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## Text

HIGHLIGHTS
OF THIS ISSUE




Bulletin No. 2021–5
February 1, 2021

These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.

ADMINISTRATIVE
REG-115057-20, page 714.

These proposed regulations amend regulations under sections 165 and 7508A, interpreting new section 7508A(d)
relating to mandatory postponements of time to perform
time-sensitive tax acts by reason of a federally declared disaster, and clarifying the definition of federally declared disaster under section 165(i)(5). Under section 7508A(a), the
Secretary has discretion to determine which taxpayers are
affected by a federally declared disaster and to specify both
the time-sensitive acts that are postponed and a period of
time that may be disregarded, up to one year, in determining whether such acts are timely performed. The proposed
regulations clarify that the phrase “in the same manner
as a period specified under [section 7508A(a)]” in section
7508A(d)(1) means that the time-sensitive acts postponed
for the mandatory 60-day period are those determined by the
Secretary under section 7508A(a). The proposed regulations
further provide that the mandatory 60-day period will only
apply if the Secretary bases his discretionary determination
on a disaster declaration that specifies an incident date. The
proposed regulations also clarify that the mandatory 60-day
period cannot exceed the one-year limitation provided under
section 7508A(a).

EMPLOYEE PLANS
Notice 2021-9, page 678.

This notice sets forth updates on the corporate bond monthly yield curve, the corresponding spot segment rates for January 2021 used under § 417(e)(3)(D), the 24-month average
segment rates applicable for January 2021, and the 30-year
Treasury rates, as reflected by the application of § 430(h)(2)
(C)(iv).

Finding Lists begin on page ii.

Rev. Rul. 2021-3, page 674.

This revenue ruling provides tables of covered compensation
under § 401(l)(5)(E) of the Internal Revenue Code and the Income Tax Regulations thereunder, effective January 1, 2021.

INCOME TAX
REG-111950-20, page 683.

These proposed regulations provide guidance under sections
1297 and 1298, including rules regarding the treatment of
certain income received or accrued by a foreign corporation
and assets held by a foreign corporation for purposes of
section 1297 and rules on whether a foreign corporation is
engaged in the active conduct of an insurance business for
purposes of section 1297(b)(2)(B). The proposed regulations
also include rules addressing the treatment of qualified improvement property under the alternative depreciation system for purposes of the global intangible low-taxed income
and the foreign-derived intangible income provisions.

Rev. Proc. 2021-12, page 681.

This revenue procedure extends to September 30, 2021,
the expiration dates relevant to the application of the safe
harbors in Rev. Proc. 2020-26, 2020-18 I.R.B. 753, and Rev.
Proc. 2020-34, 2020-26 I.R.B. 990.

T.D. 9936, page 508.

These final regulations provide guidance under sections
1291, 1297, and 1298, regarding the determination of
ownership in a passive foreign investment company and the
treatment of certain income received or accrued by a foreign corporation and assets held by a foreign corporation for
purposes of section 1297. The final regulations also provide
guidance regarding the exclusion from passive income under section 1297(b)(2)(B) for income derived by a qualifying
insurance corporation in the active conduct of an insurance
business.

T.D. 9943, page 577.

This document contains final regulations that provide additional guidance regarding the limitation on the business interest expense deduction limitation to reflect changes made
by the Tax Cuts and Jobs Act and the Coronavirus Aid, Relief, and Economic Security Act. The final regulations provide
guidance regarding which taxpayers and trades or businesses are subject to the limitation, and how the limitation applies
in consolidated group, partnership, international, and other
contexts.

T.D. 9945, page 627.

Section 1061 recharacterizes certain net long-term capital
gains of a partner that holds one or more applicable partnership interests as short-term capital gains. An applicable
partnership interest is an interest in a partnership that is
transferred to or held by a taxpayer in connection with the
performance of substantial services by the taxpayer, or any
other related person, in any applicable trade or business.
The final regulations also amend existing regulations on holding periods to clarify the holding period of a partner’s interest
in a partnership that includes an applicable partnership interest and/or a profits interest.

The IRS Mission
Provide America’s taxpayers top-quality service by helping
them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.

Introduction
The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly.
It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements of
internal practices and procedures that affect the rights and
duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service
on the application of the law to the pivotal facts stated in
the revenue ruling. In those based on positions taken in rulings to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature are
deleted to prevent unwarranted invasions of privacy and to
comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned are cautioned

against reaching the same conclusions in other cases unless
the facts and circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions and Other Related Items, and Subpart B,
Legislation and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
included in this part are Bank Secrecy Act Administrative
Rulings. Bank Secrecy Act Administrative Rulings are issued
by the Department of the Treasury’s Office of the Assistant
Secretary (Enforcement).
Part IV.—Items of General Interest.
This part includes notices of proposed rulemakings, disbarment and suspension lists, and announcements.
The last Bulletin for each month includes a cumulative index
for the matters published during the preceding months. These
monthly indexes are cumulated on a semiannual basis, and are
published in the last Bulletin of each semiannual period.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

February 1, 2021 

Bulletin No. 2021–5

Part I
26 CFR 1.1291-1; 1.1297-1; 1.1297-2; 1.1297-4;
1.1297-6; 1.1297-6; 1.1298-2; 1.1298-4

Firehock at (202) 317-4932 (not toll-free
numbers).

T.D. 9936

SUPPLEMENTARY INFORMATION:

DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1

Background

Guidance on Passive
Foreign Investment
Companies
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations regarding the determination of whether a foreign corporation
is treated as a passive foreign investment company (“PFIC”) for purposes
of the Internal Revenue Code (“Code”),
and the application and scope of certain
rules that determine whether a United
States person that indirectly holds stock
in a PFIC is treated as a shareholder of
the PFIC. The regulations affect United States persons with direct or indirect
ownership interests in certain foreign
corporations.
DATES: Effective date: These regulations
are effective on January 14, 2021.
Applicability dates: For dates of applicability see §§1.1291-1(j), 1.1297-1(g),
1.1297-2(h), 1.1297-4(g), 1.1297-6(f),
1.1298-2(g), and 1.1298-4(f).
FOR FURTHER INFORMATION
CONTACT: Concerning the regulations §§1.1291-0 and 1.1291-1, 1.1297-0
through 1.1297-2, 1.1298-0, 1.1298-2,
and 1.1298-4, Christina G. Daniels at
(202) 317-6934; concerning the regulations §§1.1297-4 and 1.1297-6, Josephine

1

On July 11, 2019, the Department of
the Treasury (“Treasury Department”)
and the IRS published proposed regulations (REG-105474-18) under sections
1291, 1297, and 1298 in the Federal
Register (84 FR 33120) (the “proposed
regulations” or “2019 proposed regulations”). All written comments received in
response to the proposed regulations are
available at www.regulations.gov or upon
request. A public hearing on the proposed
regulations was scheduled for December
9, 2019, but it was not held because there
were no requests to speak. Terms used
but not defined in this preamble have the
meaning provided in these final regulations.
In addition, on October 2, 2019,
the Treasury Department and the IRS
published proposed regulations (REG104223-18) relating to the repeal of section 958(b)(4) by the Tax Cuts and Jobs
Act, Pub. L. 115-97, 131 Stat. 2054 (2017)
(the “Act”) in the Federal Register (84
FR 52398) (the “section 958 proposed
regulations”). As in effect before its repeal, section 958(b)(4) provided that section 318(a)(3)(A), (B), and (C) (providing
for downward attribution) was not to be
applied so as to consider a United States
person (as defined in section 7701(a)(30))
as owning stock owned by a person who
is not a United States person (a “foreign
person”). After the Act repealed section
958(b)(4), stock of a foreign corporation
owned by a foreign person could be attributed to a United States person under
section 318(a)(3) for various purposes,
including for purposes of determining
whether the foreign corporation is a controlled foreign corporation within the
meaning of section 957 (“CFC”). The section 958 proposed regulations generally
made modifications to ensure that the operation of certain rules outside of subpart

F of part III of subchapter N of chapter 1
of subtitle A of the Code (“subpart F”) are
consistent with their application before the
Act’s repeal of section 958(b)(4). A public
hearing on these regulations was not held
because there were no requests to speak.
This rulemaking finalizes the portion of
the section 958 proposed regulations under section 1297 regarding the treatment
of foreign corporations for purposes of
section 1297(e).1 See Part III.D.1 of the
Summary of Comments and Explanation
of Revisions section.
A notice of proposed rulemaking published in the Proposed Rules section of
this issue of the Federal Register (REG111950-20) (the “2020 NPRM”) provides
additional guidance on the treatment of
income and assets of a foreign corporation for purposes of the PFIC rules and on
the exception from passive income under
section 1297(b)(2)(B) (“PFIC insurance
exception”).
Summary of Comments and
Explanation of Revisions
I. Overview
The final regulations retain the basic
approach and structure of the proposed
regulations, with certain revisions. This
Summary of Comments and Explanation
of Revisions section discusses those revisions as well as comments received in response to the solicitation of comments in
the notice of proposed rulemaking. Comments outside the scope of this rulemaking are generally not addressed but may
be considered in connection with the potential issuance of future guidance.
II. Comments and Revisions to Proposed
§1.1291-1 – Taxation of U.S. persons that
are shareholders of section 1291 funds
Section 1298(a) provides attribution
rules that apply to the extent the effect
is to treat stock of a PFIC as owned by
a United States person. These rules apply
when a United States person directly or
indirectly owns an interest in a PFIC, a

The other portions of the section 958 proposed regulations were finalized at 85 FR 59428.

February 1, 2021

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Bulletin No. 2021–5

partnership, an estate or a trust, or when
a United States person directly or indirectly owns 50 percent or more in value
of the stock of a corporation that is not a
PFIC. In such cases, the attribution rules
of section 1298(a) may apply to treat the
United States person as owning shares of a
PFIC owned directly or indirectly by such
an entity. Stock considered to be owned
by a person by reason of any of the foregoing rules is treated as actually owned
by that person for purposes of the further
application of those rules (the “successive
application rule”). Except as provided in
regulations, the attribution rules do not
apply to treat stock owned or treated as
owned by a United States person as owned
by any other person. The current rules in
§1.1291-1(b)(8) are consistent with these
statutory provisions.
A. Attribution of ownership through a
partnership, S corporation, estate or trust
Proposed §1.1291-1(b)(8)(iii) provided that an owner of an interest in a partnership, S corporation, estate or trust (a
“pass-through entity”) would be treated as
owning stock owned by the pass-through
entity only if the pass-through owner owns
50 percent or more of the pass-through entity. Examples in the proposed regulations
illustrated the operation of this rule in
cases where a United States person owns
50 percent, in one case, or 40 percent, in
another case, of a foreign partnership. The
preamble to the proposed regulations indicated that the proposed rule was intended
to ensure that the attribution rules apply
consistently whether a United States person owns stock of a non-PFIC foreign corporation indirectly through a partnership
or directly.
The only comment received on this
proposed rule agreed with the results of
the first example but recommended that a
different approach be taken with respect
to attribution through partnerships. The
comment responded to the statement in
the preamble that the proposed regulations would have results consistent with
an aggregate approach to partnerships by
noting that in certain circumstances the
proposed rule would deviate from a true
aggregation approach. It posited an example in which application of the rule in
the proposed regulations would prevent

Bulletin No. 2021–5

a United States person from being treated as owning stock of a PFIC owned by
a non-PFIC corporation, even though the
United States person directly and indirectly owned, in the aggregate, more than
50 percent of the stock of the non-PFIC
corporation and argued that this result was
inappropriate. Accordingly, the comment
suggested that the final regulations, instead of adopting the rule included in the
proposed regulations, adopt a rule that
uses an aggregation approach to attribution through partnerships.
The Treasury Department and the IRS
agree with the comment that the rule in
the proposed regulations could have inappropriate results, and that a partner in a
partnership should be treated as indirectly
owning the same number of shares of a
non-PFIC corporation owned by the partnership as if the partner held those shares
directly. Accordingly, the final regulations
do not adopt the rules in the proposed regulations to amend the rules of §1.12911(b)(8)(iii), relating to pass-through entities (partnerships, S corporations, estates
and nongrantor trusts).
B. Application of “top-down” approach
The preamble to the proposed regulations indicated that proposed §1.12911(b)(8)(iii) was intended to apply the
attribution rules to a tiered ownership
structure involving a pass-through entity
on a “top-down” basis, by starting with
a United States person and determining
what stock is considered owned at each
successive lower tier on a proportionate
basis. The preamble requested comments
as to whether the “top-down” approach
should be extended to attribution through
corporations.
The only comment received on the
issue indicated that the “top-down” approach should not be so extended, on the
grounds that the successive application
rule of section 1298(a)(5) requires a “bottom-up” approach (that is, applying the attribution rules to a tiered ownership structure by starting with the lowest-tier entity
and determining which persons are treated
as owning stock of that entity at each successive higher tier on a proportionate basis) for corporate structures. The comment
acknowledged that this would result in
inconsistency in attribution of ownership

509

between stock of a PFIC held through a
partnership (which, in many cases, may
be a foreign corporate entity treated as a
partnership for U.S. federal income tax
purposes as the result of a check-the-box
election) and stock of a PFIC held through
a corporation.
The Treasury Department and the IRS
have determined that the same approach
should apply to attribution through a
pass-through entity, a PFIC or a 50 percent-owned non-PFIC corporation. In
each case, the statutory language provides
that an owner of an interest in such an entity is treated as owning its proportionate
share of stock owned by the entity. The
same approach to attribution therefore
should apply regardless of which entity a
United States person holds an interest in.
The successive application rule of
section 1298(a)(5) can be applied either
under a “top-down” or “bottom-up” approach. While both approaches to attribution may treat a United States person as
owning an amount of stock of a PFIC that
is less than that person’s economic interest in the PFIC, a “top-down” approach
takes into account both the direct and indirect ownership of stock of a corporation
by the same person while the bottom-up
approach may not do so. For example, assume that U.S. individual A owns 49 percent of the partnership interests in a partnership that owns 95 percent of the stock
of a tested foreign corporation. The tested foreign corporation is not a PFIC but
owns all of the single class of stock of a
PFIC. Individual A also owns the remaining 5 percent of the tested foreign corporation’s stock directly. Under a “top-down”
approach, individual A is deemed to hold
46.55 percent of the tested foreign corporation’s stock through the partnership
and owns 5 percent of the tested foreign
corporation’s stock directly. Therefore,
individual A is treated as owning 51.55
percent of the tested foreign corporation’s
stock and 51.55 percent of the PFIC stock.
Under a “bottom-up” approach, the tested
foreign corporation owns all of the PFIC
stock; the partnership owns 95 percent
of the tested foreign corporation’s stock
and therefore is treated as owning 95 percent of the PFIC stock; and individual A
is treated as owning 49 percent of what
the partnership owns, or 46.55 percent of
the PFIC stock. In this example, the “top-

February 1, 2021

down” approach treats individual A as
owning its economic share of the PFIC’s
stock, while the “bottom-up” approach
may not take into account the PFIC stock
that is owned through the 5 percent of the
tested foreign corporation’s stock that individual A owns directly. Accordingly,
the final regulations apply a “top-down”
approach to the attribution of ownership
through all tiered ownership structures.
The final regulations also include a
new rule addressing the application of the
successive application rule to tiered ownership structures. The new rule specifically provides for a top-down approach to attribution of ownership. See §1.1291-1(b)
(8)(iv). The examples in the existing and
proposed regulations have been revised
to clarify how the top-down approach
applies to those examples. See §1.12911(b)(8)(v). A new example is added to
illustrate the operation of the successive
application rule in a fact pattern in which
a United States person owns stock of a
foreign corporation both directly and indirectly through a partnership. See §1.12911(b)(8)(v)(D).
C. Ownership attribution through
nongrantor trusts
A comment requested that the final
regulations provide additional guidance
on attributing PFIC stock held by a nongrantor trust to the beneficiaries of the
trust, suggesting that determining ownership by U.S. beneficiaries of PFIC stock
held directly or indirectly by a nongrantor
trust warrants more specificity than determining ownership in PFIC stock held directly or indirectly by other pass-through
entities.
Section 1298(a)(3) and §1.1291-1(b)
(8)(iii)(C) provide that each beneficiary is
considered to own a proportionate amount
of stock held by a foreign or domestic estate or nongrantor trust. Section 1.12911(b)(8)(i) provides that the determination
of a person’s indirect ownership is made
on the basis of all the facts and circumstances of each case and that the substance
rather than the form of the ownership is
controlling, taking into account the purposes of sections 1291 through 1298.

On December 31, 2013, the Treasury Department and the IRS published
final and temporary regulations under
several Code sections including section
1291 (78 FR 79602, as corrected at 79
FR 26836) (“2013 temporary and final
regulations”). The preamble to those
regulations provided that pending further guidance, beneficiaries of estates
and nongrantor trusts that hold PFIC
stock subject to the section 1291 regime
should use a reasonable method to determine their ownership interests in the
PFIC. The preamble to those regulations
also provided that section 1291 and the
principles of subchapter J must be applied in a reasonable manner with respect to estates and trusts, and beneficiaries thereof, to preserve or trigger the tax
and interest charge rules under section
1291. Accordingly, the preamble provided that the estate or trust, or the beneficiary thereof, must take excess distributions into account under section 1291 in
a reasonable manner, consistent with the
general operating rules of subchapter J
and that it would be unreasonable for the
shareholders of the section 1291 fund to
take the position that neither the beneficiaries nor the estate or trust are subject
to the tax and interest charge rules under
section 1291.
The Treasury Department and the IRS
remain aware of the need for guidance
regarding both the ownership attribution rules and the interaction of the rules
in subchapter J with the PFIC rules. The
Treasury Department and the IRS are also
aware that in some cases, the application
of the PFIC attribution rules may impose
tax on U.S. beneficiaries of foreign trusts
that never receive the related distributions.
The Treasury Department and the IRS believe that further guidance with respect to
the identification of indirect shareholders
in such circumstances requires coordination of the PFIC rules with the rules of
subchapter J, which is beyond the scope
of this regulation project. Pending the
issuance of further guidance, taxpayers
should continue to apply these rules in
a reasonable manner as expressed in the
preamble to the 2013 temporary and final
regulations.

III. Comments and Revisions to Proposed
§1.1297-1 – Definition of passive foreign
investment company
Proposed §1.1297-1 provided general
rules and definitions under section 1297
including general rules concerning the
application of the income test of section
1297(a)(1) (“Income Test”) and the asset
test of section 1297(a)(2) (“Asset Test”),
clarification on the scope of the section
1297(b)(1) cross-reference to section
954(c) for purposes of defining passive income, and general rules that address certain computational and characterization
issues that arise in applying the Asset Test.
A. Definition of passive income
1. In General
Section 1297(b)(1) defines passive income, for purposes of the PFIC rules, as
income of a kind that would be foreign
personal holding company income (“FPHCI”) under section 954(c), and proposed
§1.1297-1(c)(1)(i) provided accordingly
that passive income means income of a
kind that would be FPHCI under section
954(c)(1). A comment suggested that
the cross-reference to section 954(c)(1)
should incorporate only those provisions
of section 954(c) (and the regulations
thereunder) that were in effect in 1986
when section 1297 was enacted and not,
for example, section 954(c)(1)(H), relating to income from personal services
contracts, or recent revisions to the regulatory rules for active rents and royalties
under section 954(c)(2)(C). The Treasury
Department and the IRS disagree, and
believe that, in view of the original purpose of referencing section 954(c), section
1297 incorporates the law in respect of the
referenced provisions—both statutory and
regulatory—when it is applied. Compare
section 951A(d)(3).2 Therefore, the final
regulations do not adopt this comment.
2. PFIC/CFC Overlap Rule and RPII
Income
Section 1297(d) provides that, for
PFIC purposes, a corporation shall not be

As enacted, section 951A(d) contains two paragraphs designated as paragraph (3). The section 951A(d)(3) referenced in this preamble relates to the paragraph on determination of the adjusted basis in property for purposes of calculating QBAI.
2

February 1, 2021

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treated as a PFIC with respect to a shareholder during the qualified portion of such
shareholder’s holding period with respect
to stock in such corporation during which
time the corporation is a CFC (“PFIC/
CFC overlap rule”). The qualified portion of a shareholder’s holding period
generally is the period during which the
shareholder is a United States shareholder
(“U.S. shareholder”), as defined in section 951(b). Section 951(b) defines a U.S.
shareholder, for purposes of the Code, as a
U.S. person that owns 10 percent or more
of the voting power or value of a foreign
corporation. Section 957(a) provides that,
for purposes of the Code, a CFC means
any foreign corporation more than 50 percent owned (by vote or value, taking into
account section 958(b) constructive ownership rules) by U.S. shareholders on any
day during the taxable year of the foreign
corporation.
In certain circumstances, the subpart
F insurance rules lower the CFC ownership threshold requirements used to determine CFC status and eliminate the 10
percent vote or value test for determining
U.S. shareholder status that are otherwise
applicable for purposes of the Code. Under section 957(b), a special definition of
a CFC applies and lowers the more than
50 percent ownership rule to a more than
25 percent ownership rule for taking into
account section 953(a) insurance income,
but only if the foreign corporation’s gross
amount of premiums or other consideration in respect of reinsurance or the issuing of insurance or annuity contracts not
described in section 953(e)(2) exceeds 75
percent of the gross amount of all premiums or other consideration in respect of
all risks. Also, under section 953(c)(1)
(B), for purposes of taking into account
related party insurance income (“RPII”)
as defined in section 953(c)(2), the CFC
ownership requirement is reduced to a “25
percent or more” requirement. In addition,
for purposes of determining RPII, the 10
percent of vote or value test for determining U.S. shareholder status is eliminated.
See section 953(c)(1)(A). Instead, for
RPII purposes, a U.S. shareholder means
any U.S. person that directly or indirectly
owns any of the stock of the foreign corporation at any time during the foreign
corporation’s taxable year. See section
953(c)(1)(A). Constructive ownership

Bulletin No. 2021–5

under section 958(b) is not taken into account for this purpose.
A comment requested that the proposed regulations be modified to provide
an exception to the PFIC rules for all U.S.
shareholders (meaning without regard to
the 10 percent vote or value test in section 951(b)) of all CFCs (including those
that satisfy the 25 percent threshold applicable solely for the subpart F purposes
described above). The final regulations do
not adopt this comment. Consideration of
the scope of the PFIC/CFC overlap rule,
including the interaction with the RPII
rules, is beyond the scope of this rulemaking. The Treasury Department and the IRS
continue to study the interaction of these
provisions and if necessary, will provide
guidance in the future.
B. Exceptions from passive income
1. Application of Active Banking and
Active Insurance Exceptions
Proposed §1.1297-1(c)(1)(i)(A) provided that section 954(h), which excludes
from FPHCI income derived by a CFC
in the active conduct of a banking or financing business from customers outside
of the United States, applied for purposes
of determining PFIC status. The proposed
regulations also provided that section
954(i), which excludes from FPHCI certain income derived in the active conduct
of an insurance business, did not apply for
purposes of determining PFIC status. See
proposed §1.1297-1(c)(1)(i)(B). Several comments approved of the application
of section 954(h) to the determination of
whether income is treated as passive for
purposes of section 1297. One comment
noted that, in the case of tested foreign
corporations with look-through subsidiaries that are domestic corporations, section
954(h)(3)(A)(ii)(I) would result in the
section 954(h) exception being inapplicable to active financing income earned by
these subsidiaries from transactions with
local customers, even though it would
otherwise be of a type that would not be
passive. The comment suggested that section 954(h) should be applied in the PFIC
context by treating income as qualified
banking or financing income even if the
income is derived from transactions with
customers in the United States. Several

511

comments recommended that the section
954(h) exception continue to apply in the
PFIC context in the event that final regulations implementing the active banking
exception in section 1297(b)(2)(A) are adopted. Comments also requested that the
final regulations apply the section 954(i)
insurance exception for purposes of determining PFIC status of an insurance
company in a parallel manner as section
954(h).
In response to these comments, the
Treasury Department and the IRS have
further studied sections 954 and 1297 and
their legislative history. As described in
more detail in the remainder of this Part
III.B.1 of this Summary of Comments
and Explanation of Revisions section, the
Treasury Department and the IRS have
determined that sections 954(h) and (i) do
not apply for purposes of section 1297(b)
absent regulations and that the appropriate
statutory authority for any such regulations is section 1297(b)(2) rather than section 1297(b)(1). The Treasury Department
and the IRS have further concluded that
section 954(i) does not apply for purposes
of section 1297(b)(2)(B), and that certain
principles of section 954(h) should be applied for purposes of section 1297(b)(2)
(A) but that a different approach is warranted with respect to section 954(h) than
the approach taken in the proposed regulations. Accordingly, the 2020 NPRM proposes rules that would treat qualifying income of certain taxpayers that satisfy the
requirements of section 954(h) as income
derived in the active conduct of a banking
business within the meaning of section
1297(b)(2). See proposed §1.1297-1(c)
(2).
As previously discussed, section
1297(b)(1) provides that, except as otherwise provided in section 1297(b)(2),
passive income means any income of a
kind that would be FPHCI as defined in
section 954(c). The definitions of the categories of FPHCI listed in section 954(c)
describe types of gross income, for example interest, dividends, gains from the sale
of property and foreign currency gains,
as well as exceptions to those definitions.
While these definitions and exceptions in
some places refer to CFCs, the definitions
and exceptions themselves do not require
that a foreign corporation be a CFC. By
contrast, although sections 954(h) and (i)

February 1, 2021

apply “for purposes of section 954(c)(1),”
those provisions explicitly require that a
foreign corporation be a CFC to qualify
for an exception to FPHCI. Section 954(h)
applies only to eligible CFCs, as defined in
section 954(h)(2), and section 954(i) applies only to qualifying insurance company CFCs, as defined in section 953(e)(3).
Accordingly, sections 954(h) and (i) do
not apply for purposes of section 1297(b)
(1) unless a tested foreign corporation is
treated pursuant to regulations as a CFC
for that purpose or otherwise qualifies as a
CFC. See proposed §1.1297-1(c)(1)(i)(D)
of the 2019 proposed regulations (treating
a tested foreign corporation as a CFC for
purposes of applying section 954(h)).
The Treasury Department and the IRS
have further determined that any regulations treating sections 954(h) and (i) as
applicable for purposes of section 1297(b)
should be issued under section 1297(b)
(2) and not under section 1297(b)(1). As
originally enacted, section 1297(b)(1)
provided a rule of general application, and
section 1297(b)(2) provided a limited set
of exceptions to section 1297(b)(1). While
the list of exceptions in section 1297(b)(2)
has changed from time to time, that statutory scheme remains intact today. Section 1297(b)(2) provides exceptions for
income derived in the active conduct of a
banking or insurance business, subject to
various conditions. If section 954(h) or (i)
were treated as applicable for purposes of
section 1297(b)(1), section 1297(b)(2)(A)
and (B) would provide duplicative exceptions for banking or insurance income, respectively. Moreover, interpreting section
1297(b)(1) in this manner would have the
effect of narrowing the scope of the exceptions provided by section 1297(b)(2),
because the income of some foreign banks
or insurance companies would already
be treated as non-passive under section
1297(b)(1). No explicit action by Congress authorizes the narrowing of section
1297(b)(2) in this manner. The legislative
history of the enactment of section 954(h)
(as a temporary rule relating to both banking and insurance income) in 1997 and

the enactment of sections 954(h) and (i)
in 1998 are void of any indication that
Congress intended such an interpretation
of section 1297(b)(1).3 The legislative
history provides further evidence that section 954(h) was not intended to apply for
purposes of section 1297(b)(1); the conference report states that “the conferees
intend that a corporation will be considered to be engaged in the active conduct
of a banking … business if the corporation would be treated as so engaged under
the regulations proposed under” section
1297(b)(2).4 Incorporating this standard
into section 1297(b)(1) would limit the
scope of section 1297(b)(2). Accordingly,
given the specialized nature of these exceptions within the subpart F regime, the
Treasury Department and the IRS have
determined that it is inappropriate to apply
them in defining the types of income that
are “of a kind” described in section 954(c)
(that is, FPHCI) for purposes of section
1297(b)(1).
In addition, as explained in the preamble to the 2019 proposed regulations,
the Treasury Department and the IRS
have determined that because the recent
changes to section 1297(b)(2)(B) require
that income eligible for the exception be
earned by a qualifying insurance corporation, section 954(i) should not apply in addition to the newly modified exception in
section 1297(b)(2)(B). See 84 FR 33120,
at 33123. Therefore, the final regulations
do not adopt the comments requesting
that the section 954(i) exception apply for
purposes of determining PFIC status. As
a result, section 954(i) remains listed in
§1.1297-1(c)(1)(i)(B) as one of the exceptions in section 954 that is not applied in
the PFIC context.
Section 954(h) has been removed from
the list of exceptions that are applied to
PFICs with respect to section 1297(b)
(1). See §1.1297-1(c)(1)(i)(A). Despite
the conclusion that it is inappropriate to
incorporate section 954(h) as an exception to the definition of passive income
under section 1297(b)(1), the Treasury
Department and the IRS have considered

whether principles of section 954(h) could
apply in the context of the rules of section 1297(b)(2)(A). Section 1297(b)(2)
(A) provides that passive income does not
include any income derived in the active
conduct of a banking business by an institution licensed to do business as a bank
in the United States (or, to the extent provided in regulations, by any other corporation). Pursuant to this grant of regulatory
authority, the 2020 NPRM proposes an
active banking exception that incorporates
certain principles of section 954(h) in defining other corporations that are eligible
to apply this exception in addition to U.S.
licensed banks. See proposed §1.12971(c)(2). The preamble to the 2020 NPRM
discusses comments that address issues
relating to the potential application of section 954(h) in the PFIC context.
2. Treatment of Gains from Certain
Transactions
Proposed §1.1297-1(c)(1)(ii) provided
that for purposes of the Income Test, categories of income under section 954(c) that
are determined by netting gains against
losses are taken into account by a corporation on that net basis. However, under
the proposed regulations, the net amount
of income in each category of FPHCI
was calculated separately for each relevant corporation, such that net gains or
losses of a look-through subsidiary may
not be netted against net losses or gains
of another look-through subsidiary or of
a tested foreign corporation. See proposed
§1.1297-1(c)(1)(ii).
One comment recommended that the
final regulations not adopt the separate
entity approach in proposed §1.1297-1(c)
(1)(ii) and, instead, permit a tested foreign
corporation to net its gains and losses with
those of its directly or indirectly owned
look-through subsidiaries and its directly or indirectly owned partnerships. The
comment noted that the separate entity
approach could result in an overstatement
of FPHCI of an integrated business that is
conducted through multiple subsidiaries.

See H.R. Rep. No. 220, 105th Cong. 1st Sess. 623-28 (July 30, 1997) (discussing adoption of section 1297(d) CFC overlap rule and section 1296 mark-to-market rule; no discussion of contemporaneous adoption of section 954(h)); id. at 639-45 (discussing adoption of active financing income (section 954(h)) rule; no suggestion that rules apply for PFIC purposes).
4
Id. at 642; see also H.R. Rep. No. 105-825, at 1555 (Oct. 19, 1998) (Conf. Rep.) (“[I]n this regard, a corporation is considered to be engaged in the active conduct of a banking or securities
business if the corporation would be treated as so engaged under the regulations proposed under prior law section 1296(b) (as in effect prior to the enactment of the Taxpayer Relief Act of
1997)”).
3

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Bulletin No. 2021–5

The Treasury Department and the IRS
have determined that the integrated treatment proposed by the comment with respect to look-through subsidiaries and
look-through partnerships is consistent
with the statutory language treating the
owner of a look-through subsidiary as
receiving directly its proportionate share
of the income of the subsidiary, and with
the policies underlying section 1297(c).
Accordingly, §1.1297-1(c)(1)(ii) provides
that the net gains or income for a category of FPHCI that is determined by netting
gains against losses are determined at the
level of a tested foreign corporation taking
into account individual items of the tested
foreign corporation and its look-through
subsidiaries and look-through partnerships. Because these regulations do not
adopt an overall look-through approach
with respect to all partnerships, netting
is not provided with respect to gains and
losses derived from partnerships that are
not look-through partnerships. For example, netting does not apply to gains and
losses that are part of a tested foreign corporation’s distributive share from a partnership that is a related person within the
meaning of section 954(d)(3) but not a
look-through partnership.
3. Treatment of Effectively Connected
Income and Income Attributable to U.S.
Permanent Establishments
Section 952(b) excludes from subpart F
income the U.S. source income of a CFC
that is effectively connected with the conduct by such CFC of a trade or business in
the United States (“effectively connected
income”). Comments noted that the proposed regulations did not address the treatment of effectively connected income, or
the assets held to produce such income, of
a foreign corporation or the treatment of
income that is attributable to a U.S. permanent establishment, or the assets held
to produce such income. The comments
noted that section 952(b) can exclude
from subpart F income amounts that are
FPHCI in order to prevent such amounts
from being double-taxed, once directly to
the foreign corporation, and a second time
to United States shareholders of the foreign corporation, and stated that the PFIC
rules should not discriminate against income earned through a U.S. branch rather

Bulletin No. 2021–5

than through a domestic subsidiary that
may qualify for the special rules of section 1298(b)(7). These comments suggested that the final regulations either characterize such income, and the assets held to
produce such income, as non-passive or
not include such income for purposes of
the Income and Asset Tests.
As noted in Part III.B.1 of this Summary of Comments and Explanation of
Revisions, the determination of whether
amounts should be taken into account
for purposes of the Income Test or the
Asset Test is based on whether income
would be FPHCI under section 954(c),
not whether the income is treated as subpart F income. The PFIC rules address
whether income is passive, which is a
different question from whether it should
be treated as subpart F income. Section
1298(b)(7) does not provide non-passive
treatment for all income of domestic subsidiaries, but rather only for income of
domestic subsidiaries that meet specified
requirements, indicating that Congress
did not consider it appropriate to exclude
all income of domestic subsidiaries that
are subject to U.S. net income taxation
from passive income treatment. As a
corollary, the limited scope of section
1298(b)(7) implies that a broad exception for effectively connected income
is not warranted. Furthermore, section
1293(g)(1)(B)(ii) provides authority to
exclude effectively connected income of
a PFIC that is subject to U.S. net income
taxation from inclusion in the hands of a
shareholder of the PFIC that has made a
qualified electing fund election, indicating that effectively connected income is
otherwise treated as income of a tested
foreign corporation for PFIC purposes.
The Treasury Department and the IRS
have determined that an exclusion of effectively connected income (and income
attributable to a U.S. permanent establishment) from passive income would be
inconsistent with the statutory definition
of passive income in section 1297(b)(1),
with the limited application of section
1298(b)(7) and with the exclusion provided by section 1293(g)(1)(B)(ii), and that
the treatment of effectively connected income (and income attributable to a U.S.
permanent establishment) is contemplated
and appropriately addressed by the existing PFIC rules. Consequently, the final

513

regulations do not adopt the suggestions
in these comments.
C. Income subject to the related person
look-through rule
Section 1297(b)(2)(C) characterizes
dividends, interest, rents, and royalties
received or accrued from a related person
as non-passive income to the extent those
amounts are properly allocable to income
of such related person that is not passive.
Proposed §1.1297-1(c)(3) provided additional guidance on the application of
the section 1297(b)(2)(C) related person
exception for dividends, interest, rents,
and royalties. In response to comments,
changes have been made to these regulations and additional guidance has been
provided.
Under the final regulations, for purposes of the Asset Test and Income Test,
corporations and partnerships owned in
whole or part by a tested foreign corporation are generally classified into one or
more of three categories. Lower-tier entities generally are treated as one or more
of (i) a look-through subsidiary or lookthrough partnership (a “look-through entity”), (ii) a related person or (iii) an entity
that is neither a look-through entity nor a
related person. The rules for look-through
entities are discussed in Part IV of this
Summary of Comments and Explanation
of Revisions. Dividends and the distributive share of income from a lower-tier
entity that is neither a look-through entity
nor a related person generally are treated
as passive income, regardless of whether
the income of the lower-tier entity is active or passive in its hands. See §1.12971(c)(3). Similarly, ownership interests in
such entities are treated as passive assets.
See §1.1297-1(d)(4).
For purposes of section 1297(b)(2)(C),
the term related person has the meaning
provided by section 954(d)(3). See section
1297(b)(2) and §1.1297-1(f)(8). Because
the ownership threshold required for an
entity to be treated as a related person
is higher than the ownership threshold
required for an entity to be treated as a
look-through entity, there may be many
entities that qualify as both or solely as
look-through entities. However, because
section 954(d)(3) has broader attribution
rules than the rules that apply for purposes

February 1, 2021

of determining look-through entity classification, there may be entities that are
treated as related persons with respect to a
tested foreign corporation but not as lookthrough entities with respect to that tested
foreign corporation.
For purposes of section 1297(b)(2)(C),
interest, dividends, rents or royalties actually received or accrued by a tested foreign
corporation are considered received or
accrued from a related person only if the
payor of the interest, dividend, rent or royalty is a related person with respect to the
tested foreign corporation. In the case of
income received or accrued from a lookthrough entity, the rules that eliminate intercompany income described in Part IV.D
of this Summary of Comments and Explanation of Revisions apply before the rules
applicable to income received or accrued
from a related person. See §1.1297-1(c)(4)
(ii). Consequently, the rules of §1.12971(c)(4) apply to dividends, interest, rents,
and royalties received or accrued from a
look-through entity only if those amounts
are treated as regarded after application
of the intercompany income rules. These
rules also apply to income from a related person that is received or accrued by
a look-through entity. The determination
of whether income received or accrued
by a look-through entity is treated as received from a related person is made at
the level of the look-through entity, both
for purposes of determining whether the
look-through entity is a PFIC, if relevant,
and for purposes of determining whether
an upper-tier tested foreign corporation is
a PFIC. See §1.1297-2(d).
If a partnership is a related person (that
is not a look-through entity) with respect
to a tested foreign corporation or lookthrough entity, and therefore subject to
these rules, the tested foreign corporation’s
or look-through entity’s distributive share
of income from the partnership is treated
as passive or non-passive in whole or part
based on the activities of the partnership,
and the partnership interest is correspondingly treated as passive or non-passive in
whole or part. See §1.1297-1(c)(4)(vii),
(d)(3)(i), and (d)(4). An asset that gives
rise to income that is treated as in part passive and in part non-passive pursuant to
these rules is subject to the rules that apply
to dual-character assets. See §1.1297-1(d)
(3)(i).

February 1, 2021

1. Treatment of Interest
The proposed regulations provided
that, for purposes of the section 1297(b)
(2)(C) exception, interest is properly allocable to income of the related person that
is not passive income based on the relative portion of the related person’s income
for its taxable year that ends in or with the
taxable year of the recipient that is not
passive income. See proposed §1.12971(c)(3)(i). Comments generally supported
the pro rata approach taken in the proposed regulations. One comment noted
that the final regulations should clarify
that the allocation is based on the ratio of
gross non-passive income to gross total
income. Another comment that supported the pro rata approach in the proposed
regulations recommended that the final
regulations address situations in which
the related person does not have income
during the taxable year of the payment.
In such a case, this comment suggested
that the final regulations apply the principles of §1.861-9T, which provides rules
for allocating and apportioning interest
expense, to determine whether the interest payments are allocated to passive or
non-passive income of the related person.
The comment also requested that the approach using the principles of §1.861-9T
to allocate interest when the related person does not have gross income be made
available as an alternative method at the
election of the tested foreign corporation.
As suggested by the first comment, the
final regulations clarify that the ratio for
allocating interest to income is based on
gross income. See §1.1297-1(c)(4)(iii).
Similar clarifications are made for the
rule for rents and royalties. See §1.12971(c)(4)(v). The Treasury Department and
the IRS have determined that the pro rata
approach provided in the proposed regulations is the most straightforward and
consistent with the purposes of the section
1297(b)(2)(C) exception if the related person has gross income in the taxable year,
and accordingly, the final regulations do
not provide a generally applicable election to apply the principles of §1.861-9T
in lieu of the general rule. See §1.12971(c)(4)(iii).
It is anticipated that it will rarely be the
case that a related person will not have
gross income, because gross income for

514

most taxpayers is determined without taking expenses into account. However, in
the case of taxpayers that determine gross
income after taking operating expenses
into account, it is possible that a taxpayer
will not have gross income for a taxable
year. In such a case, the Treasury Department and the IRS agree that the principles
of §1.861-9T may properly apply for a
year in which the related person does not
have gross income, because §1.861-9T is
a general rule — the default rule in the
absence of a more specific rule – relating
to the allocation of interest expense. Alternatively, because section 1297(b)(2)(C)
characterizes interest received or accrued
from a related person as non-passive income to the extent it is properly allocable
to non-passive income of the related person, it may also be appropriate for interest
received or accrued by the tested foreign
corporation to be allocated entirely to passive income in such a case, and that treatment may be simpler for a tested foreign
corporation to determine. Accordingly, the
final regulations provide that for a year in
which the related person does not have
gross income, a tested foreign corporation may use the principles of §1.861-9
through -13T, applied in a reasonable and
consistent manner taking into account the
general operation of the PFIC rules and the
purpose of section 1297(b)(2)(C) in order
to allocate interest received or accrued
from the related person between passive
and non-passive income. Alternatively, at
a tested foreign corporation’s election, it
may treat the interest income entirely as
passive income.
2. Treatment of Dividends
The proposed regulations provided
that, for purposes of the section 1297(b)
(2)(C) exception, dividends are treated as
properly allocable to income of the related person that is not passive income based
on the portion of the related payor’s current earnings and profits (“E&P”) for the
taxable year that ends in or with the taxable year of the recipient that is attributable to non-passive income. See proposed
§1.1297-1(c)(3)(ii).
A comment observed that foreign corporations often do not maintain E&P based
on U.S. tax principles. The comment recommended that dividends be treated as al-

Bulletin No. 2021–5

located between passive and non-passive
amounts based on the ratio of passive to
non-passive gross income.
Two comments requested that proposed §1.1297-1(c)(3)(ii) be modified to
allocate dividend income based on both
current and accumulated E&P of the related payor to which the dividend income is
attributable, in accordance with the principles of section 316. A third comment
observed that there are administrative
benefits to characterizing dividends by
reference to current E&P, because it may
be easier to obtain relevant information
for current E&P and because the nature of
a company’s activities may change. This
comment further requested that dividends
be determined by reference to gross income over a reasonable look-back period
such as three to five years, rather than by
reference to E&P under section 316 principles, in order to reflect the economic reality of the corporation’s activities and to
avoid undue emphasis on the timing of the
dividends. The comment suggested as an
alternative that this method might apply
only if the related payor does not maintain
E&P using U.S. tax principles, while if the
related party does maintain E&P based on
U.S. tax principles, then, to the extent of
current E&P, dividends would be characterized based on the portion of the related
payor’s current-year E&P that is attributable to non-passive income, and the remaining amount would be characterized
based on the relative portion of accumulated E&P that is attributable to non-passive income. The comment suggested that
the ratio for accumulated E&P could be
based on accumulated E&P for the period
in which the related payor was a related
person under section 954(d)(3).
Another comment suggested that the
difficulty in obtaining information necessary to determine the character of accumulated E&P with respect to foreign
corporations could be addressed by allowing taxpayers to use reasonable methods
to determine the character of accumulated
E&P and proposed that characterizing the
accumulated E&P based on the current
year’s E&P be considered a reasonable
method.
The Treasury Department and the IRS
agree that dividends from related parties
should be allocated between passive and
non-passive E&P based on the principles

Bulletin No. 2021–5

of section 316, which apply generally
for purposes of the U.S. international tax
rules. Accordingly, the final regulations
adopt the recommendation to characterize
dividends in accordance with first current
and then accumulated E&P of the related
payor to which the dividend income is
attributable. See §1.1297-1(c)(4)(iv)(A).
In order to address concerns that foreign
corporations that are not CFCs may not
maintain E&P based on U.S. tax principles, taxpayers are permitted to allocate
E&P in proportion to the ratio of passive
gross income to non-passive gross income
for the relevant period. See §1.1297-1(c)
(4)(iv)(B).
The Treasury Department and the IRS
also agree with the premise of all of the
comments that if dividends are paid out
of E&P other than current E&P, either because there is no current E&P or because
the amount of the dividends exceeds the
current E&P, it would be appropriate to
take into account the character of the income supporting the dividend. The final
regulations provide that dividends paid
out of accumulated E&P are allocated between passive and non-passive E&P under
the same rules that apply with respect to
dividends paid out of current E&P. See
§1.1297-1(c)(4)(iv)(C).
The Treasury Department and the IRS
understand that it may be difficult for
shareholders to determine the character of
accumulated E&P with respect to foreign
corporations, particularly for E&P from
pre-acquisition periods. The suggestion of
referring to a look-back period of several
years is consistent with the rule for characterizing stock, discussed in Part III.D.4
of this Summary of Comments and Explanation of Revisions, which is intended to
effectively treat stock as, in whole or part,
held for the production of non-passive income if dividends received with respect
to it within a three-year period constitute
non-passive income due to the application
of section 1297(b)(2)(C). Accordingly, the
final regulations permit taxpayers to use
the default approach, consistent with general U.S. federal income tax principles, of
allocating dividends paid out of accumulated E&P based on the ratio of passive
to non-passive E&P for each prior year
(beginning with the most recently accumulated), or to use one of two administratively simpler alternatives. See id. The

515

first alternative is to allocate dividends
paid out of accumulated E&P based on the
ratio of passive to non-passive E&P that
is attributable to E&P accumulated in the
years in which the payor was related to the
recipient. If the payor has been related to
the recipient for more than three years, a
second alternative is available, which is to
allocate dividends paid out of accumulated E&P based on the ratio of passive to
non-passive E&P that is attributable to
E&P accumulated during a look-back period of the three years before the current
taxable year. See id.
D. Asset test
1. Section 958 Proposed Regulations
Shareholders of a foreign corporation
that became a CFC as a result of the repeal
of section 958(b)(4) would have to apply
the Asset Test based on the adjusted basis
of the foreign corporation’s assets under
section 1297(e). The section 958 proposed
regulations modified the definition of a
CFC for purposes of section 1297(e) to
disregard downward attribution from foreign persons. See proposed §1.1297-1(d)
(1)(iii)(A). No comments were received
with respect to this rule in the section 958
proposed regulations. Accordingly, the
rule is finalized without modification. See
§1.1297-1(d)(1)(v)(B)(2).
2. Determination of Average Amount of
Assets Based on Value or Adjusted Basis
Section 1297(e) provides that the assets of a tested foreign corporation are to
be measured based on (i) value, pursuant
to section 1297(e)(1), if it is a publicly
traded corporation for the taxable year, or
if section 1297(e)(2) does not apply to it
for the taxable year; or (ii) adjusted basis,
pursuant to section 1297(e)(2), if it is a
CFC or elects the application of section
1297(e)(2). These statutory provisions
create a hierarchy for determining the
method for measuring the assets of a tested foreign corporation, as follows: (a) first
by value, if the tested foreign corporation
is a publicly traded corporation for the
taxable year; (b) second by adjusted basis,
if the tested foreign corporation is not a
publicly traded corporation and is a CFC;
and (c) third by value, or at the election

February 1, 2021

of the tested foreign corporation, by adjusted basis, in other cases. The Treasury
Department and the IRS understand that
taxpayers typically prefer to use value to
measure assets of a tested foreign corporation.
The proposed regulations provided
that, for purposes of the Asset Test, companies that were publicly traded for only
part of the year were required to measure assets on the basis of value for the
entire year if the corporation was publicly traded on the majority of days during
the year or if section 1297(e)(2) did not
apply to the corporation on the majority
of days of the year. If the tested foreign
corporation was not publicly traded on
the majority of days during the year, the
tested foreign corporation was required to
use adjusted basis to measure assets if it
was a CFC or if an election to use adjusted basis was made under section 1297(e)
(2)(B). See proposed §1.1297-1(d)(1)(v).
The majority of days rule in the proposed
regulations would have required a tested
foreign corporation that was a CFC and
whose shares were publicly traded for less
than the majority of days during the year
to use adjusted basis to measure its assets
for that taxable year because the corporation would not have been treated as a publicly traded corporation. The requirement
to use adjusted basis might apply, for example, to a foreign corporation treated as
a CFC that issues publicly traded shares in
an initial public offering in the second half
of the year.
A comment requested that the proposed
regulations be modified to provide that
the Asset Test be applied based on value
if shares of the tested foreign corporation
were publicly traded at any time during
the taxable year. The comment asserted
that the use of value more appropriately
reflects the purposes of the PFIC rules in
general, and that the statute requires only
non-publicly traded CFCs to use basis
for purposes of the Asset Test and otherwise allows a tested foreign corporation
to apply the Asset Test based on value.
The comment also noted that, due to the
repeal of section 958(b)(4), there may be
more tested foreign corporations that are
CFCs. In such cases, less-than-10-percent
shareholders of those tested foreign corporations would be required to use basis
rather than value in determining PFIC sta-

February 1, 2021

tus. The comment requested relief from
this result. The comment further noted
that publicly traded corporations required
to use basis would not be able to take into
account goodwill and other self-created
business intangibles for purposes of the
Asset Test because such items often do not
have tax basis.
The Treasury Department and the IRS
agree with the concerns expressed by the
comment regarding the effects of the repeal of section 958(b)(4). As discussed
in Part III.D.1 of this Summary of Comments and Explanation of Revisions, this
rulemaking finalizes the portion of the
section 958 proposed regulations concerning the definition of the term CFC for
purposes of the Asset Test, which accordingly allows use of the value method of
measuring assets to the extent permissible
under the statute. See §1.1297-1(d)(1)(v)
(B)(2) (treating foreign corporations that
are CFCs solely due to the repeal of section 958(b)(4) as not CFCs for purposes
of section 1297(e)). The Treasury Department and the IRS believe that this change
may alleviate much of the concern expressed about the proposed rule because
the change makes it less likely that a tested foreign corporation will be treated as a
CFC that is required to use adjusted basis
to measure its assets.
The Treasury Department and the IRS
also agree that section 1297(e) favors the
use of value as a method to measure assets
and that the use of value aligns with the
objective of the PFIC rules. As a result,
the final regulations expand the definition
of publicly traded corporation for purposes of section 1297(e) to include more
circumstances in which a tested foreign
corporation is treated as a publicly traded foreign corporation. See §1.1297-1(f)
(7). However, the Treasury Department
and the IRS believe that it would be inappropriate to require a corporation to use
value for purposes of the Asset Test if it
was publicly traded for a de minimis period during its taxable year. Accordingly,
the final regulations provide that a publicly traded corporation, which is defined as
a corporation that has been publicly traded
in more than de minimis amounts for at
least twenty trading days (approximately
one month) during a taxable year, is required to apply the Asset Test based on
value. See §1.1297-1(d)(1)(v)(A) and (f)

516

(7). Pursuant to section 1297(e), a tested
foreign corporation that does not qualify
as a publicly traded foreign corporation
may use value to measure assets as long
as it is not a non-publicly traded CFC, but
it is not required to do so.
The comment also requested clarification on the application of section 1297(e)
in the case of tiers of tested foreign corporations. The comment recommended the
final regulations provide that, for purposes
of applying the Asset Test, a publicly traded tested foreign corporation should measure all of its assets—including the assets
of its non-publicly traded look-through
subsidiaries—based on value. The Treasury Department and the IRS generally
agree with the premise of this comment,
except in cases where section 1297(e) requires a different treatment for the assets
of subsidiaries (as discussed in the next
paragraph). For the avoidance of doubt,
the final regulations include cross-references to §1.1297-2(b)(2)(i) (which provides the rule that a tested foreign corporation is deemed to directly own the assets
of the look-through subsidiary) in the final
section 1297(e) rules. See §1.1297-1(d)(1)
(i) and (d)(1)(v)(A).
The comment also observed that, unlike the typical situation where a publicly
traded tested foreign corporation would
measure all of its assets (including the
assets of its non-publicly traded lookthrough subsidiaries) based on value in
accordance with section 1297(e)(1)(A),
it is questionable whether a CFC that is a
non-publicly traded subsidiary of a publicly traded parent corporation could also
use value, rather than basis, for purposes
of testing its own PFIC status. The comment noted that such a subsidiary might be
a CFC as a result of the repeal of section
958(b)(4). As discussed in Part III.D.1 of
this Summary of Comments and Explanation of Revisions, §1.1297-1(d)(1)(v)
(B)(2), which provides that foreign corporations that are CFCs solely due to the
repeal of section 958(b)(4) are not treated
as such for purposes of section 1297(e),
mitigates this concern. Further, if a lower-tier tested foreign corporation is a CFC
that is not publicly traded, section 1297(e)
(2)(A) requires that adjusted basis be used
as the method for measuring its assets.
Therefore, the final regulations clarify that
a lower-tier tested foreign corporation that

Bulletin No. 2021–5

is a non-publicly traded CFC must use adjusted basis and not value to measure its
assets, regardless of whether it is owned
by a publicly traded foreign corporation.
In order to clarify the application of the
statutory hierarchy for measuring a tested
foreign corporation’s assets more generally, including with respect to lower-tier
tested foreign corporations, §1.1297-1(d)
(1)(v) has been revised. The regulation
provides a hierarchy that generally applies
to every tested foreign corporation, regardless of whether it is an upper-tier or lower-tier tested foreign corporation. Pursuant
to section 1297(e) and this hierarchy, (i) a
publicly traded foreign corporation (as defined in §1.1297-1(f)(7)) must use value
to measure its assets, (ii) a non-publicly
traded CFC must use basis to measure its
assets, unless the CFC becomes a publicly traded foreign corporation (as defined
in §1.1297-1(f)(7)) during a taxable year,
and (iii) any other tested foreign corporation would use value to measure its assets
unless an election is made to use adjusted
basis, except if it is a lower-tier subsidiary
in which case additional rules apply. See
§1.1297-1(d)(1)(v)(A), (B), and (C)(1).
Section 1.1297-1(d)(1)(iii) clarifies that
the election to use adjusted basis may be
made by the tested foreign corporation or
its shareholders.
Revised §1.1297-1(d)(1)(v) provides
specific rules for measuring the assets of
lower-tier subsidiaries, which in the usual case are expected to be look-through
subsidiaries. These rules follow the same
hierarchy described in the prior paragraph,
except that the method used to measure
the assets of a lower-tier subsidiary may
be determined either by the status of the
lower-tier subsidiary if it is a publicly
traded foreign corporation or a non-publicly traded CFC, or by the status of a
tested foreign corporation that directly or
indirectly owns all or part of the shares
of the lower-tier subsidiary (a parent foreign corporation), if the parent foreign
corporation has one of those statuses. See
§1.1297-1(d)(1)(v)(C)(2).
As a general matter, the method used
by a parent foreign corporation to measure
its assets also must be used to measure the
assets of a lower-tier foreign corporation
owned in whole or part by that parent foreign corporation. This rule applies both
for purposes of determining whether the

Bulletin No. 2021–5

parent foreign corporation is a PFIC and
for purposes of determining whether the
lower-tier foreign corporation is a PFIC.
If a tested foreign corporation indirectly
owns a lower-tier subsidiary through one
or more other foreign corporations, the
status of the parent foreign corporation
in that chain of corporations that has the
highest status in the hierarchy described
above governs. See §1.1297-1(d)(1)(v)(C)
(2)(iii).
This general consistency rule does not
apply, however, if the lower-tier foreign
corporation has a status for which section
1297(e) mandates a method for measuring
assets (that is, it is a publicly traded foreign corporation or non-publicly traded
CFC). In such a case, the statutorily mandated method applies to measure the lower-tier foreign corporation’s assets, both
for purposes of determining whether the
parent foreign corporation is a PFIC and
for purposes of determining whether the
lower-tier foreign corporation is a PFIC.
For example, if a tested foreign corporation is a publicly traded foreign corporation, then both its assets and the assets of
its lower-tier subsidiaries must be measured on the basis of value, unless a lower-tier subsidiary is a non-publicly traded
CFC, in which case the assets of that subsidiary must be measured using adjusted
basis. Similarly, if a tested foreign corporation is a non-publicly traded CFC,
then both its assets and the assets of its
lower-tier subsidiaries must be measured
using adjusted basis, unless a lower-tier
subsidiary is a publicly traded foreign corporation, in which case the assets of that
subsidiary must be measured using value.
See §1.1297-1(d)(1)(v)(C)(2)(i) and (ii).
If a lower-tier tested foreign corporation
does not have a status for which section
1297(e) mandates a method for measuring
assets, and it is a subsidiary of more than
one parent foreign corporation, then U.S.
shareholders of the two different parent
corporations may be required to use different methods to measure the assets of
the lower-tier foreign corporation based
on the method used for each respective
parent foreign corporation. See the last
sentence of §1.1297-1(d)(1)(v)(C)(2)(iii)
and §1.1297-1(d)(1)(v)(E)(3) (Example
3).
The Treasury Department and the IRS
recognize that section 1297(e)(1) requires

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in many cases that a valuation must be
performed for assets of an operating company for which no publicly available valuation is available, apart from information
provided in financial statements prepared
under widely-used financial reporting
standards, and that ascertaining such a
valuation creates a compliance burden.
The Treasury Department and the IRS are
studying whether to provide rules permitting taxpayers to rely on financial statement information in appropriate cases,
and the final regulations reserve on this issue. See §1.1297-1(d)(1)(v)(D). The 2020
NPRM proposes a rule to address this issue and solicits comments on the proposed
rule. See proposed §1.1297-1(d)(1)(v)(D).
3. Treatment of Working Capital for
Purposes of Asset Test
The proposed regulations did not address the treatment of working capital for
purposes of the Asset Test. Notice 88-22,
1988-1 C.B. 489 (“Notice 88-22”) provides that cash and other current assets
readily convertible into cash, including
assets that may be characterized as the
working capital of an active business, are
treated as passive assets for purposes of
the Asset Test. Notice 88-22 indicated that
passive treatment is warranted because
working capital produces passive income
(interest income).
A comment on the proposed regulations asserted that the approach taken in
Notice 88-22 with respect to working capital undermines the purpose of the PFIC
regime to distinguish between investments
in passive assets and investments in active
businesses. The comment requested that
the final regulations adopt an approach,
similar to the treatment of dual-character
assets, pursuant to which working capital
would be bifurcated between passive and
non-passive assets in proportion to the relative amount of gross income that is passive or non-passive.
The Treasury Department and the
IRS continue to study the appropriate
treatment of working capital, and the final regulations reserve on this issue. See
§1.1297-1(d)(2). The 2020 NPRM proposes a limited exception to the treatment
of working capital to take into account the
short-term cash needs of operating companies. See proposed §1.1297-1(d)(2).

February 1, 2021

4. Assets that Produce Income Subject to
the Related Person Look-Through Rule
The proposed regulations defined the
term passive asset, consistent with section
1297(a), as an asset that produces passive
income, or which is held for the production of passive income, taking into account the rules in proposed §1.1297-1(c),
which defined passive income, and proposed §1.1297-1(d), which provided rules
for the application of the Asset Test. See
proposed §1.1297-1(f)(6). The proposed
regulations also provided that an asset
that produces both passive income and
non-passive income during a taxable year
is treated as two assets, one of which is
passive and one of which is non-passive,
with the value (or adjusted basis) of the
asset being allocated between the passive
asset and non-passive asset in proportion
to the relative amounts of passive and
non-passive income produced by the asset during the taxable year. See proposed
§1.1297-1(d)(2)(i).
A number of comments expressed concern that the proposed regulations did not
provide a general rule to characterize assets—in particular shares of stock—that
give rise to income subject to the related person look-through rule of section
1297(b)(2)(C), discussed in Part III.C of
this Summary of Comments and Explanation of Revisions. The comments suggested that the final regulations include
a rule that treats assets that give rise to
income subject to section 1297(b)(2)(C)
as a passive or non-passive asset to the
extent the income that is received with
respect to such asset is treated as passive
or non-passive by the tested foreign corporation. The Treasury Department and
the IRS agree that it is consistent with the
statutory language and intent of section
1297(a)(2) to treat assets that give rise to
both passive and non-passive income as
partly passive and partly non-passive. The
Treasury Department and the IRS believe
that it was clear under proposed §1.12971(d)(2)(i) and (f)(6) that assets that produced income subject to the related person look-through rule of section 1297(b)
(2)(C) were treated as non-passive in proportion to the non-passive income produced by the asset, subject to the special
rules in §1.1297-1(d). However, for the
avoidance of doubt, the final regulations

February 1, 2021

provide an explicit cross-reference to section 1297(b)(2)(C) to clarify that assets
that produce income subject to the related
person look-through rule are subject to
the general and special rules with respect
to treatment of assets under §1.1297-1(d),
for example related party stock, loans,
leases or licenses that produce dividends,
interest, rent or royalties that are treated
as passive and non-passive under section 1297(b)(2)(C). See §1.1297-1(d)
(3)(i). Accordingly, assets that give rise
to income subject to section 1297(b)(2)
(C) generally are treated as a passive or
non-passive asset to the extent the income
that is received with respect to such asset
is treated as passive or non-passive by the
tested foreign corporation.
The proposed regulations also provided that stock of a related person with respect to which no dividends are received
or accrued during a taxable year but that
previously generated dividends that were
characterized as non-passive income, in
whole or in part, under section 1297(b)
(2)(C) is characterized based on the dividends received or accrued with respect
thereto for the prior two years. See proposed §1.1297-1(d)(2)(iii).
Comments noted that there may be
instances in which the related person has
not paid dividends in more than two years.
One comment suggested that, in this instance, stock be apportioned in proportion
to the average percentage of the dividends
that were characterized as passive and
non-passive in the last two years in which
the related person paid dividends. If the
related person never paid a dividend that
was excluded under section 1297(b)(2)
(C), the comment recommended that the
stock be characterized based on the earnings during the last two years in which
the related person generated earnings or,
if the related person has never generated
earnings, based on the earnings that are
reasonably expected to be generated in the
future. Another comment requested that
proposed §1.1297-1(d)(2)(iii) be replaced
with a general rule with respect to stock
of a related party that would characterize
the stock based on whether the stock is
expected to generate passive income. The
comment asserted that this rule would allow for taxpayers to use reasonable methods to determine if the stock is expected to
generate passive income.

518

One comment argued that, for purposes of characterizing stock that does not
generate dividends in the current year, a
look-back period of two years would be
appropriate if the final regulations adopt
an approach that characterizes the stock
based on the character of hypothetical dividends and uses the proportionate amount
of non-passive gross income over the
look-back period to determine the character of the dividends. If such an approach is
not adopted, the comment recommended
that, instead of a look-back period of two
years, the stock could be characterized
based on dividends paid during the preceding five years or, if shorter, the period
during which the subsidiary was a related
person under section 954(d)(3).
Proposed §1.1297-1(d)(2)(iii) was
premised on the understanding that stock
that has recently generated dividends that
are, in whole or in part, non-passive under
the related person look-through rule can
be understood to be held for the production of non-passive income. If, however,
the stock has not recently generated dividends, it is more appropriate to treat the
stock as held for the production of gains
upon disposition, which would generally
be passive income. Accordingly, the Treasury Department and the IRS have determined that it would not be appropriate to
allow stock to be treated as a non-passive
asset on the basis of speculation that dividends might be received with respect to
the stock and that such dividends could be
non-passive under section 1297(b)(2)(C)
as most of the comments’ recommendations would provide. Moreover, the changes to the rules for determining the passive
or non-passive character of dividends, discussed in Part III.C.2 of this Summary of
Comments and Explanation of Revisions,
also take into account the actual history
of the stock and allow taxpayers to treat
the most recent prior years as most relevant in determining the character of the
stock. Thus, the final regulations do not
adopt these comments and, instead, the final regulations provide that stock that did
not produce dividends within the current
taxable year or within either of the preceding two taxable years is characterized as a
passive asset. See §1.1297-1(d)(3)(iii); but
see section 1297(c) and §1.1297-2(c)(1)(i)
(eliminating stock of look-through subsidiaries for purposes of the Asset Test).

Bulletin No. 2021–5

E. Stapled entities
Proposed §1.1297-1(e) provided that,
for purposes of determining whether
any stapled entity (as defined in section
269B(c)(2)) is a PFIC, all entities that are
stapled entities with respect to each other
are treated as one entity. A comment suggested that the definition of stapled entities provided in section 269B(c)(2) and
§1.269B-1 could be overbroad and thus
lead to planning opportunities for purposes of PFIC testing. Therefore, the comment recommended that the final regulations provide a more restrictive definition
for stapled entities so that, for purposes
of PFIC testing, single-entity treatment
would be limited to situations in which
nearly 100 percent of the outstanding equity interests in both entities are stapled
to each other. Alternatively, the comment
suggested, the Treasury Department and
the IRS could issue rules applicable to the
holders of stapled interests clarifying the
application of the anti-abuse rule in section 1298(b)(4) (which would treat separate classes of stock (or other interests) in
a corporation as interests in separate corporations, pursuant to regulations, where
necessary to carry out the purposes of the
PFIC regime) to such stapled interests by
providing that the rule would apply only
if unusual features exist and the arrangement would allow avoidance of the PFIC
rules. The comment also highlighted the
inappropriateness of potentially applying
the rule in proposed §1.1297-1(e) to treat
a shareholder of an entity that would not
be a PFIC, but for the rule, as the shareholder of a PFIC.
Another comment requested clarification on the extent to which stapled entities
that were treated as a single entity for purposes of PFIC testing would be treated as
a single entity with respect to other provisions in the PFIC regime. In particular, the
comment requested that the final regulations indicate whether the stapled entities
are treated as one PFIC for purposes of
including income under the PFIC regime
and for purposes of making an election
with respect to income inclusions under
the PFIC regime. Like the first comment,
it also requested guidance when not all interests are stapled.
The Treasury Department and the IRS
have determined that it is appropriate to

Bulletin No. 2021–5

apply the single entity treatment of proposed §1.1297-1(e) even when not all
interests in the stapled entities are stapled
because section 269B(c)(2) applies only
when controlling interests in the stapled
entities are stapled, but that the application of the rule should be limited to apply
only to U.S. persons that hold stapled interests and should not affect U.S. persons
that directly or indirectly own only one of
the stapled entities. Accordingly, the rule
in proposed §1.1297-1(e) is modified to
apply only if a U.S. person that would be
a shareholder of the stapled entities owns
stock in all entities that are stapled entities
with respect to each other. In this case, the
stapled entities are treated as an interest
in a single entity for all purposes of the
PFIC rules, which may have the effect of
causing a stapled entity that would not be
a PFIC on a stand-alone basis to be treated as a PFIC when stapled, or the reverse.
See §1.1297-1(e). Given these modifications to the rule and the fact that the definition of stapled entities in section 269B(c)
(2) already limits stapling to situations in
which more than 50 percent in the value
of the beneficial ownership in each of the
entities consists of stapled interests, the
Treasury Department and the IRS have
determined that it is not necessary at this
time to provide guidance on the application of section 1298(b)(4) or to further
limit the interests that can be stapled.
IV. Comments and Revisions to Proposed
§1.1297-2 – Special rules regarding lookthrough subsidiaries and look-through
partnerships
Proposed §1.1297-2 provided guidance
on the application of the look-through rule
of section 1297(c) for purposes of the Income Test and the Asset Test.
A. Overview
1. Treatment of Income and Assets
Under the final regulations, a tested
foreign corporation is treated as directly
owning the assets of, and directly deriving the gross income of, a look-through
subsidiary or look-through partnership.
See §1.1297-2(b)(2) and (b)(3). The tested
foreign corporation disregards the equity
interest in the look-through entity for pur-

519

poses of the Asset Test. See §1.1297-2(c)
(1)(i) and (c)(3). As discussed in more
detail in Part IV.D of this Summary of
Comments and Explanation of Revisions,
dividends from a lower-tier subsidiary and
distributions and the distributive share of
income from a lower-tier partnership generally are treated as if they did not exist
(“eliminated”) for purposes of the Income
Test. See §1.1297-2(c)(2)(i) and (c)(3).
For Income Test purposes, the proposed
regulations provided that the disposition
of the stock of a look-through subsidiary
is treated as the disposition of stock and
provided rules for the calculation of gain.
See proposed §1.1297-2(f)(1). The final
regulations also include rules addressing
the disposition of partnership interests in a
look-through partnership, which are similar in concept to the rules that apply to
the disposition of stock of a look-through
subsidiary, and rules addressing the disposition of partnership interests in a partnership described in section 954(c)(4)(B). See
§1.1297-2(f)(4). Where both rules could
potentially apply, the disposition is subject to the rules of section 954(c)(4). See
§1.1297-2(f)(4)(i) and (ii). Consequently,
it is anticipated that the sale of interests
in a partnership that a tested foreign corporation owns at least 25 percent of by
value generally will be subject to section
954(c)(4), and therefore will be treated as
a disposition of assets rather than a disposition of the partnership interest, while
the sale of interests in a partnership that a
tested foreign corporation owns less than
25 percent of by value may or may not be
subject to section 954(c)(4) in light of the
different 25-percent ownership test in that
statutory provision. The effect on the determination of gain under section 954(c)
(4) of partnership earnings that have been
included in income by the tested foreign
corporation but not distributed is beyond
the scope of these regulations.
Payments of interest, rent and royalties,
and the related debt obligation, lease or license, between the tested foreign corporation and the look-through entity or between look-through entities generally also
are eliminated for purposes of both the
Income and the Asset Tests, as discussed
in Part IV.D of this Summary of Comments and Explanation of Revisions. See
§1.1297-2(c)(1)(ii), (c)(2)(ii), and (c)(3).
If the obligation is between look-through

February 1, 2021

entities that are not wholly owned by the
tested foreign corporation, a proportionate
part of the obligation and income from it
is eliminated. See id.
2. Definition of Look-Through Subsidiary
A subsidiary of a tested foreign corporation is treated as a look-through subsidiary if both an asset test and an income test
are satisfied. See §1.1297-2(g)(3). If only
one test is satisfied, the subsidiary is not
treated as a look-through subsidiary. See
generally id. The asset test is satisfied for
any measuring period (for example, one
quarter of a taxable year) if on the relevant measuring date (for example, the end
of a quarter) the tested foreign corporation
owns at least 25 percent of the value of the
stock of the subsidiary. See §1.1297-2(g)
(3)(i). The income test is satisfied if either
(i) the tested foreign corporation owns an
average of at least 25 percent of the value
of the subsidiary’s stock on the measuring
dates of an entire taxable year, or (ii) the
tested foreign corporation owns at least
25 percent of the value of the subsidiary’s
stock on a measuring date and the subsidiary’s gross income for the measuring period can be determined. See §1.1297-2(g)
(3)(ii). Consequently, if a tested foreign
corporation owns at least 25 percent of a
subsidiary’s stock for part but not all of a
taxable year, the subsidiary is treated as
a look-through subsidiary for that part of
the taxable year only if the tested foreign
corporation can determine the subsidiary’s gross income on the measuring dates
within that part of the taxable year. These
rules are intended to ensure that a subsidiary is not treated as a look-through subsidiary unless the tested foreign corporation
can determine the proportionate share of
the subsidiary’s assets and income that it
is treated as directly owning and deriving.
B. Look-through partnerships
1. Overview
The proposed regulations defined a
look-through partnership as a partnership
in which the tested foreign corporation
owned at least 25 percent in value. See
proposed §1.1297-1(c)(2)(i), (d)(3)(i), and
(f)(1). The preamble to the proposed regulations indicated that the look-through

February 1, 2021

partnership rules were drafted to apply
look-through treatment as provided in
section 1297(c) consistently to lower-tier
partnerships and lower-tier corporations.
See 84 FR 33120, at 33124. The preamble
stated that the difference between the 25
percent threshold for look-through partnerships in the proposed regulations and
the treatment of partnership income for
FPHCI purposes is warranted because of
the flexibility that entities have in their
characterization under §301.7701-3 and
because of the fact that treating a subsidiary as a partnership may not have U.S.
income tax consequences for a tested foreign corporation as it could for a CFC. See
id. The preamble also noted that this rule
ensured that the tested foreign corporation would have significant control over
the partnership activities, such that a partnership interest could represent an active
business interest. See id. The preamble requested comments on whether 25 percent
was the right threshold, whether different
rules should apply to general partnerships
and limited partnerships, and whether a
material participation test should apply.
The definition of look-through partnership in the final regulations is revised to
more closely align with the definition of
look-through subsidiary. Under the final
regulations, a look-through partnership is
a partnership that would be a look-through
subsidiary with respect to the tested foreign corporation if the partnership were
a corporation. See §1.1297-2(g)(4)(i)(A).
Accordingly, as noted by one comment,
the taxpayer-favorable rules of section
1297(c) will apply to look-through partnerships, for example by allowing attribution of the activities of other affiliates
in determining whether rental or royalty income of the partnership is treated
as passive or non-passive. In response
to other comments, additional changes
have been made to the definition of lookthrough partnership to allow look-through
treatment for certain minority interests
in partnerships. See §1.1297-2(g)(4)(i)
(B). These changes are discussed in Part
IV.B.2 of this Summary of Comments and
Explanation of Revisions.
The look-through partnership rules
were located in proposed §1.1297-1,
which provided general rules concerning
the Income and Asset Tests. Because lookthrough treatment for purposes of PFIC

520

testing is provided in section 1297(c) and
§1.1297-2 provides guidance on the application of section 1297(c), the rules in the
final regulations concerning look-through
partnerships are in §1.1297-2 along with
all of the other rules discussing lookthrough treatment. See §1.1297-2(b)(3)
and (g)(4).
2. Definition of Look-Through
Partnership
Under the proposed regulations, a
look-through partnership with respect to a
tested foreign corporation was defined as
a partnership if (i) for purposes of section
1297(a)(2), the tested foreign corporation
owned at least 25 percent of its value on
a measuring date and (ii) for purposes of
section 1297(a)(1), the tested foreign corporation owned at least 25 percent of its
value on the date on which income was received or accrued by the partnership. See
proposed §1.1297-1(f)(1). The proposed
regulations also provided that, if a tested
foreign corporation owns, directly or indirectly, less than 25 percent of the value of
a partnership, the corporation’s distributive share of the partnership’s income was
treated as passive income for purposes
of the Income Test and the corporation’s
interest in the partnership was treated as
a passive asset for purposes of the Asset
Test. See proposed §1.1297-1(c)(2)(ii) and
(d)(3)(ii).
Three comments were received addressing these rules. The comments supported the proposed regulations’ general
treatment of look-through partnerships
and addressed the determination of when
a partnership is treated as a look-through
partnership. Two comments recommended that the 25-percent threshold be eliminated so that look-through treatment
would apply to all partnerships regardless
of the ownership level by the tested foreign corporation. A third comment stated
that the proper approach to partnerships
in applying look-through rules raises difficult issues and made several alternative
recommendations.
The two comments recommending that
all partnerships be treated as look-through
partnerships noted that partnerships are
pass-through entities that are generally
treated as aggregates for many purposes throughout the Code and asserted that

Bulletin No. 2021–5

section 1297(c) implicitly indicates that
aggregate treatment was intended to apply to all partnerships because it provides
a 25-percent threshold only for corporations. The comments also stated that the
differences between corporate treatment
and partnership treatment have ramifications for many other parts of the Code,
such as subpart F, GILTI, and the anti-hybrid rules. The comments asserted that minority shareholders generally cannot compel an upper-tier foreign corporation to
make an election for a lower-tier foreign
corporation to be treated as a partnership
under §301.7701-3 and that it is unlikely
that a tested foreign corporation would
make a non-commercial investment in order to benefit minority shareholders.
The Treasury Department and the IRS
do not agree with these comments, other than the comment that partnerships
are treated as aggregates for many Code
purposes. Many of the legal entities potentially treated as look-through partnerships under section 1297 would have been
treated as corporations for U.S. federal income tax purposes when section 1297(c)
was enacted, because the enactment of
section 1297(c) preceded the promulgation of §301.7701-3 by approximately ten
years and before that time foreign corporate entities were generally classified as
corporations for U.S. federal income tax
purposes. The differences between corporate treatment and partnership treatment
referred to by the comments generally are
not relevant to foreign corporations that
are not subject to U.S. net income taxation
or to U.S. shareholders as to whom a foreign corporation is not treated as a CFC.
As stated in the preamble to the proposed
regulations, an election under §301.77013 to treat a foreign subsidiary of such a
foreign corporation as a partnership for
U.S. federal income tax purposes may
have no U.S. tax consequences other than
to affect the determination of whether the
foreign corporation is a PFIC.
The Treasury Department and the IRS
recognize that minority shareholders may
not be able to compel a foreign corporation to make a U.S. tax election or to
make particular investments. However, a
foreign corporation may cause a subsidiary to make an election to be treated as a
partnership for U.S. tax purposes or take
other steps in order to avoid classification

Bulletin No. 2021–5

as a PFIC in order to retain or attract U.S.
investors, since there are likely to be no
non-tax and no foreign tax consequences
to the election.
The two comments indicated that the
subpart F regime characterizes a partner’s
distributive share of partnership income
without regard to the partner’s level of
control or involvement for purposes of
determining subpart F income and recommended that the same approach apply
in these regulations. The final regulations
do not adopt this comment. The Treasury
Department and the IRS believe that the
difference in treatment between these
regulations and the subpart F regime is
warranted in light of the fact that Congress imposed a 25-percent threshold for
look-through treatment for subsidiaries in
section 1297 but not in subpart F, and that
consistency of treatment for look-through
subsidiaries and look-through partnerships in these regulations is consistent
with Congressional intent.
One comment recommended, as an alternative to automatic passive treatment
for less than 25-percent-owned interests,
that the distributive share of income from,
and the interest in, a less than 25-percent-owned partnership be characterized
as passive only if the necessary information cannot be obtained for purposes of
the Income Test and the Asset Test. The
Treasury Department and the IRS agree
that it may be difficult for a tested foreign
corporation to obtain adequate information from a subsidiary in which a tested
foreign corporation holds a less-than-25percent investment, and that if that is the
case, the investment should be treated as
passive. The Treasury Department and the
IRS have taken this comment into account
in the new rules described at the end of
this Part IV.B.2. The Treasury Department
and the IRS do not agree that a tested
foreign corporation that has less than a
25-percent-interest in an active partnership should be able to automatically treat
such partnership interest as active if such
information is available, for the reasons
already stated.
A third comment stated that the approach proposed in the proposed regulations has the advantage of certainty and
ease of administration because it provides
a relatively clear bright-line test and limits
the need to obtain information about the

521

assets and income of a lower-tier partnership that may be difficult for small partners to obtain. The comment also noted
that the proposed approach creates greater
equivalence between lower-tier entities
that have or have not elected to be treated
as pass-through entities, but observed that
the proposed regulations did not create
complete equivalence between such entities because the distributive share from a
related partnership was not subject to the
same rules as dividends from a related
corporation. The final regulations address
this concern by providing that the distributive share derived by a tested foreign
corporation from a related partnership is
subject to rules similar to such dividends.
See §1.1297-1(c)(4)(vii).
This comment also stated that a 25-percent threshold is not a good proxy for an
active business interest and is not consistent with long-standing market practice.
The comment recommended four alternatives for the threshold for partnership
look-through treatment. Under the first
alternative, the comment suggested that
the final regulations adopt a 25 percent
threshold similar to that of section 954(c)
(4). Under a second alternative, the comment suggested that the final regulations
not take into account elections under
§301.7701-3 for purposes of PFIC testing.
Under a third alternative, the comment
proposed that the final regulations treat
every pass-through entity as an aggregate
without regard to ownership threshold.
Under the fourth alternative, the comment
recommended that the final regulations
adopt a “material participation” approach
pursuant to which look-through with respect to a partnership applies if the tested
foreign corporation materially participates
in the underlying business of the partnership.
The Treasury Department and the IRS
recognize that although Congress has
mandated a 25-percent threshold in order
to treat a corporate subsidiary as a lookthrough entity, that threshold may not be
a good proxy for an active business interest. The Treasury Department and the
IRS considered whether the alternatives
suggested would better identify an active
partnership interest. The final regulations
do not adopt any of the alternatives suggested by the third comment but do adopt
an approach similar in concept to the

February 1, 2021

fourth of the alternatives. With respect to
the first and third alternatives, the Treasury
Department and the IRS have determined
that the 25-percent threshold should be the
same for lower-tier entities regardless of
whether they have elected pass-through
treatment for the reasons already discussed. With respect to the second alternative, the Treasury Department and the
IRS do not believe that it is appropriate in
this context to draw distinctions between
entities in the legal form of a partnership
and other entities treated as partnerships
for U.S. federal income tax purposes.
In regard to the fourth alternative, the
Treasury Department and the IRS agree
that if a tested foreign corporation is actively involved in the business of a partnership with active business operations,
look-through treatment may be appropriate, even if the tested foreign corporation
is a minority investor in the partnership,
so that the tested foreign corporation may
take into account the active assets and income of the partnership rather than treating the partnership investment as passive.
The Treasury Department and the IRS
considered a material participation test
but determined that the passive activity
loss rules of section 469 are not appropriate for a foreign corporate investor in
a partnership owned directly or indirectly
by a tested foreign corporation. The section 469 material participation rules focus
primarily on the activities of individuals.
See §1.469-5 and -5T. While section 469
also provides rules for partners that are
closely held corporations, those rules are
likely to be difficult to apply and to audit
in the PFIC context.
The Treasury Department and the IRS
also considered other participation and
attribution rules of the Code, including
proposed rules addressing when a corporate partner would be attributed the trade
or business assets and activities of a partnership for purposes of the active trade or
business requirement in section 355(b).
See 88 FR 26012 (REG-123365-03) (proposing a rule that a partner that owns a
meaningful interest in a partnership would
be attributed the trade or business assets
and activities of the partnership if the partner performs active and substantial management functions for the partnership with
respect to the trade or business assets or
activities (for example, by making deci-

February 1, 2021

sions regarding significant business issues
of the partnership and regularly participating in the overall supervision, direction,
and control of the employees performing
the operational functions for the partnership)). However, the Treasury Department
and the IRS determined that such a rule
would not be appropriate for purposes of
section 1297. As stated in a comment, the
disadvantage of participation-based tests
is that they are factual and potentially subjective, and therefore less administrable.
For example, the proposed section 355(b)
test described above would be difficult for
the IRS to audit in the case of a foreign
corporation that is not controlled by U.S.
shareholders. Moreover, if the “meaningful interest” requirement applied, lookthrough treatment might apply only to a
small number of partnerships that are not
already treated as look-through partnerships. The Treasury Department and the
IRS did not consider these approaches
to be more appropriate than applying the
rules of section 1297 at the partner level as
a means of testing whether an investment
in a partnership is an active business interest. Accordingly, the definition of lookthrough partnership is further altered to
include certain partnerships in which the
tested foreign corporation owns a minority interest if the tested foreign corporation
has sufficient active assets and income as
determined under the rules of section 1297
apart from the partnership. See §1.12972(g)(4)(i)(B).
Under the final regulations, a lookthrough partnership is defined as (i) a
partnership that would be a look-through
subsidiary if such partnership were a corporation—as discussed in Part IV.B.1 of
this Summary of Comments and Explanation of Revisions—or (ii) any other
partnership if the tested foreign corporation satisfies the active partner test. See
§1.1297-2(g)(4)(i). The active partner
test is satisfied if the tested foreign corporation would not be a PFIC if both the
Income and the Asset Test were applied
to it without including its interest in any
partnership that would not be a lookthrough subsidiary if such partnership
were a corporation. See §1.1297-2(g)(4)
(ii). If the tested foreign corporation has
no passive assets or income, even a very
small active business would allow the
interest to qualify as a look-through part-

522

nership under the active partner test. On
the other hand, qualifying under the active
partner test can only prevent a partnership interest from tainting an otherwise
non-PFIC corporation, rather than be
used affirmatively. Because the Treasury
Department and the IRS understand that
it may be difficult for minority investors
in partnerships to obtain the information
necessary to apply the Income and Asset
Tests taking into consideration the income
and assets of a look-through partnership,
the final regulations provide an election
out of the look-through partnership definition for partnerships that would not be
a look-through subsidiary if such partnership were a corporation. See §1.1297-2(g)
(4)(iii). The final regulations also provide
two new examples illustrating the active
partner test. See §1.1297-2(g)(4)(iv).
C. Overlap between section 1297(c) and
section 1298(b)(7)
The proposed regulations provided that
the look-through rule of section 1297(c)
does not apply to a domestic corporation
if the stock of the domestic corporation is
characterized under section 1298(b)(7) as
a non-passive asset that produces non-passive income. See proposed §1.1297-2(b)
(2)(iii). The preamble to the proposed
regulations noted that the Treasury Department and the IRS determined that
section 1298(b)(7) should generally take
precedence over section 1297(c) when
both rules would apply simultaneously
because section 1298(b)(7) contains the
more specific rule applicable to a tested
foreign corporation that owns a domestic
subsidiary.
Comments asserted that the legislative history concerning section 1297(c)
and section 1298(b)(7) does not support
the approach taken by proposed §1.12972(b)(2)(iii). These comments argued that
section 1298(b)(7) was intended to apply
only in circumstances in which income
and assets would be passive if section
1297(c) applied. According to the comments, Congress did not intend for one
section to take precedence over the other
because the legislative history does not
discuss whether section 1298(b)(7) is
supposed to take precedence over section
1297(c) or express any limitations on the
application of section 1297(c).

Bulletin No. 2021–5

Because section 1298(b)(7) contains
the more specific rule applicable to a tested foreign corporation that owns a domestic subsidiary, the Treasury Department
and the IRS have determined that the section 1298(b)(7) coordination rule is consistent with the relevant statutory provisions and results in appropriate treatment
with respect to look-through subsidiaries.
Accordingly, the final regulations do not
adopt these comments.
D. Elimination of certain assets and
income for purposes of applying section
1297(a)
The proposed regulations provided
that, for purposes of applying the Income
and Asset Tests, certain intercompany
payments of dividends and interest from a
look-through entity, and the related stock
and debt receivables, are eliminated. See
proposed §1.1297-2(c)(1) and (2). The
preamble to the proposed regulations indicated that the Treasury Department and
the IRS intended for the elimination of
such items to prevent double counting of
intercompany income and assets. In response to comments, the final regulations
revise the rules relating to intercompany
dividends and expand the elimination
rules to address intercompany rents and
royalties and to address distributions and
the distributive share of income from a
look-through partnership.
1. Treatment of Intercompany Dividends
Proposed §1.1297-2(c)(2) provided
that, for purposes of applying the Income
Test, intercompany payments of dividends
between a look-through subsidiary and a
tested foreign corporation are eliminated
to the extent the payment is attributable to
income of a look-through subsidiary that
was included in gross income by the tested
foreign corporation for purposes of determining its PFIC status.
A comment expressed concern that the
proposed regulation did not eliminate a
payment of a dividend by a look-through
subsidiary to a tested foreign corporation
that is made out of earnings and profits
not attributable to income of the subsidiary previously included in the gross income of the tested foreign corporation for
purposes of determining its PFIC status.

Bulletin No. 2021–5

One example of such a case would be a
dividend paid after a look-through subsidiary is acquired out of earnings and profits
accumulated before the tested foreign corporation’s acquisition of the look-through
subsidiary. Another example of such a dividend would be a dividend paid to a tested
foreign corporation from a subsidiary that
was a subsidiary but not a look-through
subsidiary when the relevant earnings and
profits were accumulated and the dividend
was paid but later became a look-through
subsidiary. The comment questioned
whether a dividend from pre-acquisition
earnings and profits represents true economic income of the tested foreign corporation, since the tested foreign corporation
“purchased” the pre-acquisition earnings
and profits, and observed that it could be
difficult for a tested foreign corporation
to determine what portion of a dividend
received is attributable to pre-acquisition
earnings and profits, particularly if the acquisition was not recent. As a result, the
tested foreign corporation might not in
practice be able to determine when it can
eliminate a dividend from a look-through
subsidiary from its gross income.
The proposed regulation eliminated
dividends from a look-through subsidiary
only to the extent attributable to gross income included by the tested foreign corporation. The comment recommended
that the final regulations remove the limitation. In the alternative, the comment requested that the final regulations provide
that dividends in an amount equal to current-year earnings would be deemed attributable to income included by the tested
foreign corporation and that dividends in
excess of that amount would be deemed to
be paid first from years in which the subsidiary was a look-through subsidiary and
treated as attributable to income included
by the tested foreign corporation during
that period. As an additional alternative,
the comment proposed that taxpayers
be allowed to determine the earnings to
which dividends were considered attributable in the case of an acquisition of the
look-through subsidiary based on the ratio
of pre-acquisition earnings to post-acquisition earnings over a limited period.
The Treasury Department and the IRS
agree that dividends should be treated as
paid out of current earnings and profits
and then out of accumulated earnings and

523

profits (beginning with the most recently
accumulated), in accordance with section
316, and the final regulations so provide.
See §1.1297-2(c)(2). However, the final
regulations do not adopt the comment’s
recommendation to treat all dividends
from a look-through subsidiary as eliminated from the tested foreign corporation’s gross income even if the dividend
is paid out of earnings and profits that are
attributable to gross income of the subsidiary that the tested foreign corporation
has not included in income. As explained
in the next two paragraphs, the rules regarding dividends paid out of earnings
not taken into account by a tested foreign
corporation must be coordinated with the
rules that apply to determine residual gain
when the stock of a look-through subsidiary is sold in order to avoid elimination of
income for purposes of the Income Test.
Under §1.1297-2(f), if a tested foreign corporation disposes of the stock of
a look-through subsidiary, the amount of
gain taken into account for purposes of
the Income Test generally is the total gain
recognized by the tested foreign corporation less unremitted earnings (residual
gain). Unremitted earnings are the excess
of income taken into account by the tested foreign corporation with respect to that
look-through subsidiary less dividends
from the subsidiary. The amount of gain
derived from the disposition of stock of a
look-through subsidiary and dividends received from the look-through subsidiary is
determined on a share-by-share basis under a reasonable method. such as the rules
under section 951 or 1248.
Thus, if a look-through subsidiary with
a value of $1000 earns $20 that is taken
into account by a tested foreign corporation
owner, any gain on a sale of the subsidiary’s
stock for $1020 will be reduced by $20 of
unremitted earnings. If the subsidiary pays
a $15 dividend before the sale, the receipt
of the dividend is disregarded for purposes
of the Income Test and a sale of the subsidiary’s stock for $1005 should give rise
to the same amount of residual gain. Thus,
the $20 will be taken into account for purposes of the Income Test and will not affect the amount of residual gain regardless
of whether a dividend is paid. By contrast,
if the look-through subsidiary pays a $15
dividend out of earnings that do not reflect
income taken into account by the tested

February 1, 2021

foreign corporation, the dividend would reduce the amount of gain on the sale of the
look-through subsidiary’s stock compared
to not paying a dividend because the dividend would reduce unremitted earnings
pursuant to §1.1297-2(f). Consequently,
if the payment of the dividend were disregarded as requested by the comment, the
$15 dividend would reduce potential future
gain but never give rise to corresponding
income to the tested foreign corporation for
purposes of the Income Test.
In order to prevent such a dividend from
reducing potential future gain on the sale
of the look-through subsidiary, it would be
necessary to reduce the basis of the stock
of the look-through subsidiary held by the
tested foreign corporation or make some
other adjustment to the taxation of gain
upon the disposition of the look-through
subsidiary’s stock. A basis reduction or
adjustment of that kind raises potentially
broader issues that were not addressed in
the proposed regulations. The Treasury Department and the IRS continue to study this
recommendation and additional guidance
on such elimination is proposed in the 2020
NPRM. See proposed §1.1297-2(c)(2).
2. Treatment of Intercompany Rents and
Royalties
The proposed regulations provided that
intercompany debt receivables and interest
are eliminated in proportion to the shareholder’s direct and indirect ownership
(by value) in the look-through subsidiary
with respect to a tested foreign corporation that owns less than 100 percent of a
look-through subsidiary. See proposed
§1.1297-2(c)(1) and (2). The preamble to
the proposed regulations explained that
this rule was based on the legislative history of the PFIC rules and was intended
to prevent duplication of passive assets
or passive income, for example if a wholly-owned look-through subsidiary with
entirely passive income paid a dividend to
the tested foreign corporation parent.
Comments supported the approach
taken in the proposed regulations with
regard to interest. A comment indicated
that payments of intercompany rents and
royalties raises similar concerns with respect to double counting. Accordingly, the
comment requested that, for purposes of
applying the Income Test and the Asset

February 1, 2021

Test, the final regulations extend the elimination rules to payments of intercompany
rents and royalties and any associated intangible assets in proportion to the tested
foreign corporation’s direct and indirect
ownership (by value) in the look-through
subsidiary or look-through partnership.
The Treasury Department and the IRS
agree with the comments, and §1.12972(c) accordingly extends the rules applicable to debt and interest to rents, royalties,
leases, and licenses.
The application of the elimination rule
to leases and licenses raises issues not
present with debt receivables. A lease or
license held by a look-through entity provides legal rights to use underlying property, such as a building or an intangible.
If the lease or license is disregarded by a
tested foreign corporation, it would not be
taken into account by the tested foreign
corporation in determining whether the
underlying property produces non-passive
income or is held for the production of
non-passive income. Moreover, while the
underlying property may be used as part
of an active business, it may be used as
part of the business of the lessee or licensee and not by the owner of the property.
Accordingly, the final regulations provide
that, for purposes of the Asset Test as applied to a tested foreign corporation, the
underlying property that is the subject of
the eliminated lease or license is characterized as a passive or non-passive asset
by taking into account the activities of
qualified affiliates of the tested foreign
corporation (as discussed in Part IV.E of
this Summary of Comments and Explanation of Revisions). A new example illustrates the expansion. See §1.1297-2(c)(4)
(v).
The final regulations also address more
precisely the calculations required in order to determine how much of an obligation and related income is eliminated if the
obligation runs between two look-through
entities that are not wholly-owned. The final regulations provide that the tested foreign corporation’s proportionate share of
a LTS obligation (as defined in §1.12972(c)(1)(ii)) or a TFC obligation (as defined
in §1.1297-2(c)(1)(ii)) is the value (or
adjusted basis) of the item multiplied by
the tested foreign corporation’s percentage ownership (by value) in each relevant
look-through subsidiary. See §1.1297-2(c)

524

(1)(ii). Examples 3 and 4 of §1.1297-2(c)
(4) illustrate that when an obligation runs
between two non-wholly-owned lookthrough entities, the percentage ownership
in each of those entities is taken into account. In Example 2, LTS2 has borrowed
$200x from LTS1. The tested foreign corporation owns 40 percent of LTS1’s stock
and 30 percent of LTS2’s stock. If the loan
had been made to LTS2’s shareholders,
on a pro rata basis, 30 percent of the loan
held by LTS1 ($60x) would be a TFC obligation and 70 percent of the loan held
by LTS1 ($140x) would be a third-party
obligation. The tested foreign corporation
would be treated for purposes of the Asset
Test as owning 40 percent of the TFC obligation, which would be eliminated. See
§1.1297-2(c)(1)(ii). The tested foreign
corporation also would be treated for purposes of the Asset Test as owning 40 percent of the hypothetical $140x third-party
loan, or $56x. Examp

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Airs%3A38cb4d5fe515bd7d. Public record. Not legal advice.