 

Section 1297(a) 

The proposed regulations provided 

that, for purposes of applying the 

Income and Asset Tests, certain 

intercompany payments of dividends 

and interest from a look-through entity, 

and the related stock and debt 

receivables, are eliminated. See 

proposed § 1.1297–2(c)(1) and (2). 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. In response to comments, the 

final regulations revise the rules relating 

to intercompany dividends and expand 

the elimination rules to address 

intercompany rents and royalties and to 

address distributions and the 

distributive share of income from a 

look-through partnership. 

1. Treatment of Intercompany Dividends 

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. 

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. One 

example of such a case would be a 

dividend paid after a look-through 

subsidiary is acquired out of earnings 

and profits accumulated before the 

tested foreign corporation’s acquisition 

of the look-through subsidiary. Another 

example of such a dividend would be a 

dividend paid to a tested foreign 

corporation from a subsidiary that was 

a subsidiary but not a look-through 

subsidiary when the relevant earnings 

and profits were accumulated and the 

dividend was paid but later became a 

look-through subsidiary. The comment 

questioned whether a dividend from 

pre-acquisition earnings and profits 

represents true economic income of the 

tested foreign corporation, since the 

tested foreign corporation ‘‘purchased’’ 

the pre-acquisition earnings and profits, 

and observed that it could be difficult 

for a tested foreign corporation to 

determine what portion of a dividend 

received is attributable to preacquisition earnings and profits, 

particularly if the acquisition was not 

recent. As a result, the tested foreign 

corporation might not in practice be 

able to determine when it can eliminate 

a dividend from a look-through 

subsidiary from its gross income. 

The proposed regulation eliminated 

dividends from a look-through 

subsidiary only to the extent attributable 

to gross income included by the tested 

foreign corporation. The comment 

recommended that the final regulations 

remove the limitation. In the alternative, 

the comment requested that the final 

regulations provide that dividends in an 

amount equal to current-year earnings 

would be deemed attributable to income 

included by the tested foreign 

corporation and that dividends in 

excess of that amount would be deemed 

to be paid first from years in which the 

subsidiary was a look-through 

subsidiary and treated as attributable to 

income included by the tested foreign 

corporation during that period. As an 

additional alternative, the comment 

proposed that taxpayers be allowed to 

determine the earnings to which 

dividends were considered attributable 

in the case of an acquisition of the lookthrough subsidiary based on the ratio of 

pre-acquisition earnings to postacquisition earnings over a limited 

period. 

The Treasury Department and the IRS 

agree that dividends should be treated 

as paid out of current earnings and 

profits and then out of accumulated 

earnings and profits (beginning with the 

most recently accumulated), in 

accordance with section 316, and the 

final regulations so provide. See 

§ 1.1297–2(c)(2). However, the final 

regulations do not adopt the comment’s 

recommendation to treat all dividends 

from a look-through subsidiary as 

eliminated from the tested foreign 

corporation’s gross income even if the 

dividend is paid out of earnings and 

profits that are attributable to gross 

income of the subsidiary that the tested 

foreign corporation has not included in 

income. As explained in the next two 

paragraphs, the rules regarding 

dividends paid out of earnings not taken 

into account by a tested foreign 

corporation must be coordinated with 

the rules that apply to determine 

residual gain when the stock of a lookthrough subsidiary is sold in order to 

avoid elimination of income for 

purposes of the Income Test. 

Under § 1.1297–2(f), if a tested foreign 

corporation disposes of the stock of a 

look-through subsidiary, the amount of 

gain taken into account for purposes of 

the Income Test generally is the total 

gain recognized by the tested foreign 

corporation less unremitted earnings 

(residual gain). Unremitted earnings are 

the excess of income taken into account 

by the tested foreign corporation with 

respect to that look-through subsidiary 

less dividends from the subsidiary. The 

amount of gain derived from the 

disposition of stock of a look-through 

subsidiary and dividends received from 

the look-through subsidiary is 

determined on a share-by-share basis 

under a reasonable method, such as the 

rules under section 951 or 1248. 

Thus, if a look-through subsidiary 

with a value of $1000 earns $20 that is 

taken into account by a tested foreign 

4530 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

corporation owner, any gain on a sale of 

the subsidiary’s stock for $1020 will be 

reduced by $20 of unremitted earnings. 

If the subsidiary pays a $15 dividend 

before the sale, the receipt of the 

dividend is disregarded for purposes of 

the Income Test and a sale of the 

subsidiary’s stock for $1005 should give 

rise to the same amount of residual gain. 

Thus, the $20 will be taken into account 

for purposes of the Income Test and will 

not affect the amount of residual gain 

regardless of whether a dividend is 

paid. By contrast, if the look-through 

subsidiary pays a $15 dividend out of 

earnings that do not reflect income 

taken into account by the tested foreign 

corporation, the dividend would reduce 

the amount of gain on the sale of the 

look-through subsidiary’s stock 

compared to not paying a dividend 

because the dividend would reduce 

unremitted earnings pursuant to 

§ 1.1297–2(f). Consequently, if the 

payment of the dividend were 

disregarded as requested by the 

comment, the $15 dividend would 

reduce potential future gain but never 

give rise to corresponding income to the 

tested foreign corporation for purposes 

of the Income Test. 

In order to prevent such a dividend 

from reducing potential future gain on 

the sale of the look-through subsidiary, 

it would be necessary to reduce the 

basis of the stock of the look-through 

subsidiary held by the tested foreign 

corporation or make some other 

adjustment to the taxation of gain upon 

the disposition of the look-through 

subsidiary’s stock. A basis reduction or 

adjustment of that kind raises 

potentially broader issues that were not 

addressed in the proposed regulations. 

The Treasury Department and the IRS 

continue to study this recommendation 

and additional guidance on such 

elimination is proposed in the 2020 

NPRM. See proposed § 1.1297–2(c)(2). 

2. Treatment of Intercompany Rents and 

Royalties 

The proposed regulations provided 

that intercompany debt receivables and 

interest are eliminated in proportion to 

the shareholder’s direct and indirect 

ownership (by value) in the lookthrough subsidiary with respect to a 

tested foreign corporation that owns less 

than 100 percent of a look-through 

subsidiary. See proposed § 1.1297– 

2(c)(1) and (2). The preamble to the 

proposed regulations explained that this 

rule was based on the legislative history 

of the PFIC rules and was intended to 

prevent duplication of passive assets or 

passive income, for example if a whollyowned look-through subsidiary with 

entirely passive income paid a dividend 

to the tested foreign corporation parent. 

Comments supported the approach 

taken in the proposed regulations with 

regard to interest. A comment indicated 

that payments of intercompany rents 

and royalties raises similar concerns 

with respect to double counting. 

Accordingly, the comment requested 

that, for purposes of applying the 

Income Test and the Asset Test, the 

final regulations extend the elimination 

rules to payments of intercompany rents 

and royalties and any associated 

intangible assets in proportion to the 

tested foreign corporation’s direct and 

indirect ownership (by value) in the 

look-through subsidiary or look-through 

partnership. The Treasury Department 

and the IRS agree with the comments, 

and § 1.1297–2(c) accordingly extends 

the rules applicable to debt and interest 

to rents, royalties, leases, and licenses. 

The application of the elimination 

rule to leases and licenses raises issues 

not present with debt receivables. A 

lease or license held by a look-through 

entity provides legal rights to use 

underlying property, such as a building 

or an intangible. If the lease or license 

is disregarded by a tested foreign 

corporation, it would not be taken into 

account by the tested foreign 

corporation in determining whether the 

underlying property produces nonpassive income or is held for the 

production of non-passive income. 

Moreover, while the underlying 

property may be used as part of an 

active business, it may be used as part 

of the business of the lessee or licensee 

and not by the owner of the property. 

Accordingly, the final regulations 

provide that, for purposes of the Asset 

Test as applied to a tested foreign 

corporation, the underlying property 

that is the subject of the eliminated 

lease or license is characterized as a 

passive or non-passive asset by taking 

into account the activities of qualified 

affiliates of the tested foreign 

corporation (as discussed in Part IV.E of 

this Summary of Comments and 

Explanation of Revisions). A new 

example illustrates the expansion. See 

§ 1.1297–2(c)(4)(v). 

The final regulations also address 

more precisely the calculations required 

in order to determine how much of an 

obligation and related income is 

eliminated if the obligation runs 

between two look-through entities that 

are not wholly-owned. The final 

regulations provide that the tested 

foreign corporation’s proportionate 

share of a LTS obligation (as defined in 

§ 1.1297–2(c)(1)(ii)) or a TFC obligation 

(as defined in § 1.1297–2(c)(1)(ii)) is the 

value (or adjusted basis) of the item 

multiplied by the tested foreign 

corporation’s percentage ownership (by 

value) in each relevant look-through 

subsidiary. See § 1.1297–2(c)(1)(ii). 

Examples 3 and 4 of § 1.1297–2(c)(4) 

illustrate that when an obligation runs 

between two non-wholly-owned lookthrough entities, the percentage 

ownership in each of those entities is 

taken into account. In Example 2, LTS2 

has borrowed $200x from LTS1. The 

tested foreign corporation owns 40 

percent of LTS1’s stock and 30 percent 

of LTS2’s stock. If the loan had been 

made to LTS2’s shareholders, on a pro 

rata basis, 30 percent of the loan held 

by LTS1 ($60x) would be a TFC 

obligation and 70 percent of the loan 

held by LTS1 ($140x) would be a thirdparty obligation. The tested foreign 

corporation would be treated for 

purposes of the Asset Test as owning 40 

percent of the TFC obligation, which 

would be eliminated. See § 1.1297– 

2(c)(1)(ii). The tested foreign 

corporation also would be treated for 

purposes of the Asset Test as owning 40 

percent of the hypothetical $140x thirdparty loan, or $56x. Example 3 

illustrates the same principle. 

3. Ownership Interests and Obligations 

of a Look-Through Partnership 

The final regulations provide that for 

purposes of the Asset Test and the 

Income Test, the principles applicable 

to the elimination of stock and 

obligations of look-through subsidiaries 

and dividends, interest, rents and 

royalties paid by look-through 

subsidiaries apply to look-through 

partnerships. See § 1.1297–2(c)(3). Since 

partnerships do not pay dividends, the 

regulations provide that those principles 

apply to distributions and the 

distributive share of income from a 

look-through partnership. See id. It is 

intended that the same amount of assets 

and income will be eliminated 

regardless of whether the look-through 

entity or entities involved are lookthrough subsidiaries or look-through 

partnerships that would be look-through 

subsidiaries absent an election under 

§ 301.7701–3. 

E. Attribution of Activities of LookThrough Subsidiaries and LookThrough Partnerships 

1. Scope of Attribution 

The proposed regulations provided 

that, for purposes of section 1297, an 

item of rent or royalty income received 

or accrued by a tested foreign 

corporation (or treated as received or 

accrued by the tested foreign 

corporation pursuant to section 1297(c)) 

that would otherwise be passive income 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4531 

if character were determined based on 

the activities of the income-earning 

entity is not passive income if the item 

would be excluded from FPHCI under 

section 954(c)(2)(A) and § 1.954–2(b)(6), 

(c), and (d), determined by taking into 

account the activities performed by the 

officers and employees of the tested 

foreign corporation, certain lookthrough subsidiaries, and certain 

partnerships in which the tested foreign 

corporation or one of the look-through 

subsidiaries is a partner. See proposed 

§ 1.1297–2(e)(1). 

One comment agreed that the 

activities of the look-through subsidiary 

should be taken into account to 

determine whether an item of rent or 

royalty income of the tested foreign 

corporation is passive or non-passive 

and suggested that activity attribution 

be extended to apply to the section 

954(h) and commodity producer tests. 

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 

these final regulations do not treat 

section 954(h) as applicable for 

purposes of section 1297(b)(1), the 

portion of the comment relating to 

section 954(h) is addressed in the 

preamble to the 2020 NPRM and not 

here. However, the Treasury Department 

and the IRS agree that it is appropriate 

to extend the activity attribution rules 

for purposes of certain exceptions under 

section 954(c) that are based on whether 

the entity is engaged in the active 

conduct of a trade or business. 

Accordingly, the final regulations 

extend the activity attribution rules to 

income that would be excluded from 

FPHCI under section 954(c)(1)(B) 

(relating to property transactions), 

(c)(1)(C) (relating to commodities), 

(c)(1)(D) (relating to foreign currency 

gains), (c)(2)(A) (relating to active rents 

and royalties), (c)(2)(B) (relating to 

export financing), and (c)(2)(C) (relating 

to dealers). See § 1.1297–2(e)(1). 

Another comment noted that under 

the rule in the proposed regulations, the 

income or assets of a look-through 

subsidiary classified as non-passive in 

the hands of a tested foreign corporation 

might nevertheless be classified as 

passive in the hands of the look-through 

subsidiary, for example in the case 

where one look-through subsidiary held 

rental real estate and another lookthrough subsidiary employed the 

employees who managed the rental 

property. Under the rule in the 

proposed regulations the first lookthrough subsidiary would be a PFIC and 

residual gain with respect to the sale of 

the look-through subsidiary may be 

classified as passive, even if the 

attribution of both the property owned 

by the first subsidiary and the activities 

of the employees of the second 

subsidiary caused the rental income 

from the property to be treated as active 

for a tested foreign corporation owner. 

To mitigate this potential issue, the 

comment suggested the final regulations 

provide that such a look-through 

subsidiary be treated as a non-PFIC with 

respect to that tested foreign corporation 

under certain circumstances. The 

Treasury Department and the IRS have 

determined that the ultimate concerns 

raised by the comments should largely 

be addressed by the modifications to the 

activity attribution rules suggested by 

other comments and adopted in the 

final regulations, as discussed in Part 

IV.E.2 of this Summary of Comments 

and Explanation of Revisions. Those 

modifications should generally result in 

income and assets of a look-through 

subsidiary that are treated as nonpassive in the hands of a tested foreign 

corporation also being treated as nonpassive in the hands of the look-through 

subsidiary, in which case the lookthrough subsidiary could be a non-PFIC 

and residual gain on the sale of the lookthrough subsidiary could be 

characterized as non-passive. 

One comment recommended that 

rules in the proposed regulations be 

modified to apply the rules for active 

rents and royalties under section 

954(c)(2)(A) as they existed in 1986, as 

discussed in Part III.A of this Summary 

of Comments and Explanation of 

Revisions, and if the regulations were 

not modified in that manner the activity 

attribution rules should be revised to 

take into account the ‘‘transition’’ rules 

in the 2016 modifications to the active 

rents and royalties rules. See TD 9792 

(81 FR 76497) (adding the express 

requirement to the active development 

tests in § 1.954–2(c)(1)(i) and (d)(1)(i) 

that the relevant activities be performed 

by the lessor’s or licensor’s own officers 

or staff of employees, and providing a 

transition rule that the modified active 

development tests apply only with 

respect to property manufactured, 

produced, developed, or created, or in 

the case of acquired property, property 

to which substantial value has been 

added, on or after September 1, 2015). 

The 2016 modifications are taken into 

account through the cross-reference in 

§ 1.1297–1(c)(1)(i)(A) to section 

954(c)(2)(A) (relating to active rents and 

royalties). The Treasury Department and 

the IRS have determined that no 

revisions to the PFIC activity attribution 

rule are necessary, given that the PFIC 

activity attribution rules clearly apply to 

take into account the activities of 

officers and employees of other 

specified entities whether the rules 

under section 954(c)(2)(A) apply as 

modified (in the case of property 

manufactured, produced, developed, or 

created, or in the case of acquired 

property, property to which substantial 

value has been added, on or after 

September 1, 2015) or the rules under 

section 954(c)(2)(A) pre-modification 

apply (because no changes to the 

property have occurred since September 

1, 2015). Accordingly, the comment is 

not adopted. 

2. Ownership Threshold for Activity 

Attribution 

The proposed regulations provided 

that, for purposes of the activity 

attribution rule described in Part IV.E.1 

of this Explanation of Comments and 

Summary of Revisions, a tested foreign 

corporation may take into account the 

activities performed only by those lookthrough subsidiaries or look-through 

partnerships with respect to which the 

tested foreign corporation owns 

(directly or indirectly) more than 50 

percent by value. See proposed 

§ 1.1297–2(e)(1). The preamble to the 

proposed regulations indicated that the 

Treasury Department and the IRS 

determined that an ownership level of 

more than 50-percent would prevent the 

activities of the look-through subsidiary 

or look-through partnership from being 

attributed to an unrelated entity. 

In response to a request for comments 

in the preamble to the proposed 

regulations concerning the appropriate 

ownership threshold for attribution of 

activities, one comment recommended 

an affiliation approach for the 

ownership threshold. Under this 

approach, activities would be attributed 

among members of the income-earning 

entity’s affiliated group, determined 

under principles of § 1.904–4(b)(2)(iii) 

modified to include partnerships that 

are owned at least 50 percent by value 

and corporations that are owned at least 

50 percent by vote or value. For 

example, under this affiliation 

approach, the activities of a group 

member could be attributed not only 

‘‘up’’ to a tested foreign corporation that 

owned a sufficient amount of stock in 

that group member (as would be the 

case under the approach in the 

proposed regulations), but also ‘‘across’’ 

to a sister member that is a part of the 

affiliated group or ‘‘down’’ to a 

subsidiary member that is a part of the 

affiliated group. 

Some comments noted that an 

approach that takes into account voting 

rights in lieu of value may be 

4532 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

appropriate to take into account 

instances where more than one owner 

materially participates in the underlying 

activity. One of the comments suggested 

that an ownership threshold of at least 

25 percent by vote would provide the 

tested foreign corporation with 

sufficient control over the subsidiary for 

it to be appropriate to attribute a portion 

of the subsidiary’s activities to the 

tested foreign corporation. Another 

comment recommended an ownership 

threshold of more than 50 percent by 

vote or value by the tested foreign 

corporation, with a requirement that the 

tested foreign corporation materially 

participate in the same or 

complementary line of business of the 

activity-conducting subsidiary if it owns 

more than 50 percent by vote but less 

than 50 percent by value of the activity 

conducting subsidiary. In the 

alternative, the comment suggested that 

the activities be attributed in proportion 

to the ownership interest in the activityconducting subsidiary. 

The Treasury Department and the IRS 

disagree that satisfying a 25 percent 

threshold for ownership of an entity is 

sufficient to conclude that the entity’s 

business is sufficiently integrated with 

that of a tested foreign corporation that 

the entity’s activities should be taken 

into account for purposes of 

determining the character of income and 

assets of the tested foreign corporation. 

However, the Treasury Department and 

the IRS agree with the comments that it 

is generally appropriate to expand the 

activity attribution rule to attribute 

activities among members of an 

affiliated group, determined by applying 

a more than 50 percent threshold and by 

including partnerships and U.S. 

affiliates in which corporate members of 

the affiliated group satisfy such 

ownership requirements. Accordingly, 

the final regulations so provide. See 

§ 1.1297–2(e)(1) and (2) (defining 

qualified affiliates of the affiliated 

group). However, the Treasury 

Department and the IRS have 

determined that because the rule applies 

for purposes of section 1297(c), which 

focuses on ownership of at least 25 

percent by value, the threshold for 

inclusion in the group should be 

determined by value. See § 1.1297– 

2(e)(2)(iv). Moreover, the parent of the 

affiliated group must also be foreign (a 

foreign corporation or partnership) in 

order to apply the activity attribution 

rule. See § 1.1297–2(e)(2)(v). If the 

parent of the affiliated group were 

domestic (a U.S. corporation or 

partnership), then any qualified affiliate 

that is a foreign corporation (including 

the tested foreign corporation) would 

qualify as a controlled foreign 

corporation, and any U.S. investor with 

at least a 10 percent ownership interest 

in the tested foreign corporation would 

be subject to the subpart F rules rather 

than the PFIC rules under section 

1297(d). Accordingly, an upstream 

foreign owner of the tested foreign 

corporation and entities that are held 

directly or indirectly by such same 

upstream foreign owner as the tested 

foreign corporation may be considered 

qualified affiliates, assuming the 

requisite ownership percentage 

requirements are met. 

V. Comments and Revisions to 

Proposed § 1.1297–4—Qualifying 

Insurance Corporation 

Section 1297(f) provides that a 

qualifying insurance corporation 

(‘‘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 AIL ratio to 10 percent 

(‘‘alternative facts and circumstances 

test’’). Proposed § 1.1297–4 elaborated 

on these requirements accordingly. 

A. 25 Percent Test 

1. Applicable Insurance Liabilities 

The 25 percent test in section 

1297(f)(1)(B) requires that the ratio of a 

foreign corporation’s AIL to total assets 

exceed 25 percent. Section 1297(f)(3)(A) 

defines AIL as loss and loss adjustment 

expenses (‘‘LAE’’) and reserves (other 

than deficiency, contingency, or 

unearned premium reserves) for life and 

health insurance risks and life and 

health insurance claims with respect to 

contracts providing coverage for 

mortality or morbidity risks. 

Proposed § 1.1297–4(f)(2) provided 

that with respect to any life or property 

and casualty insurance business of a 

foreign corporation, AIL mean (1) 

occurred losses for which the foreign 

corporation has become liable but has 

not paid before the end of the last 

annual reporting period ending with or 

within the taxable year, including 

unpaid claims for death benefits, 

annuity contracts, and health insurance 

benefits; (2) unpaid expenses (including 

reasonable estimates of anticipated 

expenses) of investigating and adjusted 

unpaid losses described in (1); and (3) 

the aggregate amount of reserves 

(excluding deficiency, contingency, or 

unearned premium reserves) held for 

future, unaccrued health insurance 

claims and claims with respect to 

contracts providing coverage for 

mortality or morbidity risks, including 

annuity benefits dependent upon the 

life expectancy of one or more 

individuals. 

Comments requested that the term 

‘‘occurred losses’’ be changed because it 

is not an industry standard term. Some 

comments suggested that the word 

‘‘occurred’’ be replaced with the word 

‘‘incurred’’ or ‘‘unpaid’’ and be clarified 

to explicitly include incurred but not 

reported (‘‘IBNR’’) losses. Other 

comments suggested that the term be 

defined as the term is used in the Code, 

U.S. regulatory statements, or under 

U.S. generally accepted accounting 

principles (‘‘GAAP’’) or international 

financial reporting standards (‘‘IFRS’’). 

Two comments also requested 

clarification that unpaid LAE related to 

both paid and unpaid losses be included 

in the definition of AIL. 

The Treasury Department and the IRS 

agree that further clarification of the 

definition of AIL is necessary. While 

still covering only losses that have 

occurred, the final regulations clarify 

the definition of AIL to adopt the 

comments which requested that AIL 

include incurred losses (both reported 

and unreported) and unpaid LAE on all 

incurred losses (whether the losses are 

paid or unpaid). 

Comments differed as to what items 

should be included in the definition of 

AIL. For example, several comments 

suggested that AIL include insurance 

liabilities or loss reserves as reported on 

an AFS (without further modification) 

while other comments suggested that 

paid losses and paid LAE be included 

as AIL (even though they are not 

liabilities since they have been paid 

and, as a result, do not appear on the 

AFS as liabilities). 

A comment also requested that 

special rules be created for financial 

guaranty insurers and another comment 

requested a special rule for mortgage 

guaranty insurers. The first comment 

recommended that final regulations 

permit a financial guaranty insurer to 

include in losses the greater of two 

amounts: (1) The aggregate amount of 

reserves (excluding deficiency, 

contingency, or unearned premium 

reserves) held for future unaccrued 

insurance claims or (2) the average of 

losses incurred for policies over the 

previous ten years of the life of the 

policy, whichever is shorter. The second 

comment requested that the 25 percent 

test be waived for a foreign corporation 

engaged in the business of mortgage 

insurance and reinsurance if at least 80 

percent of its net written premiums are 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4533 

derived from mortgage guaranty 

insurance (or reinsurance) and its gross 

investment income is less than 50 

percent of its net written premiums as 

reported on its AFS. 

The final regulations do not adopt the 

suggestion that paid losses or paid LAE 

be treated as AIL nor the proposed 

special rules for financial guaranty 

insurers and mortgage guaranty 

insurers. These suggestions are contrary 

to the statute and the intent of Congress. 

Section 1297(f) is limited to amounts 

that constitute liabilities, whereas losses 

and LAE that have been paid are no 

longer liabilities and therefore do not 

qualify as AIL. Further, when losses and 

LAE are paid, assets are also reduced. It 

would not be appropriate to include loss 

and LAE amounts in the numerator of 

the 25 percent test (or alternative facts 

and circumstances test), when the 

corresponding assets are no longer 

reported on the AFS and included in the 

denominator. The statute also requires 

that liabilities include only insurance 

liabilities and further excludes certain 

types of insurance liabilities that may be 

included in a financial statement, such 

as unearned premium reserves, 

contingency reserves, and deficiency 

reserves. See section 1297(f)(3)(A); H. 

Rpt. No. 115–409, 115th Cong. 1st Sess., 

at 411; and Conference Rpt. No. 115– 

466, 115th Cong. 1st Sess., at 670 

(‘‘Unearned premium reserves with 

respect to any type of risk are not 

treated as applicable insurance 

liabilities for purposes of the 

provision.’’). Therefore, § 1.1297– 

4(f)(2)(ii) provides that liabilities not 

within the definition of AIL are not 

included in the numerator of the 25 

percent test (or alternative facts and 

circumstances test) and also specifies 

that amounts that are not insurance 

liabilities (for example, liabilities 

related to non-insurance products 

issued by an insurance company that 

may be treated as debt, such as certain 

deposit arrangements, structured 

settlements, and guaranteed investment 

contracts or GICs) are not AIL. The 

statute also does not contemplate 

averaging liabilities over a multi-year 

period because section 1297(f)(1)(B) 

provides for an annual calculation by 

looking to the foreign corporation’s AFS 

‘‘for the last year ending with or within 

the taxable year.’’ Therefore, the final 

regulations do not include special rules 

for specialty insurers that would require 

multi-year averaging or disregard the 

liability requirement. 

Section 1297(f) contemplates that QIC 

status is determined on an entity-byentity basis. Therefore, § 1.1297– 

4(f)(2)(i)(D)(2) clarifies that the 

liabilities eligible to be taken into 

account in determining AIL include 

only the liabilities of the foreign 

corporation whose QIC status is being 

determined. For example, if a parent 

and subsidiary both issue insurance 

contracts to unrelated parties and the 

AFS is a combined financial statement, 

the AIL of parent and subsidiary must 

be separately determined and each of 

parent and subsidiary includes only the 

liabilities from the contracts that it has 

issued (without regard to the contracts 

issued by the other party). This rule is 

consistent with § 1.1297–4(f)(2)(i)(D)(1) 

which provides the general principle 

that no item may be taken into account 

more than once. 

2. Conformity Among Financial 

Reporting Standards in Computing 

Applicable Insurance Liabilities 

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 annual statement 

required to be filed with the local 

regulator may typically be prepared in 

compliance with local statutory 

accounting standards. The Treasury 

Department and IRS are aware that 

GAAP, IFRS, and local statutory 

accounting sometimes have different 

categories (and nomenclature) and 

different methods of measuring losses 

and reserves for insurance companies. 

The final regulations define AIL more 

specifically so that only those liabilities 

that meet the regulatory definition are 

included in AIL irrespective of 

differences in nomenclature and 

methods that may be used by different 

financial reporting standards. 

It is anticipated that the starting point 

for determining the amount of AIL will 

be the AFS balance sheet. However, it 

may be necessary in some 

circumstances to disaggregate 

components of balance sheet liabilities 

to determine the amount of a company’s 

insurance liabilities that meet the 

regulatory definition of AIL. For 

example, the International Accounting 

Standards Board (‘‘IASB’’) issued a new 

accounting standard called IFRS 17 for 

the accounting of insurance contracts 

which was expected to become effective 

January 1, 2021, and is now deferred to 

be effective January 1, 2023. Some 

companies may have already adopted 

IFRS 17 for financial reporting purposes 

on an optional basis. IFRS 17 generally 

does not use the terms unpaid losses 

and LAE or unearned premium reserve 

on its balance sheet. Instead, those 

amounts are included in the overall 

insurance liabilities on the balance 

sheet and are required to be separately 

identified in the notes, as respectively, 

‘‘liability for incurred claims’’ and 

‘‘liability for remaining coverage.’’ 

While they bear a different name, they 

are intended to be substantially the 

same in concept to claims reserves and 

unearned premium reserves. Therefore, 

it is expected that a foreign corporation 

using IFRS 17 only include those 

amounts derived from the balance sheet 

that fall within the final regulation’s 

definition of AIL. Similarly, a foreign 

corporation using IFRS 17 (or any other 

financial reporting standard) is expected 

to exclude contingency reserves and 

deficiency reserves (in addition to 

unearned premium reserves), as 

applicable, even when those categories 

do not separately appear on the balance 

sheet as a liability and are subsumed 

within another reported line item. 

The Treasury Department and IRS 

recognize that IFRS 17 is a new 

accounting standard and that questions 

may arise as to how amounts relevant to 

the PFIC insurance exception are 

derived from an IFRS 17 AFS. Similar 

questions may also arise with respect to 

financial statements prepared using 

GAAP and local statutory accounting, 

particularly as accounting reporting 

standards evolve. The Treasury 

Department and IRS request comments 

on whether further guidance is 

necessary to clarify how AILs are 

determined or make further adjustments 

to ensure that similarly situated 

taxpayers are treated similarly without 

regard to the financial reporting 

standard adopted by the foreign 

corporation. 

B. Alternative Facts and Circumstances 

Test 

If a foreign corporation predominantly 

engaged in an insurance business fails 

the 25 percent test solely due to runoffrelated or rating-related circumstances 

involving its insurance business, and 

the ratio of its applicable insurance 

liabilities to its total assets is at least 10 

percent, section 1297(f)(2) allows a 

United States person that owns stock in 

the corporation to elect to treat such 

stock as stock of a QIC. Proposed 

§ 1.1297–4(d) provided guidance 

regarding this election. 

1. Predominantly Engaged in an 

Insurance Business 

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

passive income does not include income 

derived in the active conduct of an 

insurance business by a QIC. Section 

1297(f)(1)(A) provides that a QIC must 

be a foreign corporation which would be 

4534 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

subject to tax under subchapter L if such 

corporation were a domestic 

corporation. Then, for purposes of the 

alternative facts and circumstances test, 

section 1297(f)(2)(B)(i) adds another 

requirement that the foreign corporation 

be predominantly engaged in an 

insurance business under regulations 

provided by the Secretary based upon 

the applicable facts and circumstances. 

Proposed § 1.1297–4(d)(2) provided 

more specific guidance regarding the 

circumstances under which a foreign 

corporation is considered to be 

predominantly engaged in an insurance 

business for purposes of the alternative 

facts and circumstances test by setting 

forth a predominantly engaged test 

(separate from the active conduct test 

and the requirements of subchapter L) 

by reference to the facts and 

circumstances that tend to show (or not 

show) that a foreign corporation is 

predominantly engaged in an insurance 

business based upon the factors set forth 

in the legislative history. The proposed 

rule provided that the determination is 

made based on whether the particular 

facts and circumstances of the foreign 

corporation are comparable to 

commercial insurance arrangements 

providing similar lines of coverage to 

unrelated parties in arm’s length 

transactions. 

A comment pointed to a number of 

ambiguities in the predominantly 

engaged standard and asked for 

clarification. First, it stated that it is not 

clear whether the proposed regulation’s 

predominantly engaged test is in 

addition to the insurance company 

status test in subchapter L. Second, it 

stated that it is unclear how non-arm’s 

length insurance transactions are taken 

into account when determining whether 

more than half the business of the 

foreign corporation is the issuing of 

insurance or annuity contracts or the 

reinsuring of risks underwritten by 

insurance companies and how to 

compare related party transactions to 

commercial insurance arrangements. 

Third, it stated that it is unclear whether 

the list of facts and circumstances is an 

exclusive set of factors. 

In response to the comment, the final 

regulations make clear that the 

predominantly engaged requirement in 

the alternative facts and circumstances 

test is in addition to the subchapter L 

requirement that more than half the 

business of the foreign corporation is 

the issuing of insurance or annuity 

contracts or the reinsuring of risks 

underwritten by insurance companies. It 

also deletes the sentence regarding 

comparable commercial insurance 

arrangements because the standard was 

unclear and instead replaces it with a 

statement that the determination is 

made upon the character of the business 

actually conducted in the taxable year. 

Lastly, it clarifies that the list of facts 

and circumstances is not exclusive and 

can include other factors as may be 

relevant to a specific situation. 

2. Runoff-Related Circumstances 

Proposed § 1.1297–4(d)(3) provided 

that ‘‘runoff-related circumstances’’ 

means that the foreign corporation: (1) 

Was actively engaged in the process of 

terminating its pre-existing, active 

insurance or reinsurance underwriting 

operation pursuant to an adopted plan 

of liquidation or termination of 

operations under the supervision of its 

applicable insurance regulatory body; 

(2) did not issue or enter into any 

insurance, annuity, or reinsurance 

contract, other than a contractually 

obligated renewal of an existing 

insurance contract or a reinsurance 

contract pursuant to and consistent with 

the plan of liquidation or a termination 

of operations; and (3) made payments 

during the annual reporting period 

covered by the AFS to satisfy the claims 

under insurance, annuity, or 

reinsurance contracts, and the payments 

cause the corporation to fail to satisfy 

the 25 percent test. 

A comment recommended that the 

final regulations remove the 

requirement that the runoff company 

have a plan of liquidation, remove the 

requirement that amounts paid by the 

runoff company cause the corporation to 

fail to satisfy the 25 percent test, and 

add a condition that the foreign 

corporation has no current plan or 

intention to enter into any insurance, 

annuity, or reinsurance contract other 

than in the case of a contractually 

obligated renewal. The comment stated 

that there is no prevailing practice in 

the insurance industry for a regulator to 

supervise a plan of liquidation or 

termination of a runoff company. The 

comment further stated that runoff 

carriers may be part of a larger 

insurance group, and that management 

of the runoff business is not necessarily 

a prelude to liquidation but can be a 

way for the active insurance businesses 

to shift their core business segments and 

maximize their use of capital. In 

addition, some companies (known as 

‘‘runoff specialists’’) are in the business 

of acquiring reserve liabilities to 

profitably manage the settlement and 

payout of claims until all of the 

liabilities are exhausted. 

The Treasury Department and IRS 

have considered these comments and 

believe that the exception from the 25 

percent test should not be extended to 

runoff occurring in the context of the 

ordinary course of an ongoing business. 

The Conference Report to the Act 

describes a company with runoff-related 

circumstances as ‘‘not taking on new 

insurance business’’ and ‘‘using its 

remaining assets to pay off claims with 

respect to pre-existing insurance risks 

on its books.’’ See H.R. Rep. No. 115– 

466, at 671 (2017) (Conf. Rep.). The 

lower 10 percent threshold (which 

permits an insurance company to hold 

assets that are 1000 percent of its AIL) 

should be limited to extraordinary 

circumstances in which the insurance 

company fails the 25 percent test solely 

because it is in the process of exiting the 

insurance business and is required to 

hold additional capital in excess of the 

400 percent of AIL permitted by the 25 

percent test due to its business being in 

runoff. 

The final regulations delete, however, 

the requirement that the runoff 

company have a plan of liquidation and 

instead require that the company be in 

the process of terminating its preexisting, active conduct of an insurance 

business under the supervision of its 

applicable insurance regulatory body or 

any court-ordered receivership 

proceeding (liquidation, rehabilitation, 

or conservation), which covers a broader 

array of circumstances than the 

proposed regulation. See § 1.1297– 

4(d)(3)(i). 

The final regulations retain the 

requirement in the proposed regulations 

that the insurance company make 

claims payments during the annual 

reporting period. See § 1.1297– 

4(d)(3)(iii). However, in response to 

comments, the final regulations do not 

require such payments to cause the 

insurance company’s ratio of liabilities 

to assets to fail the 25 percent test and 

instead clarify in § 1.1297–4(d)(3)(i) that 

the company must fail to satisfy the 25 

percent test because it is required to 

hold additional assets due to its 

business being in runoff. Finally, for 

clarity and consistent with the 

comment’s suggestion, § 1.1297– 

4(d)(3)(ii) adds a condition that the 

foreign corporation has no plan or 

intention to enter into any insurance, 

annuity, or reinsurance contract other 

than in the case of a contractually 

obligated renewal. 

3. Rating-Related Circumstances 

Proposed § 1.1297–4(d)(4) provided 

that ‘‘rating-related circumstances’’ 

means that a foreign corporation’s 

failure to satisfy the 25 percent test was 

a result of specific requirements with 

respect to its capital and surplus that a 

generally recognized credit rating 

agency imposes that the foreign 

corporation must comply with to 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4535 

maintain the minimum credit rating 

required for it to be classified as secure 

to write new insurance business for the 

current year. This condition in the 

proposed regulations was based upon 

the premise that although the generally 

recognized credit rating agencies (A.M. 

Best, Fitch, Moody’s, and Standard and 

Poor) may use separate rating codes, the 

ratings could be classified into ‘‘secure’’ 

and ‘‘vulnerable’’ categories, and that 

the rating agencies require reporting 

entities to maintain a minimum amount 

of capital appropriate to support its 

overall business operations in 

consideration of its size and risk profile. 

Comments suggested that the 

proposed regulation’s reference to 

‘‘secure’’ be changed. Some comments 

suggested that the standard should be 

revised to reflect only a rating agency’s 

requirements that are ‘‘necessary’’ to 

write new business in accordance with 

the foreign corporation’s regulatory or 

board supervised business plan. 

Another comment requested that the 

term necessary be defined to mean that 

a foreign corporation complies with the 

requirements of the credit rating agency 

to maintain a rating equivalent to A¥ 

by A.M. Best for reinsurers or BBB+ by 

Standard & Poor’s for all other insurers. 

The Treasury Department and IRS 

agree that the use of the term ‘‘secure’’ 

should be amended. Therefore, the final 

regulations provide that the ratingrelated circumstances standard requires 

that the 25 percent test is not met due 

to capital and surplus amounts that a 

generally recognized credit rating 

agency considers necessary for the 

foreign corporation to obtain a public 

rating with respect to its financial 

strength, and the foreign corporation 

maintains such capital and surplus in 

order to obtain the minimum credit 

rating necessary for the current year by 

the foreign corporation to be able to 

write the business in its regulatory or 

board supervised business plan. 

A comment also requested that the 

proposed regulations be revised to 

provide that the rating-related 

circumstances standard not be an 

annual test. The comment requested 

that once the foreign corporation 

satisfies the rating-related circumstances 

standard, the alternative facts and 

circumstances test should not need to be 

reapplied unless there is a change in 

circumstances. The final regulations do 

not adopt this comment because the test 

for a foreign corporation’s PFIC status 

and the AIL tests are annual tests. 

Several comments requested that 

additional categories of rating-related 

circumstances be included under which 

certain types of entities or businesses 

would be treated as per se meeting the 

rating-related circumstances 

requirement. These businesses include 

reinsurance that is fully collateralized, 

mortgage insurance and reinsurance, 

and financial guaranty insurance. 

Another comment noted that lines of 

business that require a higher level of 

capital as compared to reserves are 

those that cover risks that are low 

frequency but high severity, such as 

catastrophic risk (for example, 

hurricanes and earthquakes) and 

financial obligation insurance such as 

mortgage and financial guaranty 

insurance. 

Comments noted that financial 

guaranty and mortgage guaranty 

insurers are generally required to 

operate as monoline businesses, such 

that the company does not have the 

option to pool its financial obligation 

risks with other types of risks (whereas 

pooling of different types of risks can 

reduce overall risk exposure, and thus 

capital needs). Comments also noted 

that the loss experience of mortgage and 

financial guaranty insurers is closely 

tied to the economy as a whole, such 

that insurance liabilities are relatively 

low when the economy is strong but 

much higher in times of economic 

crisis, and that credit rating agencies 

correspondingly expect such companies 

to hold additional capital to protect 

policyholders due to the monoline 

nature and volatility of the businesses. 

With respect to mortgage insurers, the 

Federal Housing Agency (FHA), in its 

role as regulator of Fannie Mae and 

Freddie Mac (government-sponsored 

entities who purchase or guarantee a 

majority of U.S. home mortgage loans), 

also prescribes capital requirements that 

must be satisfied by private mortgage 

insurers to be eligible to provide 

mortgage insurance on loans owned or 

guaranteed by Fannie Mae or Freddie 

Mac. These guidelines were set after the 

2007–2008 financial crisis and are 

designed to ensure that mortgage 

guaranty insurers maintain sufficient 

capital to cover obligations in times of 

financial distress, when defaults and 

foreclosures increase. Rating agencies 

evaluate satisfaction of FHA guidelines 

when rating mortgage guaranty insurers, 

and FHA and rating agency capital 

standards geared to ensuring capital 

adequacy in times of crisis may result in 

a mortgage guaranty insurer being 

required to hold an amount of capital 

that causes its current insurance 

liabilities to be less than 25 percent of 

its assets in low loss years when the 

economy is strong. 

Financial guaranty insurance is a line 

of insurance business in which an 

insurance company guarantees 

scheduled payments of interest and 

principal on a bond or other debt 

security in the event of issuer default. A 

comment explained that financial 

guaranty insurance is unique in that the 

policyholder is effectively paying for 

use of the financial guaranty insurer’s 

credit rating. For example, if a 

municipality insures its municipal bond 

obligations with a financial guarantee 

insurer, the municipality can charge a 

lower interest rate on its bond, because 

the obligation is guaranteed by the 

insurer’s high credit rating. A very high 

credit rating is thus essential for a 

financial guarantee insurer to write new 

business. Further (and similar to 

mortgage guaranty insurers) rating 

agency capital standards for financial 

guaranty insurers are geared to ensuring 

capital adequacy in times of crisis and 

may require a higher level of capital to 

get the same rating as an insurer with a 

different portfolio of risks. The 

combination of enhanced rating agency 

capital requirements and the need for a 

very high credit rating to write new 

business often results in a financial 

guaranty insurer being required to hold 

capital such that its current insurance 

liabilities are less than 25 percent of its 

assets in low loss years. 

The Treasury Department and IRS 

considered these comments and the 

circumstances under which an 

insurance company would need assets 

in excess of 400 percent of its insurance 

liabilities in order to obtain the credit 

rating needed to write new business. As 

described in comments, companies that 

may require a higher level of capital as 

compared to insurance liabilities are 

companies that provide primarily 

catastrophic loss coverage and also 

monoline companies providing 

mortgage or financial guaranty 

insurance that experience significant 

losses on a low frequency but high 

severity basis. In low loss years, these 

types of companies may have less than 

25 percent insurance liabilities to assets, 

but the additional assets may be viewed 

as necessary by rating agencies for the 

companies to meet insurance 

obligations in high loss years, and thus 

to receive the credit rating that the 

companies require to write the business 

in their business plan. Thus, the final 

regulations provide that the rating 

related circumstances exception is only 

available to a foreign corporation if it is 

a company that exclusively provides 

mortgage insurance or if more than half 

of the foreign corporation’s net written 

premiums for the annual reporting 

period (or the average of the net written 

premiums for the foreign corporation’s 

annual reporting period and the two 

immediately preceding annual reporting 

4536 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

periods) are from insurance coverage 

against the risk of loss from a 

catastrophic loss event (that is, a low 

frequency but high severity loss event). 

See § 1.1297–4(d)(4)(i). 

The final regulations also provide that 

a financial guaranty insurance company 

that fails the 25 percent test is deemed 

to satisfy the rating-related 

circumstances requirement. See 

§ 1.1297–4(d)(4)(ii). The final 

regulations define a financial guaranty 

insurance company as an insurance 

company whose sole business is to 

insure or reinsure only the type of 

business written by (or that would be 

permitted to be written by) a company 

licensed under, and compliant with, a 

U.S. state law, modeled after the 

National Association of Insurance 

Companies Financial Guaranty 

Insurance Guideline, that specifically 

governs the licensing and regulation of 

financial guaranty insurance companies. 

See § 1.1297–4(f)(5). 

The final regulations do not include a 

special rule for fully collateralized 

reinsurance because the decision to 

fully collateralize reinsurance 

obligations is not necessarily linked to 

rating agency requirements and (as 

noted in comments) many fully 

collateralized reinsurance companies do 

not obtain credit ratings. 

4. Election To Apply Alternative Facts 

and Circumstance Test 

Section 1297(f)(2) requires a United 

States person to make an election in 

order to treat a foreign corporation that 

satisfies the alternative facts and 

circumstances test as a QIC. Proposed 

§ 1.1297–4(d)(5) provided that the 

election could not be made unless the 

foreign corporation directly provided 

the United States person with a 

statement or made a publicly available 

statement, in each case indicating that 

the foreign corporation satisfied the 

requirements of the alternative facts and 

circumstances test. However, the foreign 

corporation’s statement could not be 

relied on if the shareholder knew or had 

reason to know that the statement was 

incorrect. 

One comment objected to the 

proposed rule providing that a 

shareholder cannot rely on a statement 

of the foreign corporation if it has 

reason to know that the statement is 

incorrect. The comment asserted that a 

shareholder may not have access to the 

information needed to determine the 

accuracy of a foreign corporation’s 

representations. In response to this 

comment, the final regulations clarify 

that a shareholder is permitted to rely 

on a statement provided by the foreign 

corporation unless it has reason to know 

the statement is incorrect based on 

reasonably accessible information. 

Whether information is reasonably 

accessible is determined based on all 

relevant facts and circumstances, 

including the size of the shareholder’s 

ownership interest and whether the 

shareholder is an officer or employee of 

the foreign corporation. Thus, reliance 

is not permitted under circumstances in 

which a reasonable person in the 

shareholder’s position would know, 

based on information to which the 

shareholder has reasonable access, that 

the foreign corporation’s statement is 

incorrect. In any case, an election is not 

valid unless the foreign corporation 

actually meets the requirements of 

§ 1.1297–4(d)(1), regardless of whether 

the foreign corporation represents that 

those requirements have been met. 

A shareholder makes the election on 

Form 8621, which must be attached to 

the shareholder’s U.S. federal income 

tax return (under the final regulations, 

there is no requirement to attach also 

the statement provided by the foreign 

corporation). A shareholder who makes 

the election is not required to disclose 

the value of the foreign corporation’s 

stock and, therefore, is not treated as 

having reported the foreign 

corporation’s stock as an asset on Form 

8621 for purposes of § 1.6038D– 

7(a)(1)(i)(C). As a result, the shareholder 

would be required to report the stock on 

Form 8938, subject to the thresholds 

and exceptions provided in section 

6038D and the regulations thereunder. 

The final regulations clarify that the 

election can be made by a United States 

person who holds an option to purchase 

stock in a foreign corporation that meets 

the requirements of section 1297(f)(2). 

One comment requested a special rule 

for foreign corporations owned 

indirectly through a foreign parent 

corporation, under which the foreign 

parent corporation could provide (or 

make publicly available) the statement 

required by the proposed regulations, 

and the election could be made at the 

level of the foreign parent corporation. 

In response to this comment, the final 

regulations have been modified to allow 

a foreign parent corporation to make the 

required statement publicly available on 

behalf of its subsidiaries. However, the 

final regulations do not permit the 

election to be made at the foreign parent 

level. 

Some comments asserted that it 

would be unduly burdensome for 

certain shareholders to file Form 8621 

in order to make the election under 

section 1297(f)(2). The comments 

requested that shareholders of publicly 

traded companies or small shareholders 

of non-publicly traded companies be 

deemed to make the election under 

section 1297(f)(2) without the need for 

an affirmative filing. 

In response to these comments, the 

final regulations provide that a 

shareholder in a publicly traded foreign 

corporation who owns stock (either 

directly or indirectly) with a value of 

$25,000 or less is deemed to make the 

election under section 1297(f)(2) with 

respect to the publicly traded foreign 

corporation and its subsidiaries. If a 

shareholder owns stock in a publicly 

traded foreign corporation through a 

domestic partnership, an election will 

not be deemed made unless the stock 

held by the partnership has a value of 

$25,000 or less. The same rule applies 

to stock owned through a domestic trust 

or estate, or through an S corporation. 

All the requirements necessary to 

permit an actual election under section 

1297(f)(2) must be satisfied in order to 

permit a deemed election under this 

rule. For example, an election will not 

be deemed made unless the foreign 

corporation (or its foreign parent) 

provides a statement to the United 

States person or makes a publicly 

available statement indicating that it has 

satisfied the requirements of the 

alternative facts and circumstances test. 

In addition, the final regulations 

provide that if a shareholder fails to 

make the election under section 

1297(f)(2) on its original return for a 

taxable year, the election may be made 

on an amended return, provided there is 

reasonable cause for the failure to make 

the election on the original return. A 

United States person that makes the 

election on an amended return must be 

prepared to demonstrate reasonable 

cause upon request, but is not required 

to provide documentation of reasonable 

cause when the amended return is filed. 

This rule is intended to provide relief to 

a shareholder that inadvertently 

neglects to make the election under 

section 1297(f)(2) and does not qualify 

for a deemed election (for example, if 

the shareholder owns stock with a value 

in excess of $25,000). 

C. Limitations on Amount of Applicable 

Insurance Liabilities 

1. Mechanics of the Limitation 

Proposed § 1.1297–4(e) provided rules 

limiting the amount of AIL for purposes 

of the 25 percent test and the alternative 

facts and circumstances test and stated 

that AIL may not exceed the lesser of (1) 

AIL shown on the most recent AFS, (2) 

the minimum AIL required by the 

applicable law or regulation of the 

jurisdiction of the applicable insurance 

regulatory body, and (3) AIL reported on 

the most recent financial statement 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4537 

made on the basis of GAAP or IFRS if 

such financial statement was not 

prepared for financial reporting 

purposes. 

A comment requested changes to the 

second limitation amount under the 

proposed regulations (the minimum AIL 

required by the applicable law or 

regulation of the jurisdiction of the 

applicable insurance regulatory body). 

The comment asserted that the reference 

to a ‘‘minimum amount’’ is either 

redundant (because the amount required 

under the applicable law or regulation 

will always be a minimum amount) or 

ambiguous (because the ‘‘minimum 

amount’’ could be interpreted to mean 

a hypothetical minimum amount 

required for any insurer without regard 

to its particular circumstances, 

including its lines of business). The 

same comment also noted that proposed 

§ 1.1297–4(e)(2)(ii) did not take into 

account AIL actually reported to the 

applicable insurance regulatory body, if 

lower than the minimum required 

amount (which a local regulator 

sometimes allows as a permitted 

practice). Other comments requested 

that the minimum amount required 

under the applicable law or regulation 

be determined by reference to GAAP or 

IFRS requirements. 

With respect to the third limitation 

amount under the proposed regulations 

(AIL reported on the most recent 

financial statement made on the basis of 

GAAP or IFRS if such financial 

statement was not prepared for financial 

reporting purposes), one comment 

expressed concern that a statement 

which is not prepared for financial 

reporting purposes is potentially 

unreliable and should not be used as a 

basis for determining AIL. In addition, 

the comment requested guidance as to 

the meaning of the terms ‘‘financial 

statement’’ and ‘‘financial reporting 

standard.’’ 

The limitation under § 1.1297–4(e) 

has been modified in response to these 

comments. Under the final regulations, 

a foreign corporation’s AIL may not 

exceed the lesser of (1) the amount 

shown on any financial statement filed 

(or required to be filed) with the 

applicable insurance regulatory body for 

the same reporting period covered by 

the applicable financial statement; (2) 

the amount determined on the basis of 

the most recent AFS, if the AFS is 

prepared on the basis of GAAP or IFRS, 

regardless of whether the AFS is filed 

with the applicable insurance regulatory 

body; or (3) the amount required by the 

applicable law or regulation of the 

jurisdiction of the applicable regulatory 

body (or a lower amount allowed as a 

permitted practice). If one of the 

limitation amounts is not applicable (for 

example, if the AFS is not prepared on 

the basis of GAAP or IFRS), the 

limitation is equal to the lesser of the 

other amounts described. 

Although the limitation under section 

1297(f)(3) refers to the amount reported 

to the applicable insurance regulatory 

body in the AFS, the final regulations 

clarify that an AFS prepared under 

GAAP or IFRS is taken into account as 

part of the limitation under § 1.1297– 

4(e)(2)(ii) regardless of whether it is 

filed with the local regulator. This rule 

is intended to prevent foreign 

corporations that choose not to file 

GAAP or IFRS statements with the local 

regulator from relying on statutory 

accounting standards that define 

liabilities more broadly than GAAP or 

IFRS. The limitation in the proposed 

regulations addressing financial 

statements prepared for a purpose other 

than financial reporting has been 

deleted. 

The definition of the term ‘‘financial 

statement’’ has been revised to treat a 

statement as such only if it is prepared 

for a reporting period in accordance 

with the rules of a financial accounting 

or statutory accounting standard and 

includes a complete balance sheet, 

statement of income, and a statement of 

cash flows (or equivalent statements 

under the applicable reporting 

standard). Consequently, a statutory 

accounting statement that is used for 

purposes of the limitation should 

provide all information necessary to 

apply the 25 percent test and the 

alternative facts and circumstances test. 

2. Discounting 

Under proposed § 1.1297–4(e)(3), if an 

AFS that was not prepared under GAAP 

or IFRS did not discount losses on an 

economically reasonable basis, AIL were 

required to be reduced under the 

discounting rules that would apply if a 

financial statement had been prepared 

under either GAAP or IFRS. Some 

comments requested that the 

discounting requirement be removed 

because GAAP does not require 

discounting of liabilities in certain 

circumstances. 

The Treasury Department and the IRS 

agree that AIL reported on a financial 

statement that have been discounted to 

reflect the time value of money only to 

the extent required by GAAP or IFRS 

have been discounted on an 

economically reasonable basis. 

Therefore, additional discounting of AIL 

is not necessary under circumstances in 

which it is not required under either 

GAAP or IFRS. For example, IFRS 17 

does not require discounting of 

liabilities under nonlife insurance 

contracts with terms of one year or less. 

However, the Treasury Department and 

the IRS have determined that 

discounting is required where AIL have 

not been otherwise discounted on a 

reasonable basis. Accordingly, the final 

regulations clarify that, where a 

financial statement described in 

§ 1.1297–4(e)(2) does not discount AIL 

on an economically reasonable basis, 

the foreign corporation may meet this 

requirement by choosing to apply the 

discounting methods required under 

either GAAP or IFRS. 

3. Change of Financial Reporting 

Standard 

Under proposed § 1.1297–4(e)(4), if a 

foreign corporation had previously 

prepared a financial statement under 

GAAP or IFRS, it could not cease to do 

so in subsequent years without a nonFederal tax business purpose. If the 

foreign corporation failed to prepare a 

financial statement under GAAP or IFRS 

in a subsequent year without a nonFederal tax business purpose, it was 

treated as having no AIL for purposes of 

the 25 percent test and the 10 percent 

test. 

A comment requested that this rule be 

removed because taxpayers should not 

be required to establish a business 

purpose for their choice of an 

accounting standard. In addition, 

financial reports are prepared to inform 

a corporation’s stakeholders and 

regulators of its financial condition, and 

this function is so significant that a 

corporation is unlikely to change its 

accounting standard for tax purposes. 

The Treasury Department and the IRS 

have concluded that other rules and 

limitations provided in the final 

regulations are sufficient to protect the 

integrity of the amounts reported on the 

AFS. Therefore, the final regulations 

delete the special rule addressing a 

change of financial reporting standard. 

D. Definition of an Insurance Business 

The proposed regulations defined an 

insurance business to include the 

investment activities and administrative 

services that are required to support (or 

that are substantially related to) 

insurance, annuity, or reinsurance 

contracts issued or entered into by the 

QIC. See proposed § 1.1297–5(c)(2). One 

comment interpreted this definition as 

potentially excluding any investment 

activities in excess of the minimum 

amount required to meet the QIC’s 

insurance obligations from the scope of 

the exception under section 

1297(b)(2)(B). The comment requested 

that the definition be broadened to 

include all investment activities related 

to insurance, annuity, or reinsurance 

4538 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

contracts issued or entered into by the 

QIC. Although the definition of an 

insurance business (now contained in 

§ 1.1297–4(f)(8)) has not been changed, 

it is not intended to provide a maximum 

threshold for investment assets and 

income that may qualify for non-passive 

treatment under section 1297(b)(2)(B). 

This definition merely requires a 

sufficient factual relationship between a 

company’s insurance contracts and its 

investment activity. 

VI. Comments and Revisions to 

Proposed § 1.1297–5 and New § 1.1297– 

6: Exception From the Definition of 

Passive Income for Active Insurance 

Income 

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. Proposed § 1.1297–5(b) provided a 

general rule that excluded from passive 

income certain income of a QIC and 

income of a qualifying domestic 

insurance corporation (QDIC). Proposed 

§ 1.1297–5(c) described the 

requirements for income to be treated as 

derived in the active conduct of an 

insurance business and provided rules 

for determining the amount of a QIC’s 

income that is excluded. Proposed 

§ 1.1297–5(d) provided rules for 

determining whether income of a 

domestic corporation is income of a 

QDIC. Proposed § 1.1297–5(e) provided 

that assets of a QIC are not treated as 

passive assets if they are available to 

satisfy liabilities of the QIC related to its 

insurance business. In addition, 

proposed § 1.1297–5(e) provided that 

assets of a QDIC generally are not 

treated as passive assets. Proposed 

§ 1.1297–5(f) provided a special lookthrough rule for interests held by a QIC 

in subsidiary entities. 

A. Active Conduct of an Insurance 

Business 

Under proposed § 1.1297–5(c)(1), a 

QIC’s passive income was treated as 

derived in the active conduct of an 

insurance business only if its active 

conduct percentage was at least 50 

percent. The active conduct percentage 

was computed for each taxable year 

based on the amount of expenses 

incurred by a QIC for services of its 

officers and employees (including 

employees of qualifying related entities) 

related to the production or acquisition 

of premiums and investment income as 

a fraction of all expenses related to the 

production or acquisition of premiums 

and investment income. 

Proposed § 1.1297–5(c)(3)(i) provided 

that active conduct is determined based 

on all the facts and circumstances. In 

general, a QIC was treated as actively 

conducting an insurance business only 

if the officers and employees of the QIC 

carried out substantial managerial and 

operational activities. A QIC’s officers 

and employees were considered to 

include the officers and employees of an 

affiliate if the QIC satisfied the control 

test under proposed § 1.1297–5(c)(3)(ii), 

which incorporated requirements 

relating to ownership, control and 

supervision, and compensation. 

Comments were generally critical of 

the proposed active conduct test. Some 

noted that outsourcing is a common 

practice in the insurance industry for 

reasons of cost and efficiency, and an 

insurance company should be treated as 

engaged in the active conduct of an 

insurance business even if the fees it 

pays for outsourced activities (for 

example, to investment advisors or 

insurance brokers) exceed employee 

expenses. Others expressed concern that 

some reinsurers (which hold substantial 

investments but employ a limited staff) 

and alternative risk vehicles could have 

difficulty satisfying the active conduct 

test under the proposed regulations. 

Comments also criticized the ‘‘cliff 

effect’’ of the active conduct percentage, 

which precluded an insurance company 

with an active conduct percentage that 

is slightly below 50 percent from 

treating any of its income or assets as 

non-passive under section 1297(b)(2)(B). 

Many comments recommended that 

the proposed active conduct test be 

replaced with a broader facts and 

circumstances test. Some comments 

alternatively requested that the active 

conduct percentage be used as a safe 

harbor alongside a more flexible test, or 

that the threshold for the active conduct 

percentage be reduced to 25 percent. 

A number of comments requested that 

an insurance company be treated as 

engaged in the active conduct of an 

insurance business even if its day-to-day 

activities are not performed by 

employees, so long as its officers and 

employees adequately supervise the 

outsourced functions. For example, 

some comments recommended a 

management and control test based 

upon the Limitation on Benefits Article 

of the 2016 U.S. Model Income Tax 

Convention (which requires a 

company’s executive officers and senior 

management employees to exercise dayto-day responsibility for strategic, 

financial, and operational policy 

decision-making) or regulations issued 

by the Bermuda Monetary Authority 

(which permit outsourcing subject to the 

insurance company’s supervision and 

oversight). Others proposed that if an 

entity is treated as an insurance 

company under subchapter L or is 

treated as a QIC under section 1297(f), 

it should be deemed to be engaged in 

the active conduct of an insurance 

business without meeting any 

additional requirements. 

Several comments recommended that 

the active conduct test focus on the 

assumption of insurance risk. One 

comment specifically identified 

underwriting as a core insurance 

function that must be performed by an 

insurance company’s officers and 

employees. Another requested that an 

insurance company be treated as 

engaged in the active conduct of an 

insurance business if it assumes risk 

under contracts with multiple 

counterparties that are unrelated to one 

another, or under contracts covering 

multiple divergent lines of business. 

Some comments proposed an active 

conduct test tied to the amount of 

premium and investment income earned 

by the QIC. 

For purposes of computing the active 

conduct percentage, some comments 

requested clarification about whether 

overhead and claims expenses are 

treated as expenses incurred to produce 

or acquire premium and investment 

income. One comment recommended 

that certain functions (for example, 

investment management) be excluded 

from both the numerator and 

denominator of the fraction. 

Some comments requested that the 

control test be expanded to 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. Another proposed 

that a single active conduct percentage 

be computed on an aggregate basis when 

multiple insurance companies are 

wholly owned within a single corporate 

group. 

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. Therefore, the 

Treasury Department and the IRS are 

issuing a notice of proposed rulemaking 

(the 2020 NPRM) with a new proposed 

§ 1.1297–5 published in the same issue 

of the Federal Register as these final 

regulations that proposes rules for 

determining whether an insurance 

company is engaged in the active 

conduct of an insurance business. 

The new active conduct rules are 

proposed to apply to taxable years of 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4539 

QICs beginning on or after the date the 

Treasury Decision adopting those rules 

as final regulations is published in the 

Federal Register. The rules contained in 

proposed § 1.1297–5(c) and (d) are 

withdrawn. The other rules in proposed 

§ 1.1297–5 have been modified as 

described below and are provided in the 

final regulations under new § 1.1297–6. 

B. Qualifying Domestic Insurance 

Corporations 

Proposed § 1.1297–5(d) defined a 

QDIC as a domestic corporation that is 

subject to tax as an insurance company 

under subchapter L of chapter 1 of 

subtitle A of the Code and is subject to 

Federal income tax on its net income. 

Proposed §§ 1.1297–5(b)(2) and 1.1297– 

5(e)(2) provided that a QDIC’s income 

and assets are non-passive for purposes 

of determining whether a non-U.S. 

corporation is treated as a PFIC (the 

QDIC Rule). However, proposed 

§§ 1.1297–5(b)(2) and 1.1297–5(e)(2) 

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 (QDIC Attribution Exception). 

Consequently, for attribution purposes, 

a tested foreign corporation was 

required to apply the section 1297(a) 

income and assets tests without 

applying the QDIC Rule. 

Several comments requested that the 

QDIC Attribution Exception be removed 

because U.S. shareholders of a tested 

foreign corporation that would not 

otherwise be a PFIC but that owns a 

PFIC and a U.S. insurance subsidiary 

that is a QDIC can become indirect 

owners of a PFIC as a result of the 

section 1298(a)(2) attribution rule. 

Another comment requested that, if the 

QDIC Attribution Exception is retained, 

a special exception be provided for 

active domestic mortgage insurance 

companies if certain criteria are 

satisfied. The Treasury Department and 

IRS agree that the QDIC Attribution 

Exception is overbroad, and therefore 

the final regulations do not include it. 

However, the Treasury Department and 

IRS believe that it may be appropriate to 

limit the amount of a QDIC’s assets and 

income that are treated as non-passive if 

they exceed a certain threshold. 

Accordingly, the 2020 NPRM proposes 

a new limitation. 

The final regulations also clarify that 

a U.S. insurance company must be a 

look-through subsidiary in order to 

qualify as a QDIC. If a QDIC is a lookthrough subsidiary of a QIC, the QIC’s 

proportionate share of the QDIC’s assets 

that is treated as non-passive may be 

subject to limitation under the special 

look-through rule provided in § 1.1297– 

6(d), which is described in Part VI.C of 

this Summary of Comments and 

Explanation of Revisions. Because of the 

renumbering of sections described in 

Part VI.A of this Summary of Comments 

and Explanation of Revisions, the QDIC 

rules are now contained in § 1.1297– 

6(b)(2), (c)(2), and (e)(1) of the final 

regulations. 

C. Treatment of Income and Assets of 

Certain Look-Through Subsidiaries and 

Look-Through Partnerships Held by a 

QIC 

The proposed regulations provided a 

special look-through rule that applied to 

a subsidiary entity in which the QIC 

owned at least 25 percent by value (that 

is, a look-through subsidiary or a lookthrough partnership) and which was 

subject to the look-through rules 

provided in section 1297(c), proposed 

§ 1.1297–1(c)(2) and (d)(3), and 

proposed § 1.1297–2(b)(2) (the ‘‘general 

look-through rules,’’ which are now 

provided in § 1.1297–2(b)(2) and (3)). 

Under the general look-through rules, a 

QIC is treated as earning directly its 

proportionate share of the income, and 

holding directly its proportionate share 

of the assets, of a look-through 

subsidiary or a look-through 

partnership. 

Proposed § 1.1297–5(f) provided that, 

if a QIC was treated as earning passive 

income or holding passive assets of a 

subsidiary entity under the general lookthrough rules, then the income could be 

treated as derived by the QIC in the 

active conduct of an insurance business 

(and thus treated as non-passive under 

proposed § 1.1297–5(c)), and the assets 

could be treated as assets of the QIC 

held to satisfy liabilities related to its 

insurance business (and thus treated as 

non-passive under § 1.1297–5(e)). 

However, for this rule to apply, the 

subsidiary entity’s assets and liabilities 

were required to be included in the 

QIC’s AFS. 

A number of comments asserted that 

look-through treatment should not be 

denied for subsidiary entities that do 

not have assets and liabilities included 

in the QIC’s AFS (which would 

typically occur if a subsidiary entity is 

not consolidated with the QIC under the 

relevant financial accounting standard). 

The comments noted that the equity 

value of a subsidiary entity is reflected 

on a QIC’s AFS even if it is not 

consolidated for financial reporting 

purposes. Some comments requested 

that the look-through rule under 

proposed § 1.1297–5(f) apply without 

regard to whether a subsidiary entity’s 

assets and liabilities are included in the 

QIC’s AFS. Others requested that the 

look-through rule be applied to a 

proportionate amount of the income and 

assets of a subsidiary entity, depending 

on how the value of the subsidiary 

entity is reflected on the AFS. 

In response to these comments, the 

special look-through rule for assets and 

income of a subsidiary entity held by a 

QIC (now provided in § 1.1297–6(d)) has 

been modified to apply in all cases in 

which a QIC is treated as owning the 

assets or earning the income of the 

subsidiary entity under the general lookthrough rules. However, under 

§ 1.1297–6(d)(2), the amount of assets or 

income that can be treated as nonpassive under the revised rule is limited 

to the greater of two amounts. The first 

amount is determined by multiplying 

the QIC’s proportionate share of the 

subsidiary entity’s income or assets by 

a fraction equal to (i) the net equity 

value of the QIC’s interests in the 

subsidiary entity divided by (ii) the 

value of the subsidiary entity’s assets. 

The second amount is the amount of 

income or assets that are treated as nonpassive in the hands of the subsidiary 

entity. 

If assets are measured based on value 

for purposes of applying the asset test 

under section 1297(a)(2), the amount of 

otherwise passive assets that may be 

treated as non-passive under § 1.1297– 

6(d) (that is, the first amount described 

above) is limited to the net equity value 

of the interests held by the QIC in the 

subsidiary entity. If assets are measured 

instead using adjusted bases, the 

fraction test is designed to provide a 

proportionate limitation. Two examples 

are added to illustrate the operation of 

these rules. See § 1.1297–6(d)(3). 

Several comments requested 

clarification regarding the treatment of 

an interest held by a QIC in an entity 

other than a look-through subsidiary or 

a look-through partnership (for example, 

a corporation in which a QIC owns less 

than 25 percent of the stock). The 

income and assets of such a subsidiary 

entity are not treated as earned or held 

by the QIC in the active conduct of an 

insurance business, consistent with the 

general look-through rules. However, 

the stock or partnership interest held by 

the QIC (and the income it derives from 

the subsidiary entity) is eligible for the 

exception under section 1297(b)(2)(B) 

and § 1.1297–6(b) and (c) in the same 

manner as any other (non-look-through) 

asset held by a QIC. 

VII. Comments and Revisions to 

Proposed § 1.1298–4—Rules for Certain 

Foreign Corporations Owning Stock in 

25-Percent-Owned Domestic 

Corporations 

Section 1298(b)(7) provides a special 

characterization rule that applies when 

4540 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

a tested foreign corporation owns at 

least 25 percent of the value of the stock 

of a domestic corporation and 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 qualified 

stock held by the domestic corporation 

as a non-passive asset, and the related 

income as non-passive income. 

A. Interaction of the Domestic 

Subsidiary Rule and Section 1298(a)(2) 

Attribution Rule 

The proposed regulations included 

rules that disregarded the application of 

section 1298(b)(7) for purposes of 

determining whether a foreign 

corporation is a PFIC for purposes of the 

ownership attribution rules in section 

1298(a)(2) and § 1.1291–1(b)(8)(ii) 

(‘‘domestic subsidiary attribution 

rules’’). See proposed §§ 1.1291– 

1(b)(8)(ii)(B) and 1.1298–4(e). 

Several comments recommended that 

the final regulations eliminate the 

domestic subsidiary attribution rules in 

proposed §§ 1.1291–1(b)(8)(ii)(B) and 

1.1298–4(e). These comments asserted 

that Congress intended for stock that is 

treated as non-passive pursuant to 

section 1298(b)(7) to be characterized as 

non-passive for all purposes, including 

for purposes of section 1298(a)(2). 

Specifically, some of these comments 

noted that the statutory text of section 

1298(a)(2) already specifies that 

application of section 1297(d) is 

excluded and, thus, asserted that an 

additional exclusion from section 

1298(a)(2) is precluded. The comments 

also asserted that legislative history 

suggests that Congress intended for 

section 1298(b)(7) to incentivize 

investments in domestic corporations. 

Other comments argued that the 

domestic subsidiary attribution rules 

would be administratively burdensome 

on minority shareholders who would 

not be able to obtain information with 

respect to lower-tier PFICs to comply 

with the PFIC rules. One comment 

suggested that Congress acknowledged 

the lack of control that minority 

investors have in parent companies by 

providing the 50-percent threshold in 

section 1298(a)(2) to facilitate 

administrability. Another comment 

recommended that, if the domestic 

subsidiary attribution rules are retained, 

the final regulations provide an 

exception to allow shareholders who 

own less than 5-percent of the top-tier 

foreign corporation in a structure to 

apply section 1298(b)(7) to determine 

PFIC status for purposes of the 

ownership attribution rules in section 

1298(a)(2). 

The Treasury Department and the IRS 

have given further consideration to the 

purpose of section 1298(b)(7), and have 

determined that it is appropriate for 

section 1298(b)(7) generally to apply for 

purposes of the attribution of ownership 

rules of section 1298(a), provided that 

adequate measures are taken to prevent 

taxpayers from holding primarily 

passive assets in domestic subsidiaries 

in order to avoid PFIC classification. 

The Treasury Department and the IRS 

also agree with the comment that the 

domestic subsidiary attribution rule can 

be administratively burdensome. 

Accordingly, the Treasury Department 

and the IRS have determined that the 

application of the domestic subsidiary 

anti-abuse rule discussed in Part VII.B 

of this Explanation of Comments and 

Summary of Revisions is sufficient to 

address concerns about abusive 

planning related to section 1298(b)(7) 

without a need for the domestic 

subsidiary attribution rules. Therefore, 

the domestic subsidiary attribution rules 

are eliminated in the final regulations. 

Several comments were received 

recommending clarification concerning 

the consequences of disregarding 

section 1298(b)(7) for purposes of the 

Income Test and the Asset Test and 

excepting minority shareholders from 

the domestic subsidiary rule. Because 

the final regulations do not adopt the 

domestic subsidiary attribution rules, 

these recommendations are not adopted. 

B. Revisions to Domestic Subsidiary 

Anti-Abuse Rules 

The proposed regulations provided 

that section 1298(b)(7) did not apply if 

(i) the tested foreign corporation would 

be a PFIC if the qualified stock held by 

the 25-percent-owned domestic 

corporation or any income received or 

accrued with respect thereto were 

disregarded (‘‘qualified stock anti-abuse 

rule’’) or (ii) 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). The preamble to the 

proposed regulations explained that the 

Treasury Department and the IRS 

believed that a taxpayer should not be 

permitted to use the domestic 

subsidiary rule in section 1298(b)(7) to 

avoid the PFIC rules by indirectly 

holding predominantly passive assets 

through a two-tiered chain of domestic 

subsidiaries. 

1. Qualified Stock Anti-Abuse Rule 

Several comments requested that the 

qualified stock anti-abuse rule in 

proposed § 1.1298–4(f)(1) be withdrawn. 

These comments asserted that Congress 

was aware of the potential for taxpayers 

to rely on section 1298(b)(7) to avoid 

PFIC status by treating otherwise 

passive investments as non-passive and 

intended for the accumulated earnings 

tax (‘‘AET’’) to mitigate potential abuse. 

The comments argued that the AET 

imposed on the tested foreign 

corporation, the U.S. corporate tax 

imposed on the domestic subsidiaries, 

and the withholding tax imposed on 

distributions to the tested foreign 

corporation serve to discourage a tested 

foreign corporation from artificially 

overweighting its investment assets held 

through domestic subsidiaries. Another 

comment asserted that the qualified 

stock anti-abuse rule creates a 

hypothetical PFIC test that supersedes 

the statute when it causes a tested 

foreign corporation to be a PFIC in a fact 

pattern in which the domestic 

subsidiary rule in section 1298(b)(7) 

would otherwise cause the tested 

foreign corporation to not be a PFIC. 

The Treasury Department and the IRS 

have determined that the qualified stock 

anti-abuse rule is unnecessary to 

address the concerns of abuse that were 

expressed in the preamble to the 

proposed regulations and that tailoring 

the scope of the principal purpose antiabuse rule as discussed in Part VII.B.2 

of this Summary of Comments and 

Explanation of Revisions would better 

target the concerns of abuse. 

Accordingly, the qualified stock antiabuse rule in proposed § 1.1298–4(f)(1) 

is withdrawn. 

2. Principal Purpose Anti-Abuse Rule 

Under the principal purpose antiabuse rule in proposed § 1.1298–4(f)(2), 

a principal purpose was deemed to exist 

when the 25-percent-owned domestic 

corporation was not engaged in an 

active trade or business in the United 

States. One comment asserted that the 

principal purpose anti-abuse rule in 

proposed § 1.1298–4(f)(2) was overbroad 

and should be narrowly drawn to 

prevent potential abuse. Other 

comments requested that the principal 

purpose anti-abuse rule be eliminated, 

because, according to such comments, 

Congress contemplated that taxpayers 

would plan into section 1298(b)(7) and 

intended for the AET to be the sole 

limitation on the applicability of the 

domestic subsidiary rule. Some of these 

comments asserted that the principal 

purpose anti-abuse rule was 

inconsistent with two private letter 

rulings that, according to such 

comments, endorsed the use of domestic 

subsidiaries to manage PFIC status. 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4541 

One comment noted that the 25- 

percent-owned domestic corporation is 

likely to be a holding company without 

an active trade or business and, thus, 

the tested foreign corporation would 

likely be deemed to have a principal 

purpose of avoiding PFIC classification. 

Another comment argued that the 

standard for deeming a principal 

purpose of avoiding PFIC status to exist 

is misguided because a corporation need 

not be engaged in an active trade or 

business in order to generate nonpassive income. Other comments 

expressed concern that the principal 

purpose anti-abuse rule would disallow 

planning to manage the PFIC risk of 

start-up companies and active 

companies undergoing transition. 

The Treasury Department and the IRS 

have determined that the final 

regulations should retain a principal 

purpose anti-abuse rule to prevent the 

holding of passive assets through a twotiered chain of domestic subsidiaries for 

the purpose of avoiding the PFIC rules 

with respect to passive assets held in 

foreign affiliates. Absent an anti-abuse 

rule, a two-tiered chain of domestic 

subsidiaries could be used to shield U.S. 

investors in a tested foreign corporation 

from the application of the PFIC rules 

with respect to substantial amounts of 

passive assets held by the tested foreign 

corporation or its foreign subsidiaries. 

The Treasury Department and the IRS 

have concluded that the promulgation 

of a principal purpose anti-abuse rule is 

consistent with section 1298 and the 

broad regulatory authority under section 

1298(g). The legislative history of 

section 1298(b)(7) envisions that U.S. 

shareholders that hold passive assets 

through a U.S. corporate structure rather 

than in a foreign corporation in order to 

avoid the PFIC regime will be subject to 

tax treatment essentially equivalent to 

that of the shareholders of a PFIC. While 

Congress intended that the AET serve 

this function, because the AET is rarely 

applied in practice, the Treasury 

Department and the IRS have 

determined that the AET is not, by 

itself, sufficient to curtail abuse. The 

imposition of U.S. net income tax on the 

income from passive assets held by a 

domestic subsidiary also does not serve 

as a sufficient disincentive to hold those 

assets in a domestic subsidiary, because 

the passive assets may generate a small 

amount of income or the domestic 

subsidiary may be leveraged so that its 

net income subject to taxation is much 

less than the gross income that would be 

taken into account under the PFIC rules 

if the assets were held by a foreign 

affiliate. Section 1298(g) provides 

authority to prevent abuse of the PFIC 

rules. Moreover, the Treasury 

Department and the IRS have 

determined that the comments did not 

appreciate the underlying facts of the 

private letter rulings and that the 

promulgation of the principal purpose 

anti-abuse rule is not inconsistent with 

the private letter rulings. 

However, the Treasury Department 

and the IRS agree that it is appropriate 

to more closely tailor the scope of the 

principal purpose anti-abuse rule to the 

potential abuses of greatest concern. 

Accordingly, the principal purpose antiabuse rule in the final regulations is 

modified to strike the appropriate 

balance between preventing section 

1298(b)(7) from applying 

inappropriately to avoid the PFIC rules 

and allowing for planning to manage the 

PFIC risk of start-up companies and 

active companies undergoing transition 

phases in the business cycle. Under the 

principal purpose anti-abuse rule in the 

final regulations, section 1298(b)(7) does 

not apply if either (i) a principal 

purpose for the formation, acquisition, 

or holding of stock of either domestic 

corporation was to avoid PFIC 

classification or (ii) a principal purpose 

of the capitalization or other funding of 

the second-tier domestic corporation is 

to hold passive assets through such 

corporation to avoid PFIC classification. 

See § 1.1298–4(e)(1). Unlike the 

proposed regulations, which applied the 

principal purpose anti-abuse rule only 

at the level of the upper tier domestic 

corporation, the final regulations were 

modified to apply the principal purpose 

anti-abuse rule at both levels. See id. 

Because a two-tiered domestic structure 

can be planned into at either tier level 

in the structure, the first prong of the 

anti-abuse rule—which targets corporate 

formations, acquisitions, or stock 

holding—applies at both levels. See id. 

On the other hand, the second prong of 

the anti-abuse rule—which targets 

capitalizing or funding—applies at the 

level of the second-tier domestic 

subsidiary because the benefit of section 

1298(b)(7) applies only with respect to 

assets held at that level. See id. The 

Treasury Department and the IRS 

continue to study the need to narrow 

the principal purpose anti-abuse test to 

avoid concerns with respect to 

temporary holdings of passive assets in 

a U.S. corporate structure for valid 

business reasons, and additional 

guidance on safe harbors to address 

those concerns is proposed in the 2020 

NPRM. See proposed § 1.1298–4(e)(2) 

and (e)(3). 

VIII. Comments and Revisions 

Regarding Applicability Dates 

The preamble to the proposed 

regulations generally provided that until 

they were finalized, taxpayers could 

choose to apply the proposed 

regulations other than the rules related 

to the PFIC insurance exception in their 

entirety to all open tax years as if they 

were final regulations provided that 

taxpayers consistently applied those 

rules. Similarly, the preamble provided 

that the rules of proposed §§ 1.1297–4 

and 1.1297–5 could be applied for 

taxable years beginning after December 

31, 2017, provided those rules were 

applied consistently. 

A. Applicability Dates Relating to the 

PFIC Insurance Exception 

Comments related to the PFIC 

insurance income exception requested 

that the final regulations apply to 

taxable years of a U.S. shareholder 

beginning on or after December 31, 2020 

(or such date that generally provides 

foreign corporations at least one year to 

comply with the final regulations) or the 

date of publication of the final 

regulations. Comments asserted that 

foreign corporations needed additional 

time to make changes to come into 

compliance with the regulations, and 

that U.S. shareholders needed 

additional time to evaluate whether they 

were shareholders of a PFIC. Because 

the final regulations have removed rules 

turning off the QDIC rule and section 

1298(b)(7) for purposes of testing for 

indirect ownership of a PFIC and the 

rules defining active conduct of an 

insurance business have been revised 

and reproposed, the final regulations are 

significantly less burdensome than as 

originally proposed. Accordingly, the 

Treasury Department and the IRS have 

decided that additional time is not 

necessary to comply given that section 

1297(f) has been in effect since January 

1, 2018, and §§ 1.1297–4 and 1.1297–6 

merely implement section 1297(f). 

Sections 1.1297–4(g) and 1.1297–6(f) 

therefore provide that the final PFIC 

insurance regulations apply to taxable 

years beginning on or after January 14, 

2021. Taxpayers may choose to apply 

the final PFIC insurance regulations to 

any taxable year beginning after 

December 31, 2017, provided that all of 

those rules are applied consistently with 

respect to that tested foreign corporation 

for the same year and all succeeding 

taxable years. Id. 

B. Applicability Dates Relating to Other 

Rules 

Comments with respect to the rules 

unrelated to the PFIC insurance 

4542 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

exception argued that allowing 

taxpayers to rely on the 2019 proposed 

regulations for open years would 

provide insufficient relief, given that a 

foreign corporation is generally treated 

as a PFIC on an ongoing basis with 

respect to a shareholder if it was ever 

treated as a PFIC with respect to that 

shareholder (the ‘‘once-a-PFIC, alwaysa-PFIC’’ rule). See sections 1291(a)(1) 

and 1298(b)(1) and § 1.1298–3(a). The 

comments expressed concern that a 

taxpayer that treated a tested foreign 

corporation as a PFIC in closed years, 

based on its understanding of the rules 

at that time, would be required to file 

amended returns. The comments stated 

that requiring taxpayers to file amended 

returns could limit the relief provided 

by allowing taxpayers to rely on the 

2019 proposed regulations for open 

years. One comment expressed concern 

that the application of the once-a-PFIC, 

always-a-PFIC rule in this context 

would penalize taxpayers that took 

conservative positions under prior law, 

and that filing amended returns may 

involve significant administrative 

burdens. Another comment expressed 

concern that new investors in a tested 

foreign corporation that would have 

been a PFIC under prior law but not 

under the proposed regulations would 

be subject to more favorable rules than 

historic investors in that corporation. 

Accordingly, comments requested that 

taxpayers be permitted to apply the 

regulations to closed taxable years for 

purposes of section 1298(b)(1), provided 

that the relevant tested foreign 

corporation would never have been a 

PFIC during the taxpayer’s holding 

period as a result. 

The Treasury Department and the IRS 

agree that the once-a-PFIC, always-aPFIC rule is implicated, because in some 

cases these regulations may cause a 

tested foreign corporation that was 

previously a PFIC with respect to a 

shareholder to not satisfy the Asset Test 

or Income Test going forward and 

therefore to become a ‘‘former PFIC’’ as 

defined in § 1.1291–9(j)(2)(iv), but the 

foreign corporation would still be 

treated as a PFIC with respect to the 

shareholder by reason of the once-aPFIC, always-a-PFIC rule. The Treasury 

Department and the IRS do not agree 

that taxpayers subject to the once-aPFIC, always-a-PFIC rule should be 

permitted to avoid the need to file 

amended returns or to make an election 

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

3 (‘‘purging election’’). The possible 

applicability dates of the final 

regulations do not include closed years, 

and the Treasury Department and the 

IRS do not believe that it would be 

appropriate for the final regulations to 

apply in whole or part to closed years 

for purposes of alleviating the effects of 

the once-a-PFIC, always-a-PFIC rule. For 

example, providing the relief requested 

by commenters would afford a benefit to 

taxpayers that invested in a tested 

foreign corporation treated as a section 

1291 fund in a now-closed year and 

continue to hold the stock compared to 

taxpayers that acquired the stock of the 

tested foreign corporation at the same 

time but sold the stock in a now-closed 

year, which may be viewed as unfair. If 

the tested foreign corporation would not 

be treated as a PFIC under the proposed 

regulations or the final regulations, the 

taxpayers who sold the stock during a 

closed year may have been subject to tax 

under section 1291 on an excess 

distribution while taxpayers who 

continue to hold the stock would be 

spared taxation under section 1291. 

Finally, while it is true that the 

application of the once-a-PFIC, alwaysa-PFIC rule may apply to historic 

shareholders and not to new 

shareholders, the rule as enacted by 

Congress is designed to work in that 

manner. For example, an investor that 

buys shares in a tested foreign 

corporation that is a start-up with no 

operating income may be required to 

treat that corporation as a PFIC during 

its entire holding period for the shares, 

while an investor that buys shares in the 

same corporation once it is a going 

concern may never be required to treat 

the tested foreign corporation as a PFIC. 

However, in light of the issues raised 

by commenters, the Treasury 

Department and the IRS have concluded 

that it is appropriate to provide 

taxpayers with some flexibility in 

choosing if and when to end PFIC 

treatment by causing a former PFIC to 

no longer be subject to the once-a-PFIC, 

always-a-PFIC rule. Under current law, 

a shareholder seeking to end PFIC 

treatment as a result of a change of facts 

or law would need to make a purging 

election under section 1298(b)(1) and 

§ 1.1298–3(b) or (c) on Form 8621 

attached to the shareholder’s tax return 

(including an amended return filed 

within three years of the due date, as 

extended under section 6081, of the 

original return for the election year), or 

request the consent of the Commissioner 

to make an election with respect to a 

closed taxable year under section 

1298(b)(1) and § 1.1298–3(e) (‘‘late 

purging election’’) on Form 8621–A. A 

timely purging election under section 

1298(b)(1) and § 1.1298–3(b) or (c) may 

be made if the tested foreign corporation 

ceased to qualify as a PFIC under the 

Income Test and the Asset Test in an 

open taxable year, but the election 

would not affect the treatment of the 

tested foreign corporation as a PFIC in 

the earliest open year because it takes 

effect at the end of the year for which 

the election is made, as described in the 

next paragraph. If the tested foreign 

corporation ceased to qualify as a PFIC 

at the beginning of the earliest open 

year, the shareholder may request the 

consent of the Commissioner to make a 

late purging election, as described in the 

next paragraph. 

When a deemed sale purging election 

is made, the stock of the former PFIC is 

deemed sold for its fair market value on 

the last day of the last taxable year of 

the tested foreign corporation during 

which it qualified as a PFIC (the 

‘‘termination date’’). See § 1.1298– 

3(b)(2) and (d). Accordingly, a taxpayer 

that files a timely deemed sale purging 

election for an open taxable year is 

treated as selling the stock of the PFIC 

at the end of the tested foreign 

corporation’s taxable year, and 

accordingly the shareholder is subject to 

the PFIC rules with respect to that stock 

during its relevant taxable year and any 

prior open years. If the taxpayer wishes 

to end PFIC treatment as of its earliest 

open taxable year, it must request the 

consent of the Commissioner to make a 

late purging election taking effect as of 

the end of the tested foreign 

corporation’s taxable year in the 

taxpayer’s most recent closed taxable 

year. For example, if a taxpayer had 

chosen to apply the proposed 

regulations to its earliest open taxable 

year with respect to a tested foreign 

corporation that has the same taxable 

year and that qualified as a PFIC in 

closed taxable years, and the application 

of the proposed regulations resulted in 

the tested foreign corporation no longer 

qualifying as a PFIC, to prevent PFIC 

treatment from continuing into that 

earliest open taxable year and beyond 

the taxpayer would have had to request 

the consent of the Commissioner to 

make a late purging election by filing 

Form 8621–A for the year immediately 

preceding its first open taxable year. See 

also § 1.1298–3(c) (deemed dividend 

purging election available if former PFIC 

was a CFC during its last taxable year 

that it qualified as a PFIC). The result of 

both timely and late purging elections 

with respect to former PFICs is that the 

shareholder’s holding period resets 

solely for PFIC purposes, such that the 

shareholder is treated as no longer 

holding stock of a foreign corporation 

that was ever a PFIC during the 

shareholder’s holding period, so the 

once-a-PFIC, always-a-PFIC rule no 

longer applies. 

The Treasury Department and the IRS 

are aware that the reference to ‘‘all open 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4543 

tax years’’ in the preamble to the 

proposed regulations may have caused 

confusion as to whether taxpayers could 

choose to apply the proposed 

regulations prospectively to the first 

taxable year for which they had not yet 

filed a return, or, alternatively, whether 

the proposed regulations, if applied at 

all, had to be applied to all open taxable 

years, including taxable years for which 

returns had already been filed, resulting 

in the necessity to amend returns. As 

suggested by the comments, there may 

also have been confusion regarding the 

need to make a purging election in order 

to end PFIC status, even though that is 

the result under the statute and 

regulations. 

Given these considerations, a taxpayer 

may choose to apply the final 

regulations (other than the rules related 

to the PFIC insurance exception), with 

respect to a particular tested foreign 

corporation, to any open taxable year of 

the taxpayer, provided that all of the 

rules are applied consistently with 

respect to that tested foreign corporation 

for that year and all succeeding taxable 

years. See §§ 1.1291–1(j)(4), 1.1297– 

1(g)(1), 1.1297–2(h), 1.1297–4(g), 

1.1297–6(f), 1.1298–2(g), and 1.1298– 

4(f). (This was also how the proposed 

regulations, other than the rules related 

to the PFIC insurance exception, were 

intended to apply.) For taxable years 

ending on or before December 31, 2020, 

a taxpayer may rely on proposed 

§ 1.1297–1(c)(1)(A) in the 2019 

proposed regulations concerning the 

application of section 954(h) rather than 

§ 1.1297–1(c)(1)(i)(A) with respect to a 

tested foreign corporation. 

The Treasury Department and the IRS 

recognize that the determination of 

whether to apply the 2019 proposed 

regulations or the final regulations to a 

tested foreign corporation may be 

advantageous with respect to some 

tested foreign corporations and not with 

respect to others. In order to provide 

flexibility to U.S. investors in tested 

foreign corporations, taxpayers may 

apply the final regulations in any open 

taxable year to all or less than all of the 

tested foreign corporations whose shares 

are owned by the taxpayer, subject to 

the consistency rule described in the 

prior paragraph with respect to any 

particular tested foreign corporation. 

However, if the consequence of 

applying either the proposed regulations 

or these final regulations to prior open 

taxable years is that, as of the date of 

application, a tested foreign corporation 

that was a PFIC ceases to qualify as a 

PFIC, then the once-a-PFIC, always-aPFIC rule is implicated and a taxpayer 

seeking to end PFIC status must make a 

purging election or request the consent 

of the Commissioner to make a late 

purging election. 

A taxpayer may choose to apply the 

rules to open taxable years even if a 

qualified electing fund election under 

section 1295 or a mark-to-market 

election under section 1296 was in 

effect. See section 6511(a) (period of 

limitation for filing refund claim). 

Effect on Other Documents 

The eighth (concerning the average 

value of assets for purposes of the Asset 

Test), ninth (concerning the 

characterization of assets for purposes of 

the Asset Test), fourteenth through 

sixteenth (concerning dealer inventory 

and investment assets for purposes of 

the Asset Test), eighteenth (concerning 

look-through rules for purposes of the 

Income Test), and nineteenth 

(concerning look-through treatment 

under section 1297(c)) paragraphs of 

Notice 88–22, 1988 1 C.B. 489, are 

obsoleted. 

Special Analyses 

I. Regulatory Planning and Review— 

Economic Analyses 

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 this final rule is 

regulatory. 

The final 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 

Various provisions of the tax code 

allow tax on certain sources of income 

to be deferred, which means that the 

income is not taxed when it is earned 

but at some later date, based on specific 

events or conditions. Tax deferral is 

advantageous to taxpayers because the 

taxpayer can in the meantime earn a 

return on the amount that would 

otherwise have been paid as tax. Prior 

to the Tax Cuts and Jobs Act (TCJA), 

income earned abroad by foreign 

corporations owned by U.S. taxpayers 

generally was not taxed by the United 

States until the income was repatriated 

to the United States or, as holds broadly 

for capital gains, the stock of the 

corporation was sold. However, under 

controlled foreign corporation (CFC) 

and passive foreign investment 

company (PFIC) rules, U.S. persons 

owning stock of foreign corporations 

were in some circumstances subject to 

current tax on some or all of the foreign 

corporation’s income. After TCJA, 

passive income and certain insurance 

income earned abroad by a CFC 

continues to be taxed immediately to 

the United States shareholders of the 

CFC. However, income of U.S. persons 

earned by foreign corporations that are 

not CFCs may still be eligible for 

deferral, or, in the case of certain 

corporate shareholders, exempt from 

U.S. corporate tax. Deferral is not 

available, however, for income of 

foreign corporations that are identified 

as PFICs. The immediate taxation of this 

income discourages U.S. taxpayers from 

holding mobile, passive investments, 

such as stock, in a foreign corporation 

in order to defer U.S. tax. 

The 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. Without 

the PFIC rules, the income earned by 

these assets would be subject to U.S. tax 

only when and if that income is 

distributed as dividends by the foreign 

corporation or, as capital gains, when 

the shares of the foreign corporate stock 

are sold by the U.S. shareholder. In the 

absence of the PFIC rules, these types of 

investment arrangements could 

significantly lower the effective tax rate 

on passive income faced by U.S. 

investors from that incurred if the assets 

were held directly. 

Under the PFIC statutory rules, 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 (the Income Test) or if 

at least 50 percent of the corporation’s 

assets are assets that produce passive 

income (the Asset Test). The PFIC itself 

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

regime; rather, only the U.S. owner of a 

foreign corporation is subject to that 

regime. The U.S. owner of shares of a 

foreign corporation consequently must 

4544 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

obtain the appropriate information, 

usually from the corporation, in order to 

determine whether that corporation is a 

PFIC (by satisfying these and other tests) 

and if so what tax is due as a result. 

The PFIC provisions provide a longstanding exception from these passive 

income rules for any income earned in 

the active conduct of an insurance 

business by an insurance company. This 

exception (the PFIC insurance 

exception) allows insurance companies, 

which hold significant amounts of 

investment assets (which generate 

income that would otherwise be 

classified as passive) in the normal 

course of business to fund their 

insurance obligations, to avoid PFIC 

status, provided they meet other 

statutory conditions. 

TCJA substantially revised the PFIC 

insurance exception. Before its 

amendment by TCJA, this exception was 

provided to a foreign corporation that (i) 

was predominantly engaged in an 

insurance business and (ii) would be 

taxed as an insurance company if it 

were a domestic corporation. TCJA 

modified and narrowed the PFIC 

insurance exception by requiring that 

the excepted income be derived in the 

active conduct of an insurance business 

by a ‘‘qualifying insurance corporation’’ 

(QIC). To be a QIC, a foreign insurance 

corporation must be an entity that 

would be taxed as an insurance 

company if it were a domestic 

corporation (consistent with prior-law 

requirements) and, in addition, be able 

to show that its ‘‘applicable insurance 

liabilities’’ constitute more than 25 

percent of its total assets. TCJA defines 

applicable insurance liabilities for this 

purpose as including a set of 

enumerated types of insurance-related 

loss and expense items. Failing this test, 

the Code provides that U.S. owners of 

the foreign corporation may elect to 

treat their stock in the corporation as 

stock of a QIC provided the corporation 

can satisfy an ‘‘alternative facts and 

circumstances test.’’ If a corporation is 

determined to be a QIC, only income 

that is derived in the active conduct of 

an insurance business qualifies as 

income eligible for the PFIC insurance 

exception. 

The Treasury Department and the IRS 

previously published proposed 

regulations pertaining to the PFIC 

regime and changes due to TCJA (the 

proposed regulations.) See 84 FR 33120. 

B. Need for the Final Regulations 

The final regulations are needed 

because many of the terms and 

calculations required for the 

determination of PFIC status would 

benefit from greater specificity. The 

final regulations provide such details so 

that taxpayers can readily and 

accurately determine if their investment 

is in a PFIC, given the significant tax 

consequences of owning a PFIC. The 

regulations further resolve ambiguities 

in determining ownership of a PFIC and 

in the application of the PFIC Income 

and Asset Tests. These final regulations 

are also needed to respond to comments 

received on the proposed regulations. 

The Treasury Department and the IRS 

have also identified actions or positions 

that foreign companies might take to 

claim qualification for the passive 

income exception for income earned in 

the active conduct of an insurance 

business even though the nature of their 

insurance business would not merit an 

exception under the intent and purpose 

of the statute. The final regulations are 

needed to prevent U.S. investors from 

taking certain of these tax avoidance 

measures. 

C. Overview 

The final regulations can be divided 

into two parts: General guidance 

regarding PFICs (the general rules) and 

guidance that relates specifically to the 

implementation of the PFIC insurance 

income exception (the PFIC insurance 

exception rules). 

The economic analysis first discusses 

the regulations under the general rules 

that: (1) Clarify how assets are measured 

for the PFIC Asset Test; (2) provide rules 

for applying the statutory rules 

regarding look-through subsidiaries to 

partnerships; and (3) attribute activities 

undertaken by certain affiliates of the 

corporation being tested for its PFIC 

status for the purpose of applying 

certain exceptions contained in the 

passive income definitional rules. 

The economic analysis then discusses 

the regulations under the PFIC 

insurance exception rules that provide 

guidance regarding: (1) The discounting 

of applicable insurance liabilities on 

certain financial statements; (2) issues 

related to the facts and circumstances 

test for treating a foreign corporation as 

a QIC, including (i) ‘‘runoff-related 

circumstances,’’ (ii) ‘‘rating-related 

circumstances,’’ and (iii) the deemed 

election under the facts and 

circumstances test for small 

shareholders; and (3) application of the 

insurance exception as it relates to lookthrough subsidiaries of a QIC. 

D. Economic Analysis 

1. Baseline 

In this analysis, the Treasury 

Department and the IRS assess the 

benefits and costs of the final 

regulations relative to a no-action 

baseline reflecting anticipated Federal 

income tax-related behavior in the 

absence of these final regulations. 

2. Summary of Economic Effects 

The final regulations provide 

certainty and consistency in the 

application of sections 1297 and 1298 of 

the Internal Revenue Code with respect 

to passive foreign investment companies 

and qualifying insurance corporations 

by providing definitions and 

clarifications regarding the statute’s 

terms and rules. In the absence of such 

guidance, the chances that different U.S. 

owners (or potential owners) of foreign 

companies would interpret the statute 

differentially (either differently from 

each other or distinct from the intent 

and purpose of the statute) would be 

exacerbated. This divergence in 

interpretations could cause U.S. 

investors to choose investment vehicles 

based on different interpretations of the 

statute rather than on different 

economic prospects. For example, one 

investor might undertake an investment 

opportunity that another investor might 

forego based on different interpretations 

of how the income from that investment 

would be treated under the Code. When 

economic investment is not guided by 

uniform incentives across otherwise 

similar investors and otherwise similar 

investments, the resulting pattern of 

investment will generally be inefficient. 

Thus, in the context of U.S. investment 

in foreign corporations, the final 

regulations help to ensure that similar 

economic activities, representing similar 

passive and non-passive attributes, are 

taxed similarly. The Treasury 

Department and the IRS expect that the 

definitions and guidance provided in 

the final regulations will lead to an 

improved allocation of investment 

among U.S. taxpayers, contingent on the 

overall Code. 

In assessing the economic effects of 

the final regulations, the Treasury 

Department and the IRS separately 

considered (i) those provisions that may 

reduce the opportunities for foreign 

corporations to avoid PFIC status, 

relative to the no-action baseline; and 

(ii) those provisions that may expand 

the opportunities for foreign 

corporations to avoid PFIC status, 

relative to the no-action baseline. 

As a result of the first set of 

provisions, some corporations that may 

not have had PFIC status under the 

baseline may be treated for tax purposes 

as PFICs under the final regulations. In 

response to such provisions, some 

foreign companies that are close to 

qualifying as a QIC, for example, may 

take steps to adjust operations to ensure 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4545 

5The Treasury Department and the IRS are aware 

of foreign companies that have redomiciled to the 

U.S. and thereby avoided PFIC status, although the 

number of such companies is believed to small and 

the business calculations likely involved more than 

PFIC/non-PFIC considerations. The Treasury 

Department and the IRS expect that the number of 

foreign companies that do not re-domicile but that 

are likely to change how they operate as the result 

of these final regulations will also be quite small. 

that they meet the QIC qualifications.5

Other foreign companies may not be 

able to profitably undertake these 

actions, possibly because of the 

business’s structure or the local 

regulatory environment and thus would 

now be treated as a PFIC. Yet other 

foreign companies, particularly those 

that are not reliant on U.S. investors, 

may also remain (following these 

regulations) classified for U.S. tax 

purposes as PFICs. The Treasury 

Department and the IRS expect that in 

these latter two cases, current U.S. 

owners will largely continue to retain 

their holdings of these companies but 

future investors may turn to other 

foreign corporations that are not 

classified as PFICs under the final 

regulations or to domestic investments. 

This reduction in the pool of nonPFIC investment opportunities can be 

expected to lower the after-tax return to 

U.S. investors relative to the no-action 

baseline. To the extent that investors 

retain their investments in companies 

that have been determined to be PFICs 

or turn to domestic investments, U.S. 

tax revenue may rise relative to the noaction baseline. These possible 

responses by U.S. investors (investing in 

a different non-PFIC; retaining 

investment in the PFIC; investing in 

U.S. companies) will also change the 

amount and nature of risk in the 

affected investors’ portfolios. The nature 

of this shift is difficult to gauge because 

foreign companies whose PFIC status 

may change as a result of these final 

regulations (relative to the no-action 

baseline) will generally be earning a mix 

of passive and non-passive income. 

Thus, the change in the nature of the 

risk in U.S. investors’ portfolios cannot 

be readily determined. 

As a result of the second set of 

provisions (those that expand 

opportunities for foreign companies to 

avoid PFIC status relative to the noaction baseline), some corporations that 

may have had PFIC status under the 

baseline may be determined not to be 

PFICs under the final regulations. This 

expansion of the pool of non-PFIC 

investment opportunities can be 

expected to raise the after-tax return to 

U.S. investors relative to the no-action 

baseline and, to the extent that investors 

increase their investment in foreign 

non-PFICs as a substitute for domestic 

investment, U.S. tax revenue may fall. 

These effects again also change the 

amount and nature of risk in the 

affected investors’ portfolios and in an 

undetermined direction. 

The Treasury Department and the IRS 

project that these final regulations will 

have economic effects less than $100 

million per year ($2020), relative to the 

no-action baseline. The Treasury 

Department and the IRS have not 

undertaken more precise estimates of 

the differences in economic activity that 

might result between the final 

regulations and the no-action baseline 

because they do not have readily 

available data or models that capture in 

sufficient detail the investments that 

taxpayers might make under the final 

regulations relative to the no-action 

baseline. They similarly have not 

estimated the differences in compliance 

costs or administrative burden that 

would arise under the final regulations 

or the no-action baseline because they 

do not have readily available data or 

models that capture these aspects in 

sufficient detail. 

The proposed regulations solicited 

comments on the economic effects of 

the proposed regulations. No such 

comments were received. 

3. Economic Analysis of Specific 

Provisions of the General PFIC Rules 

a. Treatment of Look-Through 

Subsidiaries and Look-Through 

Partnerships 

For the purpose of testing whether a 

foreign corporation is a PFIC, the lookthrough rule of section 1297(c) treats the 

tested foreign corporation (‘‘TFC’’) as 

holding its proportionate share of the 

assets of a look-through entity and 

having received directly its 

proportionate share of the income of the 

look-through entity. This rule affects 

both the amount of assets that the TFC 

is treated as owning and the 

characterization of those assets as 

passive or non-passive. The statute is 

silent regarding the application of lookthrough rules to a TFC’s ownership 

interest in a partnership. Therefore, the 

Treasury Department and the IRS 

deemed it necessary to provide rules 

addressing the treatment of TFC 

ownership interests in partnerships. 

One regulatory option was to apply 

rules similar to those that apply to 

subsidiaries treated as corporations for 

tax purposes. Under these rules, a 

partnership generally would be treated 

as a look-through partnership (LTP) 

only if the TFC owned at least 25 

percent of the value of the partnership 

interest during a taxable year 

(‘‘minimum ownership threshold’’). 

A second regulatory option was to 

apply a complete look-through rule to 

partnerships (‘‘aggregate approach’’). 

Under this option, a TFC would treat its 

proportionate share of partnership 

assets and income as assets and income 

of its own, regardless of the size of its 

partnership ownership share. This 

option is consistent with the 

‘‘aggregate’’ theory of partnerships 

under which each partner is treated as 

incurring an allocable share of each 

partnership item, such as gain, loss, 

income, and expense, with the tax 

attributes of that item passing through to 

the partner. 

A third regulatory option was to adopt 

an intermediate approach under which 

look-through rules would apply to 

partnerships if either (i) the partnership 

would be a look-through subsidiary if it 

were treated as a corporation, or (ii) the 

TFC partner is actively engaged in the 

business of the partnership. In practice, 

this approach is likely to have 

consequences similar to the aggregate 

approach for many TFCs engaged in an 

active business. 

The proposed regulations adopted the 

first approach, using a minimum 

ownership threshold of 25 percent. The 

2019 NPRM asked for comments 

regarding whether this threshold is the 

appropriate threshold for look-through 

partnership treatment. No comments 

were received recommending a lower 

threshold. Instead, commenters 

recommended that the aggregate 

approach be adopted, which in this 

context would be similar to a zero 

percent minimum ownership threshold. 

Under the aggregate approach, TFCs 

that are interested in attracting capital 

from U.S. investors would have an 

incentive to purchase small minority 

investment interests in one or more 

active partnerships in order to increase 

their share of non-passive assets and 

income so as to enable the TFC to avoid 

PFIC status. The TFC could do this 

without having any of the partnership 

activities being connected with the 

business of the TFC and without 

requiring the TFC to exercise control 

over any of the business activities of 

these partnerships. In this fashion, the 

aggregate option would create a bias in 

favor of business structures containing 

entities treated for U.S. tax purposes as 

partnerships and against a structure 

using corporate subsidiaries, since those 

subsidiaries would require 25 percent 

ownership shares in order to obtain 

look-through status for the TFC. This 

bias toward such business structures 

would be tax-driven rather than marketdriven and unlikely to confer general 

economic benefits. 

4546 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

An aggregate approach to LTPs could 

allow TFCs that hold significant 

amounts of passive investment assets to 

purchase sufficient amounts of minority 

investment interests in active business 

partnerships so as to increase the TFC’s 

non-passive assets and income to levels 

that enable the TFC to avoid PFIC 

status. Thus, the purpose of the PFIC 

regime could be meaningfully defeated, 

especially if foreign corporate 

subsidiaries chose to be treated as 

partnerships for this purpose. 

The Treasury Department and the IRS 

determined that minor investment 

shares of TFCs in partnerships are more 

indicative of passive investments on the 

part of TFCs, so that, in those cases, it 

is appropriate to treat the TFC’s 

distributive share of partnership income 

as wholly passive. Moreover, a 25- 

percent minimum ownership threshold 

for partnerships has the advantage of 

being consistent with the look-through 

threshold for corporate subsidiaries. It is 

also broadly consistent with a rule 

(found in the statutory definition of 

passive income) that treats sales of 

partnership interests by a CFC as sales 

of the partnership’s assets if the CFC 

owns 25 percent of the partnership’s 

capital or profits interests. The drawing 

of a bright line for strictly passive 

treatment of limited partnership 

interests offers greater compliance 

certainty and ease of tax administration 

because it reduces the informational 

requirements concerning the character 

of the assets and income of a 

partnership when the partner has only 

very limited investments. It may be 

difficult for a TFC that holds a less-than25-percent investment in either a 

subsidiary or partnership to obtain the 

necessary information for determining 

the character of its share of the entity’s 

income. Furthermore, entities with 

ownership percentages below 25 

percent generally do not exercise 

control of the decisions and actions of 

the owned entity. Consequently, there 

are both policy and administrability 

reasons supporting the treatment of 

ownership percentages of less than 25 

percent in a similar fashion for PFIC 

purposes. 

Because a 25-percent minimum 

ownership threshold for partnerships is 

not necessarily an accurate proxy for an 

active business interest, one commenter 

proposed an option under which a lookthrough approach would be taken if a 

TFC materially participates in the 

business of the partnership; in other 

words, an aggregate approach would be 

used but only if the TFC showed, 

through a separate demonstration, that 

the TFC is actively involved in the 

business of the partnership. The 

Treasury Department and the IRS agreed 

that, if a tested foreign corporation is 

actively involved in the business of a 

partnership with active business 

operations, then look-through treatment 

may be appropriate even if the TFC has 

less than a 25 percent ownership 

interest. In considering material 

participation and similar standards, 

however, the Treasury Department and 

the IRS found that current material 

participation standards under the 

passive activity loss rules are not 

appropriate in the PFIC context. Thus, 

the final regulations instead modify the 

LTP standard by introducing an active 

partner test in order to allow lookthrough treatment to be applied in 

certain cases when the ownership 

percentage falls below 25 percent. The 

active partner test is met as of a 

measurement date if the TFC would not 

be a PFIC if both the PFIC Asset Test 

and the PFIC Income Test were applied 

without regard to any partnership 

interest owned by the TFC other than 

interests in those partnerships that 

qualify as LTPs using the LTS tests. 

However, the final regulations did not 

make this modification of the lookthrough ownership test mandatory and 

instead provide an annual election to 

allow the TFC to not to treat a 

partnership qualifying under the active 

partner test as an LTP. 

The Treasury Department and the IRS 

have not estimated the volume or 

character of investment that investors 

would undertake under the 25 percent 

minimum ownership threshold relative 

to other percentages or under the 

aggregate approach applied to taxpayers 

that satisfy an active partner test 

because they do not have readily 

available data or models that capture 

this level of specificity. 

b. Attribution of Activities for LookThrough Entities 

The definition of passive income 

contains exceptions for certain income 

that is derived in the active conduct of 

a trade or business or is a gain or loss 

from the sale of certain business 

property. Under the look-through rules 

of the statute and these final regulations, 

a tested foreign corporation is treated as 

if it holds its proportionate share of the 

income and assets of its look-through 

subsidiaries (LTSs) and look-through 

partnerships (LTPs), where a 25 percent 

ownership requirement is needed to 

define such entities. Further, the passive 

or non-passive character of the 

attributed income or assets is 

determined in the hands of the LTS or 

LTP. However, for legal or commercial 

reasons, some businesses structure their 

organizations to have all employees in 

one foreign corporation, say FC1, while 

the assets of the business are held in, 

and income is received by, another 

foreign corporation, say FC2. Without 

attribution of the business activities of 

FC1 to FC2, the assets and income of the 

latter corporation do not qualify for an 

exception from the definition of passive 

income. This can result in FC1 being 

designated as a PFIC even though its 

income and assets would be treated as 

non-passive if FC1 and FC2 were 

considered as a single entity. 

To address the attribution of activities 

in foreign businesses having such 

structures, the Treasury Department and 

the IRS considered three options: (1) Do 

not allow any attribution of business 

activities among separate corporations; 

(2) allow attribution of business 

activities to a TFC from its LTSs or 

LTPs; or (3) allow attribution of 

business activities only if the entities 

are affiliated using an ownership 

standard of greater than 50 percent. 

Under the no-attribution option, a 

foreign corporate structure that 

separates activities and income could 

satisfy the passive income exception 

only if it reorganizes in a manner that 

the TFC not only earns rents, royalties 

or other normally passive income items, 

but also employs the officers and 

employees that perform the related 

business activities or owns the property 

that is being sold. This reorganization is 

potentially costly or perhaps even 

infeasible, depending on requirements 

in the foreign jurisdiction and 

commercial considerations. The 

Treasury Department and the IRS 

determined that this alternative would 

either lead to costly reorganizations or, 

in the absence of such reorganizations, 

inhibit U.S. investment in a foreign 

corporation that carries on an active 

business activity, both of which are 

economically undesirable outcomes 

relative to other regulatory options. 

Under the second option, activities of 

LTSs and LTPs could be attributed to a 

TFC in a manner similar to the lookthrough rules. The look-through rules 

attribute assets and income of a lookthrough entity to its owner on a 

proportionate share basis. There are 

some difficulties applying this concept 

in the context of attribution of activities. 

While income and assets can be 

allocated between owners based on their 

ownership percentages, activities are 

not as easily allocated among multiple 

owners. The purpose of activity 

attribution, in combination with the 

look-through rules, is effectively to treat 

the corporations as a single commercial 

enterprise; that is, as an affiliated group 

of corporations. But affiliation in this 

sense usually demands a recognition of 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4547 

a unified business purpose and 

combined business activity. The typical 

thresholds in the Code for treating 

related parties as members of an 

affiliated or consolidated or similar 

group are more than 50 percent and 80 

percent thresholds, not 25 percent. 

The third option would require morethan-50-percent ownership in order to 

be able to attribute the business 

activities of one corporation to another. 

The proposed regulations adopted this 

third alternative but limited its 

application to rents and royalties earned 

in the active conduct of a trade or 

business, taking into account only the 

activities performed by the officers and 

employees of the TFC and those of an 

LTS or LTP in which the TFC owns 

more than 50 percent by value. 

A comment pointed out this 

attribution rule would allow a TFC to 

recognize certain rents or royalties of an 

LTS as non-passive income if the 

business activity was conducted in one 

50-percent subsidiary and assets and 

income were held in a separate 50- 

percent subsidiary. However, the rule 

would not prevent the look-through 

holder of the property from being a 

PFIC, since the rule applied only to 

income received by the TFC. Comments 

also requested that activity attribution 

apply to other types of income and not 

only to rents and royalties. 

The final regulations modify the 

proposed regulations in two respects. 

First, they extend the application of the 

provision to other items of income other 

than rents and royalties that would be 

excluded from passive income if the 

income is earned in the active conduct 

of a trade or business. Second, they 

expand the types of affiliated entities 

from which activities could be 

attributed. Under these rules, an entity 

is deemed to be engaged in the active 

conduct of a trade or business by taking 

into account the activities performed by 

the officers and employees of the TFC 

as well as activities performed by the 

officers and employees of any qualified 

affiliate of the tested foreign 

corporation. For this purpose, a 

qualified affiliated group is defined 

using an affiliation standard of more 

than 50 percent. In addition, the group 

includes only LTSs and LTPs of the 

parent entity, and the parent entity must 

be a foreign corporation or partnership. 

This rule allows the LTS that holds the 

relevant assets in the preceding example 

to avoid PFIC status and extends the 

attribution rules to activities of sibling 

and parent companies of the TFC. 

Accordingly, this final regulation is 

less restrictive than current law by 

allowing a greater variety of 

organizational structures among foreign 

corporations and partnerships than 

would be available by applying the 

passive income rules under current law. 

The Treasury Department and the IRS 

project that this final regulation will 

allow entities to satisfy the passive 

income exception under conditions 

consistent with the intent and purpose 

of the statute without requiring 

potentially substantial reorganization 

costs relative to alternative regulatory 

approaches or the no-action baseline. 

The adopted activity attribution rule is 

neither overly restrictive by causing 

certain active foreign corporations to be 

treated as PFICs nor overly permissive 

by allowing U.S. shareholders to evade 

the application of the PFIC regime 

through an overindulgent application of 

attribution rules. 

4. Economic Analysis of Specific 

Provisions Related to the PFIC 

Insurance Exception 

a. Description of the PFIC Insurance 

Exception 

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 generally constitute more 

than 25 percent of its total assets. 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. 

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, 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 exists then 

an AFS can be an annual statement that 

is required to be filed with an applicable 

insurance regulatory body. Thus, the 

statute has a preference for financial 

statements prepared on the basis of 

GAAP or IFRS, which are rigorous and 

widely-respected accounting standards, 

but will permit a foreign corporation to 

have an AFS that uses a local regulatory 

accounting standard if the foreign 

corporation does not do financial 

reporting based on GAAP or IFRS. 

b. Discounting of Applicable Insurance 

Liabilities 

Accounting standards have different 

requirements regarding the use of 

discounting in the measurement of 

unpaid loss insurance reserves. 

Discounting of unpaid loss reserves 

would generally be appropriate to 

account for the amount of time expected 

before future loss payments are made. 

GAAP generally does not require the 

discounting of current non-life 

insurance liabilities but does require 

discounting for future liabilities under 

life insurance and annuity contracts. 

IFRS 17 (an IFRS standard applicable to 

insurance contracts with an anticipated 

effective date of January 1, 2023) 

requires discounting of all insurance 

liabilities whose expected payment 

exceeds one year. 

To address the discounting of AIL in 

situations where the foreign 

corporation’s AFS was not prepared on 

the basis of GAAP or IFRS, the proposed 

regulations provided that in situations 

where the taxpayer’s AFS does not 

discount reserves on an economically 

reasonable basis, then the amount of 

AIL would be reduced in accordance 

with the discounting principles that 

would have applied under GAAP or 

IFRS. The foreign corporation could 

choose whether to apply either GAAP or 

IFRS for this purpose. In view of 

comments received, the Treasury and 

the IRS reconsidered these 

requirements. 

As one alternative, the Treasury 

Department and the IRS considered not 

issuing a regulation to govern the 

discounting of insurance losses. This 

option was rejected as being possibly 

inconsistent with the intent and 

purpose of the statute because other 

financial standards specified by the 

statute have rules regarding the 

discounting of future cash flows. 

As a second alternative, the Treasury 

Department and the IRS considered 

capping the amount of AIL at the 

amounts that would be permitted to a 

domestic insurance company under the 

Internal Revenue Code; these amounts 

would have been discounted according 

to the relevant rules. This approach 

would be considerably more 

burdensome to a foreign corporation 

than other regulatory alternatives 

because, as a practical matter, it would 

require foreign corporations to apply 

complex U.S. tax rules with which they 

are likely not familiar. An excessive 

compliance burden on foreign 

corporations not subject to U.S. taxation 

would make it less likely that they 

would do the work necessary to enable 

their minority U.S. owners to determine 

4548 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

if the corporation is a PFIC. Thus, this 

alternative was rejected because it was 

not reasonable to require foreign 

companies to recalculate insurance 

liabilities based on U.S. law 

requirements and it could unduly 

inhibit U.S. investors from investing in 

foreign corporations that are legitimate 

active insurance companies, an activity 

that is economically beneficial under 

the intent and purpose of the statute. 

The final regulations specify that if an 

AFS is not prepared on the basis of 

GAAP or IFRS and does not discount 

AIL on an economically reasonable 

basis, the amount of AIL must be 

reduced by applying the discounting 

principles that would apply under 

either GAAP or IFRS. The choice of 

which accounting standard to use for 

discounting is left to the foreign 

corporation. Thus, if GAAP or IFRS 

would not require discounting for any of 

the AIL of the foreign insurer, then no 

additional discounting is required with 

respect to a non-GAAP/IFRS statement 

filed with a local regulator. 

Compared to the no-action baseline, 

this regulation could impose additional 

compliance costs on foreign insurance 

companies, although those costs are 

incurred only if the foreign corporation 

files a financial statement with a local 

insurance regulator that is not based on 

GAAP or IFRS. This additional 

compliance cost is felt indirectly by U.S. 

investors and potential investors in 

these foreign insurers. A company may 

find it too costly to comply with these 

rules in order to attract U.S. investors, 

in which case it may not be possible for 

U.S. investors to determine whether the 

company qualifies as a QIC; an 

insurance company that is not a QIC 

would likely be a PFIC. Thus, the 

Treasury Department and the IRS 

recognize that under this regulation, 

some U.S. investors may avoid investing 

in such a company, when they would 

have done so under the no-action 

baseline. The Treasury Department and 

the IRS recognize further, however, that 

such investment (under the no-action 

baseline) would not have been 

consistent with efficient behavior under 

the intent and purpose of the statute. 

The Treasury Department and the IRS 

have not estimated the amounts that 

U.S. shareholders might invest in 

foreign insurance companies with or 

without the discounting requirement 

because they do not have a model with 

this level of specificity. However, 

because the rule is quite flexible, the 

Treasury Department and the IRS 

project that the discounting requirement 

will not represent a significant cost 

burden for foreign corporations and thus 

will not have any meaningful effect on 

investment patterns by U.S. 

shareholders relative to the no-action 

baseline. 

c. Issues Related to the Alternative Facts 

and Circumstances Test 

Under the statute, a foreign 

corporation that fails the 25 percent 

AIL-to-total assets test (but satisfies the 

10 percent AIL-to-total asset test) may 

still be treated as a QIC if it satisfies a 

‘‘facts and circumstances test,’’ which 

requires that (1) the corporation is 

predominantly engaged in an insurance 

business, and (2) the failure to have AIL 

in excess of 25 percent of total assets is 

due solely to runoff-related or ratingrelating circumstances involving the 

corporation’s insurance business. Each 

of these items would benefit from 

guidance that provides further 

clarification of the terms involved. 

i. Runoff-Related Circumstances 

The proposed regulations defined a 

corporation satisfying the runoff-related 

circumstances requirement as one that 

(1) is actively engaged in the process of 

terminating its pre-existing, active 

insurance or reinsurance underwriting 

operation pursuant to an adopted plan 

of liquidation or a termination of 

operations under the supervision of its 

applicable insurance regulatory body, 

(2) does not issue or enter into any 

insurance, annuity, or reinsurance 

contract other than a contractually 

obligated renewal, consistent with the 

plan of liquidation or termination, and 

(3) is making payments during the year 

to satisfy claims, and the payments 

cause the corporation to fail the 25 

percent test. 

The Treasury Department and the IRS 

considered whether runoff-related 

circumstances should be limited to 

insurance companies that plan to 

terminate their business operations, as 

was required under the proposed 

regulations, or whether it should also 

include situations in which (1) an 

insurance company is merely shifting 

the focus of its business and running off 

contracts from an ‘‘old’’ business that it 

had entered into in the past, or (2) an 

insurance company acquires and 

manages insurance business that is in 

runoff, but the company itself does not 

have a plan of termination. Stated 

another way, this issue is whether or 

why an insurance company described in 

either of these two situations would 

require assets that are more than four 

times the company’s AIL. For example, 

foreign companies facing a planned 

termination may be required by foreign 

regulators to hold additional capital and 

assets relative to their insurance 

liabilities in order to ensure that those 

liabilities will be satisfied when the 

companies are no longer able to rely on 

new business or new inflows of equity 

or debt to bolster cash flows from which 

to pay claims. This additional capital 

may not be needed by ongoing firms in 

either of the two situations described 

above. Unfortunately, no comments on 

the proposed regulations presented data 

or other information that address this 

issue. 

The Treasury Department and the IRS 

concluded that the legislative history of 

the provision supported the argument 

that ‘‘runoff-related circumstances’’ was 

intended to be limited to situations in 

which a corporation is engaged in the 

process of terminating its pre-existing 

business, but they also concluded that 

such termination need not be pursuant 

to a supervised plan of liquidation or 

termination, and could also be pursuant 

to any court-ordered receivership 

proceeding for the company’s 

liquidation, rehabilitation, or 

conservation. The final regulations also 

clarify that the reason for failing the 25 

percent test must be that the corporation 

is required to hold additional assets due 

to its business being in runoff. 

If the definition of runoff-related 

circumstances were broadened further 

to include active, non-terminating 

businesses, then, without additional 

restrictions and rules, the facts and 

circumstances test may provide a means 

by which companies could be treated as 

QICs in a manner that is not consistent 

with the intent and purpose of the 

statute. If any company with a 

terminating line of business could 

qualify, then the 25 percent test might 

effectively become a 10 percent test, an 

outcome that would not be consistent 

with the intent and purpose of the 

statute. 

The final regulations broaden slightly 

the circumstances under which a runoff 

of business can be conducted, relative to 

the regulatory option provided in the 

proposed regulations. The Treasury 

Department and the IRS recognize that 

this change may increase the number of 

foreign insurance companies that are 

able to meet the requirements for being 

treated as a QIC relative to the proposed 

regulations. 

The Treasury Department and the IRS 

have not estimated the number of QICs 

or the nature of their operations under 

the final regulations or alternative 

regulatory approaches or the no-action 

baseline because they do not have a 

model with this level of specificity. The 

Treasury Department and the IRS do not 

have readily available data on the 

number of foreign corporations that 

would currently be conducting a runoff 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4549 

business under the conditions of the 

final regulations. 

ii. Rating-Related Circumstances 

The rating-related circumstances 

condition required under the alternative 

facts and circumstances test is not 

defined in the statute and thus requires 

regulatory guidance. The proposed 

regulations provided that a foreign 

corporation could satisfy the ratingrelated circumstances requirement if 

failure to satisfy the 25 percent QIC test 

was a result of specific capital and 

surplus requirements that a generally 

recognized credit rating agency 

(generally, A.M. Best, Fitch, Moody’s, 

and Standard and Poor) imposes, and 

that the corporation complies with these 

requirements in order to maintain a 

minimum credit rating needed by the 

corporation to be classified as ‘‘secure’’ 

to write new business for any line of 

insurance that it is underwriting. 

Upon further reflection and after 

reviewing comments on the proposed 

regulations, the Treasury Department 

and the IRS decided that the ratingrelated circumstances requirement 

should focus on those corporations that 

would need to hold assets in excess of 

400 percent of their AIL because of 

unique circumstances. The Treasury 

Department and the IRS determined that 

the proposed rule failed to capture the 

purpose of the PFIC requirements for 

QICs, but that certain types of business 

often needed higher levels of capital and 

surplus in order to meet rating 

requirements. As a result, the above 

requirements were maintained in the 

final regulations, with some technical 

changes and clarifications, but the 

provision is limited to companies that 

might require at times a higher level of 

assets to insurance liabilities. These 

companies include insurers that cover 

risks that are typically low-frequency 

events but with high aggregate costs, 

such as coverage against the risk of loss 

from a catastrophic loss event, and 

coverage by certain financial guaranty 

insurance companies. 

The final regulations restrict the 

application of the provision to a foreign 

corporation for which more than half of 

its net written premiums for the annual 

reporting period (or the average net 

written premiums over the current year 

and preceding two years) are from 

insurance coverage against the risk of 

loss from a catastrophic event. Such 

insurance is characterized by relatively 

frequent ‘‘good’’ years in which 

accumulated assets must be accrued as 

capital and surplus in order to provide 

sufficient funds to handle the relatively 

infrequent ‘‘bad’’ years in which losses 

are exceptionally large. Because unpaid 

loss reserves qualifying as AIL are 

limited to amounts that represent losses 

that have already been incurred prior to 

the end of the accounting period 

(whether or not a claim has been made), 

such reserves do not reflect the 

unknown future losses of the ‘‘bad’’ 

years. 

Under the final regulations, the ratingrelated circumstances provision is also 

available for insurers whose sole 

business is to insure or reinsure against 

a lender’s loss of all or a portion of the 

principal amount of a mortgage loan 

upon default of the mortgagor. 

Aggregate losses associated with such 

insurance are highly correlated with the 

business cycle. In low loss years, the 

ratio of total assets to AIL may exceed 

400 percent, but the additional assets 

may be viewed as necessary by rating 

agencies for the companies to meet 

insurance obligations in high loss years. 

The two largest insurance reserve 

categories of mortgage guaranty insurers 

are their unearned premium reserves 

(often including single premium 

amounts for long-term contracts) and 

contingency reserves (usually 

established as a fixed percentage of net 

written premiums), but neither of these 

types of reserves are included in the 

definition of AIL. Consequently, AIL are 

relatively small on average compared 

with the assets of these insurers. In 

addition, a mortgage guaranty insurer 

under the final regulations is required to 

operate as monoline business to qualify 

for the exception (in order to isolate the 

benefit of this provision and as 

reflective of general industry practice), 

because a monoline company does not 

have the option to pool its financial 

obligation risks with other types of risks 

(whereas pooling of different types of 

risks can reduce overall risk exposure, 

and thus capital needs). Credit rating 

agencies correspondingly expect such 

companies to hold additional assets to 

protect policyholders due to the 

monoline requirements for such 

business and because of the volatility of 

their losses. 

The final regulations also apply the 

rating-related circumstances provision 

to financial guaranty insurance 

companies. Financial guaranty 

insurance is a line of insurance business 

in which an insurer guarantees 

scheduled payments of interest and 

principal on a bond or other debt 

security in the event of issuer default. 

The policyholder of a financial guaranty 

insurer is effectively paying for use of 

the insurer’s credit rating. For example, 

if a municipality insures its municipal 

bond obligations with a financial 

guarantee insurer, the municipality can 

charge a lower interest rate on its bond, 

because the obligation is effectively 

supported by the insurer’s high credit 

rating. A very high credit rating is thus 

essential for a financial guarantee 

insurer to write new business. 

Furthermore (and similar to mortgage 

guaranty insurers), rating agency capital 

standards for financial guaranty insurers 

are geared to ensuring capital adequacy 

in times of crisis and may require a 

higher level of capital to obtain the same 

rating as an insurer with a different 

portfolio of risks. The combination of 

enhanced rating agency capital 

requirements and the need for a very 

high credit rating to write new business 

often results in a financial guaranty 

insurer being required at times to hold 

assets in excess of 400 percent of 

current insurance liabilities. The final 

regulations provide that a financial 

guaranty insurance company that fails 

the 25 percent test is deemed to 

automatically satisfy the rating-related 

circumstances requirement, but it must 

still satisfy the 10 percent test in order 

to be treated as a QIC. The Treasury 

Department and the IRS project that the 

final regulations will more accurately 

identify those insurance businesses 

whose activities are economically 

similar to the activities targeted by 

Congress in creating the PFIC insurance 

exception and the alternative facts and 

circumstances election for QIC 

treatment. 

Relative to the proposed regulations, 

the final regulations will likely permit 

fewer foreign insurance corporations to 

qualify as QICs due to rating-related 

circumstances, and therefore may result 

in more such corporations being 

designated as PFICs absent other 

changes in business practices. 

iii. Requirements for Making the Facts 

and Circumstances Election and Relief 

for Small Shareholders 

Under the statute, a U.S. shareholder 

must make an election in order to treat 

a foreign corporation that would not 

otherwise be a QIC but that satisfies the 

alternative facts and circumstances test 

(including the 10 percent test) as a QIC. 

To specify the terms of this election, the 

final regulations specify that such 

election cannot be made unless the 

foreign corporation directly provides the 

U.S. person with a statement, or makes 

a publicly available statement, 

indicating that the foreign corporation 

satisfies the requirements of the 

alternative facts and circumstances test, 

including the 10 percent test, and 

includes a brief description of its runoffrelated or rating-related circumstances. 

A shareholder generally makes the 

election on Form 8621, which must be 

attached to the shareholder’s U.S. 

4550 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

federal income tax return for each year 

in which the election applies. 

For this election, the final regulations 

further contain a provision under which 

a U.S. person who owns stock with a 

value of $25,000 or less ($50,000 or less 

if filing a joint return) in a publicly 

traded foreign corporation is deemed to 

make the alternative facts and 

circumstances election with respect to 

the publicly traded foreign corporation 

and its subsidiaries (‘‘deemed 

election’’). If a shareholder owns stock 

through a domestic partnership or other 

domestic passthrough entity, an election 

will not be deemed made unless the 

stock held by the passthrough entity has 

a value of $25,000 or less. All 

requirements necessary to permit an 

actual election must be satisfied in order 

to permit a deemed election under this 

rule. These dollar amounts were chosen 

in part because they were consistent 

with the filing thresholds for Part I of 

Form 8621. 

A deemed election provision is not 

required by the statute. The Treasury 

Department and the IRS created the 

deemed election to relieve the burden 

from taxpayers of making an actual 

election. Small domestic taxpayers may 

not be very familiar with the PFIC rules, 

may have difficulty in determining their 

ownership shares of possible PFICs and 

QICs, or may not know how to obtain 

information on whether a foreign 

corporation has provided the requisite 

statement regarding the alternative facts 

and circumstances test, especially if 

they are indirect owners. 

The Treasury Department and the IRS 

considered not providing such a 

deemed election by small shareholders 

but decided that the reduction in 

compliance burden that the deemed 

election would provide outweighed the 

tax administrative benefit that a 

requirement for an explicit election 

would provide. For example, under an 

explicit election, the IRS would know 

with certainty that the taxpayer has 

made the election. 

The Treasury Department and the IRS 

have not estimated the change in 

compliance costs or administrative 

burden under the final regulations 

versus an alternative regulatory 

approach of requiring an affirmative 

election because they do not have data 

or models that capture such items. 

d. Passive Income Exception for Income 

and Assets of QIC Look-Through 

Entities 

Under the statute, passive income 

does not include income derived in the 

active conduct of an insurance business 

by a QIC, and assets held to produce 

such income are treated as assets that 

produce non-passive income. The final 

regulations contain rules to clarify the 

application of this rule. For example, 

certain companies structure their 

insurance operations by placing some or 

all of their investment assets in one or 

more lower-tier investment corporations 

or partnerships while investment 

managers are employed by the QIC or by 

a related or unrelated service provider. 

In these cases, unless there is an 

attribution of non-passive status to the 

income and assets of the lower-tier 

affiliated company, the QIC exclusion 

granted to income earned by the 

‘‘active’’ entity is somewhat 

meaningless. 

Under the general PFIC look-through 

rules, a tested foreign corporation (TFC) 

is treated as receiving directly its 

proportionate share of the income, or 

holding its proportionate share of the 

assets, of a look-through subsidiary 

(LTS) or look-through partnership 

(LTP), but the income and assets 

generally retain the character that they 

had in the hands of the LTS or LTP for 

purposes of determining the TFC’s PFIC 

status. See § 1.1297–2(b) and (c). Under 

the proposed regulations and the final 

regulations, if certain requirements are 

met, otherwise-passive income or assets 

of an LTS or LTP owned by a QIC may 

be treated as active in the hands of the 

QIC, to the extent that such income is 

attributed to the active conduct of the 

QIC’s insurance business and such 

assets are available to satisfy liabilities 

of the QIC’s insurance business (‘‘lookthrough recharacterization rule’’). 

Under the proposed regulations, this 

attribution of non-passive character to 

otherwise-passive income and assets of 

an LTS or LTP of a QIC was not allowed 

unless the applicable financial 

statement (AFS) used to test the QIC 

status of the foreign corporation 

included the assets and liabilities of the 

subsidiary entity. This rule was 

intended to ensure that all otherwisepassive LTS or LTP assets available to 

satisfy the QIC’s insurance liabilities 

and treated as non-passive under the 

look-through recharacterization rule 

would also necessarily be taken into 

account for purposes of the 25 percent 

test for judging the corporation’s QIC 

status. However, assets and liabilities of 

a subsidiary entity are not included on 

the parent’s financial statement unless 

the financial statement is prepared on a 

consolidated basis. If the QIC’s AFS is 

prepared using separate entity 

accounting, only the QIC’s share of the 

net equity value of the lower-tier entity 

would be included in assets under the 

25 percent QIC test. Thus, a QIC could 

not take advantage of the proposed QIC 

look-through recharacterization rule 

unless it used a consolidated financial 

statement as its AFS. 

A consolidated financial statement 

generally (but not always) requires at 

least a 50 percent ownership share in a 

controlled subsidiary in order to include 

the assets and liabilities of the 

subsidiary in the consolidated financial 

statement. Less-than-50-percent 

subsidiaries generally must be 

accounted for on an equity basis, such 

that the financial statement reflects the 

net equity value of the subsidiary. Thus, 

the look-through recharacterization rule 

of the proposed regulations would not 

have allowed non-passive treatment of 

otherwise-passive assets of an LTS 

unless the QIC owned at least 50 

percent interest in the subsidiary and 

had a consolidated AFS. This meant 

that the income and assets of an LTS in 

which the QIC owned between 25 

percent and 50 percent interest would 

generally be treated as passive under the 

proposed regulations, even if all of those 

income and assets were available to 

satisfy the QIC’s insurance liabilities, 

because consolidated accounting 

treatment was not available. A 

beneficial aspect of the rule, however, 

was that it treated QICs that chose to 

place their investment assets in a 

wholly-owned subsidiary (which would 

generally be consolidated with the QIC 

for financial statement purposes) in the 

same manner as QICs that conducted 

their insurance operations and held 

their investment assets in a single 

corporation. 

These considerations led the Treasury 

Department and the IRS to adopt an 

alternative regulatory option. Under the 

final regulations, the amount of assets 

and income of an LTS or LTP that may 

be treated as non-passive assets and 

income of the QIC are limited, 

respectively, to the greater of (i) the 

QIC’s proportionate share of assets and 

income of the LTS or LTP, respectively, 

multiplied by a fraction, the numerator 

of which is the net equity value of the 

interests held by the QIC in the LTS or 

LTP, and the denominator of which is 

the QIC’s proportionate share of the 

value of assets of the LTS or LTP; or (ii) 

the QIC’s proportionate share of assets 

and income that are treated as nonpassive in the hands of the LTS or LTP 

without regard to the look-through 

recharacterization rule. This rule 

reflects the idea that only assets of the 

LTP or LTS that exceed the liabilities of 

the look-through entity are available to 

satisfy liabilities of the insurance 

business of the QIC and should be 

excludible from passive income under 

the QIC look-through recharacterization 

rule. However, if the general lookthrough rules determine a greater 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4551 

amount of non-passive assets or income, 

then that rule prevails. 

When assets are measured by value, 

rather than by adjusted basis, part (i) of 

the above asset formula reduces the 

amount of potentially non-passive assets 

to the net equity value of the QIC’s 

ownership interest in the LTS or LTP. 

This is the same asset value used in the 

25 percent test for testing QIC status in 

the case of a non-consolidated AFS. 

Thus, this solution ensures that assets 

treated as being available to satisfy 

insurance liabilities of the QIC are also 

taken into account for the purpose of the 

25 percent test for judging the 

corporation’s QIC status. 

Whenever the QIC’s subsidiary has 

liabilities, this rule will likely limit the 

amount of the subsidiary’s assets and 

income that are treated as non-passive 

under the look-through 

recharacterization rule, in which case 

the QIC would have a greater value of 

non-passive assets if it operated instead 

as a single corporation. However, the 

value of total assets used in the 25 

percent test would also be 

correspondingly higher in that case, 

perhaps making it less likely for the 

foreign insurance company to satisfy the 

25 percent test. 

The Treasury Department and the IRS 

have not estimated whether the adopted 

option would lead to different values for 

amounts treated as non-passive assets 

and non-passive income of QICs under 

the insurance exception relative to the 

no-action baseline. The Treasury and 

the IRS do not have data or models that 

could estimate quantitatively the 

relative impacts of the alternatives 

considered. However, the adopted 

option is expected to result in a more 

accurate identification of non-passive 

income used in the active conduct of the 

QIC’s insurance business and nonpassive assets used to satisfy the 

insurance liabilities of the QIC relative 

to the no-action baseline and alternative 

regulatory approaches. 

5. Number of Affected Taxpayers 

A U.S. person must generally file a 

separate Form 8621 for each PFIC for 

which it has an ownership interest. 

Exceptions currently exist for persons 

that indirectly own PFIC stock through 

another U.S. shareholder of a PFIC, 

unless such persons are required to 

report PFIC income or need to file a 

Form 8621 in order to make an election. 

Further exceptions exist under current 

rules, including exemptions for taxexempt entities and for taxable U.S. 

shareholders owning less than $25,000 

in aggregate PFIC stock ($50,000 if filing 

a joint return) that is not owned through 

another U.S. shareholder of a PFIC or 

through another PFIC (unless such 

shareholders are required to report PFIC 

income or need to file a Form 8621 in 

order to make an election). 

The accompanying table indicates 

how many persons have filed at least 

one Form 8621 between 2016 and 2018 

based on currently available IRS master 

files of tax return filings. To date, nearly 

62,000 Forms 8621 have been filed for 

2018. Over 70 percent of the filings are 

individuals. 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, but may also have 

corporate partners. It is likely there is 

some double counting whereby both 

partnerships and partners are filing a 

Form 8621 for the same PFIC. C 

corporations constitute just over one 

percent of these filings. Just under two 

percent of Forms 8621 do not identify 

on the form the filing status of the filer. 

TABLE

Number of U.S. persons 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 

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

In 2018, reporting taxpaying persons 

filed an average of 12 Forms 8621. This 

average was 11 forms for individuals, 16 

forms for partnerships and other passthrough entities, and 28 forms for C 

corporations. 

The Treasury Department and the IRS 

do not have information in current tax 

filings regarding how many U.S. persons 

own shares in qualifying insurance 

companies or how many potential 

filings of Form 8621 would be avoided 

by the regulatory provision regarding a 

small investor deemed election for 

applying the facts and circumstances 

test for purposes of the insurance 

income exception to passive income. In 

2018 there were 40 actual such elections 

made on Form 8621, 26 of which 

involved partnerships and 11 of which 

involved non-grantor trusts, and only 

one that was an individual. 

The numbers in the accompanying 

table provide a general idea of the 

number of entities that must pay 

attention to the final regulations but do 

not measure the number of investors 

whose investment decisions are affected 

by the final regulations. This is because 

most current PFICs will remain PFICs 

after application of the final regulations. 

Similarly, most non-PFIC foreign 

corporations will continue not to be 

PFICs after application of the final 

regulations. The Treasury Department 

and the IRS expect that only a small 

percentage of current PFIC and nonPFIC shareholders will be affected by 

these regulations. 

II. Paperwork Reduction Act 

The collections of information in 

these final regulations are in § 1.1297– 

1(d)(1)(ii)(B), (d)(1)(iii), and (d)(1)(iv), 

§ 1.1297–4(d)(5)(i), (ii), and (iii), and 

§ 1.1298–4(d)(2). The information in all 

of the collections of information 

provided will be used by the IRS for tax 

compliance purposes. 

A. Collections of Information Under 

Existing Tax Forms 

The collections of information in 

§ 1.1297–1(d)(1)(ii)(B), (d)(1)(iii), and 

(d)(1)(iv) are required to be provided by 

taxpayers that make an election or 

revoke an election to use an alternative 

measuring period or adjusted bases to 

measure assets for purposes of the Asset 

Test with respect to a foreign 

corporation. These collections of 

information are satisfied by filing Form 

8621 or attachments thereto. For 

purposes of the Paperwork Reduction 

Act, 44 U.S.C. 3501 et seq. (‘‘PRA’’), the 

reporting burden associated with the 

4552 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

6Upper bound estimates of the number of filers 

who will file attachments to specific tax forms are 

derived by multiplying the number of filers shown 

in the Table in I.D.4. by 10 percent, for each filing 

status. The Table in I.D.4 shows that there were 

43,406 individuals, 16,607 passthrough entities, 739 

corporations, and 1,084 unknown filers who filed 

Form 8621 in 2018 using currently available filings, 

for a total of 61,836 filers. 

collection of information in the Form 

8621 will be reflected in the Paperwork 

Reduction Act Submission associated 

with that form (OMB control number 

1545–1002). If a Form 8621 is not 

required to be filed, the collections of 

information under § 1.1297– 

1(d)(1)(ii)(B), (d)(1)(iii), and (d)(1)(iv) 

are satisfied by attaching a statement to 

the taxpayer’s return. For purposes of 

the PRA, the reporting burden 

associated with these collections of 

information will be reflected in the 

Paperwork Reduction Act Submissions 

associated with Forms 990–PF and 990– 

T (OMB control number 1545–0047); 

Form 1040 (OMB control number 1545– 

0074); Form 1041 (OMB control number 

1545–0092); Form 1065 (OMB control 

number 1545–0123); and Forms 1120, 

1120–C, 1120–F, 1120–L, 1120–PC, 

1120–REIT, 1120–RIC, and 1120–S 

(OMB control number 1545–0123). 

The collection of information in 

§ 1.1297–4(d)(5)(iii) is required to be 

provided by taxpayers that make an 

election under section 1297(f)(2) to treat 

a foreign corporation as a QIC in order 

to qualify for the exception from passive 

income under section 1297(b)(2)(B). In 

response to comments addressing the 

notice of proposed rulemaking 

preceding the final regulations, the 

Treasury Department and the IRS have 

revised the collection of information 

with respect to section 1297(f)(2). 

The collection of information in 

§ 1.1297–4(d)(5)(iii) requires a United 

States person to make an election with 

respect to an eligible foreign corporation 

under section 1297(f)(2) by completing 

the appropriate part of Form 8621 (or 

successor form) for each taxable year of 

the United States person in which the 

election applies. In response to 

comments, § 1.1297–4(d)(5)(iv) 

generally provides that any United 

States person that owns stock in a 

publicly traded foreign corporation 

eligible for the election with a value of 

$25,000 or less ($50,000 or less if a joint 

return) is deemed to make the election 

under section 1297(f)(2) without the 

need to file Form 8621. This rule is 

intended to provide relief to small 

shareholders who may not be aware that 

an election is required. In addition, 

§ 1.1297–4(d)(5)(iii) provides that the 

election under section 1297(f)(2) may be 

made on an amended return. 

The collection of information in 

§ 1.1297–4(d)(5)(iii) is satisfied by filing 

Form 8621. For purposes of the PRA, 

the reporting burden associated with the 

collection of information in the Form 

8621 will be reflected in the Paperwork 

Reduction Act Submission associated 

with Form 8621 (OMB control number 

1545–1002). 

The number of entities subject to 

these collections of information will be 

those entities filing Form 8621 or 

attaching a statement to their tax return. 

The number of filers of Form 8621 in 

2018 based on current filings was 

approximately 62,000. The Treasury 

Department and the IRS project that at 

most, an additional 10 percent of filers 

(6,200) that were not required to file 

Form 8621 in 2018 may be subject to 

these collections of information. Thus, 

the upper bound estimate of the number 

of entities subject to these collections of 

information is 68,200. 

The accompanying Table shows the 

upper bound estimates of the number of 

filers filing an election, by Form. The 

first column shows estimates under the 

assumption that all filers will file the 

required election by filing Form 8621. 

The second column shows these 

estimates under the assumptions that: (i) 

Filers who generally file Form 8621 will 

file the required election as part of the 

filing of Form 8621; and (ii) an 

additional ten percent of filers will file 

the required election as an attachment 

to Form 1040, 1065, 1120–S, 1120, or 

other form, as appropriate.6

Number of filers 

(upper bound), 

assuming all 

elections are 

made on 

Form 8621 

Number of filers 

(upper bound), 

assuming a 

portion of 

elections are 

made as 

attachments to 

standard forms 

Attachment to Form 1040 ............................................................................................................................ 0 4,300 

Attachment to Form 1065 or 1120–S .......................................................................................................... 0 1,700 

Attachment to Form 1120 other than 1120–S ............................................................................................. 0 100 

Attachment to Form 1040, 1065, 1120–S, 1120 or other form (2018 Filing status unknown) ................... 0 100 

Form 8621 ................................................................................................................................................... 68,200 62,000 

Total ...................................................................................................................................................... 68,200 68,200 

Source: Compliance Data Warehouse (IRS). See text for explanation. 

The current status of the PRA 

submissions related to the tax forms on 

which reporting under these regulations 

will be required is summarized in the 

following table. The burdens associated 

with the information collections in the 

forms are included in aggregated burden 

estimates for the OMB control numbers 

1545–0047 (which represents a total 

estimated burden time for all forms and 

schedules for tax-exempt entities of 50.5 

million hours and total estimated 

monetized costs of $3.59 billion 

($2018)), 1545–0074 (which represents a 

total estimated burden time for all forms 

and schedules for individuals of 1.784 

billion hours and total estimated 

monetized costs of $31.764 billion 

($2017)), 1545–0092 (which represents a 

total estimated burden time for all forms 

and schedules for trusts and estates of 

307.8 million hours and total estimated 

monetized costs of $9.95 billion 

($2016)), and 1545–0123 (which 

represents a total estimated burden time 

for all forms and schedules for 

corporations of 3.157 billion hours and 

total estimated monetized costs of 

$58.148 billion ($2017)). The burden 

estimates provided in the OMB control 

numbers in the following table are 

aggregate amounts that relate to the 

entire package of forms associated with 

the OMB control number, and will in 

the future include, but not isolate, the 

estimated burden of only those 

information collections associated with 

these final regulations. These numbers 

are therefore unrelated to the future 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4553 

calculations needed to assess the burden 

imposed by these regulations. To guard 

against over-counting the burden that 

international tax provisions imposed 

before the Act, the Treasury Department 

and the IRS urge readers to recognize 

that these burden estimates have also 

been cited by regulations (such as the 

foreign tax credit regulations, 84 FR 

69022) that rely on the applicable OMB 

control numbers in order to collect 

information from the applicable types of 

filers. 

In 2018, the IRS released and invited 

comment on drafts of Forms 990–PF 

(Return of Private Foundation or Section 

4947(a)(1) Trust Treated as Private 

Foundation), 990–T (Exempt 

Organization Business Income Tax 

Return), 1040 (U.S. Individual Income 

Tax Return), 1041 (U.S. Income Tax 

Return for Estates and Trusts), 1065 

(U.S. Return of Partnership Income), 

1120 (U.S. Corporation Income Tax 

Return), and 8621 (Return by a 

Shareholder of a Passive Foreign 

Investment Co. or Qualified Electing 

Fund). The IRS received comments only 

regarding Forms 1040, 1065, and 1120 

during the comment period. After 

reviewing all such comments, the IRS 

made the forms available on December 

21, 2018 for use by the public. 

The Treasury Department and the IRS 

have not estimated the burden for any 

new information collections arising 

from either the Act or these final 

regulations. The Treasury Department 

and the IRS request comment on all 

aspects of information collection 

burdens related to the final regulations. 

In addition, when available, drafts of 

IRS forms are posted for comment at 

https://apps.irs.gov/app/picklist/list/ 

draftTaxForms.htm. 

Form Type of filer OMB No.(s) Status 

Forms 990 ............................... Tax exempt entities (NEW 

Model).

1545–0047 Approved by OIRA 2/12/2020 until 2/28/2021. 

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201912-1545-014 

Form 1040 ............................... Individual (NEW Model) .......... 1545–0074 Approved by OIRA 1/30/2020 until 1/31/2021. 

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201909-1545-021 

Form 1041 ............................... Trusts and estates .................. 1545–0092 Approved by OIRA 5/08/2019 until 5/31/2022. 

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201806-1545-014 

Form 1065 and 1120 ............... Business (NEW Model) .......... 1545–0123 Approved by OIRA 1/30/2020 until 1/31/2021. 

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201907-1545-001 

Form 8621 ............................... Share-holders ......................... 1545–1002 Approved by OIRA 12/31/2018 until 12/31/2021. 

Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201805-1545-007 

B. Collections of Information Generally 

Not Included on Existing Forms 

The collection of information in 

§ 1.1298–4(d)(2) is required for a foreign 

corporation that relies on the rule in 

section 1298(b)(7) and § 1.1298–4(b)(1). 

This collection of information is 

satisfied by filing a statement attached 

to the foreign corporation’s return. For 

purposes of the PRA, the reporting 

burden associated with this collection of 

information will be reflected in the 

Paperwork Reduction Act Submissions 

associated with Form 1120–F (OMB 

control number 1545–0123). The 

number of affected filers, burden 

estimates, and PRA status for this OMB 

control number are discussed in 

connection with the Form 1120 in Part 

II.A of the Special Analyses. 

Alternatively, if a foreign corporation 

is not required to file a return, the 

collection of information in § 1.1298– 

4(d)(2) is satisfied by the foreign 

corporation’s maintaining a statement in 

its records or including it in its public 

filings. 

The collection of information in 

§ 1.1297–4(d)(5)(i) and (ii) is required 

for a foreign corporation for which a 

taxpayer makes an election under 

section 1297(f)(2). In response to 

comments addressing the notice of 

proposed rulemaking preceding the 

final regulations, the Treasury 

Department and the IRS have revised 

the collection of information from 

foreign corporations with respect to 

section 1297(f)(2). The collection of 

information under § 1.1297–4(d)(5)(i) 

and (ii) requires a foreign corporation to 

provide a statement to a shareholder or 

make a statement publicly available. In 

response to comments, § 1.1297– 

4(d)(5)(i) permits a foreign parent 

corporation to make a publicly available 

statement on behalf of its subsidiaries. 

The collection of information 

contained in § 1.1298–4(d)(2) (for 

foreign corporations that are not 

required to file Form 1120–F) and 

§ 1.1297–4(d)(5)(i) and (ii) has been 

reviewed and approved by the Office of 

Management and Budget under control 

number [X]. 

An agency may not conduct or 

sponsor, and a person is not required to 

respond to, a collection of information 

unless it displays a valid control 

number assigned by the Office of 

Management and Budget. 

Books or records relating to a 

collection of information must be 

retained as long as their contents may 

become material in the administration 

of any internal revenue law. Generally, 

tax returns and tax return information 

are confidential, as required by 26 

U.S.C. 6103. 

III. Regulatory Flexibility Act 

Pursuant to the Regulatory Flexibility 

Act (5 U.S.C. chapter 6), it is hereby 

certified that the final 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 (‘‘small 

entities’’). 

The statutory provisions in sections 

1291 through 1298 (the ‘‘PFIC regime’’) 

generally affect U.S. taxpayers that have 

ownership interests in foreign 

corporations that are not CFCs. 

A U.S. person must generally file a 

separate Form 8621 for each PFIC for 

which it has an ownership interest. To 

date, nearly 62,000 Forms 8621 have 

been filed for 2018. Over 70 percent of 

the filings are individuals. Another 27 

percent are pass-through entities, the 

overwhelming number of which are 

4554 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

partnerships, but which also include S 

corporations, estates, and non-grantor 

trusts. These pass-through entities 

primarily have individuals as partners, 

shareholders, or beneficiaries, but may 

also have corporate partners. It is likely 

there is some double counting whereby 

both partnerships and partners are filing 

a Form 8621 for the same PFIC. C 

corporations constitute just over one 

percent of these filings. Nearly two 

percent of Forms 8621 do not identify 

the filing status of the filer. 

Regardless of the number of small 

entities potentially affected by the final 

regulations, the Treasury Department 

and the IRS have concluded that there 

is no significant economic impact on 

small entities as a result of the final 

regulations based on the following 

argument. 

To provide a bound on the impact of 

these regulations on businesses, the 

Treasury Department and the IRS 

calculated the ratio of the PFIC regime 

tax to (gross) total income for 2013 

through 2018 for C corporations that 

filed the Form 8621. Total income was 

determined by matching each C 

corporation filing the Form 8621 to its 

Form 1120. Ordinary QEF income, QEF 

capital gains, and mark-to-market 

income were assumed to be taxed at 35 

percent (21 percent for 2018), and the 

section 1291 tax and interest charge 

were included as reported. Only those 

corporations where a match was found 

and that had positive total income were 

included in the analysis. For the 

approximately 150 to 300 C 

corporations for which a match was 

available in a given year, the average 

annual ratio of the calculated tax to total 

income was never greater than 0.00035 

percent. For the approximately 60 to 

200 C corporations with total income of 

$25 million or less for which a match 

was available, the average annual ratio 

was never greater than 1.08 percent. 

2013 2014 2015 2016 2017 2018 

($ millions) 

All C corporations 

Tax ................................................................................... 5 12 14 8 22 42 

Total Income .................................................................... 4,204,795 10,154,520 19,935,845 20,076,876 21,625,159 13,317,244 

Tax to Total Income ......................................................... 0.000% 0.000% 0.000% 0.000% 0.000% 0.000% 

C corporations with total income of $25 million or less 

Tax ................................................................................... (*) (*) 4 4 5 3 

Total Income .................................................................... 463 563 627 573 460 741 

Tax to Total Income ......................................................... 0.060% 0.014% 0.576% 0.689% 1.068% 0.400% 

Source: RAAS, CDW. 

* Indicates less than $1 million. 

The economic impact of the final 

regulations will generally be a small 

fraction of the calculated tax and thus 

considerably smaller than the effects 

reported in the table. Thus, the 

economic impact of the final regulations 

should not be regarded as significant 

under the Regulatory Flexibility Act. 

A portion of the economic impact of 

the final regulations may derive from 

the collection of information 

requirements imposed by § 1.1297– 

1(d)(1)(ii)(B), (d)(1)(iii)(B), and (d)(1)(iv) 

and § 1.1297–4(d)(5)(iii). The Treasury 

Department and the IRS have 

determined that the average burden is 1 

hour per response. The IRS’s Research, 

Applied Analytics, and Statistics 

division estimates that the appropriate 

wage rate for this set of taxpayers is $95 

per hour. Thus, the annual burden per 

taxpayer from the collection of 

information requirement is $95. These 

requirements apply only if a taxpayer 

chooses to make an election or rely on 

a favorable rule. 

Accordingly, it is hereby certified that 

the final rule would not have a 

significant economic impact on a 

substantial number of small entities. 

Pursuant to section 7805(f), the 

proposed regulations preceding these 

final regulations (REG–105474–18) were 

submitted to the Chief Counsel for 

Advocacy of the Small Business 

Administration for comment on their 

impact on small business. The proposed 

regulations also solicited comments 

from the public on both the number of 

entities affected (including whether 

specific industries are affected) and the 

economic impact of this proposed rule 

on small entities. No comments were 

received. 

IV. 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. 

V. 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 

final 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. 

VI. Congressional Review Act 

Pursuant to the Congressional Review 

Act (5 U.S.C. 801 et seq.), the Office of 

Information and Regulatory Affairs 

designated this rule as not a ’major rule’, 

as defined by 5 U.S.C. 804(2). 

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. 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4555 

Drafting Information 

The principal drafters of these 

regulations are Josephine Firehock and 

Christina Daniels 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. 

Adoption of Amendments to the 

Regulations 

Accordingly, 26 CFR part 1 is 

amended as follows: 

PART 1—INCOME TAXES 

■ Paragraph 1. The authority citation 

for part 1 is amended by adding entries 

for §§ 1.1297–1, 1.1297–2, 1.1297–4, 

1.1297–5, 1.1297–6, 1.1298–2, and 

1.1298–4 in numerical order to read in 

part as follows: 

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

Section 1.1297–1 also issued under 26 

U.S.C. 1298(g). 

Section 1.1297–2 also issued under 26 

U.S.C. 1298(g). 

* * * * * 

Section 1.1297–4 also issued under 26 

U.S.C. 1297(b)(2)(B) and 1298(g). 

Section 1.1297–5 also issued under 26 

U.S.C. 1297(b)(2)(B) and 1298(g). 

Section 1.1297–6 also issued under 26 

U.S.C. 1297(b)(2)(B) and 1298(g). 

* * * * * 

Section 1.1298–2 also issued under 26 

U.S.C. 1298(b)(3) and (g). 

Section 1.1298–4 also issued under 26 

U.S.C. 1298(g). 

* * * * * 

■ Par. 2. Section 1.1291–0 is amended 

by: 

■ 1. Redesignating the entry for 

§ 1.1291–1(b)(8)(iv) as the entry for 

§ 1.1291–1(b)(8)(v). 

■ 2. Adding a new entry for § 1.1291– 

1(b)(8)(iv). 

■ 3. Adding entries for newly 

redesignated § 1.1291–1(b)(8)(v)(A) and 

(B), (b)(8)(v)(A)(1) and (2), 

(b)(8)(v)(A)(2)(i) and (ii), (b)(8)(v)(B)(1) 

and (2), (b)(8)(v)(C), (b)(8)(v)(C)(1) and 

(2), (b)(8)(v)(D), (b)(8)(v)(D)(1) and (2). 

The revisions and additions read as 

follows: 

§ 1.1291–0 Treatment of shareholders of 

certain passive foreign investment 

companies; table of contents. 

* * * * * 

§ 1.1291–1 Taxation of U.S. persons that 

are shareholders of section 1291 funds. 

* * * * * 

(b) * * * 

(8) * * * 

(iv) Successive application. 

(v) Examples. 

(A) Example 1. 

(1) Facts. 

(2) Results. 

(i) Treatment of DC. 

(ii) Treatment of A. 

(B) Example 2. 

(1) Facts. 

(2) Results. 

(C) Example 3. 

(1) Facts. 

(2) Results. 

(D) Example 4. 

(1) Facts. 

(2) Results. 

* * * * * 

■ Par. 3. Section 1.1291–1 is amended 

by: 

■ 1. Redesignating paragraph (b)(8)(iv) 

as paragraph (b)(8)(v). 

■ 2. Adding new paragraph (b)(8)(iv). 

■ 3. Redesignating Example 1 in newly 

redesignated paragraph (b)(8)(v) as 

paragraph (b)(8)(v)(A). 

■ 4. Revising newly redesignated 

paragraph (b)(8)(v)(A). 

■ 5. Adding paragraphs (b)(8)(v)(B), (C), 

and (D). 

■ 6. Revising paragraph (j)(3). 

■ 7. Adding paragraph (j)(4). 

The revisions and additions read as 

follows: 

§ 1.1291–1 Taxation of U.S. persons that 

are shareholders of section 1291 funds. 

* * * * * 

(b) * * * 

(8) * * * 

(iv) Successive application. Stock 

considered to be owned by a person by 

reason of paragraphs (b)(8)(ii) or (iii) of 

this section is, for purposes of applying 

such paragraphs, considered to be 

actually owned by such person. Subject 

to the limitations provided in section 

1298(a) and paragraphs (b)(8)(ii) and 

(b)(8)(iii) of this section, this paragraph 

applies by successively considering a 

person as actually owning its 

proportionate share of stock or other 

equity interest directly held by an entity 

directly owned by the person. Paragraph 

(b)(8)(ii)(C)(2) of this section applies 

after the other subparagraphs of 

paragraph (b)(8) of this section. 

(v) Examples. The rules of this 

paragraph (b)(8) are illustrated by the 

following examples: 

(A) Example 1—(1) Facts. A is a 

United States person who owns 49% of 

the stock of FC1, a foreign corporation 

that is not a PFIC, and separately all of 

the stock of DC, a domestic corporation 

that is not an S corporation. DC, in turn, 

owns the remaining 51% of the stock of 

FC1, and FC1 owns 100 shares of stock 

in a PFIC that is not a controlled foreign 

corporation (CFC) within the meaning of 

section 957(a). The remainder of the 

PFIC’s shares are owned by unrelated 

foreign persons. 

(2) Results—(i) Treatment of DC. 

Under paragraph (b)(8)(ii)(A) of this 

section, DC is considered to actually 

own 51 shares of the PFIC stock directly 

held by FC1 because DC directly owns 

50% or more of the stock of FC1. 

(ii) Treatment of A. In determining 

whether A is considered to own 50% or 

more of the value of FC1 for purposes 

of applying paragraphs (b)(8)(ii)(A) and 

(b)(8)(iv) of this section to the PFIC 

stock held through FC1, A is considered 

under paragraphs (b)(8)(ii)(C)(1) and 

(b)(8)(iv) of this section as indirectly 

owning all the stock of FC1 that DC 

directly owns, before the application of 

paragraph (b)(8)(ii)(C)(2) of this section. 

Because A also directly owns 49% of 

the stock of FC1, before the application 

of paragraph (b)(8)(ii)(C)(2) of this 

section A would be treated as owning 

all 100 shares of PFIC stock held by 

FC1. However, because 51 shares of the 

PFIC stock held by FC1 are indirectly 

owned by DC under paragraph 

(b)(8)(ii)(A) of this section, pursuant to 

the limitation imposed by paragraph 

(b)(8)(ii)(C)(2) of this section, only the 

remaining 49 shares of the PFIC stock 

are considered as indirectly owned by A 

under paragraph (b)(8) of this section. 

(B) Example 2—(1) Facts. B, a United 

States citizen, owns 50% of the interests 

in Foreign Partnership, a foreign 

partnership treated as a partnership for 

U.S. federal income tax purposes, the 

remaining interests in which are owned 

by an unrelated foreign person. Foreign 

Partnership owns 100% of the stock of 

FC1 and 50% of the stock of FC2, the 

remainder of which is owned by an 

unrelated foreign person. Both FC1 and 

FC2 are foreign corporations that are not 

PFICs. FC1 and FC2 each own 50% of 

the stock of FC3, a foreign corporation 

that is a PFIC. 

(2) Results. Under paragraphs 

(b)(8)(iii)(A) and (b)(8)(iv) of this 

section, for purposes of determining 

whether B is a shareholder of FC3, B is 

considered to actually own 50% (50% × 

100%) of the stock of FC1 and 25% 

(50% × 50%) of the stock of FC2. Under 

paragraphs (b)(8)(ii)(A) and (b)(8)(iv) of 

this section, B is then considered to own 

25% (50% × 100% × 50%) of the stock 

of FC3 indirectly through FC1, and thus 

is a shareholder of FC3 for purposes of 

the PFIC provisions. Because B is 

considered to own less than 50% of 

FC2, B is not considered to own any 

stock of FC3 indirectly through FC2. 

(C) Example 3—(1) Facts. The facts 

are the same as in paragraph 

(b)(8)(v)(B)(1) of this section (the facts in 

4556 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

Example 2), except that B owns 40% of 

the interests in Foreign Partnership. 

(2) Results. Under paragraph 

(b)(8)(iii)(A) and (b)(8)(iv) of this 

section, for purposes of determining 

whether B is a shareholder of FC3, B is 

considered to actually own 40% (40% × 

100%) of the stock of FC1 and 20% 

(40% × 50%) of the stock of FC2, and 

thus is not considered to own 50% or 

more of the stock of FC1 or FC2. Under 

paragraphs (b)(8)(ii)(A) and (b)(8)(iv) of 

this section, B is not considered to own 

any stock of FC3 indirectly through FC1 

or FC2. 

(D) Example 4—(1) Facts. The facts 

are the same as in paragraph 

(b)(8)(v)(C)(1) of this section (the facts in 

Example 3), except that FP owns only 

80% of FC1 and B also directly owns 

20% of FC1. 

(2) Results. Under paragraph 

(b)(8)(iii)(A) and (b)(8)(iv) of this 

section, for purposes of determining 

whether B is a shareholder of FC3, B is 

considered to own 32% (40% × 80%) of 

the stock of FC1 and 20% (40% × 50%) 

of the stock of FC2. Because B directly 

owns 20% of FC1, B is considered to 

actually own 52% (32% + 20%) of the 

stock of FC1 in total. Under paragraphs 

(b)(8)(ii)(A) and (b)(8)(iv) of this section, 

B is considered to own 26% (52% × 

50%) of the stock of FC3 indirectly 

through FC1, and thus is a shareholder 

of FC3 for purposes of the PFIC 

provisions. B is not considered to own 

any stock of FC3 indirectly through FC2. 

* * * * * 

(j) * * * 

(3) Except as otherwise provided in 

paragraph (j)(4) of this section, 

paragraphs (b)(2)(ii) and (v), (b)(7) and 

(8), and (e)(2) of this section apply to 

taxable years of shareholders ending on 

or after December 31, 2013. 

(4) Paragraphs (b)(8)(iv) and 

(b)(8)(v)(A), (B), (C), and (D) of this 

section apply for taxable years of 

shareholders beginning on or after 

January 14, 2021. A shareholder may 

choose to apply such paragraphs for any 

open taxable year beginning before 

January 14, 2021, provided that, with 

respect to a tested foreign corporation, 

the shareholder consistently applies 

such paragraphs and the provisions of 

§§ 1.1297–1 (except that consistent 

treatment is not required with respect to 

§ 1.1297–1(c)(1)(i)(A)), 1.1297–2, 

1.1297–4, 1.1297–6, 1.1298–2, and 

1.1298–4 for such year and all 

subsequent years. 

■ Par. 4. Section 1.1297–0 is amended 

by revising the introductory text and 

adding entries for §§ 1.1297–1, 1.1297– 

2, 1.1297–4, 1.1297–5, and 1.1297–6 in 

numerical order to read as follows: 

§ 1.1297–0 Table of contents. 

This section contains a listing of the 

headings for §§ 1.1297–1, 1.1297–2, 

1.1297–3, 1.1297–4, 1.1297–5, and 

1.1297–6. 

§ 1.1297–1 Definition of passive foreign 

investment company. 

(a) Overview. 

(b) Dividends included in gross income. 

(1) General rule. 

(2) Example. 

(i) Facts. 

(ii) Results. 

(c) Passive income. 

(1) Foreign personal holding company 

income. 

(i) General rule. 

(ii) Determination of gross income or gain 

on a net basis for certain items of foreign 

personal holding company income. 

(iii) Amounts treated as dividends. 

(2) [Reserved]. 

(3) Passive treatment of dividends and 

distributive share of partnership income. 

(4) Exception for certain interest, 

dividends, rents, and royalties received from 

a related person. 

(i) In general. 

(ii) Ordering rule. 

(iii) Allocation of interest. 

(iv) Allocation of dividends. 

(A) In general. 

(B) Dividends paid out of current earnings 

and profits. 

(C) Dividends paid out of accumulated 

earnings and profits. 

(v) Allocation of rents and royalties. 

(vi) Determination of whether amounts are 

received or accrued from a related person. 

(vii) Allocation of distributive share of 

income from related partnership. 

(d) Asset test. 

(1) Calculation of average annual value (or 

adjusted bases). 

(i) General rule. 

(ii) Measuring period. 

(A) General rule. 

(B) Election to use alternative measuring 

period. 

(C) Short taxable year. 

(iii) Adjusted basis election. 

(iv) Time and manner of elections and 

revocations. 

(A) Elections. 

(B) Revocations and subsequent elections. 

(v) Method of measuring assets. 

(A) Publicly traded foreign corporations. 

(B) Non-publicly traded controlled foreign 

corporation. 

(1) In general. 

(2) Controlled foreign corporation 

determination. 

(C) Other foreign corporations. 

(1) In general. 

(2) Lower-tier subsidiaries. 

(i) Lower-tier subsidiaries that are publicly 

traded foreign corporations. 

(ii) Lower-tier subsidiaries that are nonpublicly traded controlled foreign 

corporations. 

(iii) Other lower-tier subsidiaries. 

(D) [Reserved]. 

(E) Examples. 

(1) Example 1. 

(i) Facts. 

(ii) Results. 

(2) Example 2. 

(i) Facts. 

(ii) Results. 

(3) Example 3. 

(i) Facts. 

(ii) Results. 

(2) [Reserved]. 

(3) Dual-character assets. 

(i) General rule. 

(ii) Special rule when only part of an asset 

produces income. 

(iii) Special rule for stock that previously 

produced income that was excluded from 

passive income under section 1297(b)(2)(C). 

(iv) Example. 

(A) Facts. 

(B) Results. 

(4) Passive treatment of stock and 

partnership interests. 

(5) Dealer property. 

(e) Stapled stock. 

(f) Definitions. 

(1) Measuring date. 

(2) Measuring period. 

(3) Non-passive asset. 

(4) Non-passive income. 

(5) Passive asset. 

(6) Passive income. 

(7) Publicly traded foreign corporation. 

(8) Related person. 

(9) Tested foreign corporation. 

(g) Applicability date. 

(1) In general. 

(2) Paragraph (d)(1)(v)(B)(2) of this section. 

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

partnerships. 

(a) Overview. 

(b) General rules. 

(1) Tested foreign corporation’s ownership 

of a corporation. 

(2) Tested foreign corporation’s 

proportionate share of the assets and income 

of a look-through subsidiary. 

(i) Proportionate share of subsidiary assets. 

(ii) Proportionate share of subsidiary 

income. 

(A) General rule. 

(B) Partial year. 

(iii) Coordination of section 1297(c) with 

section 1298(b)(7). 

(3) Tested foreign corporation’s 

proportionate share of the assets and income 

of a look-through partnership. 

(i) Proportionate share of partnership 

assets. 

(ii) Proportionate share of partnership 

income. 

(A) General rule. 

(B) Partial year. 

(4) Examples. 

(i) Example 1. 

(A) Facts. 

(B) Results. 

(1) LTS. 

(2) TFC. 

(ii) Example 2. 

(A) Facts. 

(B) Results. 

(iii) Example 3. 

(A) Facts. 

(B) Results. 

(c) Elimination of certain intercompany 

assets and income. 

(1) General rule for asset test. 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4557 

(i) LTS stock. 

(ii) LTS obligation. 

(2) General rule for income test. 

(i) LTS stock. 

(ii) LTS obligation. 

(3) Partnerships. 

(4) Examples. 

(i) Example 1. 

(A) Facts. 

(B) Results. 

(1) LTS. 

(2) TFC. 

(ii) Example 2. 

(A) Facts. 

(B) Results. 

(iii) Example 3. 

(A) Facts. 

(B) Results. 

(iv) Example 4. 

(A) Facts. 

(B) Results. 

(v) Example 5. 

(A) Facts. 

(B) Results. 

(1) Asset test. 

(2) Income test. 

(3) Treatment of intangible and rental 

property. 

(d) Related person determination for 

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

(1) General rule. 

(2) Example. 

(i) Facts. 

(ii) Results. 

(e) Treatment of activities of certain lookthrough subsidiaries and look-through 

partnerships for purposes of certain 

exceptions. 

(1) General rule. 

(2) Qualified affiliate. 

(3) Examples. 

(i) Example 1. 

(A) Facts. 

(B) Results. 

(1) Qualified affiliates. 

(2) FS1 and FS2. 

(3) FS4. 

(ii) Example 2. 

(A) Facts. 

(B) Results. 

(iii) Example 3. 

(A) Facts. 

(B) Results. 

(f) Gain on disposition of a look-through 

subsidiary or look-through partnership. 

(1) [Reserved]. 

(2) Amount of gain taken into account from 

disposition of look-through subsidiary. 

(3) Characterization of residual gain as 

passive income. 

(4) Gain taken into account from 

disposition of 25%-owned partnerships and 

look-through partnerships. 

(i) Section 954(c)(4) partnerships. 

(ii) Look-through partnerships. 

(5) Examples. 

(i) Example 1. 

(A) Facts. 

(B) Results. 

(ii) Example 2. 

(A) Facts. 

(B) Results. 

(iii) Example 3. 

(A) Facts. 

(B) Results. 

(g) Definitions. 

(1) Direct LTS obligation. 

(2) Indirect LTS obligation. 

(3) Look-through subsidiary. 

(4) Look-through partnership. 

(i) In general. 

(ii) Active partner test. 

(A) Partnership interest under asset test. 

(B) Partnership income under income test. 

(iii) Election. 

(iv) Examples. 

(A) Example 1. 

(1) Facts. 

(2) Results. 

(i) Active partner test with respect to 

partnership interest. 

(ii) Active partner test with respect to 

partnership income. 

(iii) Qualification of look-through 

partnership. 

(B) Example 2. 

(1) Facts. 

(2) Results. 

(i) Active partner test with respect to 

partnership interest. 

(ii) Active partner test with respect to 

partnership income. 

(iii) Failure to qualify as look-through 

partnership. 

(5) LTS debt. 

(6) LTS lease. 

(7) LTS license. 

(8) LTS obligation. 

(9) LTS stock. 

(10) Qualified affiliate. 

(11) Residual gain. 

(12) TFC obligation 

(13) Unremitted earnings. 

(h) Applicability date. 

* * * * * 

§ 1.1297–4 Qualifying insurance 

corporation. 

(a) Scope. 

(b) Qualifying insurance corporation. 

(c) 25 percent test. 

(d) Election to apply the alternative facts 

and circumstances test. 

(1) In general. 

(2) Predominantly engaged in an insurance 

business. 

(i) In general. 

(ii) Facts and circumstances. 

(iii) Examples of facts indicating a foreign 

corporation is not predominantly engaged in 

an insurance business. 

(3) Runoff-related circumstances. 

(4) Rating-related circumstances. 

(5) Election. 

(i) In general. 

(ii) Information provided by foreign 

corporation. 

(iii) Time and manner for making the 

election. 

(iv) Deemed election for small shareholders 

in publicly traded companies. 

(A) In general. 

(B) Publicly traded stock. 

(v) Options. 

(6) Stock ownership. 

(e) Rules limiting the amount of applicable 

insurance liabilities. 

(1) In general. 

(2) General limitation on applicable 

insurance liabilities. 

(3) Discounting. 

(4) [Reserved]. 

(5) [Reserved]. 

(f) Definitions. 

(1) Applicable financial statement. 

(i) GAAP statements. 

(ii) IFRS statements. 

(iii) Regulatory annual statement. 

(iv) [Reserved]. 

(2) Applicable insurance liabilities. 

(i) In general. 

(ii) Amounts not specified in paragraph 

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

(3) Applicable insurance regulatory body. 

(4) Applicable reporting period. 

(5) Financial guaranty insurance company. 

(6) Financial statements. 

(i) In general. 

(ii) [Reserved]. 

(iii) [Reserved]. 

(7) Generally accepted accounting 

principles or GAAP. 

(8) Insurance business. 

(9) International financial reporting 

standards or IFRS. 

(10) Mortgage insurance company. 

(11) Total assets. 

(g) Applicability date. 

§ 1.1297–5 [Reserved]. 

§ 1.1297–6 Exception from the definition of 

passive income for active insurance 

income. 

(a) Scope. 

(b) Exclusion from passive income of active 

insurance income. 

(c) Exclusion of assets for purposes of the 

passive asset test under section 1297(a)(2). 

(d) Treatment of income and assets of 

certain look-through subsidiaries and look 

through partnerships for purposes of the 

section 1297(b)(2)(B) exception. 

(1) General rule. 

(2) Limitation. 

(3) Examples. 

(i) Example 1: QIC holds all the stock of 

an investment subsidiary. 

(A) Facts. 

(B) Result. 

(C) Alternative Facts. 

(1) Facts. 

(2) Result. 

(ii) Example 2: QIC holds all the stock of 

an operating subsidiary. 

(A) Facts. 

(B) Result. 

(e) Qualifying domestic insurance 

corporation. 

(1) General rule. 

(2) [Reserved]. 

(3) [Reserved]. 

(f) Applicability date. 

■ Par. 5. Sections 1.1297–1 and 1.1297– 

2 are added to read as follows: 

§ 1.1297–1 Definition of passive foreign 

investment company. 

(a) Overview. This section provides 

rules concerning the income test set 

forth in section 1297(a)(1) and the asset 

test set forth in section 1297(a)(2). 

Paragraph (b) of this section provides a 

rule relating to the definition of gross 

income with respect to certain 

dividends that are excluded from gross 

income under section 1502 for purposes 

of section 1297. Paragraph (c) of this 

4558 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

section provides rules relating to the 

definition of passive income for 

purposes of section 1297. Paragraph (d) 

of this section provides rules relating to 

the asset test of section 1297. See 

§§ 1.1297–2 and 1.1297–6 for additional 

rules concerning the treatment of the 

income and assets of a corporation 

subject to look-through treatment under 

section 1297(c). Paragraph (e) of this 

section provides rules relating to the 

determination of passive foreign 

investment company (PFIC) status for 

stapled entities. Paragraph (f) of this 

section provides definitions applicable 

for this section, and paragraph (g) of this 

section provides the applicability date 

of this section. 

(b) Dividends included in gross 

income—(1) General rule. For purposes 

of section 1297, gross income includes 

dividends that are excluded from gross 

income under section 1502 and 

§ 1.1502–13. 

(2) Example—(i) Facts. USP is a 

domestic corporation that owns 30% of 

TFC, a foreign corporation. The 

remaining 70% of TFC is owned by FP, 

a foreign corporation that is unrelated to 

USP. TFC owns 25% of the value of 

USS1, a domestic corporation. USS1 

owns 80% of the value of USS2, a 

domestic corporation. USS1 and USS2 

are members of an affiliated group (as 

defined in section 1504(a)) filing a 

consolidated return. USS2 distributes a 

dividend to USS1 that is excluded from 

USS1’s income pursuant to § 1.1502–13 

for purposes of determining the U.S. 

Federal income tax liability of the 

affiliated group of which USS1 and 

USS2 are members. 

(ii) Results. Although the dividend 

received by USS1 from USS2 is 

excluded from USS1’s income for 

purposes of determining the U.S. 

Federal income tax liability of the 

affiliated group of which USS1 and 

USS2 are members, pursuant to 

paragraph (b)(1) of this section, for 

purposes of section 1297, USS1’s gross 

income includes the USS2 dividend. 

Accordingly, for purposes of section 

1297, TFC’s gross income includes 25% 

of the dividend received by USS1 from 

USS2 pursuant to section 1297(c) and 

§ 1.1297–2(b)(2)(ii). See section 

1298(b)(7) and § 1.1298–4 for rules 

concerning the characterization of the 

USS2 dividend. 

(c) Passive income—(1) Foreign 

personal holding company income—(i) 

General rule. For purposes of section 

1297(b)(1), except as otherwise provided 

in section 1297(b)(2), this section, and 

§ 1.1297–6, the term passive income 

means income of a kind that would be 

foreign personal holding company 

income as defined under section 954(c). 

For the purpose of this paragraph 

(c)(1)— 

(A) The exceptions to foreign personal 

holding company income in section 

954(c)(1), 954(c)(2)(A) (relating to active 

rents and royalties), 954(c)(2)(B) 

(relating to export financing income), 

and 954(c)(2)(C) (relating to dealers) are 

taken into account; 

(B) The exceptions in section 

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

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

(relating to certain amounts received 

from related controlled foreign 

corporations), and 954(i) (relating to 

entities engaged in the active conduct of 

an insurance business) are not taken 

into account; 

(C) The rules in section 954(c)(4) 

(relating to sales of certain partnership 

interests) and 954(c)(5) (relating to 

certain commodity hedging 

transactions) are taken into account; and 

(D) An entity is treated as a controlled 

foreign corporation within the meaning 

of section 957(a) for purposes of 

applying an exception to foreign 

personal holding company income in 

section 954(c)(1)(B)’s flush language, 

(1)(C)(ii), (1)(D), (4), and (5) and § 1.954– 

2 and for purposes of identifying 

whether a person is a related person 

with respect to such entity within the 

meaning of section 954(d)(3). 

(ii) Determination of gross income or 

gain on a net basis for certain items of 

foreign personal holding company 

income. For purposes of section 1297, 

the excess of gains over losses from 

property transactions described in 

section 954(c)(1)(B), the excess of gains 

over losses from transactions in 

commodities described in section 

954(c)(1)(C), the excess of foreign 

currency gains over foreign currency 

losses described in section 954(c)(1)(D), 

and positive net income from notional 

principal contracts described in section 

954(c)(1)(F) are taken into account as 

gross income. The excess of gains over 

losses (or, with respect to notional 

principal contracts, positive net income) 

for a category of transactions is 

calculated by a tested foreign 

corporation taking into account 

individual items of gain or loss (or, with 

respect to notional principal contracts, 

net income or net deduction) recognized 

by the tested foreign corporation and 

those items of gain or loss (or, with 

respect to notional principal contracts, 

net income or net deduction) treated as 

recognized by the tested foreign 

corporation with respect to its lookthrough subsidiaries and look-through 

partnerships pursuant to section 1297(c) 

and § 1.1297–2(b)(2) or (3). 

(iii) Amounts treated as dividends. 

For purposes of section 1297, the term 

dividend includes all amounts treated 

as dividends for purposes of this 

chapter, including amounts treated as 

dividends pursuant to sections 302, 304, 

356(a)(2), 964(e), and 1248. 

(2) [Reserved]. 

(3) Passive treatment of dividends and 

distributive share of partnership 

income. For purposes of section 1297, a 

tested foreign corporation’s share of 

dividends received from a corporation 

that is not a look-through subsidiary (as 

defined in § 1.1297–2(g)(3)) and 

distributive share of any item of income 

of a partnership that is not a lookthrough partnership (as defined in 

§ 1.1297–2(g)(4)) with respect to a tested 

foreign corporation are treated as 

passive income, except to the extent that 

the item of income would not be treated 

as passive under section 1297(b)(2)(C) 

and paragraph (c)(4) of this section. 

(4) Exception for certain interest, 

dividends, rents, and royalties received 

from a related person—(i) In general. 

For purposes of section 1297(b)(2)(C), 

interest, dividends, rents, or royalties 

actually received or accrued by a tested 

foreign corporation are considered 

received or accrued from a related 

person only if the payor of the interest, 

dividend, rent, or royalty is a related 

person (within the meaning of section 

954(d)(3)) with respect to the tested 

foreign corporation, taking into account 

paragraph (c)(1)(i)(D) of this section. For 

rules determining when amounts 

received or accrued by a look-through 

subsidiary or look-through partnership 

(and treated as received directly by a 

tested foreign corporation pursuant to 

section 1297(c) and § 1.1297–2(b)(2) and 

(b)(3)) are treated as received from a 

related person, see § 1.1297–2(d). 

(ii) Ordering rule. Gross income that 

is interest, a dividend, or a rent or 

royalty that is, in each case, received or 

accrued from a related person is 

allocated to income that is not passive 

under the rules of this paragraph (c)(4). 

If the related person is also a lookthrough subsidiary or a look-through 

partnership with respect to the tested 

foreign corporation, this paragraph (c)(4) 

applies after the application of the 

intercompany income rules of § 1.1297– 

2(c). 

(iii) Allocation of interest. For 

purposes of section 1297(b)(2)(C), 

interest that is received or accrued, as 

applicable based on the recipient’s 

method of accounting, from a related 

person is allocated to income of the 

related person that is not passive 

income in proportion to the ratio of the 

portion of the related person’s nonpassive gross income for its taxable year 

that ends with or within the taxable year 

of the recipient to the total amount of 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4559 

the related person’s gross income for the 

taxable year. If the related person does 

not have gross income for the taxable 

year that ends with or within the taxable 

year of the recipient, the interest is 

either allocated to income of the related 

person that is not passive income to the 

extent the related person’s deduction for 

the interest would be allocable to nonpassive income of the related person 

under the principles of §§ 1.861–9 

through 1.861–13T, applied in a 

reasonable and consistent manner 

taking into account the general 

operation of the PFIC rules and the 

purpose of section 1297(b)(2)(C) or, 

alternatively, at the election of the 

tested foreign corporation is treated as 

allocated entirely to passive income. 

(iv) Allocation of dividends—(A) In 

general. For purposes of section 

1297(b)(2)(C), the principles of § 1.316– 

2(a) apply in determining from what 

year’s earnings and profits a dividend 

from a related person is treated as 

distributed. A dividend is considered to 

be distributed, first, out of the earnings 

and profits of the taxable year of the 

related person that includes the date the 

dividend is distributed (current earnings 

and profits) and that ends with or 

within the taxable year of the recipient; 

second, out of the earnings and profits 

accumulated for the immediately 

preceding taxable year of the related 

person; third, out of the earnings and 

profits accumulated for the second 

preceding taxable year of the related 

person; and so forth. For purposes of 

paragraph (c)(4)(iv) of this section, the 

principles of § 1.243–4(a)(6) apply with 

respect to a deficit in an earnings and 

profits account for a prior year. 

(B) Dividends paid out of current 

earnings and profits. To the extent that 

a dividend is paid out of current 

earnings and profits of the related 

person for its taxable year that ends 

with or within the taxable year of the 

recipient, the dividend is treated as paid 

ratably out of earnings and profits 

attributable to passive income and to 

non-passive income. The portion of the 

current earnings and profits that is 

treated as paid out of non-passive 

income of the related person may be 

determined by multiplying the current 

earnings and profits by the ratio of the 

related person’s non-passive gross 

income as determined under this 

section (including paragraph (c)(1)(ii) of 

this section) for the taxable year to its 

total gross income as determined under 

this section (including paragraph 

(c)(1)(ii) of this section) for that year. 

(C) Dividends paid out of 

accumulated earnings and profits. To 

the extent that a dividend from a related 

person is treated as paid out of the 

related person’s accumulated earnings 

and profits, the dividend is treated as 

paid ratably out of accumulated 

earnings and profits of the related 

person for prior taxable years (beginning 

with the most recently accumulated) 

that are attributable to passive income 

and to non-passive income, which may 

be determined in the same manner as in 

paragraph (c)(4)(iv)(B) of this section. 

Alternatively, the accumulated earnings 

and profits may be allocated based on 

the ratio of accumulated earnings and 

profits that are attributable to passive 

income and to non-passive income 

during either the related party period or 

the three-year period. The related party 

period is the entire period during which 

the related person was related to the 

recipient. The three-year period is the 

three taxable years immediately 

preceding the related person’s taxable 

year that ends with or within the 

current taxable year of the recipient. 

The three-year period may be used only 

if the related person has been related to 

the recipient for a period longer than the 

three taxable years immediately 

preceding the recipient’s taxable year. 

(v) Allocation of rents and royalties. 

For purposes of section 1297(b)(2)(C), 

rents and royalties that are received or 

accrued, as applicable based on the 

recipient’s method of accounting, from 

a related person are allocable to income 

of the related person that is not passive 

income to the extent the related person’s 

deduction for the rent or royalty is 

allocable to non-passive gross income of 

the related person under the principles 

of §§ 1.861–8 through 1.861–14T. 

(vi) Determination of whether 

amounts are received or accrued from a 

related person. For purposes of section 

1297(b)(2)(C), the determination of 

whether interest, dividends, rents, and 

royalties were received or accrued from 

a related person is made on the date of 

the receipt or accrual, as applicable 

based on the recipient’s method of 

accounting, of the interest, dividend, 

rent, or royalty. 

(vii) Allocation of distributive share of 

income from related partnership. For 

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

foreign corporation includes its 

distributive share as provided in section 

704 of the separate items of passive or 

non-passive income from a partnership 

that is a related person (and not a lookthrough partnership) with respect to the 

tested foreign corporation for the taxable 

year of the tested foreign corporation. 

(d) Asset test—(1) Calculation of 

average annual value (or adjusted 

bases)—(i) General rule. For purposes of 

section 1297, the calculation of the 

average percentage of assets held by a 

tested foreign corporation during its 

taxable year that produce passive 

income or that are held for the 

production of passive income is 

determined based on the average of the 

fair market values, or the average of the 

adjusted bases, as appropriate, of the 

passive assets and total assets held 

(including assets treated as held 

pursuant to section 1297(c) and 

§ 1.1297–2(b)(2)(i) and (b)(3)) by the 

foreign corporation on the last day of 

each measuring period (measuring date) 

of the foreign corporation’s taxable year. 

The average of the fair market values (or 

the average of the adjusted bases) of the 

foreign corporation’s passive assets or 

total assets for the taxable year is equal 

to the sum of the values (or adjusted 

bases) of the passive assets or total 

assets, as applicable, on each measuring 

date of the foreign corporation’s taxable 

year, divided by the number of 

measuring dates in the taxable year. 

(ii) Measuring period—(A) General 

rule. Except as otherwise provided in 

paragraph (d)(1)(ii)(B) of this section, 

the measuring periods for a tested 

foreign corporation are the four quarters 

that make up the foreign corporation’s 

taxable year. 

(B) Election to use alternative 

measuring period. The average 

percentage of assets held by a tested 

foreign corporation during its taxable 

year that produce passive income or that 

are held for the production of passive 

income may be calculated using a 

period that is shorter than a quarter 

(such as a week or month). The same 

period must be used to measure the 

assets of the foreign corporation for the 

first year (including a short taxable year) 

that this alternative measuring period is 

used, and for any and all subsequent 

years, unless a revocation is made. An 

election to use an alternative measuring 

period or a revocation of such an 

election must be made in accordance 

with the rules of paragraph (d)(1)(iv) of 

this section. 

(C) Short taxable year. For purposes 

of applying section 1297 to a tested 

foreign corporation that has a taxable 

year of less than twelve months (short 

taxable year), the average values (or 

adjusted bases) are determined based on 

the measuring dates of the foreign 

corporation’s taxable year that fall 

within the short taxable year, and by 

treating the last day of the short taxable 

year as a measuring date. 

(iii) Adjusted basis election. An 

election under section 1297(e)(2)(B) 

with respect to an eligible tested foreign 

corporation or a revocation of such an 

election may be made by the tested 

foreign corporation or alternatively by 

the owner (as defined in paragraph 

(d)(1)(iv) of this section). If made by the 

4560 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

owner, the election must be made in 

accordance with the rules of paragraph 

(d)(1)(iv) of this section. 

(iv) Time and manner of elections and 

revocations—(A) Elections. An owner 

(as defined in this paragraph (d)(1)(iv)) 

of a foreign corporation makes an 

election described in paragraph 

(d)(1)(ii)(B) or (d)(1)(iii) of this section 

for a taxable year in the manner 

provided in the Instructions to Form 

8621 (or successor form), if the owner is 

required to file a Form 8621 (or 

successor form) with respect to the 

foreign corporation for the taxable year 

of the owner in which or with which the 

taxable year of the foreign corporation 

for which the election is made ends. If 

the owner is not required to file Form 

8621 (or successor form) with respect to 

the foreign corporation for the taxable 

year, the owner makes such an election 

by filing a written statement providing 

for the election and attaching the 

statement to an original or amended 

Federal income tax return for the 

taxable year of the owner in which or 

with which the taxable year of the 

foreign corporation for which the 

election is made ends clearly indicating 

that such election has been made. An 

election can be made by an owner only 

if the owner’s taxable year for which the 

election is made, and all taxable years 

that are affected by the election, are not 

closed by the period of limitations on 

assessments under section 6501. 

Elections described in paragraphs 

(d)(1)(ii)(B) and (d)(1)(iii) of this section 

are not eligible for relief under 

§ 301.9100–3 of this chapter. For 

purposes of this paragraph (d)(1)(iv), an 

owner of a foreign corporation is a 

United States person that is eligible 

under § 1.1295–1(d) to make a section 

1295 election with respect to the foreign 

corporation, or would be eligible under 

§ 1.1295–1(d) to make a section 1295 

election if the foreign corporation were 

a PFIC. 

(B) Revocations and subsequent 

elections. An election described in 

paragraph (d)(1)(ii)(B) or (d)(1)(iii) of 

this section made pursuant to paragraph 

(d)(1)(iv)(A) of this section is effective 

for the taxable year of the foreign 

corporation for which it is made and all 

subsequent taxable years of such 

corporation unless revoked by the 

Commissioner or the owner (as defined 

in paragraph (d)(1)(iv)(A) of this section) 

of the foreign corporation. The owner of 

a foreign corporation may revoke such 

an election at any time. If an election 

described in paragraph (d)(1)(ii)(B) or 

(d)(1)(iii) of this section has been 

revoked under this paragraph 

(d)(1)(iv)(B), a new election described in 

paragraph (d)(1)(ii)(B) or (d)(1)(iii) of 

this section, as applicable, cannot be 

made until the sixth taxable year 

following the year for which the 

previous election was revoked, and such 

subsequent election cannot be revoked 

until the sixth taxable year following the 

year for which the subsequent election 

was made. The owner revokes the 

election for a taxable year in the manner 

provided in the Instructions to Form 

8621 (or successor form), if the owner is 

required to file a Form 8621 (or 

successor form) with respect to the 

foreign corporation for the taxable year 

of the owner in which or with which the 

taxable year of the foreign corporation 

for which the election is revoked ends, 

or by filing a written statement 

providing for the revocation and 

attaching the statement to an original or 

amended Federal income tax return for 

the taxable year of the owner in which 

or with which the taxable year of the 

foreign corporation for which the 

election is revoked ends clearly 

indicating that such election has been 

revoked, if the owner is not required to 

file Form 8621 (or successor form) with 

respect to the foreign corporation for the 

taxable year. 

(v) Method of measuring assets—(A) 

Publicly traded foreign corporations. 

For purposes of section 1297, the assets 

of a publicly traded foreign corporation 

as defined in paragraph (f)(7) of this 

section (including assets treated as held 

pursuant to section 1297(c) and 

§ 1.1297–2(b)(2)(i) and (b)(3)(i), other 

than assets of a look-through subsidiary 

described in paragraph (d)(1)(v)(B) of 

this section) must be measured for all 

measuring periods of the taxable year on 

the basis of value. 

(B) Non-publicly traded controlled 

foreign corporation—(1) In general. For 

purposes of section 1297, the assets of 

a controlled foreign corporation that is 

not described in paragraph (d)(1)(v)(A) 

of this section (including assets treated 

as held pursuant to section 1297(c) and 

§ 1.1297–2(b)(2)(i) and (b)(3)(i), other 

than assets held by a look-through 

subsidiary described in paragraph 

(d)(1)(v)(A) of this section) must be 

measured for all measuring periods of 

the taxable year during which the 

foreign corporation is a controlled 

foreign corporation on the basis of 

adjusted basis. 

(2) Controlled foreign corporation 

determination. For purposes of section 

1297(e)(2)(A) and this paragraph 

(d)(1)(v), the term controlled foreign 

corporation has the meaning provided 

in section 957, determined without 

applying subparagraphs (A), (B), and (C) 

of section 318(a)(3) so as to consider a 

United States person as owning stock 

which is owned by a person who is not 

a United States person. 

(C) Other foreign corporations—(1) In 

general. Except as provided in 

paragraph (d)(1)(v)(C)(2) of this section, 

the assets of a foreign corporation that 

is not described in paragraphs 

(d)(1)(v)(A) or (d)(1)(v)(B) of this section 

(including assets treated as held 

pursuant to section 1297(c) and 

§ 1.1297–2(b)(2)(i)) and (b)(3)(i), other 

than assets held by a look-through 

subsidiary described in paragraphs 

(d)(1)(v)(A) or (d)(1)(v)(B) of this 

section) are measured for all measuring 

periods of the taxable year on the basis 

of value, unless a tested foreign 

corporation or a shareholder makes an 

election under section 1297(e)(2)(B) in 

accordance with paragraph (d)(1)(iii) of 

this section. In the case of a foreign 

corporation that is described in 

paragraph (d)(1)(v)(B) of this section for 

some but not all measuring periods 

during a taxable year, this paragraph 

(d)(1)(v)(C)(1) applies to the remaining 

measuring period or periods during that 

taxable year. 

(2) Lower-tier subsidiaries—(i) Lowertier subsidiaries that are publicly traded 

foreign corporations. For purposes of 

applying section 1297(a)(2) to the assets 

of a foreign corporation that is a lowertier subsidiary of a foreign corporation 

that directly or indirectly owns all or 

part of the lower-tier subsidiary (a 

parent foreign corporation), if the lowertier subsidiary is described in paragraph 

(d)(1)(v)(A), the rules of paragraph 

(d)(1)(v)(A) apply. The previous 

sentence applies both for purposes of 

applying section 1297(a)(2) to the lowertier subsidiary as a tested foreign 

corporation, and for purposes of 

applying section 1297(a)(2) to a parent 

foreign corporation with respect to the 

assets of the lower-tier subsidiary. 

(ii) Lower-tier subsidiaries that are 

non-publicly traded controlled foreign 

corporations. For purposes of applying 

section 1297(a)(2) to the assets of a 

foreign corporation that is a lower-tier 

subsidiary of a parent foreign 

corporation, if the lower-tier subsidiary 

is described in paragraph (d)(1)(v)(B), 

the rules of paragraph (d)(1)(v)(B) apply. 

The previous sentence applies both for 

purposes of applying section 1297(a)(2) 

to the lower-tier subsidiary as a tested 

foreign corporation, and for purposes of 

applying section 1297(a)(2) to a parent 

foreign corporation with respect to the 

assets of the lower-tier subsidiary. 

(iii) Other lower-tier subsidiaries. For 

purposes of applying section 1297(a)(2) 

to a foreign corporation that is a lowertier subsidiary of a parent foreign 

corporation, if the lower-tier subsidiary 

is not described in paragraphs 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4561 

(d)(1)(v)(A) or (d)(1)(v)(B) of this 

section, the assets of the lower-tier 

subsidiary (including assets treated as 

held pursuant to section 1297(c) and 

§ 1.1297–2(b)(2)(i) and (b)(3)(i)) must be 

measured under the rules of the same 

paragraph of this section (d)(1)(v) that 

applies to the parent foreign 

corporation. The previous sentence 

applies both for purposes of applying 

section 1297(a)(2) to the lower-tier 

subsidiary as a tested foreign 

corporation, and for purposes of 

applying section 1297(a)(2) to a parent 

foreign corporation. If a tested foreign 

corporation indirectly owns a lower-tier 

subsidiary that is not described in 

paragraphs (d)(1)(v)(A) or (d)(1)(v)(B) of 

this section through one or more other 

foreign corporations, the status of any 

parent foreign corporation in that chain 

of corporations that is described in 

paragraph (d)(1)(v)(A) of this section, or 

if there is no such parent foreign 

corporation then the status of any parent 

foreign corporation in that chain of 

corporations that is described in 

paragraph (d)(1)(v)(B) of this section, 

determines the basis on which the assets 

of the lower-tier subsidiary are 

measured. In the case of a foreign 

corporation that is a lower-tier 

subsidiary with respect to more than 

one parent foreign corporation, this rule 

applies separately to measure the assets 

of the lower-tier subsidiary with respect 

to each parent foreign corporation. 

(D) [Reserved]. 

(E) Examples. The following examples 

illustrate the application of this 

paragraph (d)(1)(v). 

(1) Example 1—(i) Facts. USP, a 

domestic corporation, owns 60% of 

TFC1, which is a foreign corporation. 

The remaining 40% of TFC1’s stock is 

regularly traded on a national securities 

exchange that is registered with the 

Securities and Exchange Commission 

and continues to be until September 1 

of the taxable year, when USP acquires 

all of TFC1’s stock pursuant to a tender 

offer. TFC1 owns 30% of the stock of 

FS1, a foreign corporation that is neither 

a publicly traded foreign corporation 

nor a controlled foreign corporation. 

(ii) Results. TFC1 is a controlled 

foreign corporation with respect to USP. 

TFC1 also is a publicly traded foreign 

corporation until September 1 of the 

taxable year. For purposes of section 

1297, the assets of TFC1 (including the 

assets of FS1 treated as held by TFC1 

pursuant to section 1297(c) and 

§ 1.1297–2(b)(2)(i)) must be measured 

on the basis of value for each measuring 

period ending before September 1, 

pursuant to paragraph (d)(1)(v)(A) of 

this section. For purposes of applying 

section 1297 to FS1 as a tested foreign 

corporation with respect to USP, the 

assets of FS1 must be measured using 

the same method as is used for TFC1’s 

assets, pursuant to paragraph 

(d)(1)(v)(C)(2) of this section. 

(2) Example 2—(i) Facts. A, a United 

States person, owns 1% of the stock of 

TFC2, a foreign corporation that is 

neither a publicly traded foreign 

corporation nor a controlled foreign 

corporation. TFC2 owns 25% of the 

stock of FS2, a foreign corporation that 

is neither a publicly traded foreign 

corporation nor a controlled foreign 

corporation. 

(ii) Results. For purposes of applying 

section 1297 to TFC2, the assets of TFC2 

(including the assets of FS2 treated as 

held by TFC2 pursuant to section 

1297(c) and § 1.1297–2(b)(2)(i)) are 

measured for all measuring periods of 

the taxable year on the basis of value, 

unless A or TFC2 makes an election 

under section 1297(e)(2)(B) in 

accordance with paragraph (d)(1)(iii) of 

this section, pursuant to paragraph 

(d)(1)(v)(C)(1) of this section. For 

purposes of applying section 1297 to 

FS2 as a tested foreign corporation with 

respect to A, the assets of FS2 must be 

measured using the same method as is 

used for TFC2’s assets, pursuant to 

paragraph (d)(1)(v)(C)(2) of this section. 

(3) Example 3—(i) Facts. The facts are 

the same as in paragraph 

(d)(1)(v)(E)(2)(i) (the facts in Example 2), 

except that the 75% of FS2’s stock not 

owned by TFC2 is owned by TFC3, a 

publicly traded foreign corporation that 

is neither related to TFC2 nor to A. B, 

a United States person that is neither 

related to A nor to TFC2, owns 1% of 

the stock of TFC3. 

(ii) Results. For purposes of applying 

section 1297 to TFC2, the results are the 

same as in paragraph (d)(1)(v)(E)(2)(ii) 

(the results in Example 2). For purposes 

of applying section 1297 to FS2 as a 

tested foreign corporation with respect 

to A, the assets of FS2 must be 

measured using the same method as is 

used for TFC2’s assets, pursuant to 

paragraph (d)(1)(v)(C)(2) of this section. 

For purposes of applying section 1297 

to TFC3, the assets of TFC3 must be 

measured by reference to value pursuant 

to paragraph (d)(1)(v)(A) because it is a 

publicly traded corporation. For 

purposes of applying section 1297 to 

FS2 as a tested foreign corporation with 

respect to B, the assets of FS2 must be 

measured by reference to value because 

TFC3 is a publicly traded foreign 

corporation, pursuant to paragraphs 

(d)(1)(v)(C)(2) and (d)(1)(v)(A) of this 

section. 

(2) [Reserved]. 

(3) Dual-character assets—(i) General 

rule. Except as otherwise provided in 

paragraph (d)(3)(ii) or (d)(3)(iii) of this 

section and in § 1.1297–2(c), for 

purposes of section 1297, an asset (or 

portion of an asset) that produces both 

passive income and non-passive income 

during a taxable year (dual-character 

asset), including stock and other assets 

that produce passive and non-passive 

income under section 1297(b)(2)(C) and 

paragraph (c)(4) of this section, is 

treated as two assets for each measuring 

period in the taxable year, one of which 

is a passive asset and one of which is 

a non-passive asset. The value (or 

adjusted basis) of the dual-character 

asset is allocated between the passive 

asset and the non-passive asset in 

proportion to the relative amounts of 

passive income and non-passive income 

produced by the asset (or portion of an 

asset) during the taxable year. See 

paragraph (d)(3)(iii) of this section for a 

special rule concerning stock that has 

previously produced dividends subject 

to the exception provided in section 

1297(b)(2)(C). For purposes of section 

1297(b)(2)(C), a partnership interest in a 

partnership that is a related person to 

the tested foreign corporation is treated 

as producing passive or non-passive 

income in proportion to the tested 

foreign corporation’s distributive share 

of partnership passive or non-passive 

income for the taxable year under 

paragraph (c)(4)(vii) of this section. 

(ii) Special rule when only part of an 

asset produces income. For purposes of 

section 1297, when only a portion of an 

asset produces income during a taxable 

year or a portion of a taxable year, the 

asset is treated as two assets for that 

period, one of which is characterized as 

a passive asset or a non-passive asset 

based on the income that it produces, 

and one of which is characterized based 

on the income that it is held to produce. 

The value (or adjusted basis) of the asset 

is allocated between the two assets 

pursuant to the method that most 

reasonably reflects the uses of the 

property. In the case of real property, an 

allocation based on the physical use of 

the property generally is the most 

reasonable method. 

(iii) Special rule for stock that 

previously produced income that was 

excluded from passive income under 

section 1297(b)(2)(C). Stock with respect 

to which no dividends are received 

during a taxable year, but with respect 

to which dividends were received 

during one or both of the prior two 

taxable years, is characterized based on 

the relative portion of the dividends 

received that was passive or nonpassive. If the dividends were in whole 

excluded from passive income under 

section 1297(b)(2)(C) and paragraph 

(c)(4)(iv) of this section, the stock is 

4562 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

treated as a single non-passive asset. If 

the dividends were in part excluded 

from passive income under section 

1297(b)(2)(C) and paragraph (c)(4)(iv) of 

this section, the stock is treated as two 

assets, one of which is a passive asset 

and one of which is a non-passive asset. 

The value (or adjusted basis) of the 

stock is allocated between the two assets 

in proportion to the average percentage 

of aggregate dividends received in the 

prior two taxable years that were 

characterized as passive income and the 

average percentage of aggregate 

dividends received in the prior two 

years that were characterized as nonpassive income, for the previous two 

taxable years pursuant to section 

1297(b)(2)(C) and paragraph (c)(4)(iv) of 

this section. If the tested foreign 

corporation did not receive any 

dividends from the stock for the current 

taxable year or within either of the prior 

two taxable years of the tested foreign 

corporation, then the stock is treated as 

a passive asset. 

(iv) Example. The following example 

illustrates the application of this 

paragraph (d)(3). 

(A) Facts. (1) USP is a domestic 

corporation that owns 30% of TFC, a 

foreign corporation. The remaining 70% 

of TFC is owned by FP, a foreign 

corporation that is unrelated to USP. 

TFC owns 20% of the value of FS1, a 

foreign corporation, and FP owns the 

remaining 80% of the value of FS1. FP, 

TFC, and FS1 are not controlled foreign 

corporations within the meaning of 

section 957(a), and each has a calendar 

year taxable year. 

(2) In Year 1, FS1 had current 

earnings and profits of $1000x, 

attributable to passive income of $500x 

and non-passive income of $500x, and 

paid $300x of dividends to TFC. In Year 

2, FS1 had current earnings and profits 

of $1000x, attributable to passive 

income of $100x and non-passive 

income of $900x, and paid $100x of 

dividends to TFC. In Year 3, FS1 has 

passive income of $200x and nonpassive income of $800x and does not 

pay a dividend. 

(3) Throughout Year 3, TFC holds an 

obligation of FS1 with respect to which 

FS1 pays $100x of interest. 

(4) In addition to the stock in FS1 and 

the FS1 obligation, TFC holds an office 

building, 40% of which is rented to FP 

throughout Year 3 for $100x per quarter. 

During Year 3, FP has only passive 

income. The remaining 60% of the 

office building is leased throughout 

Year 3 to an unrelated person for $300x 

per quarter, and TFC’s own officers or 

staff of employees regularly perform 

active and substantial management and 

operational functions while the property 

is leased. 

(B) Results. (1) For purposes of section 

1297(b)(2)(C), FP is a ‘‘related person’’ 

with respect to TFC because FP owns 

more than 50% of the vote or value of 

TFC, and FS1 is a ‘‘related person’’ with 

respect to TFC because FP owns more 

than 50% of the vote or value of both 

TFC and of FS1. 

(2) Under paragraph (c)(4)(iv) of this 

section, the dividends paid by FS1 in 

Year 1 were characterized as 50% 

passive income ($150x) and 50% nonpassive income ($150x). Under 

paragraph (c)(4)(iv) of this section, the 

dividends paid by FS1 in Year 2 were 

characterized as 10% passive income 

($10x) and 90% non-passive income 

($90x). Accordingly, the average 

percentage of dividends for the previous 

two taxable years that were 

characterized as passive income is 40% 

(((10% × $100x) + (50% × $300x))/ 

($100x + $300x)), and the average 

percentage of dividends characterized as 

non-passive income is 60% (((90% × 

$100x) + (50% × $300x))/($100x + 

$300x)). Thus, under paragraph 

(d)(3)(iii) of this section, 60% of each 

share of stock of FS1 is characterized as 

a non-passive asset and 40% is 

characterized as a passive asset for each 

quarter of Year 3 for purposes of 

applying section 1297(a)(2) to determine 

whether TFC is a PFIC. 

(3) Under paragraph (c)(4)(iii) of this 

section, the interest received by TFC 

from FS1 is characterized as 20% 

($200x/($200x + $800x)) passive income 

and thus 80% non-passive income for 

purposes of applying section 1297(a)(1) 

to determine whether TFC is a PFIC. 

Accordingly, under paragraph (d)(3)(i) 

of this section, 20% of the obligation of 

FS1 is characterized as a passive asset 

and 80% as a non-passive asset for each 

quarter of Year 3 for purposes of 

applying section 1297(a)(2) to determine 

whether TFC is a PFIC. 

(4) Under paragraph (c)(4)(v) of this 

section, the rent received from FP 

throughout Year 3 is characterized as 

100% passive income. Under paragraph 

(c)(1)(i)(A) of this section and section 

954(c)(2)(A), the rent received from the 

unrelated person is characterized as 

100% non-passive income. Accordingly, 

under paragraph (d)(3)(i) of this section, 

the 40% of the office building rented to 

FP has a value of 25% (($100x × 4)/ 

(($100x × 4) + ($300x × 4))) of the value 

of the office building and that 25% is a 

passive asset, and the 60% of the office 

building rented to the unrelated person 

has a value of 75% (($300x × 4)/(($100x 

× 4) + ($300x × 4))) of the value of the 

office building and is a non-passive 

asset for purposes of applying section 

1297(a)(2) to determine whether TFC is 

a PFIC. 

(4) Passive treatment of stock and 

partnership interests. For purposes of 

section 1297(a)(2), shares of stock in a 

corporation that is not a look-through 

subsidiary (as defined in § 1.1297– 

2(g)(3)) and partnership interests in a 

partnership that is not a look-through 

partnership (as defined in § 1.1297– 

2(g)(4)) with respect to a tested foreign 

corporation for a taxable year or portion 

thereof are treated as passive assets for 

the taxable year or relevant portion 

thereof, except to the extent the stock or 

partnership interest is treated as a dualcharacter asset under section 

1297(b)(2)(C) and paragraph (d)(3) of 

this section because it produces both 

passive and non-passive income, or the 

stock or partnership interest produces 

solely non-passive income for the 

taxable year under section 1297(b)(2)(C) 

and paragraph (c)(4) of this section or 

under paragraph (d)(5) of this section. 

(5) Dealer property. For purposes of 

section 1297(a)(2), an asset that 

produces, or would produce upon 

disposition, income or gain that is, or 

would be, excluded from passive 

income pursuant to section 954(c)(2)(C) 

is treated as a non-passive asset. 

(e) Stapled stock. If a United States 

person that would be a shareholder 

(within the meaning of § 1.1291–1(b)(7) 

and (b)(8)) of a stapled entity (as defined 

in section 269B(c)(2)) owns stock in all 

entities that are stapled entities with 

respect to each other and the shares are 

stapled interests (as defined in section 

269B(c)(3)), the United States person’s 

interests in the stapled entities are 

treated as an interest in a single entity 

that holds all of the assets of the stapled 

entities, conducts all of the activities of 

the stapled entities, and derives all of 

the income of the stapled entities for all 

purposes of the PFIC regime. 

(f) Definitions. The following 

definitions apply for purposes of this 

section and § 1.1297–2: 

(1) Measuring date. The term 

measuring date has the meaning 

provided in paragraph (d)(1)(i) of this 

section. 

(2) Measuring period. The term 

measuring period means a three-month 

period or an alternative measuring 

period, within the meaning provided in 

paragraph (d)(1)(ii) of this section. 

(3) Non-passive asset. The term nonpassive asset means an asset other than 

a passive asset. 

(4) Non-passive income. The term 

non-passive income means income 

other than passive income. 

(5) Passive asset. The term passive 

asset means an asset that produces 

passive income, or which is held for the 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4563 

production of passive income, taking 

into account the rules in paragraphs (c) 

and (d) of this section. 

(6) Passive income. The term passive 

income has the meaning provided in 

paragraph (c)(1) of this section. 

(7) Publicly traded foreign 

corporation. The term publicly traded 

foreign corporation means a foreign 

corporation the stock of which is 

regularly traded on an exchange 

described in section 1297(e)(3), other 

than in de minimis quantities, for at 

least twenty trading days during a 

taxable year. 

(8) Related person. For purposes of 

applying the rules with respect to 

section 1297(b)(2)(C), the term related 

person means a related person within 

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

(9) Tested foreign corporation. The 

term tested foreign corporation means a 

foreign corporation the PFIC status of 

which is being tested under section 

1297(a). 

(g) Applicability date—(1) In general. 

Except as otherwise provided in 

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

of this section apply to taxable years of 

shareholders beginning on or after 

January 14, 2021. A shareholder may 

choose to apply such rules for any open 

taxable year beginning before January 

14, 2021, provided that, with respect to 

a tested foreign corporation, the 

shareholder consistently applies the 

provisions of this section (except that 

consistent treatment is not required 

with respect to paragraph (c)(1)(i)(A) of 

this section) and § 1.1291–1(b)(8)(iv) 

and (b)(8)(v)(A), (B), (C), and (D) and 

§§ 1.1297–2, 1.1298–2, and 1.1298–4 for 

such year and all subsequent years. 

(2) Paragraph (d)(1)(v)(B)(2) of this 

section. Paragraph (d)(1)(v)(B)(2) of this 

section applies to taxable years of 

shareholders ending on or after October 

1, 2019. For taxable years of 

shareholders ending before October 1, 

2019, a shareholder may apply 

paragraph (d)(1)(v)(B)(2) of this section 

to the last taxable year of a foreign 

corporation beginning before January 1, 

2018, and each subsequent taxable year 

of the foreign corporation, provided that 

the shareholder and United States 

persons that are related (within the 

meaning of section 267 or 707) to the 

taxpayer consistently apply such 

paragraph with respect to all foreign 

corporations. 

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

partnerships. 

(a) Overview. This section provides 

rules concerning the treatment of 

income and assets of a look-through 

subsidiary (as defined in § 1.1297– 

2(g)(3)) or look-through partnership (as 

defined in § 1.1297–2(g)(4)) for purposes 

of determining whether a tested foreign 

corporation (as defined in § 1.1297– 

1(f)(9)) is a passive foreign investment 

company (PFIC) under section 1297(a). 

Paragraph (b) of this section provides 

guidance for purposes of section 1297(c) 

on how to determine a tested foreign 

corporation’s ownership in a 

corporation and how to determine a 

tested foreign corporation’s 

proportionate share of a look-through 

subsidiary’s or look-through 

partnership’s assets and income. 

Paragraph (c) of this section provides 

rules that eliminate certain income and 

assets related to look-through 

subsidiaries and look-through 

partnerships for purposes of 

determining a tested foreign 

corporation’s PFIC status. Paragraph (d) 

of this section provides a rule to 

determine whether certain income 

received or accrued by look-through 

subsidiaries and look-through 

partnerships is received or accrued from 

a related person for purposes of section 

1297(b)(2)(C). Paragraph (e) of this 

section provides rules concerning the 

attribution of activities from qualified 

affiliates (as defined in § 1.1297–2(e)(2)) 

for purposes of characterizing the 

income and assets of a look-through 

subsidiary or look-through partnership. 

Paragraph (f) of this section provides 

rules for determining the amount of gain 

from the direct or indirect sale or 

exchange of stock of a look-through 

subsidiary or partnership interests in a 

partnership described in section 

954(c)(4) that is taken into account 

under section 1297(a) and for 

determining the passive or non-passive 

character of gain from the sale of a lookthrough subsidiary. Paragraph (g) of this 

section provides definitions applicable 

for this section, and paragraph (h) of 

this section provides the applicability 

date of this section. 

(b) General rules—(1) Tested foreign 

corporation’s ownership of a 

corporation. For purposes of section 

1297(c) and this section, the principles 

of section 958(a) and the regulations in 

this chapter under that section 

applicable to determining direct or 

indirect ownership by value apply to 

determine a tested foreign corporation’s 

percentage ownership (by value) in the 

stock of another corporation. These 

principles apply whether an 

intermediate entity is domestic or 

foreign. 

(2) Tested foreign corporation’s 

proportionate share of the assets and 

income of a look-through subsidiary—(i) 

Proportionate share of subsidiary assets. 

For each measuring period (as defined 

in § 1.1297–1(f)(2)), a tested foreign 

corporation is treated as if it held its 

proportionate share of each asset of a 

look-through subsidiary, determined 

based on the tested foreign corporation’s 

percentage ownership (by value) (as 

determined under paragraph (b)(1) of 

this section)) of the look-through 

subsidiary on the measuring date (as 

defined in § 1.1297–1(f)(1)). A tested 

foreign corporation’s proportionate 

share of a look-through subsidiary’s 

asset is treated as producing passive 

income, or being held to produce 

passive income, to the extent the asset 

produced, or was held to produce, 

passive income in the hands of such 

look-through subsidiary under the rules 

of paragraph (b)(2)(ii) of this section. 

(ii) Proportionate share of subsidiary 

income—(A) General rule. A tested 

foreign corporation is treated as if it 

received directly its proportionate share 

of each item of gross income or loss of 

a corporation for a taxable year if the 

corporation is a look-through subsidiary 

with respect to the tested foreign 

corporation for the taxable year of the 

tested foreign corporation. In such case, 

a tested foreign corporation’s 

proportionate share of a look-through 

subsidiary’s gross income or loss is 

determined based on the corporation’s 

average percentage ownership (by value) 

of the look-through subsidiary. The 

exceptions to passive income in section 

1297(b)(2) and the relevant exceptions 

to foreign personal holding company 

income in section 954(c) 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. See 

paragraph (d) of this section for rules 

determining whether a person is a 

related person for purposes of applying 

section 1297(b)(2)(C) in the case of 

income received or accrued by a 

subsidiary that is treated as received 

directly by a tested foreign corporation 

pursuant to this paragraph (b)(2). 

(B) Partial year. When a corporation is 

not a look-through subsidiary with 

respect to a tested foreign corporation 

for an entire taxable year of the tested 

foreign corporation, the tested foreign 

corporation may be treated as if it 

received directly its proportionate share 

of the gross income or loss of the first 

corporation for each measuring period 

in the year for which the first 

4564 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

corporation is a look-through 

subsidiary, if the conditions in 

paragraph (g)(3)(ii)(B) of this section are 

satisfied. In such case, a tested foreign 

corporation’s proportionate share of a 

look-through subsidiary’s gross income 

or loss is determined based on the tested 

foreign corporation’s percentage 

ownership (by value) (as determined 

under paragraph (b)(1) of this section) of 

the look-through subsidiary on the 

relevant measuring date. 

(iii) Coordination of section 1297(c) 

with section 1298(b)(7). A tested foreign 

corporation is not treated under section 

1297(c) and this paragraph (b) as 

holding its proportionate share of the 

assets of a domestic corporation, or 

receiving directly its proportionate 

share of the gross income or loss of the 

domestic corporation, if the stock of the 

domestic corporation is treated as an 

asset that is not a passive asset (as 

defined in § 1.1297–1(f)(5)) that 

produces income that is not passive 

income (as defined in § 1.1297–1(f)(6)) 

under section 1298(b)(7) (concerning the 

treatment of certain foreign corporations 

owning stock in certain 25-percentowned domestic corporations). See 

§ 1.1298–4 for rules governing the 

application of section 1298(b)(7). 

(3) Tested foreign corporation’s 

proportionate share of the assets and 

income of a look-through partnership— 

(i) Proportionate share of partnership 

assets. For each measuring period (as 

defined in § 1.1297–1(f)(2)), a tested 

foreign corporation is treated as if it 

held its proportionate share of each 

asset of a look-through partnership, 

determined based on the tested foreign 

corporation’s percentage ownership (by 

value) (as determined under paragraph 

(b)(1) of this section)) of the lookthrough partnership on the measuring 

date (as defined in § 1.1297–1(f)(1)). A 

tested foreign corporation’s 

proportionate share of a look-through 

partnership’s asset is treated as 

producing passive income, or being held 

to produce passive income, to the extent 

the asset produced, or was held to 

produce, passive income in the hands of 

the partnership under the rules in 

paragraph (b)(3)(ii) of this section. 

(ii) Proportionate share of partnership 

income—(A) General rule. A tested 

foreign corporation is treated as if it 

received directly its proportionate share 

of any item of gross income or loss of 

a partnership that is a look-through 

partnership with respect to the tested 

foreign corporation for the taxable year 

of the tested foreign corporation. The 

exceptions to passive income in section 

1297(b)(2) and the relevant exceptions 

to foreign personal holding company 

income in section 954(c) 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. See 

paragraph (d) of this section for rules 

determining whether a person is a 

related person for purposes of applying 

section 1297(b)(2)(C) in the case of 

income received or accrued by a 

partnership that is treated as received 

directly by a tested foreign corporation 

pursuant to this paragraph (b)(3). 

(B) Partial year. When a partnership is 

not a look-through partnership with 

respect to a tested foreign corporation 

for an entire taxable year of the tested 

foreign corporation, the tested foreign 

corporation may be treated as if it 

received directly its proportionate share 

of the gross income of the partnership 

for each measuring period in the year 

for which the partnership is a lookthrough partnership, provided that the 

conditions set forth in paragraph 

(g)(3)(ii)(B) of this section would be 

satisfied if the partnership were a 

corporation. 

(4) Examples. The following examples 

illustrate the rules of this paragraph (b). 

For purposes of these examples, USP is 

a domestic corporation; TFC, LTS, and 

FS are foreign corporations that are not 

controlled foreign corporations within 

the meaning of section 957(a); USP 

owns 30% of TFC; and LTS owns 25% 

of the only class of FS stock. 

(i) Example 1—(A) Facts. TFC directly 

owns 80% of the only class of LTS stock 

for TFC’s and LTS’s entire taxable year. 

(B) Results—(1) LTS. Under paragraph 

(b)(1) of this section and pursuant to the 

principles of section 958(a), LTS owns 

25% of the value of FS. Under 

paragraph (b)(2)(i) and (ii) of this 

section, in determining whether LTS is 

a PFIC under section 1297(a), LTS is 

treated as if it held 25% of each of FS’s 

assets on each of the measuring dates in 

its taxable year and received directly 

25% of the gross income of FS for the 

taxable year. 

(2) TFC. Under paragraph (b)(1) of this 

section and pursuant to the principles of 

section 958(a), TFC owns 80% of the 

value of LTS and indirectly owns 20% 

of the value of FS. Under paragraph 

(b)(2) of this section, in determining 

whether TFC is a PFIC under section 

1297(a), TFC is treated as if it held 80% 

of each of LTS’s assets on each of the 

measuring dates in its taxable year and 

received directly 80% of the gross 

income of LTS for the taxable year. 

However, because TFC indirectly owns 

less than 25% of FS, FS is not a lookthrough subsidiary with respect to TFC 

and, therefore, TFC is treated as if it 

held a 20% interest in the stock of FS 

(and not the assets of FS), and received 

80% of any dividends paid from FS to 

LTS (and not any income of FS). 

(ii) Example 2—(A) Facts. TFC 

directly owns 25% of the only class of 

LTS stock on the last day of each of the 

first three quarters of its taxable year but 

disposes of its entire interest in LTS 

during the fourth quarter of its taxable 

year. 

(B) Results. Under paragraph (b)(1) 

and pursuant to the principles of section 

958(a), on each of its first three 

measuring dates, TFC owns 25% of the 

value of LTS and indirectly owns 6.25% 

of the value of FS. Under paragraph 

(g)(3) of this section, if information 

about the gross income of LTS for each 

of the first three quarters of its taxable 

year is available to TFC, LTS is treated 

as a look-through subsidiary with 

respect to TFC for those quarters 

because TFC owned 25% of the value of 

LTS on the measuring dates with 

respect to those measuring periods. In 

that case, under paragraph (b)(2) of this 

section, in determining whether TFC is 

a PFIC under section 1297(a), TFC is 

treated as if it held 25% of each of LTS’s 

assets and received directly 25% of the 

gross income of LTS on each of the first 

three measuring dates in its taxable 

year. For each of its first three quarters, 

if LTS is treated as a look-through 

subsidiary with respect to TFC under 

paragraph (g)(3) of this section, then 

TFC is treated as if it held a 6.25% 

interest in the stock of FS (and not the 

assets of FS) and received 25% of any 

dividends paid from FS to LTS (and not 

any income of FS). Under paragraph 

(g)(3) of this section, if information 

about the gross income of LTS for each 

of the first three quarters of its taxable 

year is not available to TFC, then LTS 

is not a look-through subsidiary with 

respect to TFC. 

(iii) Example 3—(A) Facts. TFC 

directly owns 100% of the only class of 

LTS stock for TFC’s and LTS’s entire 

taxable year. TFC sells one item of 

property described in section 

954(c)(1)(B)(i) for a gain of $25x and 

another for a loss of $10x, and no 

exception from passive income applies 

to either amount. During the taxable 

year, FS sells one item of property 

described in section 954(c)(1)(B)(i) for a 

gain of $50x and another for a loss of 

$55x; no exception from passive income 

applies to either amount. 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4565 

(B) Results. Under paragraph (b)(1) of 

this section and pursuant to the 

principles of section 958(a), TFC owns 

100% of the value of LTS, and TFC 

indirectly owns 25% of the value of FS. 

Under paragraph (b) of this section, in 

determining whether TFC is a PFIC 

under section 1297(a), TFC is treated as 

if it held 100% of LTS’s assets on each 

of the measuring dates in its taxable 

year and received directly 100% of the 

gross income of LTS for the taxable year. 

Furthermore, TFC is treated as if it held 

25% of each of FS’s assets and received 

directly 25% of the gross income of FS. 

Pursuant to § 1.1297–1(c)(1)(ii), the 

excess of gains over losses from 

property transactions described in 

section 954(c)(1)(B) is taken into 

account as gross income for purposes of 

section 1297, and items of gain or loss 

of look-through subsidiaries are treated 

as recognized by a tested foreign 

corporation. Accordingly, TFC takes 

into account the net $5x loss from the 

sales of property by FS. TFC’s income 

from its own sales of property 

constitutes passive income pursuant to 

§ 1.1297–1(c) and section 954(c)(1)(B), 

although, pursuant to § 1.1297– 

1(c)(1)(ii), only the excess of gains over 

losses, $15x ($25x ¥ $10x), is taken into 

account as gross income for purposes of 

section 1297. As a result, TFC’s income 

(including the $5x loss from FS), all of 

which is passive income, equals $10x 

($15x ¥ $5x) of gross income. 

(c) Elimination of certain 

intercompany assets and income—(1) 

General rule for asset test—(i) LTS 

stock. For purposes of section 

1297(a)(2), a tested foreign corporation 

does not take into account the value (or 

adjusted basis) of stock of a lookthrough subsidiary (LTS stock), 

including LTS stock that the tested 

foreign corporation is treated as owning 

on a measuring date pursuant to section 

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

this section. Furthermore, for purposes 

of section 1297(a)(2), a tested foreign 

corporation does not take into account 

the value (or adjusted basis) of its own 

stock that it is treated as owning on a 

measuring date pursuant to section 

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

this section. 

(ii) LTS obligation. For purposes of 

section 1297(a)(2), a tested foreign 

corporation does not take into account 

the value (or adjusted basis) of its 

proportionate share of a direct LTS 

obligation, an indirect LTS obligation or 

a TFC obligation that it is treated as 

owning on a measuring date. The term 

direct LTS obligation means a debt 

obligation of, lease to, or license to a 

look-through subsidiary (LTS debt, LTS 

lease, and LTS license, respectively, and 

LTS obligation collectively) from the 

tested foreign corporation that the tested 

foreign corporation owns on a 

measuring date, and the term indirect 

LTS obligation means a LTS obligation 

from a look-through subsidiary that the 

tested foreign corporation is treated as 

owning on a measuring date pursuant to 

section 1297(c) and paragraph (b)(2) or 

(b)(3) of this section. The term TFC 

obligation means a debt obligation of, 

lease to, or a license to the tested foreign 

corporation from a look-through 

subsidiary that the tested foreign 

corporation is treated as owning on a 

measuring date pursuant to section 

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

this section. The tested foreign 

corporation’s proportionate share of a 

LTS obligation or a TFC obligation is the 

value (or adjusted basis) of the item 

multiplied by the tested foreign 

corporation’s percentage ownership (by 

value) in each relevant look-through 

subsidiary. For purposes of section 

1297(a)(2) and § 1.1297–1(d) as applied 

to a tested foreign corporation, property 

subject to a LTS lease or LTS license or 

a lease or license to the tested foreign 

corporation is characterized as either 

producing passive income or nonpassive income (or both) by taking into 

account the activities of the qualified 

affiliates (as defined in paragraph (e)(2) 

of this section) of the entity that owns 

the property. For this purpose, the 

activities of the entity that owns the 

property that is subject to the lease or 

license are not taken into account to the 

extent that they relate to the lease or 

license. 

(2) General rule for income test—(i) 

LTS stock. For purposes of section 

1297(a)(1), a tested foreign corporation 

does not take into account dividends 

derived with respect to LTS stock, 

including dividends that the tested 

foreign corporation is treated as 

receiving on a measuring date pursuant 

to section 1297(c) and paragraph (b)(2) 

or (b)(3) of this section; provided that, 

notwithstanding the foregoing, a tested 

foreign corporation takes into account 

dividends that are attributable to 

income that was not treated as received 

directly by the tested foreign 

corporation pursuant to paragraph (b)(2) 

of this section. For this purpose, the 

rules of § 1.1297–1(c)(4)(iv)(A) apply to 

determine the earnings and profits from 

which a dividend is paid, substituting 

the term ‘‘look-through subsidiary’’ for 

‘‘related person.’’ 

(ii) LTS obligation. For purposes of 

section 1297(a)(1), a tested foreign 

corporation does not take into account 

its proportionate share of interest, rents, 

or royalties derived with respect to 

direct or indirect LTS obligations or 

TFC obligations. The tested foreign 

corporation’s proportionate share of 

interest, rents, or royalties is the amount 

of the item multiplied by the tested 

foreign corporation’s percentage 

ownership (by value) in each relevant 

look-through subsidiary. 

(3) Partnerships. For purposes of 

section 1297(a)(1) and (a)(2), the 

principles of paragraphs (c)(1) and (2) of 

this section apply with respect to 

ownership interests in, debt of, and 

leases or licenses to a look-through 

partnership (as defined in paragraph 

(g)(4) of this section), and with respect 

to distributions and the distributive 

shares of income from a look-through 

partnership and interest, rents, or 

royalties derived with respect to the 

debt, leases or licenses of a look-through 

partnership. 

(4) Examples. The following examples 

illustrate the rules of this paragraph (c). 

For purposes of these examples, USP is 

a domestic corporation; USP owns 30% 

of TFC; TFC, LTS, LTS1, LTS2, and FS 

are foreign corporations that are not 

controlled foreign corporations within 

the meaning of section 957(a); FPS is a 

foreign partnership; and TFC, LTS1, and 

LTS2 measure assets for purposes of 

section 1297(a)(2) based on value. 

(i) Example 1—(A) Facts. TFC directly 

owns 80% of the only class of LTS stock 

for TFC’s and LTS’s entire taxable year, 

and LTS is a look-through subsidiary (as 

defined in paragraph (g)(3) of this 

section) with respect to TFC. LTS owns 

25% of the only class of FS stock, and 

FS is a look-through subsidiary with 

respect to LTS. Pursuant to the 

principles of section 958(a), TFC owns 

80% of the value of LTS, LTS owns 25% 

of the value of FS, and TFC indirectly 

owns 20% of the value of FS. During the 

first quarter of the taxable year, LTS 

received a $20x dividend from FS. 

(B) Results—(1) LTS. Under paragraph 

(c)(1)(i) of this section, for purposes of 

applying section 1297(a)(2) to LTS, 

LTS’s assets do not include the stock of 

FS. Under paragraph (c)(2)(i) of this 

section, for purposes of applying section 

1297(a)(1) to LTS, LTS’s income does 

not include the $20x dividend from FS. 

(2) TFC. Under paragraph (c)(1)(i) of 

this section, for purposes of applying 

section 1297(a)(2) to TFC, TFC’s assets 

do not include the stock of LTS. Under 

paragraph (b)(2)(ii)(A) of this section, for 

purposes of applying section 1297(a)(1) 

to TFC, TFC is treated as receiving 

directly the income of LTS. Because 

TFC indirectly owns less than 25% of 

FS, FS is not a look-through subsidiary 

with respect to TFC and, therefore, 

TFC’s assets include the value of TFC’s 

20% interest in the stock of FS and do 

not include 20% of FS’s assets. 

4566 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

Similarly, TFC is treated as if it received 

$16x (80% × $20x) of the $20x dividend 

paid from FS to LTS (and not any 

income of FS). Because the dividend 

constitutes gross income to LTS 

(although it is eliminated for purposes 

of applying section 1297(a)(1) to LTS), 

TFC is treated as receiving the dividend 

from FS directly under paragraph 

(b)(2)(ii)(A) of this section. Because the 

dividend is from a subsidiary that is not 

a look-through subsidiary with respect 

to TFC, paragraph (c)(2)(i) of this section 

does not apply to eliminate the $16x 

dividend for purposes of section 

1297(a). 

(ii) Example 2—(A) Facts. TFC 

directly owns 40% of the value of LTS1 

stock on each of the measuring dates, 

and thus is treated under paragraph 

(b)(1) of this section as owning 40% of 

LTS1’s assets on each of the measuring 

dates. TFC’s assets include a loan to 

LTS1 with a balance of $1,000x on each 

of the measuring dates. During the first 

quarter of the taxable year, TFC received 

$20x of dividends from LTS1, which 

were attributable to income of LTS1 

treated as received directly by TFC 

pursuant to paragraph (b)(2) of this 

section, and $30x of interest on the loan, 

both of which were paid in cash. 

(B) Results. Under paragraph (c)(1)(i) 

of this section, for purposes of applying 

section 1297(a), TFC’s assets do not 

include the stock of LTS1, and TFC’s 

income does not include the $20x of 

dividends received from LTS1 pursuant 

to paragraph (c)(2)(i) of this section. 

Similarly, under paragraph (c)(1)(ii) of 

this section TFC’s assets include only 

$600x ($1,000x loan ¥(40% × $1,000x)) 

of the loan to LTS1, and under 

paragraph (c)(2)(ii) of this section, TFC’s 

income includes only $18x ($30x 

interest ¥ (40% × $30x)) of the interest 

from LTS1. However, TFC’s assets 

include the entire $50x of cash ($20x of 

dividends and $30x of interest) received 

from LTS1. 

(iii) Example 3—(A) Facts. The facts 

are the same as in paragraph (c)(4)(ii)(A) 

of this section (the facts in Example 2), 

except that TFC also directly owns 30% 

of the value of LTS2 stock on each of the 

measuring dates, and thus is treated 

under paragraph (b)(1) of this section as 

owning 30% of LTS2’s assets, and 

LTS1’s assets also include a loan to 

LTS2 with a balance of $200x on each 

of the measuring dates. During the first 

quarter of the taxable year, LTS1 

received $5x of interest on the loan, 

which was paid in cash. 

(B) Results. The results are the same 

as in paragraph (c)(4)(i)(B) of this 

section (the results in Example 1), 

except that TFC’s assets also do not 

include the stock of LTS2. Similarly, 

although TFC would be treated under 

paragraph (b)(2) of this section as 

owning $80x (40% × $200x) of the LTS1 

loan to LTS2, under paragraph (c)(1)(ii) 

of this section TFC does not take into 

account its proportionate share of an 

indirect LTS obligation and accordingly, 

TFC does not take into account $24x 

(30% × $80x) of the loan to LTS2. As a 

result, TFC’s assets include only $56x 

($80x ¥ $24x) of the LTS1 loan to 

LTS2. Furthermore, although TFC 

would be treated under paragraph (b)(2) 

of this section as receiving $2x (40% × 

$5x) of the interest received by LTS1 

from LTS2, under paragraph (c)(2)(ii) of 

this section TFC does not take into 

account its proportionate share of 

interest with respect to an indirect LTS 

obligation and thus, TFC does not take 

into account $0.60x (30% × $2x) of the 

interest received by LTS1. Accordingly, 

TFC’s income includes only $1.40x ($2x 

¥ $0.60x) of the interest from LTS2. 

Furthermore, TFC’s assets include $2x 

(40% × $5x) of LTS1’s cash received 

from LTS2. 

(iv) Example 4—(A) Facts. TFC 

directly owns 80% of the value of LTS1 

stock on each of the measuring dates, 

and thus is treated under paragraph 

(b)(1) of this section as owning 80% of 

LTS1’s assets on each of the measuring 

dates. TFC also directly owns 50% of 

the value in FPS on each of the 

measuring dates. LTS1’s assets include 

the remaining 50% of the value in FPS 

and a loan to FPS with a balance of 

$500x on each of the measuring dates. 

FPS’s assets include a loan to TFC with 

a balance of $1000x on each of the 

measuring dates. During the first 

measuring period of the taxable year, 

FPS received $30x of interest from TFC, 

and LTS1 received $15x of interest from 

FPS, both of which were paid in cash. 

During the last measuring period of the 

taxable year, FPS received $80x of 

income from an unrelated person in 

cash and distributed $60x of such 

income in cash to TFC and LTS1 in 

proportion to their interests in FPS. 

(B) Results. Under paragraph (c)(1)(i) 

and (ii) of this section, for purposes of 

applying section 1297(a), TFC’s assets 

do not include the stock of LTS1, the 

interests in FPS owned by TFC directly 

and through LTS1, any of the loan by 

FPS to TFC, or any of the loan by LTS1 

to FPS. Similarly, under paragraph 

(c)(2)(i) and (ii) of this section, TFC’s 

income does not include any of the $30x 

of interest received by FPS from TFC, 

any of the $15x of interest received by 

LTS1 from FPS, or any of the $60x of 

distributions received by TFC and LTS1 

from FPS. However, on each of the 

measuring dates, TFC’s assets include 

$27x ((50% × $30x) + (80% × 50% × 

$30x)) of the $30 of cash received by 

FPS from TFC and $12x (80% × $15x) 

of the $15x of cash received by LTS1 

from FPS. Moreover, on the last 

measuring date of the taxable year, 

TFC’s assets include $18x ((50% × $20x) 

+ (80% × 50% × $20x)) of the $20x 

($80x¥$60x) of cash received by FPS 

from the unrelated person and retained 

by FPS and $54x ((50% × $60x) + (80% 

× 50% × $60x)) of the $60x cash 

received by FPS from the unrelated 

person and distributed. Furthermore, 

TFC’s income includes $72x ((50% × 

$80x) + (80% × 50% × $80x)) of the 

$80x of income received by FPS from an 

unrelated person. 

(v) Example 5—(A) Facts. TFC 

directly owns 80% of the value of the 

stock of LTS1 and 60% of the value of 

the stock of LTS2 on each of the 

measuring dates, and thus is treated 

under paragraph (b)(1) of this section as 

owning 80% of LTS1’s assets and 60% 

of LTS2’s assets on each of the 

measuring dates. TFC’s assets include a 

license for the use of its intangible 

property by LTS1 with a value of 

$5,000x on each of the measuring dates, 

LTS1’s assets include a sub-license of 

such license to LTS2 with a value of 

$2,000x on each of the measuring dates, 

and LTS2’s assets include a lease of its 

building to LTS1 with a value of 

$4,000x on each of the measuring dates. 

LTS1 and LTS2 each use the intangible 

property that is the subject of the license 

and sub-license in its respective trade or 

business, and LTS1 uses the building in 

its trade or business. During the last 

quarter of the taxable year, TFC received 

a royalty of $500x from LTS1 with 

respect to the license, and LTS1 

received a royalty of $200x from LTS2 

with respect to the sub-license, both of 

which were paid in cash. LTS2 received 

$100x of rent paid in cash from LTS1 

during each quarter of the taxable year 

with respect to the building lease. 

(B) Results—(1) Asset test. Under 

paragraph (c) of this section, for 

purposes of applying section 1297(a)(2) 

to TFC’s final measuring period, the 

following analysis applies. TFC’s assets 

do not include the stock of LTS1 and 

LTS2. Similarly, TFC’s assets include 

only $1,000x ($5,000x license ¥ (80% 

× $5,000x)) of the license to LTS1. 

However, TFC’s assets include the 

entire $500x of cash it received from 

LTS1 as a result of the royalty. 

Moreover, although TFC would be 

treated under paragraph (b)(2) of this 

section as owning $1,600x (80% × 

$2,000x) of the LTS1 sub-license to 

LTS2, under paragraph (c)(1)(ii) of this 

section TFC does not take into account 

its proportionate share of an indirect 

LTS obligation, and accordingly TFC 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4567 

does not take into account $960x (60% 

× $1,600x) of LTS1’s sub-license to 

LTS2. As a result, TFC’s assets include 

$640x ($1,600x ¥ $960x) of the sublicense. In addition, TFC’s assets 

include $160x (80% × $200x) of LTS1’s 

cash received from LTS2 as a result of 

the royalty to LTS1. Similarly, although 

TFC would be treated under paragraph 

(b)(2) of this section as owning $2,400x 

(60% × $4,000x) of the LTS2 lease to 

LTS1, under paragraph (c)(1)(ii) of this 

section TFC does not take into account 

$1,920x (80% × $2,400x) of the LTS2 

building lease, and accordingly, its 

assets include $480x ($2,400x ¥ 

$1,920x) of the lease. TFC’s assets also 

include $240x (60% × $100x × 4) of 

LTS2’s cash received from LTS1 as a 

result of the rental payment to LTS2. 

(2) Income test. Under paragraph 

(c)(2)(ii) of this section, because TFC 

does not take into account its 

proportionate share of a direct LTS 

obligation, TFC’s income includes only 

$100x ($500x royalty ¥ (80% × $500x)) 

of the royalties from LTS1. Furthermore, 

although TFC would be treated under 

paragraph (b)(2) of this section as 

receiving $160x (80% × $200x) of the 

royalty received by LTS1 from LTS2, 

under paragraph (c)(2)(ii) of this section 

TFC does not take into account its 

proportionate share of royalties derived 

with respect to an indirect LTS 

obligation, and accordingly TFC does 

not take into account $96x (60% × 

$160x) of the royalty received by LTS1. 

As a result, TFC’s income includes only 

$64x ($160x ¥ $96x) of the royalty from 

LTS2. Similarly, although TFC would be 

treated under paragraph (b)(2) of this 

section as receiving $240x (60% × $100x 

× 4) of the rent received by LTS2 from 

LTS1, under paragraph (c)(2)(ii) of this 

section TFC does not take into account 

its proportionate share of rent derived 

with respect to an indirect LTS 

obligation, and accordingly TFC does 

not take into account $192x (80% × 

$240) of the rent received by LTS2. 

Therefore, TFC’s income includes only 

$48 ($240x ¥ $192x) of the rent 

received from LTS1. 

(3) Treatment of intangible and rental 

property. For purposes of determining 

whether the intangible property that 

TFC owns and the building that TFC is 

treated as owning under paragraph 

(b)(2) of this section is held in the 

production of passive income, the 

activities performed by TFC and its 

qualified affiliates with respect to the 

property are taken into account under 

paragraphs (c)(1)(ii) and (e) of this 

section. Because TFC is the common 

parent of the affiliated group (as 

determined under paragraph (e)(2) of 

this section) that includes LTS1 and 

LTS2, LTS1 and LTS2 are qualified 

affiliates of TFC and the activities of 

their officers and employees with 

respect to the intangible property and 

building are taken into account to 

determine whether the building and 

intangible property would be treated as 

passive assets. 

(d) Related person determination for 

purposes of section 1297(b)(2)(C)—(1) 

General rule. For purposes of section 

1297(b)(2)(C), interest, dividends, rents 

or royalties received or accrued by a 

look-through subsidiary (and treated as 

received directly by a tested foreign 

corporation pursuant to section 1297(c) 

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

considered received or accrued from a 

related person only if the payor of the 

interest, dividend, rent or royalty is a 

related person (within the meaning of 

section 954(d)(3)) with respect to the 

look-through subsidiary, taking into 

account § 1.1297–1(c)(1)(i)(D). Similarly, 

for purposes of 1297(b)(2)(C), interest, 

dividends, rents or royalties received or 

accrued by a look-through partnership 

(and treated as received directly by a 

tested foreign corporation pursuant to 

paragraph (b)(3) of this section) are 

considered received or accrued from a 

related person only if the payor of the 

interest, dividend, rent or royalty is a 

related person (within the meaning of 

section 954(d)(3)) with respect to the 

look-through partnership, taking into 

account § 1.1297–1(c)(1)(i)(D). 

(2) Example. The following example 

illustrates the rule of this paragraph (d). 

(i) Facts. USP is a domestic 

corporation that owns 30% of TFC. TFC 

directly owns 30% of the value of FS1 

stock, and thus under paragraph (b) of 

this section is treated as owning 30% of 

FS1’s assets and earning 30% of FS1’s 

gross income. The remaining FS1 stock 

is owned by an unrelated foreign 

person. FS1 directly owns 60% of the 

vote of FS2 stock and 20% of the value 

of FS2 stock. The remaining vote and 

value of FS2 stock are owned by an 

unrelated foreign person. TFC, FS1, and 

FS2 are foreign corporations that are not 

controlled foreign corporations within 

the meaning of section 957(a). FS1 

receives a $100x dividend from FS2. 

(ii) Results. Pursuant to section 

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

section, TFC is treated as receiving 

directly $30x of the dividend income 

received by FS1. FS2 is a related person 

(within the meaning of section 

954(d)(3)) with respect to FS1 for 

purposes of section 1297(b)(2)(C) 

because FS1 owns more than 50% of the 

vote of FS2. FS2 is not a related person 

(within the meaning of section 

954(d)(3)) with respect to TFC for 

purposes of section 1297(b)(2)(C) 

because TFC indirectly does not own 

more than 50% of the vote or value of 

the FS2 stock. Under paragraph (d)(1) of 

this section, for purposes of determining 

whether the dividend income received 

by FS1 is subject to the exception in 

section 1297(b)(2)(C) for purposes of 

testing the PFIC status of TFC, the 

dividend is treated as received from a 

related person because FS1 and FS2 are 

related persons within the meaning of 

section 1297(b)(2)(C). Therefore, to the 

extent the dividend income received by 

FS1 would be properly allocable to 

income of FS2 that is not passive 

income, the dividend income that TFC 

is treated as receiving under section 

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

section is treated as non-passive income 

(as defined in § 1.1297–1(f)(4)). 

(e) Treatment of activities of certain 

look-through subsidiaries and lookthrough partnerships for purposes of 

certain exceptions—(1) General rule. An 

item of income received by a tested 

foreign corporation (including an 

amount treated as received or accrued 

pursuant to section 1297(c) and 

paragraph (b)(2) or (b)(3) of this section) 

that would be passive income in the 

hands of the entity that actually 

received or accrued it is not passive if 

the item would be excluded from 

foreign personal holding company 

income under the following exceptions 

contained in section 954(c) that are 

based on whether the entity is engaged 

in the active conduct of a trade or 

business, determined by taking into 

account the activities performed by the 

officers and employees of the tested 

foreign corporation as well as activities 

performed by the officers and 

employees of any qualified affiliate of 

the tested foreign corporation— 

(i) Section 954(c)(1)(B) and § 1.954– 

2(e)(1)(ii) and (3)(ii), (iii) and (iv); 

(ii) Section 954(c)(1)(C) and § 1.954– 

2(f)(1)(ii) and (2)(iii)(D); 

(iii) Section 954(c)(1)(D) and § 1.954– 

2(g)(2)(ii); 

(iv) Section 954(c)(2)(A) and § 1.954– 

2(b)(6), (c), and (d); 

(v) Section 954(c)(2)(B) and § 1.954– 

2(b)(2); and 

(vi) Section 954(c)(2)(C) and § 1.954– 

2(h)(3)(ii). 

(2) Qualified affiliate. The term 

qualified affiliate means a corporation 

or a partnership that is included in an 

affiliated group that includes the tested 

foreign corporation. For purposes of this 

paragraph (e), the term affiliated group 

has the meaning provided in section 

1504(a), except that— 

(i) The affiliated group is determined 

without regard to sections 1504(a)(2)(A), 

(b)(2) and (b)(3); 

4568 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

(ii) Subject to paragraph (e)(2)(iii) of 

this section, a partnership is treated as 

an includible corporation; 

(iii) The common parent of the 

affiliated group is not a domestic 

corporation or domestic partnership; 

(iv) Section 1504(a)(2)(B) is applied 

by substituting ‘‘more than 50 percent’’ 

for ‘‘at least 80 percent’’; 

(v) A foreign corporation or foreign 

partnership must be the common parent 

of the affiliated group; 

(vi) Subject to paragraph (e)(2)(vii) of 

this section, a partnership is included as 

a member of the affiliated group if more 

than 50 percent of the value of its 

capital interests or profits interests is 

owned by one or more corporations or 

partnerships that are included in the 

affiliated group; and 

(vii) A corporation or a partnership 

that is not the common parent of an 

affiliated group is included in the 

affiliated group only if it would be a 

look-through subsidiary or look-through 

partnership, as applicable, of the 

common parent if the common parent 

were a tested foreign corporation. 

(3) Examples. The following examples 

illustrate the rule of this paragraph (e). 

(i) Example 1—(A) Facts. USP is a 

domestic corporation that directly owns 

20% of the outstanding stock of FS1. 

The remaining 80% of the outstanding 

stock of FS1 is directly owned by a 

foreign person that is not related to USP. 

FS1 directly owns 100% of the value of 

the outstanding stock of FS2 and 

directly owns 80% of the value of the 

outstanding stock of FS3. The remaining 

20% of the value of the outstanding 

stock of FS3 is directly owned by a 

foreign person that is not related to USP. 

FS2 directly owns 80% of the value of 

the outstanding stock of FS4. The 

remaining 20% of the value of the 

outstanding stock of FS4 is directly 

owned by a foreign person that is not 

related to USP. FS1, FS2, FS3 and FS4 

are all organized in Country A and are 

not controlled foreign corporations 

within the meaning of section 957(a). 

FS4 owns real property that is leased to 

a person that is not a related person, but 

does not perform any activities. FS1 and 

FS2 also do not perform any activities. 

Officers and employees of FS3 in 

Country A perform activities with 

respect to the real property of FS4 that, 

if performed by officers or employees of 

FS4, would allow the rental income in 

the hands of FS4 to qualify for the 

exception from foreign personal holding 

company income in section 954(c)(2)(A) 

and § 1.954–2(b)(6) and (c)(1)(ii). 

(B) Results—(1) Qualified affiliates. 

FS1 is the common parent of the 

affiliated group (as determined under 

paragraph (e)(2) of this section) that 

includes FS2, FS3, and FS4 because (i) 

FS1 owns more than 50% by value of 

FS2 and FS3, (ii) FS2 owns more than 

50% by value of FS4, and (iii) FS2, FS3, 

and FS4 would be look-through 

subsidiaries with respect to FS1 if FS1 

were the tested foreign corporation. 

Accordingly, each of FS1, FS2, FS3 and 

FS4 are qualified affiliates (as 

determined under paragraph (e)(2) of 

this section) with respect to the other 

members of the group for purposes of 

determining whether FS1, FS2, FS3, or 

FS4 is a PFIC . 

(2) FS1 and FS2. Under this paragraph 

(e), for purposes of determining whether 

the rental income actually received by 

FS4 with respect to the real property 

owned and rented by FS4 and treated 

under section 1297(c) and paragraph 

(b)(2) of this section as received directly 

by FS1 or by FS2, respectively, is 

passive income for purposes of section 

1297, the activities of FS3 are taken into 

account because FS3 is a qualified 

affiliate of FS1 and FS2, respectively. 

Thus, the exception in section 

954(c)(2)(A) would apply, and the rental 

income treated as received by FS1 or by 

FS2, respectively, would be treated as 

non-passive income for purposes of 

determining whether FS1 or FS2 is a 

PFIC. 

(3) FS4. Under this paragraph (e), for 

purposes of determining whether the 

rental income received by FS4 with 

respect to the real property owned and 

rented by FS4 is passive income for 

purposes of section 1297, the activities 

of FS3 are taken into account, because 

FS3 is a qualified affiliate of FS4. Thus, 

the exception in section 954(c)(2)(A) 

would apply, and the rental income 

received by FS4 would be treated as 

non-passive income for purposes of 

determining whether FS4 is a PFIC. 

(ii) Example 2—(A) Facts. The facts 

are the same as in paragraph (e)(3)(i)(A) 

of this section (the facts in Example 1), 

except that FS2 also owns real property 

that is leased to a person that is not a 

related person, and the officers and 

employees of FS2 in Country A engage 

in activities that would allow rental 

income received by FS2 with respect to 

its real property to qualify for the 

exception in section 954(c)(2)(A) and 

§ 1.954–2(b)(6) and (c)(1)(iv), relying on 

the rule in § 1.954–2(c)(2)(ii) that 

provides that an organization is 

substantial in relation to rents if active 

leasing expenses equal or exceed 25% of 

adjusted leasing profit. However, the 

active leasing expenses of FS1 are less 

than 25% of its adjusted leasing profit, 

which includes the rental income of FS4 

treated as received directly by FS1 as 

well as the rental income of FS2 treated 

as received directly by FS1. 

(B) Results. Because FS2’s rental 

income constitutes non-passive income 

as a result of the application of 

§ 1.1297–1(c)(1)(i)(A) and section 

954(c)(2)(A), it is treated as non-passive 

income that FS1 is treated as receiving 

directly under section 1297(c) and 

paragraph (b)(2) of this section for 

purposes of determining whether FS1 is 

a PFIC, and accordingly, it is not 

necessary to rely on paragraph (e) of this 

section. 

(iii) Example 3—(A) Facts. The facts 

are the same as in paragraph (e)(3)(i)(A) 

of this section (the facts in Example 1), 

except that USP directly owns 60% of 

the outstanding stock of FS1. 

(B) Results. Under paragraph (e)(2)(iii) 

of this section, USP cannot be the 

common parent of an affiliated group for 

purposes of paragraph (e)(2) of this 

section because it is a domestic 

corporation. Because FS1 is a foreign 

corporation, FS1 may be the common 

parent of an affiliated group for 

purposes of paragraph (e)(2) of this 

section. The results therefore are the 

same as in paragraph (e)(3)(i)(B) of this 

section (the results in Example 1). 

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

partnership—(1) [Reserved]. 

(2) Amount of gain taken into account 

from disposition of look-through 

subsidiary. For purposes of section 

1297(a)(1), section 1298(b)(3), and 

§ 1.1298–2, the amount of gain that is 

taken into account by a tested foreign 

corporation from the 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 look-through 

subsidiary by other look-through 

subsidiaries or by look-through 

partnerships, 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) or (b)(3) of this 

section) from the disposition of the 

stock of the look-through 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) or (b)(3) of this 

section 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) 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4569 

received by the tested foreign 

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

stock, determined without regard to 

paragraph (c)(2)(i) 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 under a reasonable method. 

(3) Characterization of residual gain 

as passive income. For purposes of 

section 1297(a)(1), section 1298(b)(3), 

and § 1.1298–2, the residual gain from 

the direct or indirect disposition of 

stock of a look-through subsidiary is 

characterized as passive income or nonpassive income based on the relative 

amounts of passive assets and nonpassive assets (as defined in § 1.1297– 

1(f)(5) and (3), respectively) of the 

disposed-of look-through subsidiary 

(and any other look-through subsidiary 

to the extent owned indirectly through 

the look-through subsidiary) treated as 

held by the tested foreign corporation 

on the date of the disposition of the 

look-through subsidiary. For the 

purpose of this paragraph (f)(3), the 

relative amounts of passive assets and 

non-passive assets held by the lookthrough subsidiary are measured under 

the same method (value or adjusted 

bases) used to measure the assets of the 

tested foreign corporation for purposes 

of section 1297(a)(2). 

(4) Gain taken into account from 

disposition of 25%-owned partnerships 

and look-through partnerships—(i) 

Section 954(c)(4) partnerships. The 

amount of gain derived from a tested 

foreign corporation’s direct or indirect 

(through a look-through subsidiary or 

look-through partnership) disposition of 

partnership interests in a partnership 

described in section 954(c)(4) (treating 

the tested foreign corporation as if it 

were a controlled foreign corporation) 

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 determined under 

section 954(c)(4). 

(ii) Look-through partnerships. In the 

case of a look-through partnership that 

is not described in paragraph (f)(4)(i) of 

this section, the principles of 

paragraphs (f)(2) and (f)(3) of this 

section apply to determine the amount 

and characterization of gain derived 

from a tested foreign corporation’s 

direct or indirect (through a lookthrough subsidiary or look-through 

partnership) disposition of partnership 

interests of the look-through partnership 

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. 

(5) Examples. The following examples 

illustrate the rules of this paragraph (f). 

For purposes of the examples in this 

paragraph (f)(5), USP is a domestic 

corporation, TFC and FS are foreign 

corporations that are not controlled 

foreign corporations within the meaning 

of section 957(a), and USP, TFC, and FS 

each has a single class of stock with 100 

shares outstanding and a calendar 

taxable year. 

(i) Example 1—(A) Facts. USP owned 

30% of the outstanding stock of TFC 

throughout Years 1, 2, 3, and 4. In Year 

1, TFC purchased 5 shares of FS stock, 

representing 5% of the stock of FS, from 

an unrelated person. On the first day of 

Year 3, TFC purchased 20 shares of FS 

stock, representing 20% of the stock of 

FS, from an unrelated person. TFC 

owned 25% of the outstanding stock of 

FS throughout Years 3 and 4. Before 

Year 3, TFC did not include any amount 

in income with respect to FS under 

section 1297(c)(2). During Years 3 and 4, 

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

included in income, in the aggregate, 

$40x of income with respect to FS under 

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

this section. TFC did not receive 

dividends from FS during Year 1, 2, 3, 

or 4. For purposes of section 1297(a)(2), 

TFC measures its assets based on their 

fair market value as provided under 

section 1297(e). On the last day of Year 

4, TFC recognizes a loss with respect to 

the sale of 5 shares of FS stock, and a 

$110x gain with respect to the sale of 20 

shares of FS stock. On the date of the 

sale, FS owns non-passive assets with 

an aggregate fair market value of $150x, 

and passive assets with an aggregate fair 

market value of $50x. 

(B) Results. For purposes of applying 

section 1297(a)(1) to TFC for Year 4, 

TFC must take into account $78x of 

residual gain, as provided by paragraph 

(f)(2) of this section, which equals the 

amount by which the $110x gain 

recognized on the sale of 20 shares in 

FS exceeds the aggregate pro rata share 

of $32x income ($40x × 20/25) taken 

into account by TFC with respect to the 

20 shares in FS under section 1297(c) 

and paragraph (b)(2) of this section 

during Years 3 and 4. There is zero 

residual gain on the sale of 5 shares of 

FS stock because they were sold at a 

loss. Under paragraph (f)(3) of this 

section, $58.50x of the residual gain is 

non-passive income ($78x × ($150x/ 

$200x)) and $19.50x is passive income 

($78x × ($50x/$200x)). 

(ii) Example 2—(A) Facts. The facts 

are the same as in paragraph (f)(5)(i)(A) 

of this section (the facts in Example 1), 

except that in Year 1, TFC purchased 15 

shares of FS stock, representing 15% of 

the stock of FS, from an unrelated 

person, and on the first day of Year 3, 

TFC purchased an additional 15 shares 

of FS stock, representing 15% of the 

stock of FS, from an unrelated person, 

and on the last day of Year 4, TFC 

recognizes gain of $10x of the sale of 15 

shares of FS stock purchased in Year 1, 

and gain of $60x on the sale of the other 

15 shares of FS stock purchased in Year 

3. 

(B) Results. For purposes of applying 

section 1297(a)(1) to TFC for Year 4, 

TFC must take into account $40x of 

residual gain with respect to the 15 

shares acquired in Year 3, as provided 

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

equals the amount by which the $60x 

gain recognized on the sale of those 15 

shares exceeds the aggregate pro rata 

share of $20x income ($40x × 15/30) 

taken into account by TFC with respect 

to those 15 shares in FS under section 

1297(c)(2) during Years 3 and 4. There 

is zero residual gain on the sale of the 

15 shares of FS stock acquired in Year 

1 because the $10x of gain does not 

exceed the aggregate pro rata share of 

$20x income taken into account by TFC 

with respect to those 15 shares of FS 

under section 1297(c) and paragraph 

(b)(2) of this section. Under paragraph 

(f)(3) of this section, $30x of the residual 

gain is non-passive income ($40x × 

($150x/$200x)) and $10x is passive 

income ($40x × ($50x/$200x)). 

(iii) Example 3—(A) Facts. The facts 

are the same as in paragraph (f)(5)(ii)(A) 

of this section (the facts in Example 2), 

except that TFC received, in the 

aggregate, $20x of dividends from FS 

during Year 2. 

(B) Results. The results are the same 

as in paragraph (f)(5)(ii)(B) of this 

section (the results in Example 2) with 

respect to the 15 shares acquired in Year 

3 ($40x of residual gain attributable to 

the 15 shares acquired in Year 3). For 

purposes of applying section 1297(a)(1) 

to TFC for Year 4, TFC must also take 

into account $10x of residual gain with 

respect to the 15 shares acquired in Year 

1. As provided by paragraph (f)(2) of 

this section, the residual gain equals the 

amount by which the $10x gain 

recognized on the sale of those 15 shares 

exceeds the unremitted earnings with 

respect to those shares. The unremitted 

earnings with respect to the 15 shares 

acquired in Year 1 are $0x, the amount 

by which the pro rata share of aggregate 

income ($20x) taken into account by 

TFC with respect to those 15 shares of 

FS stock under section 1297(c) and 

paragraph (b)(2) of this section in Years 

3 and 4 exceeds the aggregate pro rata 

amount of dividends with respect to 

those 15 shares of FS stock ($20x) 

4570 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

received by TFC from FS in Year 2. 

Total residual gain therefore is $50x 

($40x + $10x). Under paragraph (f)(3) of 

this section, $37.50x of the residual gain 

is non-passive income ($50x × ($150x/ 

$200x)) and $12.50x is passive income 

($50x × ($50x/$200x)). 

(g) Definitions. The following 

definitions apply for purposes of 

§ 1.1297–1 and this section: 

(1) Direct LTS obligation. The term 

direct LTS obligation has the meaning 

provided in paragraph (c)(1)(ii) of this 

section. 

(2) Indirect LTS obligation. The term 

indirect LTS obligation has the meaning 

provided in paragraph (c)(1)(ii) of this 

section. 

(3) Look-through subsidiary. The term 

look-through subsidiary means, with 

respect to a tested foreign corporation, 

a corporation as to which the asset test 

of paragraph (g)(3)(i) and the income 

test of paragraph (g)(3)(ii) of this section 

are satisfied on each measuring date 

during the taxable year of a tested 

foreign corporation. If a corporation 

satisfies both the asset test of paragraph 

(g)(3)(i) and the income test of 

paragraph (g)(3)(ii)(B) for some but not 

all measuring periods within the taxable 

year of a tested foreign corporation, the 

subsidiary is treated as a look-through 

subsidiary only for those measuring 

periods in which both tests are satisfied. 

(i) For purposes of section 1297(a)(2) 

and paragraph (b)(2)(i) of this section, a 

corporation at least 25 percent of the 

value of the stock of which is owned (as 

determined under paragraph (b)(1) of 

this section) by the tested foreign 

corporation on the measuring date (as 

defined in § 1.1297–1(f)(1)); 

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

either— 

(A) For the taxable year, a corporation 

with respect to which the average 

percentage ownership (which is equal to 

the percentage ownership (by value) (as 

determined under paragraph (b)(1) of 

this section) on each measuring date 

during the taxable year, divided by the 

number of measuring dates in the year) 

by the tested foreign corporation during 

the tested foreign corporation’s taxable 

year is at least 25 percent; or 

(B) For a measuring period (as defined 

in § 1.1297–1(f)(2)), a corporation at 

least 25 percent of the value of the stock 

of which is owned (as determined under 

paragraph (b)(1) of this section) by the 

tested foreign corporation on the 

measuring date, provided all items of 

gross income of the corporation for each 

of the measuring periods in the taxable 

year for which the tested foreign 

corporation owns at least 25 percent of 

the value (as determined under 

paragraph (b)(1) of this section) on the 

relevant measuring dates can be 

established; and 

(iii) For purposes of paragraph (f) of 

this section and § 1.1298–2, a 

corporation at least 25 percent of the 

value of the stock of which is owned (as 

determined under paragraph (b)(1) of 

this section) by the tested foreign 

corporation immediately before the 

disposition of stock of the corporation. 

(4) Look-through partnership—(i) In 

general. The term look-through 

partnership means, with respect to a 

tested foreign corporation— 

(A) A partnership that would be a 

look-through subsidiary (as defined in 

paragraph (g)(3) of this section) if such 

partnership were a corporation; or 

(B) A partnership that is not described 

in paragraph (g)(4)(i)(A) of this section, 

if the tested foreign corporation satisfies 

both of the active partner tests set forth 

in paragraphs (g)(4)(ii)(A) and (B) of this 

section on the measurement date or for 

the taxable year, as applicable, unless an 

election is made under paragraph 

(g)(4)(iii) of this section. 

(ii) Active partner test—(A) 

Partnership interest under asset test. For 

purposes of paragraph (b)(3)(i) of this 

section, paragraph (g)(4)(i)(B) of this 

section applies for the measuring period 

only if the tested foreign corporation 

would not be a PFIC if section 

1297(a)(1) and (2) and the regulations 

thereunder were applied to the tested 

foreign corporation without regard to 

any partnership interest owned by the 

tested foreign corporation that is not a 

partnership described in paragraph 

(g)(4)(i)(A) of this section. For purposes 

of the preceding sentence, the active 

partner test is applied on the 

measurement date (as defined in 

§ 1.1297–1(f)(1)). 

(B) Partnership income under income 

test. For purposes of paragraph (b)(3)(ii) 

of this section, paragraph (g)(4)(i)(B) of 

this section applies for the taxable year 

of the tested foreign corporation or for 

a measuring period (as defined in 

§ 1.1297–1(f)(2)), as applicable, only if 

the tested foreign corporation would not 

be a PFIC if section 1297(a)(1) and (2) 

and the regulations thereunder were 

applied to the tested foreign corporation 

without regard to any partnership 

interest owned by the tested foreign 

corporation that is not a partnership 

described in paragraph (g)(4)(i)(A) of 

this section. For purposes of the 

preceding sentence, the active partner 

test is applied on the measuring date (as 

defined in § 1.1297–1(f)(1)) or for the 

taxable year, as applicable using the 

same period that was used under 

paragraph (g)(3)(ii) of this section. 

(iii) Election. For any taxable year, an 

election may be made with respect to a 

partnership described in paragraph 

(g)(4)(i)(B) of this section to not apply 

the provisions of this paragraph (g)(4) to 

such partnership. 

(iv) Examples. The following 

examples illustrate the rules of this 

paragraph (g)(4). For purposes of the 

examples in this paragraph (g)(4)(iv), 

TFC is a foreign corporation that is not 

a controlled foreign corporation; FC1 

and FC2 are foreign corporations that 

are not controlled foreign corporations; 

FPS is a foreign partnership; TFC owns 

100% of the single class of stock of FC1 

and FC2; FC2 owns 10% of the value of 

FPS, and the remaining 90% of FPS is 

owned by an unrelated foreign person; 

and TFC, FC1, FC2, and FPS are all 

calendar year taxpayers. 

(A) Example 1—(1) Facts. During Year 

1, FC1 generated $100x of non-passive 

income, FC2 generated $150x of nonpassive income, and FPS generated $50x 

of income. On all of the measurement 

dates in Year 1, FC1 has assets with a 

value of $1000x that FC1 uses in its 

trade or business generating non-passive 

income, FC2 has assets with a value of 

$1500x that FC2 uses in its trade or 

business generating non-passive 

income, and FPS has assets with a value 

of $500x. 

(2) Results—(i) Active partner test 

with respect to partnership interest. 

Pursuant to section 1297(c) and 

§ 1.1297–2(b)(2), TFC is treated as 

holding directly the assets held by FC1 

and FC2. For purposes of the active 

partner test under paragraph (g)(4)(ii)(B) 

of this section, TFC does not take into 

account its interest in FPS to determine 

whether it would be a PFIC. Because 

100% ($2500x/$2500x) of the assets of 

FC1 and FC2 that TFC is treated as 

directly holding, without taking into 

account the interest in FPS, generates 

non-passive income, TFC satisfies the 

active partner test in paragraph 

(g)(4)(ii)(B) of this section. 

(ii) Active partner test with respect to 

partnership income. Pursuant to section 

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

section, TFC is treated as if it received 

directly its proportionate share of 

income of FC1 and FC2. For purposes of 

the active partner test under paragraph 

(g)(4)(ii)(A) of this section, TFC does not 

take into account its interest in FPS to 

determine whether it would be a PFIC. 

Because 100% ($250x/$250x) of the 

income of FC1 and FC2 that TFC is 

treated as directly receiving, without 

taking into account the interest in FPS, 

is non-passive income, TFC satisfies the 

active partner test in paragraph 

(g)(4)(ii)(A) of this section with respect 

to the income of FPS. 

(iii) Qualification of look-through 

partnership. For purposes of paragraph 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4571 

(b)(3) of this section, FPS qualifies as a 

look-through partnership because TFC 

satisfies the active partner tests of both 

paragraphs (g)(4)(i)(A) and (B) of this 

section. Unless an election is made not 

to treat FPS as a look-through 

partnership under paragraph (g)(4)(iii) 

of this section, TFC is treated as 

receiving directly $5x of income (10% × 

$50x), TFC’s pro rata share of the 

income of FPS, the character of which 

is determined at the level of FPS for 

purposes of section 1297. In addition, 

TFC is treated as holding directly $50x 

of FPS’s assets (10% × $500x), TFC’s 

proportionate share of the assets held by 

FPS. The character of those assets as 

passive or non-passive is determined in 

the hands of FPS for purposes of section 

1297. 

(B) Example 2—(1) Facts. During Year 

1, FC1 generated $50x of passive 

income, FC2 earned $175x of nonpassive income, and FPS generated $50x 

of income. On all of the measurement 

dates in Year 1, FC1 has assets with a 

value of $1100x that produce passive 

income, and FC2 has assets with a value 

of $900x that FC2 uses in its trade or 

business generating non-passive 

income. The value of FPS is $1000x 

taking into account its assets and 

liabilities. 

(2) Results—(i) Active partner test 

with respect to partnership interest. 

Pursuant to section 1297(c) and 

§ 1.1297–2(b)(2), TFC is treated as 

holding directly the assets held by FC1 

and FC2. For purposes of the active 

partner test under paragraph (g)(4)(ii)(B) 

of this section, TFC does not take into 

account its interest in FPS to determine 

whether it would be a PFIC. 

Accordingly, 55% ($1100x/$2000x) of 

the assets that TFC is treated as directly 

holding, without taking into account the 

interest in FPS, generate passive 

income. 

(ii) Active partner test with respect to 

partnership income. Pursuant to section 

1297(c) and § 1.1297–2(b)(2), TFC is 

treated as if it received directly its 

proportionate share of income of FC1 

and FC2. For purposes of the active 

partner test under paragraph (g)(4)(ii)(A) 

of this section, TFC does not take into 

account its interest in FPS to determine 

whether it would be a PFIC. 

Accordingly, 77.8% ($175x/$225x) of 

the income that TFC is treated as 

directly receiving, without taking into 

account the interest in FPS, is nonpassive income. 

(iii) Failure to qualify as look-through 

partnership. TFC satisfies the active 

partner test in paragraph (g)(4)(ii)(A) of 

this section but does not satisfy the 

active partner test in paragraph (g)(4)(ii) 

(B) of this section. Therefore, FPS does 

not qualify as a look-though 

partnership. Under paragraph (b)(3)(iii) 

of this section, TFC’s share of income 

with respect to FPS is treated as passive 

income for purposes of section 1297 and 

TFC’s $100x interest (10% × $1000x) in 

FPS is treated as a passive asset for 

purposes of section 1297. 

(5) LTS debt. The term LTS debt has 

the meaning provided in paragraph 

(c)(1)(ii) of this section. 

(6) LTS lease. The term LTS lease has 

the meaning provided in paragraph 

(c)(1)(ii) of this section. 

(7) LTS license. The term LTS license 

has the meaning provided in paragraph 

(c)(1)(ii) of this section. 

(8) LTS obligation. The term LTS 

obligation has the meaning provided in 

paragraph (c)(1)(ii) of this section. 

(9) LTS stock. The term LTS stock has 

the meaning provided in paragraph 

(c)(1)(i) of this section. 

(10) Qualified affiliate. The term 

qualified affiliate has the meaning 

provided in paragraph (e)(2) of this 

section. 

(11) Residual gain. The term residual 

gain has the meaning provided in 

paragraph (f)(2) of this section. 

(12) TFC obligation. The term TFC 

obligation has the meaning provided in 

paragraph (c)(1)(ii) of this section. 

(13) Unremitted earnings. The term 

unremitted earnings has the meaning 

provided in paragraph (f)(2) of this 

section. 

(h) Applicability date. The rules of 

this section apply to taxable years of 

shareholders beginning on or after 

January 14, 2021. A shareholder may 

choose to apply such rules for any open 

taxable year beginning before January 

14, 2021, provided that, with respect to 

a tested foreign corporation, the 

shareholder consistently applies the 

provisions of § 1.1291–1(b)(8)(iv) and 

(b)(8)(v)(A), (B), (C), and (D) and 

§§ 1.1297–1 (except that consistent 

treatment is not required with respect to 

§ 1.1297–1(c)(1)(i)(A)), 1.1298–2, and 

1.1298–4 for such year and all 

subsequent years. 

■ Par. 6. Sections 1.1297–4, 1.1297–5, 

and 1.1297–6 are added to read as 

follows: 

§ 1.1297–4 Qualifying insurance 

corporation. 

(a) Scope. This section provides rules 

for determining whether a foreign 

corporation is a qualifying insurance 

corporation for purposes of section 

1297(f). Paragraph (b) of this section 

provides the general rule for 

determining whether a foreign 

corporation is a qualifying insurance 

corporation. Paragraph (c) of this section 

describes the 25 percent test in section 

1297(f)(1)(B). Paragraph (d) of this 

section contains rules for applying the 

alternative facts and circumstances test 

in section 1297(f)(2). Paragraph (e) of 

this section contains rules limiting the 

amount of applicable insurance 

liabilities for purposes of the 25 percent 

test described in paragraph (c) of this 

section and the alternative facts and 

circumstances test described in 

paragraph (d) of this section. Paragraph 

(f) of this section provides definitions 

that apply for purposes of this section. 

Paragraph (g) of this section provides 

the applicability date of this section. 

(b) Qualifying insurance corporation. 

For purposes of section 1297(b)(2)(B), 

this section, and §§ 1.1297–5 and 

1.1297–6, with respect to a U.S. person, 

a qualifying insurance corporation (QIC) 

is a foreign corporation that— 

(1) Is an insurance company as 

defined in section 816(a) that would be 

subject to tax under subchapter L if the 

corporation were a domestic 

corporation; and 

(2) Satisfies— 

(i) The 25 percent test described in 

paragraph (c) of this section; or 

(ii) The requirements for an election 

to apply the alternative facts and 

circumstances test as described in 

paragraph (d) of this section and a 

United States person has made an 

election as described in paragraph (d)(5) 

of this section. 

(c) 25 percent test. A foreign 

corporation satisfies the 25 percent test 

if the amount of its applicable insurance 

liabilities exceeds 25 percent of its total 

assets. This determination is made on 

the basis of the applicable insurance 

liabilities and total assets reported on 

the corporation’s applicable financial 

statement for the applicable reporting 

period. 

(d) Election to apply the alternative 

facts and circumstances test—(1) In 

general. A United States person that 

owns stock in a foreign corporation that 

fails to qualify as a QIC solely because 

of the 25 percent test may elect to treat 

the stock of the corporation as stock of 

a QIC if the foreign corporation— 

(i) Is predominantly engaged in an 

insurance business as described in 

paragraph (d)(2) of this section; 

(ii) Failed to satisfy the 25 percent test 

solely due to runoff-related 

circumstances, as described in 

paragraph (d)(3) of this section, or 

rating-related circumstances, as 

described in paragraph (d)(4) of this 

section; and 

(iii) Reports an amount of applicable 

insurance liabilities that is at least 10 

percent of the amount of the total assets 

on the corporation’s applicable financial 

4572 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

statement for the applicable reporting 

period. 

(2) Predominantly engaged in an 

insurance business—(i) In general. A 

foreign corporation is not considered 

predominantly engaged in an insurance 

business in any taxable year unless 

more than half of the business of the 

foreign corporation is the issuing of 

insurance or annuity contracts or the 

reinsuring of risks underwritten by 

insurance companies. This 

determination is made based on the 

character of the business actually 

conducted in the taxable year. The fact 

that a foreign corporation has been 

holding itself out as an insurer for a long 

period is not determinative of whether 

the foreign corporation is 

predominantly engaged in an insurance 

business. 

(ii) Facts and circumstances. Facts 

and circumstances to consider in 

determining whether a foreign 

corporation is predominantly engaged 

in an insurance business include (but 

are not limited to)— 

(A) Claims payment patterns for the 

current year and prior years; 

(B) The foreign corporation’s loss 

exposure as calculated for a regulator or 

for a credit rating agency, or, if those are 

not calculated, for internal pricing 

purposes; 

(C) The percentage of gross receipts 

constituting premiums for the current 

and prior years; and 

(D) The number and size of insurance 

contracts issued or taken on through 

reinsurance by the foreign corporation. 

(iii) Examples of facts indicating a 

foreign corporation is not 

predominantly engaged in an insurance 

business. Examples of facts that may 

indicate a foreign corporation is not 

predominantly engaged in an insurance 

business include (but are not limited 

to)— 

(A) A small overall number of insured 

risks with low likelihood but large 

potential costs; 

(B) Employees and agents of the 

foreign corporation focused to a greater 

degree on investment activities than 

underwriting activities; and 

(C) Low loss exposure. 

(3) Runoff-related circumstances. 

During the annual reporting period 

covered by the applicable financial 

statement, a foreign corporation fails to 

satisfy the 25 percent test solely due to 

runoff-related circumstances only if the 

corporation— 

(i) Was engaged in the process of 

terminating its pre-existing, active 

conduct of an insurance business 

(within the meaning of section 

1297(b)(2)(B)) under the supervision of 

its applicable insurance regulatory body 

or pursuant to any court-ordered 

receivership proceeding (liquidation, 

rehabilitation, or conservation) and fails 

to satisfy the 25 percent test because the 

corporation is required to hold 

additional assets due to its business 

being in runoff; 

(ii) Has no plan or intention to enter 

into, and did not issue or enter into, any 

insurance, annuity, or reinsurance 

contract, other than a contractually 

obligated renewal of an existing 

insurance contract or a reinsurance 

contract pursuant to and consistent with 

the termination of its active conduct of 

an insurance business; and 

(iii) Made payments during the 

annual reporting period covered by the 

applicable financial statement as 

required to satisfy claims under 

insurance, annuity, or reinsurance 

contracts. 

(4) Rating-related circumstances. A 

foreign corporation fails to satisfy the 25 

percent test solely due to rating-related 

circumstances only if— 

(i) The 25 percent test is not met due 

to capital and surplus amounts that a 

generally recognized credit rating 

agency considers necessary for the 

foreign corporation to obtain a public 

rating with respect to its financial 

strength, and the foreign corporation 

maintains such capital and surplus in 

order to obtain the minimum credit 

rating necessary for the annual reporting 

period by the foreign corporation to be 

able to write the business in its 

regulatory or board supervised business 

plan. This paragraph (c)(4)(i) applies 

only if the foreign corporation is a 

mortgage insurance company (as 

defined in paragraph (f)(10) of this 

section) or if more than half of the 

foreign corporation’s net written 

premiums for the annual reporting 

period (or the average of the net written 

premiums for the foreign corporation’s 

annual reporting period and the two 

immediately preceding annual reporting 

periods) are from insurance coverage 

against the risk of loss from a 

catastrophic loss event (that is, a low 

frequency but high severity loss event); 

or 

(ii) The foreign corporation is a 

financial guaranty insurance company 

(as defined in paragraph (f)(5) of this 

section). 

(5) Election—(i) In general. A United 

States person may make the election 

under section 1297(f)(2) for its taxable 

year if the foreign corporation directly 

provides the United States person a 

statement, signed by a responsible 

officer of the foreign corporation or an 

authorized representative of the foreign 

corporation, or the foreign corporation 

(or its foreign parent corporation on its 

behalf) makes a publicly available 

statement (such as in a public filing, 

disclosure statement, or other notice 

provided to United States persons that 

are shareholders of the foreign 

corporation) that it satisfied the 

requirements of section 1297(f)(2) and 

paragraph (d)(1) of this section during 

the foreign corporation’s applicable 

reporting period. However, a United 

States person may not rely upon any 

statement by the foreign corporation (or 

its foreign parent corporation) to make 

the election under section 1297(f)(2) if 

the shareholder knows or has reason to 

know based on reasonably accessible 

information that the statement made by 

the foreign corporation (or its foreign 

parent corporation) was incorrect. 

(ii) Information provided by foreign 

corporation. In addition to a statement 

that the foreign corporation satisfied the 

requirements of section 1297(f)(2) and 

paragraph (d)(1) of this section, the 

statement described in paragraph 

(d)(5)(i) of this section also must 

include: 

(A) The ratio of applicable insurance 

liabilities to total assets for the 

applicable reporting period; and 

(B) A statement indicating whether 

the failure to satisfy the 25 percent test 

described in paragraph (c) of this 

section was the result of runoff-related 

or rating-related circumstances, along 

with a brief description of those 

circumstances. 

(iii) Time and manner for making the 

election. Except as provided in 

paragraph (d)(5)(iv), the election 

described in paragraph (d)(1) of this 

section may be made by a United States 

person who owns stock in the foreign 

corporation by completing the 

appropriate part of Form 8621 (or 

successor form) for each taxable year of 

the United States person in which the 

election applies. A United States person 

must attach the Form 8621 (or successor 

form) to its original or amended Federal 

income tax return for the taxable year of 

the United States person to which the 

election relates. A United States person 

can attach the Form 8621 (or successor 

form) to an amended return for the 

taxable year of the United States person 

to which the election relates if the 

United States person can demonstrate 

the reason for not filing the form with 

its original return was due to reasonable 

cause. 

(iv) Deemed election for small 

shareholders in publicly traded 

companies—(A) In general. A United 

States person who owns publicly traded 

stock in a foreign corporation will be 

deemed to make the election under 

section 1297(f)(2) with respect to the 

foreign corporation and its subsidiaries 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4573 

if the following requirements are 

satisfied: 

(1) The stock of the foreign 

corporation that is owned by the United 

States person (including stock owned 

indirectly) has a value of $25,000 or less 

($50,000 or less in the case of a joint 

return) on the last day of the United 

States person’s taxable year and on any 

day during the taxable year on which 

the United States person disposes of 

stock of the foreign corporation; and 

(2) If the United States person owns 

stock of the foreign corporation 

indirectly through a domestic 

partnership, domestic trust, domestic 

estate, or S corporation (a domestic 

pass-through entity), the stock of the 

foreign corporation that is owned by the 

domestic pass-through entity has a 

value of $25,000 or less on the last day 

of the taxable year of the domestic passthrough entity that ends with or within 

the United States person’s taxable year 

and on any day during the taxable year 

of the domestic pass-through entity on 

which it disposes of stock of the foreign 

corporation. 

(B) Publicly traded stock. For the 

purpose of paragraph (d)(5)(iv)(A) of 

this section, stock is publicly traded if 

it would be treated as marketable stock 

within the meaning of section 1296(e) 

and § 1.1296–2 (without regard to 

§ 1.1296–2(d)) if the election under 

section 1297(f)(2) is not made. 

(v) Options. If a United States person 

is considered to own stock in a foreign 

corporation by reason of holding an 

option, the United States person may 

make the election under section 

1297(f)(2) (or may be deemed to make 

an election under paragraph (d)(5)(iv) of 

this section) with respect to the foreign 

corporation or its subsidiaries in the 

same manner as if the United States 

person owned stock in the foreign 

corporation. 

(6) Stock ownership. For purposes of 

this section, ownership of stock in a 

foreign corporation means either direct 

ownership of such stock or indirect 

ownership determined using the rules 

specified in § 1.1291–1(b)(8). 

(e) Rules limiting the amount of 

applicable insurance liabilities—(1) In 

general. For purposes of determining 

whether a foreign corporation satisfies 

the 25 percent test described in 

paragraph (c) of this section or the 10 

percent test described in paragraph 

(d)(1)(iii) of this section, the rules of this 

paragraph (e) apply to limit the amount 

of applicable insurance liabilities of the 

foreign corporation. 

(2) General limitation on applicable 

insurance liabilities. The amount of 

applicable insurance liabilities may not 

exceed any of the amounts described in 

paragraphs (e)(2)(i) to (iii) of this 

section. This paragraph (e)(2) applies 

after applying paragraph (e)(3) of this 

section. 

(i) The amount of applicable 

insurance liabilities of the foreign 

corporation shown on any financial 

statement that the foreign corporation 

filed or was required to file with its 

applicable insurance regulatory body for 

the financial statement’s applicable 

reporting period; 

(ii) If the foreign corporation’s 

applicable financial statement is 

prepared on the basis of either GAAP or 

IFRS, the amount of the foreign 

corporation’s applicable insurance 

liabilities determined on the basis of its 

applicable financial statement, whether 

or not the foreign corporation files the 

statement with its applicable insurance 

regulatory body; or 

(iii) The amount of applicable 

insurance liabilities required for the 

foreign corporation by the applicable 

law or regulation of the jurisdiction of 

the applicable insurance regulatory 

body at the end of the applicable 

reporting period (or a lesser amount of 

applicable insurance liabilities, if the 

foreign corporation is holding a lesser 

amount as a permitted practice of the 

applicable regulatory body). 

(3) Discounting. If an applicable 

financial statement or a financial 

statement described in paragraph (e)(2) 

of this section is prepared on the basis 

of an accounting method other than 

GAAP or IFRS and does not discount 

applicable insurance liabilities on an 

economically reasonable basis, the 

amount of applicable insurance 

liabilities may not exceed the amount of 

applicable insurance liabilities on the 

financial statement reduced by applying 

the discounting methods that would 

apply under either GAAP or IFRS to the 

insurance or annuity contracts to which 

the applicable insurance liabilities at 

issue relate. The foreign corporation 

may choose whether to apply either 

GAAP or IFRS discounting methods for 

this purpose. 

(4) [Reserved]. 

(5) [Reserved]. 

(f) Definitions. The following 

definitions apply for purposes of this 

section. 

(1) Applicable financial statement. 

The term applicable financial statement 

means the foreign corporation’s 

financial statement prepared for 

financial reporting purposes, listed in 

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

section, and that has the highest 

priority. The financial statements are, in 

order of descending priority— 

(i) GAAP statements. A financial 

statement that is prepared in accordance 

with GAAP; 

(ii) IFRS statements. A financial 

statement that is prepared in accordance 

with IFRS; or 

(iii) Regulatory annual statement. A 

financial statement required to be filed 

with the applicable insurance regulatory 

body. 

(iv) [Reserved]. 

(2) Applicable insurance liabilities— 

(i) In general. The term applicable 

insurance liabilities means, with respect 

to any life or property and casualty 

insurance business— 

(A) Reported losses (which are 

expected payments to policyholders for 

sustained losses related to insured 

events under an insurance contract that 

have occurred and have been reported 

to, but not paid by, the insurer as of the 

financial statement end date), and 

incurred but not reported losses (which 

are expected payments to policyholders 

for sustained losses relating to insured 

events under an insurance contract that 

have occurred but have not been 

reported to the insurer as of the 

financial statement end date); 

(B) Unpaid loss adjustment expenses 

(including reasonable estimates of 

anticipated loss adjustment expenses) 

associated with investigating, 

defending, settling, and adjusting paid 

losses, unpaid reported losses, and 

incurred but not reported losses (of the 

type described in paragraph (f)(2)(i)(A) 

of this section) as of the financial 

statement end date; and 

(C) The aggregate amount of reserves 

(excluding deficiency, contingency, or 

unearned premium reserves) held as of 

the financial statement end date to 

mature or liquidate potential, future 

claims for death, annuity, or health 

benefits that may become payable under 

contracts providing, at the time the 

reserve is computed, coverage for 

mortality or morbidity risks; 

(D) Provided, however, that— 

(1) No item or amount shall be taken 

into account more than once in 

determining applicable insurance 

liabilities; 

(2) The applicable insurance 

liabilities eligible to be taken into 

account in applying this paragraph (f)(2) 

include only the applicable insurance 

liabilities of the foreign corporation 

whose QIC status is being determined; 

and 

(3) [Reserved]. 

(ii) Amounts not specified in 

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

Amounts not specified in paragraph 

(f)(2)(i) of this section are not applicable 

insurance liabilities. For example, the 

term applicable insurance liability does 

4574 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

not include any amount held by an 

insurance company as a deposit liability 

that is not an insurance liability, such 

as a funding agreement, a guaranteed 

investment contract, premium or other 

deposit funds, structured settlements, or 

any other substantially similar contract 

issued by an insurance company. The 

term applicable insurance liabilities also 

does not include the amount of any 

reserve for a life insurance or annuity 

contract the payments of which do not 

depend on the life or life expectancy of 

one or more individuals. 

(3) Applicable insurance regulatory 

body. The term applicable insurance 

regulatory body means the entity that 

has been established by law to license 

or authorize a corporation to engage in 

an insurance business, to regulate 

insurance company solvency, and, in 

the case of an applicable financial 

statement described in paragraph 

(f)(1)(iii), is the entity to which the 

applicable financial statement is 

provided. 

(4) Applicable reporting period. The 

term applicable reporting period is the 

last annual reporting period for a 

financial statement ending with or 

within the taxable year of a U.S. person 

owning stock in a foreign corporation, 

within the meaning of paragraph (d)(6) 

of this section. 

(5) Financial guaranty insurance 

company. The term financial guaranty 

insurance company means any 

insurance company whose sole business 

is to insure or reinsure only the type of 

business written by, or that would be 

permitted to be written by a company 

licensed under, and compliant with, a 

U.S. state law, modeled after the 

Financial Guaranty Insurance Guideline 

as established by National Association 

of Insurance Companies, that 

specifically governs the licensing and 

regulation of financial guaranty 

insurance companies. 

(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, and 

a statement of cash flows (or equivalent 

statements under the applicable 

reporting standard). 

(ii) [Reserved]. 

(iii) [Reserved]. 

(7) Generally accepted accounting 

principles or GAAP. The term generally 

accepted accounting principles or 

GAAP means United States generally 

accepted accounting principles 

described in standards established and 

made effective by the Financial 

Accounting Standards Board. 

(8) Insurance business. For purposes 

of this section, § 1.1297–5, and 

§ 1.1297–6, insurance business means 

the business of issuing insurance and 

annuity contracts and the reinsuring of 

risks underwritten by insurance 

companies, together with those 

investment activities and administrative 

services that are required to support (or 

are substantially related to) insurance, 

annuity, or reinsurance contracts issued 

or entered into by the foreign 

corporation. 

(9) International financial reporting 

standards or IFRS. The term 

international financial reporting 

standards or IFRS means accounting 

standards established and made 

effective by the International 

Accounting Standards Board. 

(10) Mortgage insurance company. 

For purposes of this section, mortgage 

insurance company means any 

insurance company whose sole business 

is to insure or reinsure against a lender’s 

loss of all or a portion of the principal 

amount of a mortgage loan upon default 

of the mortgagor. 

(11) Total assets. For purposes of 

section 1297(f) and this section, a 

foreign corporation’s total assets are the 

aggregate value of the real property and 

personal property that the foreign 

corporation reports on its applicable 

financial statement as of the financial 

statement end date. 

(g) Applicability date. The rules of 

this section apply to taxable years of 

shareholders beginning on or after 

January 14, 2021. A shareholder may 

choose to apply such rules 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 the provisions of this section 

and § 1.1297–6 for such year and all 

subsequent years. 

§ 1.1297–5 [Reserved]. 

§ 1.1297–6 Exception from the definition of 

passive income for active insurance 

income. 

(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 and rules related 

to certain income of a qualifying 

domestic insurance corporation. 

Paragraph (b) of this section provides a 

general rule that excludes from passive 

income certain income of a qualifying 

insurance corporation (QIC), as defined 

in § 1.1297–4(b), and certain income of 

a qualifying domestic insurance 

corporation. Paragraph (c) of this section 

provides rules excluding certain assets 

for purposes of the passive asset test 

under section 1297(a)(2). Paragraph (d) 

of this section provides rules concerning 

the treatment of income and assets of 

certain look-through subsidiaries and 

look-through partnerships of a QIC. 

Paragraph (e) of this section provides 

rules relating to qualifying domestic 

insurance corporations. Paragraph (f) of 

this section provides the applicability 

date of this section. 

(b) Exclusion from passive income of 

active insurance income. For purposes 

of section 1297 and § 1.1297–1, passive 

income does not include— 

(1) Income that a QIC derives in the 

active conduct of an insurance business 

(within the meaning of section 

1297(b)(2)(B)); and 

(2) Income of a qualifying domestic 

insurance corporation. 

(c) Exclusion of assets for purposes of 

the passive asset test under section 

1297(a)(2). For purposes of section 1297 

and § 1.1297–1, passive assets (as 

defined in § 1.1297–1(f)(5)), do not 

include— 

(1) Assets of a QIC available to satisfy 

liabilities of the QIC related to its 

insurance business (as defined in 

§ 1.1297–4(f)(8)), if the QIC is engaged 

in the active conduct of an insurance 

business (within the meaning of section 

1297(b)(2)(B)); and 

(2) Assets of a qualifying domestic 

insurance corporation. 

(d) Treatment of income and assets of 

certain look-through subsidiaries and 

look-through partnerships for purposes 

of the section 1297(b)(2)(B) exception— 

(1) General rule. For purposes of 

applying paragraphs (b)(1) and (c)(1) of 

this section, a QIC is treated as receiving 

the income or holding the assets of a 

look-through subsidiary or look-through 

partnership to the extent provided in 

section 1297(c) and § 1.1297–2(b)(2) or 

§ 1.1297–2(b)(3). Subject to the 

limitation of paragraph (d)(2) of this 

section, a QIC’s proportionate share of 

the income or assets of a look-through 

subsidiary or look-through partnership 

may be treated as earned or held 

directly by the QIC, and thus as nonpassive under paragraphs (b)(1) and 

(c)(1) of this section, if the requirements 

of those paragraphs are satisfied. 

(2) Limitation. A QIC that is engaged 

in the active conduct of an insurance 

business (within the meaning of section 

1297(b)(2)(B)) may not treat its 

proportionate share of the income or 

assets of a look-through subsidiary or 

look-through partnership as non-passive 

to the extent that it exceeds the greater 

of— 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4575 

(i) The QIC’s proportionate share of 

the income or assets, respectively, of the 

look-through subsidiary or look-through 

partnership multiplied by a fraction, the 

numerator of which is the net equity 

value of the interests held by the QIC in 

the look-through subsidiary or lookthrough partnership, and the 

denominator of which is the value of the 

QIC’s proportionate share of the assets 

of the look-through subsidiary or lookthrough partnership; and 

(ii) The QIC’s proportionate share of 

the income or assets, respectively, of the 

look-through subsidiary or look-through 

partnership that are treated as nonpassive in the hands of the look-through 

subsidiary or look-through partnership. 

(3) Examples. The following examples 

illustrate the rules of this section. 

(i) Example 1: QIC holds all the stock 

of an investment subsidiary—(A) Facts. 

(1) F1 is a foreign corporation. In Year 

1, F1 meets the definition of a QIC 

under section 1297(f) and § 1.1297–4 

and is engaged in the active conduct of 

an insurance business within the 

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

Throughout Year 1, F1 owns all the 

stock of F2, a foreign corporation that is 

not a QIC and is engaged solely in the 

investment of passive assets. The stock 

of F2 is an asset that is available to 

satisfy liabilities of F1 related to its 

insurance business within the meaning 

of paragraph (c)(1) of this section. The 

assets of F1 are measured on the basis 

of value under § 1.1297–1(d)(1)(v)(C). 

(2) Throughout Year 1, F2 owns assets 

with a value of $1,000x and adjusted 

bases of $500x, all of which are treated 

as passive in the hands of F2. F2 has 

outstanding debt with a principal 

amount of $250x. On the financial 

statement end date of F1’s applicable 

financial statement, the net equity value 

of the F2 stock held by F1 is $750x. In 

Year 1, F2 earned $100x of income that 

is treated as passive in the hands of F2. 

(B) Result—(1) Because F1 owns all of 

the stock of F2, F2 is a look-through 

subsidiary of F1 within the meaning of 

§ 1.1297–2(g)(3). Under section 1297(c) 

and § 1.1297–2(b)(2), F1 is treated as if 

it held 100% of the assets of F2 and 

received directly 100% of the income of 

F2. Under paragraph (d)(1) of this 

section, because F1 is engaged in the 

active conduct of an insurance business 

and the stock of F2 is an asset that is 

available to satisfy the insurance 

liabilities of F1, F1 treats its 

proportionate share of the income and 

assets of F2 as non-passive. The amount 

of income and assets that is treated as 

non-passive is subject to the limitation 

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

(2) Under paragraph (d)(2) of this 

section, the amount of F1’s 

proportionate share of F2’s income that 

is treated as non-passive cannot exceed 

the greater of two amounts: $75x, which 

is F1’s proportionate share of F2’s 

income ($100x) multiplied by 75% (the 

net equity value of the F2 stock held by 

F1, which is $750x, divided by the 

value of F1’s proportionate share of F2’s 

assets, which is $1,000x); and zero, 

which is F1’s proportionate share of the 

income of F2 that is treated as nonpassive in the hands of F2. Therefore, 

for the purpose of characterizing F1’s 

proportionate share of F2’s income, 

$75x is treated as non-passive, and $25x 

is treated as passive. 

(3) Under paragraph (d)(2) of this 

section, the amount of F1’s 

proportionate share of F2’s assets that is 

treated as non-passive cannot exceed 

the greater of two amounts: $750x, 

which is F1’s proportionate share of 

F2’s assets ($1,000x) multiplied by 75% 

(the net equity value of the F2 stock 

held by F1, which is $750x, divided by 

the value of F1’s proportionate share of 

F2’s assets, which is $1,000x); and zero, 

which is F1’s proportionate share of the 

assets of F2 that are treated as nonpassive in the hands of F2. Therefore, 

for the purpose of characterizing F1’s 

proportionate share of the assets of F2, 

$750x is treated as non-passive, and 

$250x is treated as passive. 

(C) Alternative facts—(1) Facts. The 

facts are the same as in paragraph 

(d)(3)(i)(A) of this section (paragraph (A) 

of this Example 1), except that the assets 

of F1 are measured on the basis of 

adjusted basis under § 1.1297– 

1(d)(1)(v)(C) pursuant to a valid election 

under § 1.1297–1(d)(1)(iii). 

(2) Result. The result with respect to 

F1’s proportionate share of the income 

of F2 is the same as in paragraph 

(d)(3)(i)(B)(2) of this section (paragraph 

(B)(2) of this Example 1). Because the 

assets of F1 are measured on the basis 

of adjusted basis under § 1.1297– 

1(d)(1)(v)(C), F1’s proportionate share of 

the passive assets of F2 is equal to 

$500x (100% of $500x adjusted bases). 

Under paragraph (d)(2) of this section, 

the amount of F1’s proportionate share 

of F2’s assets that may be treated as nonpassive cannot exceed the greater of two 

amounts: $375x, which is F1’s 

proportionate share of F2’s passive 

assets ($500x) multiplied by 75% (the 

net equity value of the F2 stock held by 

F1, which is $750x, divided by the 

value of F1’s proportionate share of F2’s 

assets, which is $1,000x); and zero, 

which is F1’s proportionate share of the 

assets of F2 that are treated as nonpassive in the hands of F2. Therefore, 

for the purpose of characterizing F1’s 

proportionate share of the assets of F2, 

$375x is treated as non-passive, and 

$125x is treated as passive. 

(ii) Example 2: QIC holds all the stock 

of an operating subsidiary—(A) Facts. 

(1) F1 is a foreign corporation. In Year 

1, F1 meets the definition of a QIC 

under section 1297(f) and § 1.1297–4 

and is engaged in the active conduct of 

an insurance business within the 

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

Throughout Year 1, F1 owns all the 

stock of F2, a foreign corporation 

engaged in a manufacturing business 

that is not a QIC. The stock of F2 is an 

asset that is available to satisfy 

liabilities of F1 related to its insurance 

business within the meaning of 

paragraph (c)(1) of this section. The 

assets of F1 are measured on the basis 

of value under § 1.1297–1(d)(1)(v)(C). 

(2) Throughout Year 1, F2 owns assets 

with a value of $1,200x, of which 

$1,000x is treated as non-passive and 

$200x is treated as passive in the hands 

of F2. F2 has outstanding debt of $600x. 

On the financial statement end date of 

F1’s applicable financial statement, the 

net equity value of the F2 stock held by 

F1 is $600x. In Year 1, F2 earned $120x 

of income, of which, in the hands of F2, 

$100x is treated as non-passive and 

$20x is treated as passive. 

(B) Result—(1) Because F1 owns all 

the stock of F2, F2 is a look-through 

subsidiary of F1 within the meaning of 

§ 1.1297–2(g)(3). Under section 1297(c) 

and § 1.1297–2(b)(2), F1 is treated as if 

it held 100% of the assets of F2 and 

received directly 100% of the income of 

F2. Under paragraph (d)(1) of this 

section, because F1 is engaged in the 

active conduct of an insurance business 

and the stock of F2 is an asset that is 

available to satisfy the insurance 

liabilities of F1, F1 treats its 

proportionate share of the income and 

assets of F2 as non-passive. The amount 

of income and assets that is treated as 

non-passive is subject to the limitation 

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

(2) Under paragraph (d)(2) of this 

section, the amount of F1’s 

proportionate share of F2’s income that 

is treated as non-passive cannot exceed 

the greater of two amounts: $60x, which 

is F1’s proportionate share of F2’s 

income ($120x) multiplied by 50% (the 

net equity value of the F2 stock held by 

F1, which is $600x, divided by the 

value of F1’s proportionate share of F2’s 

assets, which is $1,200x); and $100x, 

which is F1’s proportionate share of the 

income of F2 that is treated as nonpassive in the hands of F2. Therefore, 

for the purpose of characterizing F1’s 

proportionate share of F2’s income, 

$100x is treated as non-passive, and 

$20x is treated as passive. 

4576 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

(3) Under paragraph (d)(2) of this 

section, the amount of F1’s 

proportionate share of F2’s assets that is 

treated as non-passive cannot exceed 

the greater of two amounts: $600x, 

which is F1’s proportionate share of 

F2’s income ($1,200x) multiplied by 

50% (the net equity value of the F2 

stock held by F1, which is $600x, 

divided by the value of F1’s 

proportionate share of F2’s assets, 

which is $1,200x); and $1,000x, which 

is F1’s proportionate share of the assets 

of F2 that are treated as non-passive in 

the hands of F2. Therefore, for the 

purpose of characterizing F1’s 

proportionate share of the assets of F2, 

$1,000x is treated as non-passive, and 

$200x is treated as passive. 

(e) Qualifying domestic insurance 

corporation—(1) General rule. A 

domestic corporation (or a foreign 

corporation that is treated as a domestic 

corporation pursuant to a valid section 

953(d) election and that computes its 

reserves as a domestic insurance 

company would under subchapter L) is 

a qualifying domestic insurance 

corporation if it is— 

(i) Subject to tax as an insurance 

company under subchapter L of the 

Internal Revenue Code; 

(ii) Subject to federal income tax on 

its net income; and 

(iii) A look-through subsidiary of a 

tested foreign corporation. 

(2) [Reserved]. 

(3) [Reserved]. 

(f) Applicability date. The rules of this 

section apply to taxable years of 

shareholders beginning on or after 

January 14, 2021. A shareholder may 

choose to apply such rules 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 the provisions of this section 

and § 1.1297–4, for such year and all 

subsequent years. 

■ Par. 7. Section 1.1298–0 is amended 

by: 

■ 1. Revising the introductory text. 

■ 2. Adding entries for §§ 1.1298–2 and 

1.1298–4 in numerical order. 

The revision and additions read as 

follows: 

§ 1.1298–0 Passive foreign investment 

company—table of contents. 

This section contains a listing of the 

paragraph headings for §§ 1.1298–1, 

1.1298–2, 1.1298–3, and 1.1298–4. 

* * * * * 

§ 1.1298–2 Rules for certain corporations 

changing businesses. 

(a) Overview. 

(b) Change of business exception. 

(c) Special rules. 

(d) Disposition of stock in a look-through 

subsidiary or partnership interests in a lookthrough partnership. 

(e) Application of change of business 

exception. 

(f) Examples. 

(1) Example 1. 

(i) Facts. 

(ii) Results. 

(2) Example 2. 

(i) Facts. 

(ii) Results. 

(g) Applicability date. 

* * * * * 

1.1298–4 Rules for certain foreign 

corporations owning stock in 25-percentowned domestic corporations. 

(a) Overview. 

(b) Treatment of certain foreign 

corporations owning stock in a 25-percentowned domestic corporation. 

(1) General rule. 

(2) Qualified stock and second-tier 

domestic corporation. 

(c) Indirect ownership of stock through a 

partnership. 

(d) Section 531 tax. 

(1) Subject to section 531 tax. 

(2) Waiver of treaty benefits. 

(i) Tested foreign corporation that files, or 

is required to file, a Federal income tax 

return. 

(ii) Tested foreign corporation that is not 

required to file a Federal income tax return. 

(e) Anti-abuse rule. 

(1) General rule. 

(2) [Reserved]. 

(3) [Reserved]. 

(f) Applicability date. 

■ Par. 8. Section 1.1298–2 is added to 

read as follows: 

§ 1.1298–2 Rules for certain corporations 

changing businesses. 

(a) Overview. This section provides 

rules under section 1298(b)(3) and 

1298(g) that apply to certain foreign 

corporations that dispose of one or more 

active trades or businesses for purposes 

of determining whether a foreign 

corporation is treated as a passive 

foreign investment company (PFIC). 

Paragraph (b) of this section provides a 

rule that applies to certain foreign 

corporations that dispose of one or more 

active trades or businesses. Paragraph 

(c) of this section provides special rules. 

Paragraph (d) of this section provides a 

rule for the treatment of the disposition 

of the stock of a look-through subsidiary 

(as defined in § 1.1297–2(g)(3)) or 

partnership interests in a look-through 

partnership (as defined in § 1.1297– 

2(g)(4)). Paragraph (e) of this section 

provides guidance on when a tested 

foreign corporation can apply the 

change of business exception. Paragraph 

(f) provides examples illustrating the 

application of the rules in this section. 

Paragraph (g) provides the applicability 

date for this section. 

(b) Change of business exception. A 

corporation is not treated as a PFIC for 

a taxable year if— 

(1) Neither the corporation (nor any 

predecessor) was a PFIC for any prior 

taxable year; 

(2) Either— 

(i) Substantially all of the passive 

income of the corporation for the 

taxable year is attributable to proceeds 

from the disposition of one or more 

active trades or businesses; or 

(ii) Following the disposition of one 

or more active trades or businesses, 

substantially all of the passive assets of 

the corporation on each of the 

measuring dates that occur during the 

taxable year and after the disposition are 

attributable to proceeds from the 

disposition; and 

(3) The corporation reasonably does 

not expect to be and is not a PFIC for 

either of the first two taxable years 

following the taxable year. 

(c) Special rules. The rules in this 

paragraph (c) apply for purposes of 

section 1298(b)(3) and this section. 

(1) Income is attributable to proceeds 

from the disposition of one or more 

active trades or businesses to the extent 

the income is derived from the 

investment of the proceeds from the 

disposition of assets used in the active 

trades or businesses. 

(2) Assets are attributable to proceeds 

from the disposition of one or more 

active trades or businesses only to the 

extent the assets are the proceeds of the 

disposition of assets used in the active 

trades or businesses, or are derived from 

the investment of the proceeds. 

(3) 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 do not 

include the officers and employees of 

related entities as provided in 

§ 1.367(a)–2(d)(3). However, if activities 

performed by the officers and 

employees of a look-through subsidiary 

of a corporation (including a lookthrough subsidiary with respect to 

which paragraph (d) of this section 

applies) or of a look-through partnership 

would be taken into account by the 

corporation pursuant to § 1.1297–2(e) if 

it applied, such activities are taken into 

account for purposes of the 

determination of the existence of an 

active trade or business and the 

determination of whether assets are 

used in an active trade or business. 

(4) In the case of a corporation that 

satisfies the condition in paragraph 

(b)(2)(ii) of this section, the condition in 

paragraph (b)(3) of this section is 

deemed to be satisfied if the corporation 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4577 

completely liquidates by the end of the 

taxable year following the year with 

respect to which the tested foreign 

corporation applies the exception in 

paragraph (b) of this section. 

(d) Disposition of stock of a lookthrough subsidiary or partnership 

interests in a look-through partnership. 

For purposes of paragraph (b) of this 

section, the proceeds from a tested 

foreign corporation’s disposition of the 

stock of a look-through subsidiary or of 

partnership interests in a look-through 

partnership are treated as proceeds from 

the disposition of a proportionate share 

of the assets held by the look-through 

subsidiary or look-through partnership 

on the date of the disposition, based on 

the method (value or adjusted bases) 

used to measure the assets of the tested 

foreign corporation for purposes of 

section 1297(a)(2). The proceeds 

attributable to assets used by the lookthrough subsidiary or look-through 

partnership in an active trade or 

business are treated as proceeds 

attributable to the disposition of an 

active trade or business. 

(e) Application of change of business 

exception. A tested foreign corporation 

can apply the exception in paragraph (b) 

of this section with respect to a taxable 

year of a disposition of an active trade 

or business or an immediately 

succeeding taxable year, but cannot 

apply the exception with respect to 

more than one taxable year for a 

disposition. 

(f) Examples. The following examples 

illustrate the rules of this section. For 

purposes of these examples: USP is a 

domestic corporation; TFC and FS are 

foreign corporations that are not 

controlled foreign corporations (within 

the meaning of section 957(a)); each 

corporation has outstanding a single 

class of stock; USP has owned its 

interest in TFC since the formation of 

TFC; each of USP, TFC, and FS have a 

calendar taxable year; and for purposes 

of section 1297(a)(2), TFC measures the 

amount of its assets based on value. 

(1) Example 1—(i) Facts. (A) USP 

owns 15% of the outstanding stock of 

TFC. TFC owns 30% of the outstanding 

stock of FS. FS operates an active trade 

or business and 100% of its assets are 

used in the active trade or business. The 

value of FS’s non-passive assets (as 

defined in § 1.1297–1(f)(3)) is $900x; the 

value of FS’s passive assets (which 

include cash and cash equivalents) is 

$100x. TFC has not been treated as a 

PFIC for any taxable year before Year 1 

and has no predecessor. In addition to 

holding the FS stock, TFC directly 

conducts its own active trade or 

business. The value of TFC’s nonpassive assets (other than FS stock) is 

$50x; the value of TFC’s passive assets 

(other than FS stock and assets received 

during Year 1) is $30x. TFC earns $1x 

of non-passive income (as defined in 

§ 1.1297–1(f)(4)) from its directly 

conducted active trade or business. 

(B) On January 1, Year 1, TFC sells all 

of its FS stock for $300x. The residual 

gain computed under § 1.1297–2(f)(1) on 

the sale of the FS stock is $10x. Under 

§ 1.1297–2(f)(3), $9x of residual gain is 

characterized as non-passive income 

and $1x of residual gain is characterized 

as passive income. TFC earned $5x of 

passive income from the investment of 

the proceeds from the disposition of the 

FS stock during each quarter of Year 1, 

and TFC maintained those earnings 

($20x in total) as well as the disposition 

proceeds in cash for the remainder of 

the year. TFC reinvests the proceeds of 

the FS stock sale in an active trade or 

business during Year 2, and, thus, TFC 

is not a PFIC in Year 2 and Year 3. Less 

than 75% of TFC’s gross income in Year 

1 is passive income (($20x + $1x)/($10x 

+ $20x + $1x) = 68%). However, subject 

to the application of section 1298(b)(3) 

and this section, TFC would be a PFIC 

in Year 1 under section 1297(a)(2) 

because the proceeds from the sale of 

the FS stock ($300x) together with TFC’s 

other passive assets exceed 50% of 

TFC’s total assets on each quarterly 

measuring date. For example, on the 

first quarterly measuring date TFC’s 

ratio of passive assets to total assets is 

(($300x + $30x + $5x)/($300x + $30x + 

$5x + $50x)) and on the fourth quarterly 

measuring date TFC’s ratio of passive 

assets to total assets is (($300x + $30x 

+ $20x)/($300x + $30x + $20x + $50x)), 

each of which exceeds 87%. Therefore, 

TFC chooses to apply the change of 

business exception in paragraph (b) of 

this section to Year 1. 

(ii) Results. (A) Under paragraph (d) of 

this section, for purposes of applying 

section 1298(b)(3)(B)(i) in Year 1, TFC’s 

proceeds from the disposition of the 

stock of FS that are attributable to assets 

used by FS in an active trade or 

business are considered as from the 

disposition of an active trade or 

business. Because 100% of FS’s assets 

are used in its active trade or business, 

all of TFC’s proceeds are considered as 

from the disposition of an active trade 

or business. Therefore, under paragraph 

(c)(1) of this section, the passive income 

considered attributable to proceeds from 

a disposition of one or more active 

trades or businesses is $20x (from 

investment of disposition proceeds). 

Because TFC reasonably does not expect 

to be a PFIC in Year 2 and Year 3, and 

TFC is not, in fact, a PFIC for those 

years, TFC will not be treated as a PFIC 

in Year 1 by reason of section 1298(b)(3) 

and paragraph (b) of this section, based 

on the satisfaction of the condition in 

paragraph (b)(2)(i) of this section, 

because the 95% ($20x/($20x + $1x)) of 

TFC’s passive income for Year 1 that is 

attributable to proceeds of the 

disposition of FS’s active trade or 

business constitutes substantially all of 

its passive income. 

(B) TFC would also not be treated as 

a PFIC in Year 1 by reason of section 

1298(b)(3) and paragraph (b) of this 

section, based on the satisfaction of the 

condition in paragraph (b)(2)(ii) of this 

section, because the over 91% of TFC’s 

passive assets on the quarterly 

measuring dates during Year 1 following 

the disposition of the stock of FS that is 

attributable to proceeds of the 

disposition of FS’s active trade or 

business constitutes substantially all of 

its passive assets. For example, on the 

first quarterly measuring date TFC’s 

ratio of passive assets attributable to the 

proceeds of the disposition of FS’s 

active trade or business to its total 

passive assets is 91% ($305x/($305x + 

$30x)), and the same ratio for the fourth 

quarterly measuring date is 91.4% 

($320x/($320x + $30x)). 

(C) Under paragraph (e) of this 

section, TFC cannot claim the section 

1298(b)(3) exception in relation to the 

income attributable to the proceeds of 

the FS stock sale in Year 2 because TFC 

already claimed the exception for Year 

1. 

(2) Example 2—(i) Facts. The facts are 

the same as in paragraph (f)(1)(i) of this 

section (the facts in Example 1), except 

that during the first quarter of Year 1, 

TFC earned only $4x of passive income 

($1x per quarter) from the investment of 

the proceeds from the disposition of the 

FS stock and earned $12x of passive 

income ($3x per quarter) from its other 

passive assets and maintained such 

earnings in cash for the remainder of the 

year. 

(ii) Results. The results are the same 

as in paragraph (f)(1)(ii) of this section 

(the facts in Example 1), except that 

under paragraph (c)(1) of this section, 

the passive income considered 

attributable to proceeds from a 

disposition of one or more active trades 

or businesses is $4x (from investment of 

disposition proceeds). Because 24% 

($4x/($4x + $12x + $1x)) of TFC’s 

passive income for Year 1 is attributable 

to proceeds of the disposition of FS’s 

active trade or business, and 24% does 

not constitute substantially all of TFC’s 

passive income for Year 1, TFC does not 

qualify for the exception from treatment 

as a PFIC in section 1298(b)(3) and 

paragraph (b)(2)(i) of this section for 

Year 1. However, under paragraphs 

(b)(2)(ii) and (d) of this section, more 

4578 Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 

than $300x ($300x disposition proceeds 

+ amounts earned from investment of 

disposition proceeds) of TFC’s passive 

assets held on each quarterly measuring 

date after the disposition is considered 

attributable to the disposition of an 

active trade or business. Because TFC 

reasonably does not expect to be a PFIC 

in Year 2 and Year 3, and TFC is not, 

in fact, a PFIC for those years, TFC will 

not be treated as a PFIC in Year 1 by 

reason of paragraph (b) of this section, 

based on the satisfaction of the 

condition in paragraph (b)(2)(ii) of this 

section, assuming that the average 89% 

of TFC’s passive assets on the quarterly 

measuring dates during Year 1 following 

the disposition of the stock of FS that is 

attributable to proceeds of the 

disposition of FS’s active trade or 

business constitutes substantially all of 

its passive assets. 

(g) Applicability date. The rules of 

this section apply to taxable years of 

shareholders beginning on or after 

January 14, 2021. A shareholder may 

choose to apply such rules for any open 

taxable year beginning before January 

14, 2021, provided that, with respect to 

the tested foreign corporation, the 

shareholder consistently applies the 

provisions of this section and § 1.1291– 

1(b)(8)(iv) and (b)(8)(v)(A), (B), (C), and 

(D) and §§ 1.1297–1 (except that 

consistent treatment is not required 

with respect to § 1.1297–1(c)(1)(i)(A)), 

1.1297–2, and 1.1298–4 for such year 

and all subsequent years. 

■ Par. 9. Section 1.1298–4 is added to 

read as follows: 

§ 1.1298–4 Rules for certain foreign 

corporations owning stock in 25-percentowned domestic corporations. 

(a) Overview. This section provides 

rules under section 1298(b)(7) that 

apply to certain foreign corporations 

that own stock in 25-percent-owned 

domestic corporations (as defined in 

paragraph (b) of this section) for 

purposes of determining whether a 

foreign corporation is a passive foreign 

investment company (PFIC). Paragraph 

(b) of this section provides the general 

rule. Paragraph (c) of this section 

provides rules concerning ownership of 

25-percent-owned domestic 

corporations or qualified stock (as 

defined in paragraph (b)(2) of this 

section) through partnerships. 

Paragraph (d) of this section provides 

rules for determining whether a foreign 

corporation is subject to the tax imposed 

by section 531 (the section 531 tax) and 

for waiving treaty benefits that would 

prevent the imposition of such tax. 

Paragraph (e) of this section provides an 

anti-abuse rule for the application of 

section 1298(b)(7). Paragraph (f) 

provides the applicability date for this 

section. 

(b) Treatment of certain foreign 

corporations owning stock in a 25- 

percent-owned domestic corporation— 

(1) General rule. Except as otherwise 

provided in paragraph (e) of this 

section, when a tested foreign 

corporation (as defined in § 1.1297–1(f)) 

is subject to the section 531 tax (or 

waives any benefit under any treaty that 

would otherwise prevent the imposition 

of the tax), and owns (directly or 

indirectly under the rules in paragraph 

(c) of this section) at least 25 percent (by 

value) of the stock of a domestic 

corporation (a 25-percent-owned 

domestic corporation), for purposes of 

determining whether the foreign 

corporation is a PFIC, any qualified 

stock held directly or indirectly under 

the rules in paragraph (c) of this section 

by the 25-percent-owned domestic 

corporation is treated as an asset that 

does not produce passive income (and 

is not held for the production of passive 

income), and any amount included in 

gross income with respect to the 

qualified stock is not treated as passive 

income. 

(2) Qualified stock and second-tier 

domestic corporation. For purposes of 

this section, the term qualified stock 

means any stock in a C corporation that 

is a domestic corporation and that is not 

a regulated investment company or real 

estate investment trust and the term 

second-tier corporation means the 

corporation. 

(c) Indirect ownership of stock 

through a partnership. For purposes of 

paragraph (b)(1) of this section, a tested 

foreign corporation that is a partner in 

a partnership is considered to own its 

proportionate share of any stock of a 

domestic corporation held by the 

partnership, and a domestic corporation 

that is a partner in a partnership is 

considered to own its proportionate 

share of any qualified stock held by the 

partnership. An upper-tier partnership’s 

attributable share of the stock of a 

domestic corporation or of qualified 

stock held by a lower-tier partnership is 

treated as held by the upper-tier 

partnership for purposes of applying the 

rule in this paragraph (c). 

(d) Section 531 tax—(1) Subject to 

section 531 tax. For purposes of 

paragraph (b) of this section, a tested 

foreign corporation is considered 

subject to the section 531 tax regardless 

of whether the tax is imposed on the 

corporation and of whether the 

requirements of § 1.532–1(c) are met. 

(2) Waiver of treaty benefits—(i) 

Tested foreign corporation that files, or 

is required to file, a Federal income tax 

return. For purposes of paragraph (b) of 

this section, a tested foreign corporation 

that files, or is required to file, a Federal 

income tax return waives the benefit 

under a treaty that would otherwise 

prevent the imposition of the section 

531 tax by attaching to its original or 

amended return for the taxable year for 

which section 1298(b)(7) and paragraph 

(b)(1) of this section are applied or any 

prior taxable year a statement that it 

irrevocably waives treaty protection 

against the imposition of the section 531 

tax, effective for all prior, current, and 

future taxable years, provided the 

taxable year for which the return is filed 

and all subsequent taxable years are not 

closed by the period of limitations on 

assessments under section 6501. 

(ii) Tested foreign corporation that is 

not required to file a Federal income tax 

return. For purposes of paragraph (b) of 

this section, a tested foreign corporation 

that is not required to file a Federal 

income tax return waives the benefit 

under a treaty that would otherwise 

prevent the imposition of the section 

531 tax by a date no later than nine 

months following the close of the 

taxable year for which section 

1298(b)(7) and paragraph (b)(1) of this 

section are applied by— 

(A) Adopting a resolution or similar 

governance document that confirms that 

it has irrevocably waived any treaty 

protection against the imposition of the 

section 531 tax, effective for all prior, 

current, and future taxable years, and 

maintaining a copy of the resolution (or 

other governance document) in its 

records; or 

(B) In the case of a tested foreign 

corporation described in section 

1297(e)(3), including in its public filings 

a statement that it irrevocably waives 

treaty protection against the imposition 

of the section 531 tax, effective for all 

prior, current, and future taxable years. 

(e) Anti-abuse rule—(1) General rule. 

Paragraph (b) of this section does not 

apply with respect to qualified stock in 

a second-tier domestic corporation 

owned by a 25-percent-owned domestic 

corporation if a principal purpose for 

the formation of, acquisition of, or 

holding of stock of the 25-percentowned domestic corporation or the 

second-tier domestic corporation, or for 

the capitalization or other funding of the 

second-tier domestic corporation, is to 

hold passive assets (as defined in 

§ 1.1297–1(f)(5)) through the second-tier 

domestic corporation to avoid 

classification of the tested foreign 

corporation as a PFIC. 

(2) [Reserved]. 

(3) [Reserved]. 

(f) Applicability date. The rules of this 

section apply to taxable years of 

shareholders beginning on or after 

Federal Register / Vol. 86, No. 10 / Friday, January 15, 2021 / Rules and Regulations 4579 

Janyuary 14, 2021. A shareholder may 

choose to apply such rules for any open 

taxable year beginning before January 

14, 2021, provided that, with respect to 

a tested foreign corporation, the 

shareholder consistently applies the 

provisions of this section and § 1.1291– 

1(b)(8)(iv) and (b)(8)(v)(A), (B), (C), and 

(D) and §§ 1.1297–1 (except that 

consistent treatment is not required 

with respect to § 1.1297–1(c)(1)(i)(A)), 

1.1297–2, and 1.1298–2 for such year 

and all subsequent years. 

Sunita Lough, 

Deputy Commissioner for Services and 

Enforcement. 

Approved: November 19, 2020. 

David J. Kautter, 

Assistant Secretary of the Treasury (Tax 

Policy). 

[FR Doc. 2020–27009 Filed 1–14–21; 8:45 am] 

BILLING CODE 4830–01–P