July 1, 1991
TO: TAX MEMBERS NO. 23-91
CLOSED-END FUND MEMBERS NO. 27-91
INTERNATIONAL COMMITTEE NO. 11-91
ACCOUNTING/TREASURERS COMMITTEE NO. 16-91
RE: TAX SIMPLIFICATION LEGISLATION INTRODUCED
__________________________________________________________
The "Tax Simplification Act of 1991" has been introduced in
the House and Senate. The bill, identified in the House as H.R.
2777, addresses two issues of concern to regulated investment
companies ("RICs"): the taxation of stock in passive foreign
investment companies ("PFICs") and simplification of the rules
concerning the limitation on foreign tax credits applicable to
individual investors.
The bill creates a new definition, the passive foreign
corporation or "PFC", which replaces, among other definitions,
the definition of a PFIC. A PFC is any foreign corporation if
(1) 60 percent or more of its gross income is passive income
(compared to a 75 percent requirement under the current PFIC
definition), (2) 50 percent or more of its assets by value
(measured on average over the year) produce or are held for the
production of passive income, or (3) it is registered under the
Investment Company Act of 1940 as either a management company or
a unit investment trust. Under a new election, PFCs which meet
certain requirements can elect to be treated as foreign
corporations.
PFIC Provisions
The bill adds a mark-to-market system of taxation for PFICs
to the two existing tax regimes for PFICs, current inclusion
under the qualified electing fund or "QEF" rules and the deferred
interest charge method. As proposed, QEF rules will be available
to any U.S. person owning less than 25 percent of the stock of a
PFC that is not U.S. controlled (U.S. control is generally
defined as five or fewer U.S. persons owning more than 50 percent
of the PFC stock).
Shareholders not electing QEF treatment are subject to one
of two methods for taxing the economic equivalent of the PFC's
current income. Under the bill, the mark-to-market system will
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be mandatory for all taxpayers holding marketable PFC stock. For
these purposes, all PFCs held by open-end registered investment
companies will be considered marketable, as will such stock held
by a closed-end fund, unless the Internal Revenue Service
promulgates regulations which disallow such treatment for closed-
end funds.
Gains on PFIC stock will be recognized in full as ordinary
gain. Mark-to-market losses will be ordinary to the extent of
prior net gains, referred to in the bill as "unreversed
inclusions". Mark-to-market losses in excess of unreversed
inclusions will be suspended (i.e., no basis adjustment is made
in that year and no loss is recognized). In addition, upon
actual disposition, losses will be treated as ordinary to the
extent of unreversed inclusions. However, losses in excess of
unreversed inclusions will be treated as capital losses upon
disposition.
Under special RIC rules, mark-to-market gain is treated as
a dividend for purposes of the 90 percent test of Internal
Revenue Code section 851(b)(2) and the 30 percent limitation of
section 851(b)(3).
Foreign Tax Credit Provisions
Consistent with the Institute's prior requests, the bill
would also allow individuals with no more than $200 of foreign
taxes which can be claimed as a credit and with no foreign source
income other than passive income (i.e., dividends, interest,
etc.) to elect a simplified foreign tax credit limitation equal
to the lesser of the actual foreign taxes paid or 25 percent of
the individual's foreign source income. (See Institute
Memorandum to Tax Committee No. 2-91, dated January 30, 1991.)
The explanation to the bill specifically states that a Form 1116,
the individual foreign tax credit reporting form, should not be
required. The simplified limitation will only be available to
persons who receive a payee statement, such as a Form 1099, with
the amount of the foreign taxes reported on the form.
Both provisions of the bill are generally effective for
taxable years of U.S. persons beginning after December 31, 1991.
The pertinent sections of the bill and explanation are attached.
We will keep you informed of further developments.
David J. Mangefrida, Jr.
Assistant Counsel - Tax
Attachment