Application of Sec. 1297(d) Overlap Rule to PFIC Shares Held by a U.S. Partnership

By Nita Asher, J.D., LL.M., Washington, DC

In Letter Ruling 200943004, the IRS ruled that a controlled foreign corporation (CFC) will not be treated as a passive foreign investment company (PFIC) with respect to a domestic partnership that wholly owns the CFC or with respect to U.S. persons that indirectly own less than 10% of the voting power of the CFC (through the domestic partnership) under the subpart F/PFIC overlap rule of Sec. 1297(d) during the portion of the U.S. partnership’s holding period that it actually owns the CFC stock.


Congress enacted the PFIC regime in 1986 to address concerns about a U.S. person’s ability to defer U.S. federal income tax by investing in foreign corporations and to convert the ordinary income of those foreign investments to capital gain on disposition of the shares of such foreign corporations (H.R. Conf. Rep’t No. 841, 99th Cong., 2d Sess. II-641 (1986)). The PFIC rules are intended to address both the anti-deferral and character-conversion concerns expressed by Congress.

In 1997, Congress recognized that the PFIC rules and the CFC rules could apply simultaneously to a single U.S. person. To avoid unnecessary complexity, Congress added the overlap rule under Sec. 1297(d) (formerly Sec. 1297(e)). That rule provides that if a PFIC also is a CFC, U.S. shareholders (as defined in Sec. 951(b)) of the CFC generally will not be subject to the PFIC rules.

Notwithstanding the policy underlying the overlap rule, certain U.S. persons that indirectly invest in a PFIC through a U.S. partnership arguably could be subject to both the CFC rules and the excess distribution rules under Sec. 1291. Although Sec. 1298(a) states that PFIC ownership generally is not reattributed from one U.S. person to another U.S. person, the legislative history of Sec. 1298(a), the PFIC ownership attribution rules under Prop. Regs. Sec. 1.1291-1(b)(8), and certain other provisions in the regulations suggest that the IRS may view U.S. persons that indirectly invest in a PFIC through a U.S. partnership as owners of the PFIC stock for purposes of the PFIC rules.

The overlap rule could be viewed as exempting from the PFIC rules only U.S. persons that qualify as U.S. shareholders within the meaning of Sec. 951(b). Under that view, any U.S. person that does not qualify as a U.S. shareholder with respect to such PFIC (such as a U.S. partner in a U.S. partnership that indirectly owns a minority interest in the PFIC—i.e., less than 10% voting power) might be subject to the PFIC rules and not eligible for relief under the overlap rule. This result would be inconsistent with the purpose of the overlap rule, namely, to eliminate the complexity caused by subjecting a U.S. person to both the PFIC and subpart F rules.

Letter Ruling 200943004

In Letter Ruling 200943004, domestic and foreign public unit holders invest in a U.S. partnership (Partnership Y) indirectly through a foreign partnership (Partnership X) and a foreign disregarded entity (Corp. D). The domestic unit holders are U.S. corporations and individuals who are citizens of the United States, U.S. residents, and domestic flowthrough entities with U.S. partners and beneficiaries, respectively (domestic unit holders). No domestic unit holder currently owns directly, indirectly, or constructively 10% or more of the total voting power of Partnership X (although a domestic unit holder conceivably could own such an amount in the future). Partnership Y wholly owns Corp. F, a Country J corporation that is treated as a corporation for U.S. federal tax purposes.

Partnership X entered into certain transactions. Following these transactions, Corp. F wholly owned Corps. G, H, and I (collectively, the LLCs), which are all Country J corporations, each of which has elected to be treated as a disregarded entity for U.S. federal tax purposes. The LLCs will earn income that is expected to be passive income within the meaning of Sec. 1297(a).

Corp. F qualifies as a CFC, as defined under Sec. 957(a), because Partnership Y is a domestic partnership that owns 100% of the Corp. F stock. In addition, Corp. F expects to qualify as a PFIC (without taking into account the application of Sec. 1297(d), as defined under Sec. 1297(a)).

Following the transactions, the domestic unit holders will own stock of Corp. F indirectly through X, Corp. D, and Y. No domestic unit holder will own directly, indirectly, or constructively 10% or more of the total voting power of the Corp. F stock (although a domestic unit holder conceivably could own such an amount in the future).

The IRS ruled that Corp. F will not be treated as a PFIC with respect to Partnership Y or the domestic unit holders under Sec. 1297(d) during the portion of Y’s holding period that Y actually owns Corp. F stock, to the extent Corp. F qualifies as a CFC during the period. The IRS noted, however, that this ruling does not apply to a U.S. person who beneficially owns an interest in Partnership Y directly or indirectly through a CFC, and it cited to Notice 2009-7 in support of this position.

In Notice 2009-7, the IRS identified as a transaction of interest a type of transaction in which a U.S. shareholder of CFCs that in turn owns stock in lower-tier CFCs through a domestic partnership takes the position that subpart F income of the lower-tier CFC or an amount determined under Sec. 956(a) does not result in income inclusions under Sec. 951(a) for the U.S. taxpayer. According to the notice, “the IRS and Treasury Department believe that the position [that] there is no income inclusion to Taxpayer under Section 951 is contrary to the purpose and intent of the provisions of subpart F of the Code.”

Practical Implications

Letter Ruling 200943004 provides helpful insight into IRS thinking with respect to the application of the PFIC/CFC overlap rule in the partnership context. Taxpayers who are indirect interest holders in foreign corporations (that are both CFCs and PFICs) through U.S. partnerships should consider whether the rationale of this ruling may apply to their particular situation. However, such taxpayers should be mindful that only the taxpayer that is the subject of a particular letter ruling may rely on that ruling or otherwise cite it as precedent.

Editor: Annette B. Smith, CPA


Annette Smith is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington, DC.

For additional information about these items, contact Ms. Smith at (202) 414-1048 or

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