Look-Through Rules Applied to PFIC's U.S. Income

Third Party Communication: None

This is in response to a letter received in this office dated July 25, 2012, in which a ruling is requested to clarify the proper application of certain look-through rules for purposes of determining whether Corp X is a passive foreign investment company within the meaning of section 1297.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

Corp X has always been a holding company and has never been engaged directly in the conduct of business activities. Since its formation in Year 1, US Corp Y has been engaged in a business involving the development, marketing, and support of certain application software for businesses. US Corp Z has been engaged in the conduct of a financing business since its formation.

Nearly all of the income of US Corp Z has consisted of interest earned on receivables purchased in the course of US Corp Z's financing business. The amount of income earned by US Corp Y in the conduct of its business is less than * * *% of the total income of Corp X, US Corp Y, and US Corp Z combined. In Year 3 and each subsequent taxable year, the gross amount of interest income earned by US Corp Y has been less than the amount of gross income earned by US Corp Y in the course of its business.

The income of Corp X has consisted almost exclusively of dividends received from US Corp Y. Nearly all of these dividends have been immediately re-distributed by Corp X as dividends to its shareholders. In Year 3 and each subsequent taxable year, the gross amount of interest income earned by Corp X (when aggregated with the gross amount of interest income earned by US Corp Y) has been less than the amount of gross income earned by US Corp Y in the course of its business from the sales and support of software applications.

US Corp Y and US Corp Z have historically earned significant amounts of taxable income, all of which has been subject to U.S. federal income tax.

The portion of the outstanding shares of Corp X owned, directly or indirectly, by individuals who are citizens or residents of the United States for federal income tax purposes has been greater than * * *% at all times since the beginning of Year 3.

The board of directors of Corp X has adopted a resolution confirming that Corp X has irrevocably waived any protection under the U.S.-Country M treaty against the imposition of the U.S. accumulated earnings tax, effective for all prior, current, and future taxable years.

Section 1297(b)(1) provides that, for purposes of section 1297(a), the term "passive income" means any income (other than income qualifying under the exceptions set forth in section 1297(b)(2)) which is of a kind which would be foreign personal holding company income as defined in section 954(c).

Section 1297(b)(2)(C) contains a look-through rule under which a dividend, interest, or royalty payment that is received by a foreign corporation from a related person is not treated as passive income to the extent that the payment is allocable to income of the payor that is not passive income.

Section 1297(c) contains a look-through rule that provides that if a foreign corporation owns, directly or indirectly, at least 25 percent of the value of the stock of another corporation, then the foreign corporation is treated (for purposes of section 1297(a)) as holding its proportionate share of the assets, and as receiving directly its proportionate share of the income of, the 25-percent owned subsidiary.

Section 1298(b)(7) contains a look-through rule that provides that if a foreign corporation owns 25 percent or more of the shares of a domestic corporation (first-tier domestic corporation), and if the foreign corporation is either subject to the U.S. accumulated earnings tax or waives any benefit under any treaty which otherwise would prevent the imposition of the accumulated earnings tax, then for purposes of determining whether the foreign corporation is a PFIC: (1) any shares of another domestic corporation, other than a regulated investment company or real estate investment trust (second-tier domestic corporation), that are held by the first-tier domestic corporation are treated as not being a passive asset; and (2) any amount included in the gross income of the first-tier domestic corporation with respect to the shares of such second-tier domestic corporation are treated as not being passive income.

Unless an income tax treaty provides otherwise, a foreign corporation (other than a PFIC) that has any shareholder who is a U.S. citizen or resident is subject to the accumulated earnings tax with respect to the corporation's U.S.-source income (including U.S.-source dividend and interest income that is not effectively connected with a trade or business conducted within the United States by the foreign corporation). See section 532; Treas. Reg. §§ 1.532-1(c) and 1.535-1(b).

An article of the U.S.-Country M treaty provides that a Country M corporation may be subject to the U.S. accumulated earnings tax for a particular taxable year if 50% or more in value of the outstanding voting shares of the corporation is owned, directly or indirectly, throughout the last half of the taxable year by citizens or residents of the United States (other than certain citizens of Country M) or by residents of a country other than the U.S. or Country M.

The legislative history of section 1298(b)(7) states:

This private letter ruling is directed only to the taxpayer who requested it. Code section 6110(k)(3) provides that it may not be used or cited as precedent.

A copy of this letter must be attached to any income tax return to which it is relevant. Alternatively, taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter ruling.

In accordance with the Power of Attorney on file with this office, copies of this letter are being sent to Taxpayer's representatives.