Clarifying Subpart F and PFIC Income Inclusion Upon Renunciation of U.S. Citizenship (IRC §§ 877A(g), 951, 965, 1291)
By Marsha-laine Dungog,1 Roy Berg,2 and Liguo Cooper Xu3
Synopsis:4 A U.S. shareholder of a foreign corporation may be subject to Subpart F income inclusion under Code Section 951 or passive foreign income company ("PFIC") income inclusion under Code Section 1291. Such income inclusion under the Subpart F or PFIC regime comes into play because of the shareholder’s status as a "United States person" ("U.S. shareholder") as defined under Code Sections 951(b) and 957(c). In general, Code Section 957(c) defines a U.S. person as a citizen or resident of the United States, a domestic partnership, domestic corporation, and domestic trust. However, for purposes of Code Section 951, such U.S. person must own or is considered as owning, 10 percent or more of the voting stock of a foreign corporation.5 For tax years beginning after January 1, 2018, a U.S. shareholder is any U.S. person who owns or is deemed to own, 10 percent or more of the voting stock or total value of all shares of the classes of stock of such foreign corporation.6
When a U.S. shareholder of a foreign corporation renounces his U.S. citizenship pursuant to Code Section 877A (g), such U.S. shareholder’s status as a "United States person" terminates on the day of renunciation. As a corollary, he also terminates his U.S. shareholder status on that same day since he no longer holds 10 percent of a foreign corporation as a U.S. person. He is then required to file a final U.S. tax return for the taxable year ending on his or her date of renunciation (the "Final Stub Period Return"). Prevailing U.S. tax laws and regulations do not provide any definitive guidance on how to calculate the Subpart F income or PFIC income inclusion (as the case may be) of a former U.S. shareholder for purposes of filing his or her Final U.S. Tax Return.
The recent codification of Code Section 965 under the Tax Cut and Jobs Act of 2017 ("TJCA") creates additional complexity to the Final Stub Period Return of a U.S. shareholder who renounces in 2017 because Code Section 965 imposes a one-time repatriation tax ("Transition Tax"), for the last taxable year of a foreign corporation beginning before January 1, 2018, on a U.S. shareholder’s pro rata share of such foreign corporation’s accumulated post-1986 deferred foreign income whether held in liquid or illiquid assets form. This provision applies to all specified foreign corporations ("SFC") that are controlled foreign corporations ("CFCs"), other than PFICs, and foreign corporations in which a U.S. person owns a 10 percent voting interest.7 The complexity arises because such entities, which include CFCs, must determine their deferred foreign income based on the greater of the aggregate post-1986 accumulated foreign earnings and profits ("E&P") as of November 2, 2017 or December 31, 2017, not reduced by distributions during the taxable year ending with or including the measurement date.8 Therefore the issue that arises is whether the Transition Tax would continue to apply to a U.S. shareholder who has renounced either before November 2, 2017 or prior to December 31, 2017 since the renouncing U.S. shareholder will not own any shares of the CFC as of the last day of the CFC taxable year, as otherwise required for a Code Section 951(a) income inclusion altogether.