Noah,
This question is off topic. It has already been asked and answered in another thread but I forget which one.
Thanks, new user and I meant to post in a different thread
Welcome. Not a problem. I was trying to point you in the right direction for the answer.
From what my CPA told me, it doesnāt matter what level of the fundās involvement to the business they invest in. He told me that all of the foreign PE/VC funds most likely will meet the definition of the PFIC under the Asset test. They meet asset test by having assets that produce, or could produce passive income or have asset such as cash or bare land that produce no income. My CPA explained further that when the fund is spinning up gathering the capital, that capital meets the asset test.
Yeah, not really a surprise. Itās possible for one of these funds to not be a PFIC if you apply the look-through rule (stripping away the SPVs) and if whatās underneath is an actual active business. One can make an argument for Rock, since it will be an active manager of the underlying assets and the gains are arguably not passive - and thereās a definite carve-out under sec954, if it applies. But itās easier to just say itās a PFIC than dance around trying to define it, since the consequences of being wrong are fairly dire, and it has the upside of turning all cap gains into long-term irrespective of their actual classification.
I was kind of wondering whether the cash in the bank during accumulation phase would count - itās not being held for the purposes of passive income, after all - but of course if the bank actually paid interest on the cash balance then that would be passive income.
This shit is so sneaky. There are stocks you buy as pink-sheets in the US, or youāll buy shares of these companies on Toronto using your IB or TD account, seemingly innocuous, and no one has any idea that theyāre actually PFICs til you get a form in the mail at tax time and oops guess what. (I know a few. I havenāt bought them.)
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Thatās exactly how I feel, too. Especially, on top of penalties, the failure to file form 8621 means your return is incomplete and the IRS can audit that return forever!
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I found a useful guide on PFIC and QEF election published b NEI, a Canadian investment firm. I copied and pasted the most relevant part here:
Generally: By making a QEF election, a U.S. Holder will not be subject to the special rules discussed above under
āAbsent a QEF Election.ā Instead, such Holder will include its pro rata share of the PFICās ordinary earnings and net
capital gain for the taxable year in income, regardless of whether any amounts are distributed to such Holder during
such taxable year.
Impact of QEF Election: A U.S. Holder who has made a QEF election includes its pro rata share of the PFICās ordinary
earnings and net capital gain in the Holderās income for each taxable year. No portion of such inclusions of ordinary
earnings would qualify as āqualified dividend income.ā The U.S. Holder would increase the tax basis in its PFIC
ownership interest to reflect the Holderās pro rata share of the PFICās ordinary earnings and net capital gain. Any
distribution earnings with respect to which the U.S. Holder has already been taxed would be excluded from income
upon receipt by such Holder, and such Holder would decrease the tax basis of its ownership interest by such
distribution. Gain or loss realized on a sale or exchange of the Fund units will be a capital gain or loss.
PFIC Losses: A U.S. Holder would not be entitled to a deduction for its pro rata share of any losses incurred by the
PFIC for such year.
Timing Considerations: The QEF election may be made for the first year in which an investor holds Fund units. The
QEF election is effective for the taxable year in which the election is made and all subsequent taxable years of the
Fund in which an investor holds an ownership interest.
Iām currently in a high tax bracket and expect to be in a much lower tax bracket in 5-7 years. Therefore Iām interested in a fund that has low ordinary earnings and deferred capital gains until that later time when Iāll probably be in the 0% LTCG bracket. Any suggestions on funds that meet that criteria?
Thanks for the information.
It will be interesting to see which funds declare themselves PFIC or not. In my discussions with Rock Capital, they did not believe they would qualify until the end of their term, so they might meet your criteria. Time will tell if that is is the case.
Iām confused, why would a fund that doesnāt qualify for PFIC meet my criteria? Iām under the impression as an American citizen, we really want a fund qualifies for PFIC and that we should take the QEF election.
My understanding (so take it with a grain of salt) is that if a fund has profits, itās lawyers will declare itself a PFIC. Your best bet as a US citizen (usually) is then to take the QEF election and pay taxes on said profits on an annual basis, rather than at the end plus a whole lot of penalties from IRS. The problem is that often - and more so with these GV funds - the profits from the fund arenāt actually paid out to you until the end of the term when divestment begins. So, you need to pay taxes on profits you havenāt actually received a share of yet. Add to it that I am not sure if you get any credit for any losses by the fund - seems like you donāt from that I have read.
All taken together, I think we would all rather avoid this whole PFIC hassle. Therefore, if you have a fund that does not take actual profits until the end, that would avoid the need for PFIC at all. Some funds donāt engage in rental income and focus on renovation. Hence, they have no profits until they actually sell their renovated properties. Hope that makes sense.
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Iām under the impression as an American citizen, we really want a fund qualifies for PFIC ā¦
I donāt know about you, but Iād dearly love for my investment not to qualify as a PFIC or CFC or any other poison mess like that. If it has to be PFIC, QEF (or readily marked to market) is the way to go. PFIC is a punitive status that incurs high taxes and requires complex, expensive tax preparation.
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Oh, looks like I completely misunderstood.
Besides the increased complexity of filing taxes with a PFIC, what are the other negative consequences? How are PFICs with QEF election taxed differently than other funds? Is the issue that within PFIC funds, dividends and capital gains incurred by the fund are treated as ordinary income for the shareholder and capital losses cannot be reported?
I donāt have much knowledge on how a fundsā activities affects taxes of its shareholders as I currently only invest in passively managed index funds.
PFICs are a complex topic. Search for PFIC QEF 8621 and youāll find good info from tax accountancy firms. To make a long story short, if you are invested in a PFIC that isnāt actively traded (for mark-to-market treatment) and doesnāt support QEF, the penalties will eventually exceed the profits.
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I know they say that, but given what I see there, itās almost the sort of thing I would want MY lawyer to review to see if they agree. If you find out 6 years in that they were wrong all along, itād really suck. In their case Iād prefer they declared PFIC up front; the net of it is the same, because theyāre effectively not making money until at least the 3.5yr mark anyway so thereās no taxes to be paid; the fund is marked to marked EOY but since the value of the property in the portfolio doesnāt go up until itās renovated and sold, thereās nothing to mark up. Butā¦ messy and complicated.
I wonder what the reporting/registration requirements are for the fund itself. Does it have to register itself to accept US investors? or does it just have to crank out the reports? In other words, who really is the entity liable to the IRS for accuracy, you or the fund? Iām guessing it might be you.
I actually believe it is the fund to declare themselves as PFIC and if they do to provide you with the necessary financial information. If they declare they are not a PFIC - and make sure this makes sense to your own team - then they are not.
Yes, it is you that is responsible for the accuracy. The IRS has no jurisdiction over a foreign investment fund. (FATCA is another story as that is regulated by the US Treasury). The fund needs to make the decision whether they must comply. However, if the fund makes the wrong decision then you will be the one to suffer. I have addressed this with one fund by having them issue a statement that they are not making a determination whether they are subject to PFIC or not, but irrespective they will issue an annual statement. That should be sufficient.
As for the fund, I donāt think there is any registration required. They just issue the annual statement from their accounting firm.
This is all just my opinion so you should consult your lawyer or accountant.
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I would like to find a US-based tax preparation professional with expertise in PFIC. Anyone have recommendations? TIA!
Regarding the earlier thread about whether Rock Capital may not qualify as a PFIC until later in their business cycle, and whether one should treat it as a PFIC preemptively:
I found an interesting post yesterday:
Under very limited circumstancesāand only when the taxpayer fails to file the election based on a reasonable belief that the investment was not a PFICāthe taxpayer may file a retroactive QEF election as described in Regs. Sec. 1.1295-3.
That regulation is available from the following link. Without a bit of sarcasm, itās very much worth your while to read it if you are following this topic:
The gist of it is that you may file a āprotective statementā starting with the first tax year of ownership, stating under penalty of perjury that you believe in good faith that the investment is not a PFIC. A declaration by the fund to that effect, plus a sniff test rationalization that the active line of business does not match the passive income template for a PFIC, seems (from my armchair amateur perspective) like a reasonable basis for such a statement.
This article covers similar ground:
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Great info thanks!
So your choices really come down to either 1) Designate as a QEF regardless or 2) File a protective statement from year 1 onwards. The only problem is that to designate as a QEF, the fund needs to give you the annual financial statement, as if they are a PFIC. It might show all zeros, which is fine, but the fund has to agree to do that, while still denying they are a PFIC.
Iām not enjoying the US IRS at the moment (not that any of us ever really do).
Agree, thanks David. I didnāt see that one.
No one likes the IRS. That said, I often find that the IRS ends up being reasonably reasonable when you do make good faith efforts. This would seem like that. That said, youāll probably pay a lawyer a pretty penny to write that justification. Or you get Rockās lawyer to do it.
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