Concept of Passive Foreign Investment Company

Internal Revenue Service tax code defines passive investment company as partnerships, investments, mutual funds which are done in foreign by pooling funds with minimum one US shareholder. The Internal Revenue Service has rigorous and exceedingly intricate tax standards for PFICs. Even though the lower capital gains tax rate would normally apply to personal income if it came from U.S.-based business assets, most PFIC investors have to pay an enhanced tax rate on capital gains and dividends that result from increases in share prices.

Internal Revenue Service has set two standards to consider any company a passive foreign investment company. First one is known as Income test and asset test. 

• Income Test: At least 75% of the corporation's gross income is "passive"—that is, derived investments or other sources not related to regular business operations.
• Asset Test: At least 50% of the company's assets are investments, which produce income in the form of earned interest, dividends, or capital gains. To apply the asset test, the fair market value of the foreign firms assets are used, which are based on the assets value by the end of each quarter.

Passive income can include: Income earned from specific contracts for personal service, interest, income from notional contracts, dividends, payments in lieu of dividends, royalties, net foreign currency gains, annuities, net gains from commodity transactions, income equivalent to interest, rents.

Employers and other organisations with globally mobile persons should evaluate their PFIC regulations every year to see if their workers' or partners' investments in foreign firms might be triggered. The final regulations include new exclusions and clarifications that should be considered when assessing the relevant filing duties.

PFICs were acknowledged in 1986 as a consequence of tax revisions. The modifications were made to eliminate a tax loophole that some US taxpayers were employing to avoid paying taxes on their overseas investments. The enacted tax changes aimed not only to remove this tax avoidance loophole and bring such assets under U.S. taxation, but also to tax such investments at high rates in order to deter taxpayers from doing so.

The IRS and the US Treasury Department recommended revisions to the criteria for taxing PFICs in December 2018. If passed, the proposed regulation will simplify some of the existing restrictions under the Foreign Account Tax Compliance Act (FATCA) and define an investment entity more accurately. In July 2019, more suggested amendments were presented, with the goal of clarifying the aforementioned insurance exclusion.
 

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