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New Regulations May Help Foreign Corporations Undertaking an IPO Avoid PFIC Status

January 8, 2021

On December 4, 2020, the U.S. Treasury Department (“Treasury”) and the IRS issued final regulations (“Final Regulations”) relating to passive foreign investment companies (“PFICs”), including rules regarding the definition of PFIC and the indirect ownership of PFICs. The Final Regulations, with some adjustments, largely retain and broaden the scope of the taxpayer-friendly approaches and principles set forth in regulations proposed in 2019 (the “2019 Proposed Regulations”). As a result, the Final Regulations offer welcome guidance for (a)  foreign corporations with U.S. owners or desiring to offer their shares to U.S. investors in determining their status as PFICs, and (b) U.S. persons in determining whether they are indirect U.S. owners of equity in a PFIC. In particular, the Final Regulations include a favorable rule for foreign corporations looking to undertake an initial public offering (“IPO”) of their stock in the middle of a taxable year that will make it less likely for them to have to inform their prospective shareholders that they may be PFICs. They also eliminate an undesirable side effect of the repeal, as part of the 2017 Tax Cuts and Jobs Act (the “TCJA”), of Section 958(b)(4), which will reduce the number of foreign corporations that must conclude they are PFICs.1


A foreign corporation is a PFIC for U.S. federal income tax purposes for any taxable year in which (i) at least 75% of its gross income is “passive” income (the “Income Test”), or (ii) at least 50% of the average value of its gross assets consist of assets that produce or are held to produce passive income (the “Asset Test”). For this purpose, passive income generally includes interest, dividends, rents, royalties, and income from the sale of property held for investment. If a foreign corporation is a PFIC, a direct or indirect U.S. owner of equity in that PFIC is generally subject to an adverse tax regime. Any gain from the disposition of its equity in that PFIC and certain distributions by the PFIC are taxed at punitive ordinary income rates, rather than the more favorable rates that apply to an individual’s capital gains or “qualified dividends.” They also trigger an added interest charge determined as if the recharacterized gain was earned ratably during the shareholder’s holding period. These adverse consequences can be mitigated, however, if certain elections are made effective for the first year in which a U.S. person is a direct or indirect owner of equity in a PFIC. Failure to make these elections triggers a so-called “once a PFIC, always a PFIC” rule, pursuant to which the U.S. direct or indirect owner will continue to be subject to the adverse regime above, even for years in which the foreign corporation would not otherwise qualify as a PFIC under both the Income Test and the Asset Test.

Asset Test

An issue of significance for a foreign corporation determining whether they are or may become PFICs under the Asset Test is whether they may use the fair market value (“FMV”) of their assets, including goodwill, or whether they must instead use the adjusted tax basis in those assets. Which method applies is determined as follows: (a) if the foreign corporation is a publicly traded corporation for the taxable year, it uses FMV; (b) if, for the taxable year, it is a controlled foreign corporation (“CFC”)2 and not publicly traded, it must use adjusted tax basis; and (c) in all other cases, it uses FMV unless it has made an election to use adjusted tax basis.

Significance of Value Based Asset Test for CFCs Undertaking an IPO

Typically, using the FMV method makes it less likely that a foreign corporation is or will become a PFIC (given that the corporation is unlikely to have material tax basis in its self-created assets, such as intellectual property and goodwill), making that method more desirable. In this respect, an issue has long existed for foreign corporations that are CFCs (e.g., because their controlling founders may be U.S. citizens or permanent residents, even though they may live outside the United States) and are planning an IPO of their stock in the middle of a taxable year. Until the 2019 Proposed Regulations and the Final Regulations were issued, it appeared as though these foreign corporations might not be allowed to use the FMV method when determining whether they were likely to be PFICs under the Asset Test for their IPO year. As a result, they made Asset Test determinations using the adjusted tax basis method, which often caused them to conclude they were likely to be PFICs for the year of the IPO, making their stock less attractive to certain U.S. investors.

Relief in 2019 Proposed Regulations and Final Regulations

The 2019 Proposed Regulations addressed the uncertainty about which method a CFC should apply for purposes of the Asset Test for the year of its IPO. Such foreign corporation was to use the generally more favorable FMV method in a given taxable year if it was publicly traded for the majority of that taxable year. This rule helped those foreign corporations that were able to complete an IPO in the first half of their taxable year to avoid PFIC status.

The Final Regulations further expand the relief offered in the 2019 Proposed Regulations by treating a foreign corporation whose stock was publicly traded for 20 trading days (approximately one month) or longer during a taxable year as “a publicly traded corporation for the taxable year.” Under the Final Regulations, therefore, a foreign corporation generally will use the FMV method when making PFIC determinations so long as its IPO takes place before the last month of its taxable year. This is a welcome development that provides greater timing flexibility for foreign corporations planning an IPO.

CFC Determination

As discussed above, a CFC is generally required to determine whether it is a PFIC under the Asset Test by using the adjusted tax basis method, which is more likely to cause it to also be a PFIC. This issue was exacerbated by the repeal of Section 958(b)(4) as part of the TCJA. Section 958(b)(4) historically prevented a U.S. person from being attributed ownership of the equity of a foreign corporation or partnership that was owned directly or indirectly by the foreign corporation’s foreign shareholder(s). Exhibit A below uses a simple fact pattern to illustrate the impact of the repeal of Section 958(b)(4).

Exhibit A: Before the TCJA, US Sub is not treated as owning any interests in Foreign Sub. After the TCJA, US Sub constructively owns Foreign Sub as a result of downward attribution of Foreign Parent’s interest in Foreign Sub. Because US Sub constructively owns 100% of Foreign Sub, Foreign Sub is a CFC even if Foreign Parent is not a CFC.

The repeal of Section 958(b)(4) was intended to combat certain tax planning of foreign multinational groups that Congress perceived to be aggressive and presumably was not intended to have collateral consequences for U.S. owners of PFICs. Nevertheless, by causing many foreign corporations to be CFCs after the TCJA that had not previously been CFCs, it triggered the need for those corporations to use the adjusted tax basis method for purposes of making PFIC determinations under the Asset Test, often with adverse implications for their U.S. direct and indirect owners.

In October 2019, the IRS and Treasury issued proposed regulations on Section 958(b)(4), in which the downward attribution was “turned off” for purposes of the PFIC rules. The Final Regulations reaffirm that approach and a foreign corporation that is a CFC solely because of the repeal of Section 958(b)(4) thus will generally use the FMV method when making PFIC determinations.

A foreign corporation that was treated as a PFIC solely because the repeal of Section 958(b)(4) caused it to be classified as a CFC may, in some cases, revert to its pre-TCJA classification as not a PFIC for taxable years beginning on or after the Final Regulations are filed in the Federal Register.3 In addition, taxpayers who consistently apply certain provisions of the Final Regulations may use the FMV method for purposes of the Asset Test for any such foreign corporation for any open taxable year (generally, three years) beginning before the date the Final Regulations are filed in the Federal Register.

Other Observations

In addition to the above, the Final Regulations and proposed regulations issued on the same date as the Final Regulations (the “2020 Proposed Regulations”) introduce a number of important changes and guidance (many of which are taxpayer-friendly). For example, they clarify indirect ownership determinations in tiered ownership structures, the treatment of intercompany items, and provide rules regarding the assets and income attributed from a foreign corporation’s subsidiaries. Prospective U.S. investors in foreign corporations should assess the impact of the new rules before acquiring (directly or indirectly) interests in foreign corporations, and current U.S. owners of equity in foreign corporations should review their holdings to understand how the new rules may affect their tax treatment going forward.

Finally, the Final Regulations and the 2020 Proposed Regulations provide significant changes with regard to the application of the PFIC rules to U.S. owners of foreign corporations that are in the business of banking or providing insurance. Foreign companies engaged in these businesses should consider how the Final Regulations and the 2020 Proposed Regulations will impact their PFIC status as well.

Applicability Date

While the Final Regulations are currently applicable to all taxpayers, the 2020 Proposed Regulations will not apply until the date they are published as final regulations in the Federal Register. Until finalization, taxpayers may rely upon one or more rules set forth in the 2020 Proposed Regulations provided they consistently follow each such rule for each subsequent year before the taxable year beginning before the date of their finalization. As discussed above under the heading “CFC Determination,” certain rules in the Final Regulations may be applied on a retroactive basis.


The Final Regulations and the 2020 Proposed Regulations contain a number of taxpayer-friendly rules for U.S. owners of equity in foreign corporations, a welcome development given the significant tax impact to them of those corporations being or becoming PFICs. The PFIC rules are complex and cannot be analyzed in a vacuum. We recommend foreign corporations and their U.S. owners review their current and anticipated PFIC status under the new rules as soon as possible.

Please contact the attorneys listed on this Client Alert or your O’Melveny counsel for questions regarding the information discussed herein.

1All section references are to the Internal Revenue Code of 1986, as amended from time to time (the “Code”), and to the Treasury Regulations promulgated thereunder.

2For U.S. federal income tax purposes, a CFC is defined as a foreign corporation if more than 50% of its vote or value of its stock is owned, directly, indirectly or by attribution by U.S. persons who own, directly, indirectly or by attribution, 10% or more of the vote or value of such stock.

3As of the date of this client alert, the Final Regulations are yet to be filed in the Federal Register, although this is expected to occur in the very near future.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Luc Moritz, an O’Melveny partner licensed to practice law in California, Alexander Anderson, an O’Melveny partner licensed to practice law in New York, Billy Abbott, an O’Melveny counsel licensed to practice law in California and New York, and Dawn Lim, an O’Melveny associate licensed to practice law in New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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