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Passive Foreign Investment Company (PFIC)

A Limited Company (i.e. registered company) which is a foreign company/corporation whose major income comes from various investments (known as investment incomes) is called as a “Passive Foreign Investment Company”.

In short a ‘Passive Foreign Investment Companies’ are known as PFIC.

Sections 1291 through 1297 of Income Tax code of U.S.A. of IRC provide the rules for U.S. tax payers who invest in passive foreign investment companies.

There are two ways to identify whether a foreign corporation is a PFIC or not.
  1. Income Test : For any taxable year, if out of the gross income of the foreign corporation, 75 % consists of Passive Incomes; or
  2. Asset Test : For any taxable year, if out of the total assets of the foreign corporation at least 50% of the assets produce (or which are held for the production of) passive income.
How to measure the Assets for the Asset test??

There two methods.
  1. If the foreign corporation is a publicly traded corporation for that taxable year then fair market value of the asset will be taken into consideration; 
  2. If the foreign corporation is a controlled foreign corporation then the value of the asset will be based on the adjusted bases (as determined for the purposes of computing earnings and profits) of the assets of a foreign corporation.
A taxpayer who elects to apply the adjusted bases, and then wants to change back to the 1st method can do so with the consent of the Secretary(IRS).

The “Passive Income” for the above purpose means
  • Dividends, 
  • interest, 
  • royalties, 
  • rents, 
  • annuities, 
  • net gains (excess of gains over losses) from commodities transactions(viz. futures, forwards, etc.),
  • excess of foreign currency gains over foreign currency losses, 
  • any income equivalent to interest, including income from commitment fees (or similar amounts) for loans actually made, 
  • income from notional principal contracts, 
  • payments in lieu of dividends, 
  • amounts received under a contract under which the corporation is to furnish personal services (including the amounts received from the sale or other disposition of such a contract).
Certain incomes are excluded from the purview of ‘passive income’, those are the incomes:
  1. derived in the active conduct of a banking business;
  2. derived in the active conduct of an insurance business;
  3. which is interest, a dividend, or a rent or royalty, which is received or accrued from a related person to the extent such amount is properly allocable to income of such related person which is not passive income, or
  4. which is export trade income of an export trade corporation.
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