PFIC SHAREHOLDERS' QEF ELECTIONS FOR PRIOR YEARS ARE DUE WITH THE 1988 TAX RETURN, SERVICE ANNOUNCES.

Notice 88-125

This notice provides guidance for U.S. persons that are shareholders of a passive foreign investment company (PFIC) and wish to make a qualified electing fund (QEF) election for taxable years of the PFIC beginning after December 31, 1986.

CHANGE IN LAW

Section 1295 of the Internal Revenue Code of 1986, which provides a QEF election for PFICs, was amended by section 6127 of the Technical and Miscellaneous Revenue Act of 1988, Pub. L. 100-647, 102 Stat. 3342 (the Act). The amendment substitutes a shareholder QEF election for the original QEF election by the PFIC. Under former law, a QEF election by a PFIC caused all U.S. persons that were shareholders of the QEF to be taxed currently on their shares of the PFIC's earnings under section 1293. Section 1295, as amended, binds only the electing shareholder and causes only the electing shareholder to be taxed currently on the earnings of the PFIC. Each U.S. person that is a shareholder of a PFIC and wishes to be taxed currently on earnings of the PFIC must make a QEF election under section 1295 as amended.

EFFECT OF THE AMENDMENT

The amendment to section 1295 of the Code is retroactive; it is effective for taxable years of the PFIC beginning after December 31, 1986. Accordingly, any QEF election that was made by a PFIC (or by a shareholder on behalf of the PFIC) has no legal effect. No further action should be taken with respect to any such election. Section 1293 will not apply to a shareholder of a PFIC that made the election under former law.

Because of the amendment to section 1295 of the Code, section 1.1295-1T of the Temporary Income Tax Regulations and Notice 88-31, 1988-13 I.R.B. 21, have no effect. Shareholders that wish to make the QEF election should not follow either the regulations or the notice. The Internal Revenue Service will issue new regulations under section 1295, as amended, governing the shareholder election. Until regulations are issued, the shareholder QEF election must be made as provided in this notice.

EFFECT OF THE ELECTION

The effect of an election is to treat the PFIC as a QEF with respect to the electing shareholder for each taxable year of the PFIC ending in a taxable year of the shareholder for which the election is effective. An election is effective for the shareholder's taxable year for which it is made and all subsequent taxable years of the shareholder. An election may be revoked only with the consent of the Secretary.

WHO MAKES THE ELECTION

IN GENERAL

Any U.S. person that is a shareholder of a PFIC, including a shareholder that holds its stock of the PFIC in bearer form, may make a QEF election for a taxable year of the shareholder in which a post-1986 taxable year of the PFIC ends.

DIRECT AND INDIRECT OWNERS

GENERAL RULE

In a chain of ownership, only the first U.S. person that is a direct or indirect owner of stock of the PFIC, determined pursuant to the application of section 1297 of the Code, may make the election under section 1295.

EXAMPLES

(1) A U.S. person that is a partner in a U.S. partnership that is a shareholder of a PFIC will be taxed currently on its distributive share of PFIC earnings only if the U.S. partnership makes a QEF election. All U.S. persons that are partners in the U.S. partnership that makes a QEF election will be taxed currently on the earnings of the PFIC.

(2) A U.S. person that is a partner in a foreign partnership that is a shareholder of a PFIC will be taxed currently on its distributive share of PFIC earnings if the U.S. partner makes a QEF election. In the case of an election by a partner of a foreign partnership, only the partner that makes an election will be taxed currently on earnings of the PFIC.

(3) All shareholders of an S corporation, as defined in section 1361(a) of the Code, that is a shareholder of a PFIC will be taxed currently on their respective shares of the PFIC earnings only if the S corporation makes a QEF election.

ELECTION BY MEMBER OF CONSOLIDATED RETURN GROUP

The common parent of an affiliated group of corporations that joins in filing a consolidated income tax return shall make, pursuant to section 1.1502-77(a) of the Income Tax Regulations, a QEF election for all members of the affiliated group that are shareholders in a PFIC. An election by a common parent will be effective for all members of the affiliated group that own stock in the PFIC at the time the election is made or at any time thereafter. A separate election must be made by the common parent for each PFIC in which a member of the affiliated group is a shareholder.

TIME AND MANNER OF MAKING THE ELECTION

TIME FOR MAKING THE ELECTION

GENERAL RULE

The QEF election must be made on or before the due date, as extended, for filing the shareholder's income tax return for the taxable year for which the election is made. A shareholder that fails to make a timely election because of a reasonable belief that the corporation was not a PFIC shall be permitted to make an election as provided by regulations to be issued by the Internal Revenue Service.

RETROACTIVE QEF ELECTION

Section 6127(c)(2) of the Act provides that the period in which an election may be made shall not expire before 60 days after the date of enactment (60 days after November 10, 1988), thereby permitting a QEF election to be made for a taxable year of the shareholder beginning before 1988. A QEF election made on or before the due date, as extended, for filing the shareholder's income tax return for its taxable year beginning in 1988 will be effective retroactive to PFIC taxable years beginning on or after January 1, 1987, provided the shareholder specifies that the election is being made for a prior taxable year and complies with the rules described below.

MANNER OF MAKING THE ELECTION

GENERAL RULE

A shareholder makes a QEF election by attaching a statement captioned "Shareholder Section 1295 Election Statement" (election statement), a statement captioned "PFIC Annual Information Statement" (annual information statement), and Form 8621 to a timely filed income tax return in which the shareholder reports its inclusion of PFIC income for the year to which the election applies. A copy of the election statement must also be filed with the Internal Revenue Service Center, P.0. Box 21086, Philadelphia, Pennsylvania 19114 at the time the election statement is file with the return.

RETROACTIVE QEF ELECTION

A shareholder makes a QEF election under section 6127(c)(2) of the Act for a taxable year of the shareholder beginning before 1988 as follows. The shareholder must specify that the election is being made for a prior taxable year.

If a shareholder did not include PFIC income in the first taxable year to which the election applies, the shareholder makes the QEF election by attaching the election statement, the annual information statement, and Form 8621 to an amended income tax return in which the shareholder includes PFIC income for that year. The amended income tax return must be filed by the due date, as extended, for filing the shareholder's income tax return for its taxable year beginning in 1988. If the shareholder has already included PFIC income for the first taxable year to which the election applies, the shareholder makes the QEF election by attaching the election statement and annual information statement to its timely filed income tax return for its taxable year beginning in 1988. A copy of the election statement also must be filed with the Internal Revenue Service Center, P.0. Box 21086, Philadelphia, Pennsylvania 19114 at the time the election statement is filed with the return.

SHAREHOLDER ELECTION STATEMENT

The shareholder election statement must contain the following information and representations:

(1) The shareholder's name, address, taxpayer identification number, and first taxable year of the shareholder for which the election is made.

(2) A statement that the shareholder is making the election under section 1295 of the Code.

(3) The name, address, taxpayer identification number (if any) and country and year of incorporation of the PFIC.

(4) The first taxable year of the PFIC to which the election applies.

(5) The number of shares of each class of stock of the PFIC held by the shareholder during its taxable year for which the election applies.

The shareholder must sign the election statement under penalties of perjury stating that the information and representations provided are true, correct, and complete to the best of the shareholder's knowledge and belief.

PFIC ANNUAL INFORMATION STATEMENT

A shareholder obtains the PFIC annual information statement from the PFIC. The annual information statement must be attached to a shareholder's income tax return in which PFIC income is included and must contain the following information and representations:

(1) The first and last days of the taxable year of the PFIC to which the information statement applies.

(2) The shareholder's pro rata share of the ordinary earnings and net capital gain of the PFIC for the taxable year of the PFIC specified in paragraph (1), or sufficient information to enable the shareholder to calculate its pro rata share of the ordinary earnings and net capital gain of the PFIC for the taxable year specified in paragraph (I).

(3) The amount of cash and fair market value of other property distributed or deemed distributed to the shareholder during the taxable year of the PFIC specified in paragraph (1).

(4) A statement that the PFIC will permit the shareholder to inspect and copy the PFIC's permanent books of account, records, and such other documents as may be maintained by the PFIC that are necessary to establish that PFIC ordinary earnings and net capital gain, as provided in section 1293(e) of the Code, are computed in accordance with U.S. income tax principles.

In rare and unusual circumstances, the Service will consider alternative documentation requirements necessary to verify the ordinary earnings and net capital gain of a PFIC other than the documentation requirements described in paragraph (4). Such alternative documentation requirements will be allowed only pursuant to a private letter ruling and a closing agreement issued to a PFIC and describing an alternative method of verifying PFIC ordinary earnings and net capital gain. A copy of the private letter ruling and the closing agreement issued to the PFIC must be attached to the return with which a shareholder makes a QEF election in lieu of the statement otherwise required by paragraph (4).

If the PFIC has not obtained a private letter ruling from the Service approving an alternative method of verifying PFIC ordinary earnings and net capital gain by the time a shareholder is required to make a QEF election, the shareholder must attach the annual information statement containing the paragraph (4) verification requirement to the return with which the shareholder makes a QEF election.

A shareholder's failure to produce books and records of the PFIC substantiating that the PFIC ordinary earnings and net capital gain reported by the shareholder were calculated in accordance with U.S. income tax principles or to comply with the requirements included in a ruling concerning an alternative method of verifying PFIC ordinary earnings and net capital gain will result in termination or invalidation of the shareholder's QEF election.

In the case of a U.S. person that is an indirect owner of stock of a PFIC, a statement issued by a nominee or shareholder of record containing the information described in paragraph (1) and reporting the indirect owner's pro rata share of amounts described in paragraphs (2) and (3) may be attached to an income tax return in which the indirect owner includes PFIC income in lieu of the annual information statement issued by the PFIC if the following conditions are satisfied:

(a) The PFIC issues an annual information statement to the nominee or shareholder of record.

(b) The representations and income information contained in the annual information statement issued to the nominee or shareholder of record provide the basis for the information contained in the statement issued to the indirect owner.

(c) The annual information statement issued by the PFIC to the nominee or shareholder of record contains the representation set forth in paragraph (4) above, or the indirect owner attaches a private letter ruling obtained by the PFIC from the Service approving an alternative method of verifying PFIC ordinary earnings and net capital gain as described above.

The indirect owner must attach a copy of the private letter ruling and closing agreement to the income tax return with which a QEF election is made.

FORM 8621

Form 8621, "Return by a Shareholder of a Passive Foreign Investment Company or a Qualified Electing Fund," will be revised to require a U.S. person that is a shareholder of a PFIC to report its shareholdings in the PFIC during the shareholder's taxable year.

SECTION 1294 ELECTION

The Internal Revenue Service announced in Notice 88-31, 1988-13 I.R.B. 21, that section 1.1294-1T(c)(2) of the temporary regulations will be amended to provide that a shareholder that wishes to make the election under section 1294 of the Code to extend the time for payment of tax on its share of the undistributed earnings of the PFIC, but is required under section 1.1294-1T(c)(1) to make the election before March 15, 1989, will have until March 15, 1989, to amend its tax return and make the election under section 1294. The Service will now amend section 1.1294-1T(c)(2) to provide that a shareholder that wishes to make the election under section 1294 to extend the time for payment of tax on its share of the undistributed earnings of the PFIC included in income in a taxable year of the shareholder beginning before 1988 will have until the date the shareholder timely files its income tax return for its taxable year beginning in 1988 to amend an income tax return for a previous taxable year and make the election under section 1294.

EFFECTIVE DATE

This document is an "administrative pronouncement" as that term is used in section 1.6661-3(b)(2) of the income tax regulations and may be relied upon to the same extent as a revenue ruling or a revenue procedure. See Rev. Rul. 87-138, 1987-2 C.B. 287. Taxpayers may rely upon this notice until regulations are published. The regulations will be effective for taxable years beginning after December 31, 1986.

EFFECT ON OTHER DOCUMENTS

Notice 88-31 is obsolete.

DRAFTING INFORMATION

The principal author of this notice is Joseph S. Henderson of the Office of the Associate Chief Counsel (International). For further information, call Mr. Henderson at (202) 634-5404 (not a toll-free call).