The passive foreign investment company (“PFIC”) rules generally impose unfavorable tax treatment on certain U.S. shareholders of foreign corporations that generate excess passive income or hold excess passive assets. In January 2021, the Treasury and IRS (the “Treasury”) issued final regulations (the “2020 Final Regulations”) and re-proposed certain regulations under Code Sec. 1297 (the “2020 Proposed Regulations”), which significantly challenge the ability of a foreign corporation that is carrying on active (in an ordinary sense) financial services and lending business to qualify as a non-PFIC, unless the corporation is licensed as a bank in its charter country and accepts deposits from and lends to unrelated customers as part of its banking business. The 2020 Final Regulations and 2020 Proposed Regulations presented a change of direction from the regulations that the Treasury proposed in 2019 (the “2019 Proposed Regulations”), which, had they been adopted as proposed, would have confirmed that the definition of passive income for PFIC purposes excludes certain active finance income defined under Code Sec. 954(h) (the “active financing exception,” or “AFE”). The Treasury’s reversal was largely unexpected by the market and tax practitioners. Proposed confirmation of the AFE’s applicability to the PFIC regime had been met with unified approval of the commentators, and many tax practitioners had already generally shared the interpretation of the statute and legislative history that the Treasury presented as an explanation for its initial proposal, even before the Treasury issued the 2019 Proposed Regulations.

Originally published in International Tax Journal - July/August 2021.