[Federal Register Volume 61, Number 250 (Friday, December 27, 1996)]
[Rules and Regulations]
[Pages 68149-68155]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-32246]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 8701]
RIN 1545-AC06


Treatment of Shareholders of Certain Passive Foreign Investment 
Companies

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final regulations that provide rules 
for making the deemed sale and deemed dividend elections under section 
1291(d)(2). These regulations reflect changes to the law made by the 
Tax Reform Act of 1986 and the Technical and Miscellaneous Revenue Act 
of 1988, and apply to a shareholder of a passive foreign investment 
company (PFIC) that elects under section 1295 to treat the PFIC as a 
qualified electing fund (QEF) for a taxable year after the first 
taxable year during the shareholder's holding period that the foreign 
corporation was a PFIC.

DATES: These regulations are effective December 27, 1996.
    Applicability: For the specific dates of applicability, see 
Secs. 1.1291-9(k) and 1.1291-10(i).

FOR FURTHER INFORMATION CONTACT: Gayle Novig, (202) 622-3880 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in these final regulations 
have been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under 
control numbers 1545-1028 and 1545-1304. All of these paperwork 
requirements will be consolidated under control number 1545-1507. 
Responses to these collections of information are mandatory.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number.
    The estimated annual burden per respondent varies from .75 hour to 
1 hour, depending on individual circumstances, with an estimated 
average of .76 hour.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, 
DC 20224, and to the Office of Management and Budget, Attn: Desk 
Officer for the Department of the Treasury, Office of Information and 
Regulatory Affairs, Washington, DC 20503.
    Books or records relating to this collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    This document contains final regulations to be added to the Income 
Tax Regulations (26 CFR part 1) under section 1291(d)(2) of the 
Internal Revenue Code. The final regulations provide rules for making a 
deemed sale or deemed dividend election to purge a shareholder's 
holding period of stock of a PFIC of those taxable years during which 
the PFIC was not a QEF. The Tax Reform Act of 1986 added section 
1291(d)(2)(A), relating to the deemed sale election, effective for 
taxable years of foreign corporations beginning after December 31, 
1986. The Technical and Miscellaneous Revenue Act of 1988 amended 
section 1291(d)(2) to add new section 1291(d)(2)(B), relating to the 
deemed dividend election, effective for taxable years of foreign 
corporations beginning after December 31, 1986.
    On March 2, 1988, temporary regulations (TD 8178) relating to the 
deemed sale election under section 1291(d)(2)(A), in addition to 
elections under sections 1294, 1295, and 1297, were published in the 
Federal Register (53 FR 6770). A notice of proposed rulemaking (INTL-
941-86) cross-referencing the temporary regulations was also published 
in the Federal Register for the same day (53 FR 6781).
    On April 1, 1992, temporary regulations (TD 8404) relating to both 
the deemed sale and deemed dividend elections under section 1291(d)(2) 
(A) and (B), were published in the Federal Register (57 FR 10992). A 
notice of proposed rulemaking (INTL-941-86; INTL-656-87; INTL-704-87) 
cross-referencing the temporary regulations was published in the 
Federal Register for the same day (57 FR 11024).
    Written comments responding to these notices were received. No 
public hearing was held for the notice of proposed rulemaking published 
on March 2, 1988. A public hearing was held November 23, 1992, for the 
notice of proposed rulemaking published April 1, 1992. After 
consideration of all the comments, the proposed regulations under 
section 1291(d)(2) are adopted as revised by this Treasury decision, 
and the corresponding temporary regulations are removed. Substantive 
revisions are discussed below. All other revisions are stylistic, and 
are primarily intended to conform the regulations under Sec. 1.1291-10 
to those under Sec. 1.1291-9.

Explanation of Provisions and Revisions and Summary of Comments

1. Introduction

    A shareholder of a foreign corporation that qualifies as a PFIC 
under the

[[Page 68150]]

income or asset test of section 1296 is subject to the special interest 
charge regime of section 1291 with respect to certain distributions by 
the PFIC and dispositions of the stock of the PFIC. Provided the PFIC 
complies with certain election requirements, a shareholder may elect 
under section 1295 to treat the PFIC as a QEF. If the election is made, 
the shareholder is subject to the current inclusion regime of section 
1293. If the shareholder makes the section 1295 election for the first 
year of its holding period for the foreign corporation during which 
year the foreign corporation is a PFIC, the shareholder is only subject 
to PFIC taxation under the current inclusion regime. Such a PFIC is a 
pedigreed QEF with respect to the shareholder. However, if the 
shareholder makes the section 1295 election for a later year, the 
shareholder is subject to both the interest charge regime of section 
1291 and the current inclusion regime of section 1293. Such a PFIC is 
an unpedigreed QEF with respect to the shareholder. To limit its PFIC 
taxation to the current inclusion regime of section 1293, a shareholder 
that makes the section 1295 election may also make a section 1291(d)(2) 
election to purge its holding period of the years, or parts of years, 
before the effective date of the QEF election during which the foreign 
corporation was a PFIC (nonQEF years). Thereafter, the PFIC will be 
treated as a pedigreed QEF with respect to the shareholder.
    Section 1291(d)(2) provides two methods to purge the nonQEF years 
from a shareholder's holding period of PFIC stock. A shareholder may 
elect under section 1291(d)(2)(A) to be treated as having sold the 
stock of the PFIC. The gain on the deemed sale is subject to the 
interest charge regime and therefore taxed as an excess distribution 
under section 1291. Alternatively, if the PFIC is a controlled foreign 
corporation (CFC), any U.S. person that is a shareholder of the PFIC 
may elect under section 1291(d)(2)(B) to be treated as receiving a 
dividend in the amount of its pro rata share of the post-1986 
undistributed earnings and profits of the PFIC. The deemed dividend is 
taxed to the shareholder as an excess distribution under the interest 
charge regime. If either election is made, the shareholder's holding 
period is treated, for purposes of the PFIC rules, as beginning on the 
date of the deemed sale or dividend (qualification date).

2. Revisions to the Regulations

    Section 1.1291-9 provides the rules for making the deemed dividend 
election under section 1291(d)(2)(B) with respect to a PFIC that is a 
CFC. Section 1.1291-10 provides the rules for making the deemed sale 
election under section 1291(d)(2)(A). The final regulations generally 
follow the proposed regulations with the exceptions described below.
a. Qualification Date
    The 1988 temporary regulations under Sec. 1.1291-10T provided that, 
in general, the date of the deemed sale, referred to as the 
qualification date, is the first day of the first taxable year of the 
corporation that it is treated as a QEF under section 1295 (first QEF 
year). However, the temporary and proposed amendments to Sec. 1.1291-
10T published in 1992 changed the qualification date for elections made 
after May 1, 1992, to the first day of the taxable year for which the 
shareholder made the QEF election (shareholder's election year). 
Similarly, under the temporary and proposed Sec. 1.1291-9 regulations, 
the qualification date is the first day of the shareholder's election 
year.
    Commenters described a potential problem with the designation of 
the first day of the shareholder's election year as the qualification 
date where the corporation and the shareholder have different taxable 
years. In this circumstance, the purging election would not avoid 
application of the interest charge regime to distributions and 
dispositions during the period between the first day of the 
corporation's first QEF year and the first day of the shareholder's 
election year.
    In response to comments, the final regulations adopt the definition 
of qualification date used in the 1988 temporary regulations for 
purposes of both the deemed sale and deemed dividend elections made on 
or after January 27, 1997. For the period after March 31, 1995, to 
January 26, 1997, the final regulations adopt the definition of 
qualification date of the 1992 temporary regulations. In addition, the 
final regulations permit a shareholder that made the deemed sale or 
deemed dividend election after May 1, 1992 and on or before January 27, 
1997 to amend its election and treat the deemed sale or deemed dividend 
as occurring on the first day of the PFIC's first QEF year, provided 
the periods of limitations on assessment for the taxable year that 
includes that date and for the shareholder's election year have not 
expired.
    In response to comments, the final regulations also clarify that if 
the shareholder's holding period under section 1223 includes the first 
day of the first QEF year, the shareholder will be treated as holding 
the stock on that date. Therefore, the shareholder may make a section 
1291(d)(2) election for the first QEF year.
b. Elections Made With Respect to Former PFICs
    Section 1.1291-9(h) of the proposed regulations provides that a 
shareholder cannot apply the deemed dividend rules of section 
1291(d)(2)(B) to purge PFIC taint, pursuant to section 1297(b)(1), from 
the stock of a foreign corporation that no longer is a PFIC under 
either the asset or income test of section 1296(a), but whose stock 
nevertheless is treated as stock of a PFIC with respect to a 
shareholder pursuant to section 1297(b)(1) (former PFIC). In addition, 
the proposed regulations provide that the section 1291(d)(2)(B) 
election cannot be made with respect to a corporation that will not 
qualify as a PFIC under section 1296(a)(1) or (2) in the first QEF 
year.
    Several commenters disagreed with the position taken in 
Sec. 1.1291-9(h) of the proposed regulations. Section 1.1291-9(i)(1) of 
the final regulations does not accept these comments and adopts the 
rule of the proposed regulation denying application of the rules of 
section 1291(d)(2)(B) for purposes of a section 1297(b)(1) election. In 
addition, Sec. 1.1291-9(i)(2) modifies the rule of proposed regulation 
Sec. 1.1291-9(h)(2) to clarify that the section 1295 and 1291(d)(2)(B) 
elections cannot be made with respect to a former PFIC. Section 1.1291-
10(h) of the final regulations adopts a similar rule, clarifying that a 
shareholder of a former PFIC cannot make the section 1295 and 
1291(d)(2)(A) elections. Thus, section 1295 and section 1291(d)(2) 
elections may only be made with respect to a foreign corporation that 
is a PFIC by definition under section 1296. Accordingly, the deemed 
sale election of section 1297(b)(1) remains the only means by which a 
shareholder may purge a former PFIC of its PFIC taint.
c. Qualification as a CFC
    The final regulations, in response to comments, clarify that a 
shareholder may make the deemed dividend election provided the PFIC 
qualifies as a CFC for its first QEF year.
d. Time for Making the Elections
    In response to comments, the final regulations clarify the time for 
making the deemed sale and dividend elections. The regulations provide 
that if the shareholder and the PFIC have the same taxable year, and 
therefore the first day of the shareholder's election year and the 
qualification date are the same, the shareholder may make the election 
in the same return in which it makes the

[[Page 68151]]

section 1295 election or in an amended return. The regulations also 
provide that if the shareholder and the PFIC have different taxable 
years and therefore the qualification date precedes the first day of 
the shareholder's election year, the shareholder must make the deemed 
sale or deemed dividend election in an amended return. If the 
shareholder is making the section 1291(d)(2) election in an amended 
return, the amended return must be filed within three years of the due 
date, as extended under section 6081, for the return for the taxable 
year that includes the qualification date.
e. Post-1986 Accumulated Earnings and Profits
    The proposed regulations provide that the shareholder's old holding 
period for purposes of the PFIC rules ends on the qualification date, 
but also provide that its new holding period begins on the 
qualification date. These rules may have caused confusion concerning 
the last day of the holding period for purposes of determining post-
1986 accumulated earnings and profits. The final regulations revise the 
holding period rules to provide that the shareholder's holding period 
ends on the day before the qualification date for purposes of 
calculating the amount of the deemed dividend.

Special Analyses

    It has been determined that this Treasury Decision is not a 
significant regulatory action as defined in E.O. 12866. Therefore, a 
regulatory assessment is not required. It also has been determined that 
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) 
does not apply to these regulations, and because the notice of proposed 
rulemaking preceding the regulations was issued prior to March 29, 
1996, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. These regulations, which have a retroactive effective date, 
satisfy the Administrative Procedure Act's requirement in section 
553(d) for good cause because they provide necessary guidance for the 
period after March 31, 1995, and because they are not detrimental to 
taxpayers. These regulations are necessary because they provide 
taxpayers with the rules needed to make the elections under section 
1291(d)(2). Pursuant to section 7805(f) of the Internal Revenue Code, 
the notices of proposed rulemaking preceding these regulations were 
submitted to the Small Business Administration for comment on their 
impact on small business.

Drafting Information

    The principal author of these regulations is Gayle Novig, Office of 
the Associate Chief Counsel (International). However, other personnel 
from the IRS and Treasury Department participated in their development.

List of Subjects

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 is amended by 
removing the entry for section 1.1291-9T and the entry for sections 
1.1291-10T, 1.1294-1T, 1.1295-1T, and 1.1297-3T, and by adding entries 
in numerical order to read as follows:

    Authority: 26 U.S.C. 7805 * * *.

    Section 1.1291-9 also issued under 26 U.S.C. 1291(d)(2).
    Section 1.1291-10 also issued under 26 U.S.C. 1291(d)(2).
    Section 1.1294-1T also issued under 26 U.S.C. 1294.
    Section 1.1297-3T also issued under 26 U.S.C. 1297(b)(1). * * *

    Par. 2. Section 1.1291-0 is added to read as follows:


Sec. 1.1291-0   Treatment of shareholders of certain passive foreign 
investment companies; table of contents.

    This section contains a listing of the headings for Secs. 1.1291-9 
and 1.1291-10.

Sec. 1.1291-9  Deemed dividend election.

    (a) Deemed dividend election.
    (1) In general.
    (2) Post-1986 earnings and profits defined.
    (i) In general.
    (ii) Pro rata share of post-1986 earnings and profits 
attributable to shareholder's stock.
    (A) In general.
    (B) Reduction for previously taxed amounts.
    (b) Who may make the election.
    (c) Time for making the election.
    (d) Manner of making the election.
    (1) In general.
    (2) Attachment to Form 8621.
    (e) Qualification date.
    (1) In general.
    (2) Elections made after March 31, 1995, and before January 27, 
1997.
    (i) In general.
    (ii) Exception.
    (3) Examples.
    (f) Adjustment to basis.
    (g) Treatment of holding period.
    (h) Coordination with section 959(e).
    (i) Election inapplicable to shareholder of former PFIC.
    (1) Coordination with section 1297(b)(1).
    (2) Former PFIC.
    (j) Definitions.
    (1) Passive foreign investment company (PFIC).
    (2) Types of PFICs.
    (i) Qualified electing fund (QEF).
    (ii) Pedigreed QEF.
    (iii) Unpedigreed QEF.
    (iv) Former PFIC.
    (3) Shareholder.
    (k) Effective date.

Sec. 1.1291-10  Deemed sale election.

    (a) Deemed sale election.
    (b) Who may make the election.
    (c) Time for making the election.
    (d) Manner of making the election.
    (e) Qualification date.
    (1) In general.
    (2) Elections made after March 31, 1995, and before January 27, 
1997.
    (i) In general.
    (ii) Exception.
    (f) Adjustments to basis.
    (1) In general.
    (2) Adjustment to basis for section 1293 inclusion with respect 
to deemed sale election made after March 31, 1995, and before 
January 27, 1997.
    (g) Treatment of holding period.
    (h) Election inapplicable to shareholder of former PFIC.
    (i) Effective date.


Sec. 1.1291-0T  [Amended]

    Par. 3. Section 1.1291-0T is amended as follows:
    1. Remove from the introductory text the language ``1.1291-9T, 
1.1291-10T,''.
    2. Remove the entries for Sec. 1.1291-9T and Sec. 1.1291-10T from 
the table.
    Par. 4. Section 1.1291-9 is added to read as follows:


Sec. 1.1291-9  Deemed dividend election.

    (a) Deemed dividend election--(1) In general. This section provides 
rules for making the election under section 1291(d)(2)(B) (deemed 
dividend election). Under that section, a shareholder (as defined in 
paragraph (j)(3) of this section) of a PFIC that is an unpedigreed QEF 
may elect to include in income as a dividend the shareholder's pro rata 
share of the post-1986 earnings and profits of the PFIC attributable to 
the stock held on the qualification date (as defined in paragraph (e) 
of this section), provided the PFIC is a controlled foreign corporation 
(CFC) within the meaning of section 957(a) for the taxable year for 
which the shareholder elects under section 1295 to treat the PFIC as a 
QEF (section 1295 election). If the shareholder makes the deemed 
dividend election, the PFIC will become a

[[Page 68152]]

pedigreed QEF with respect to the shareholder. The deemed dividend is 
taxed under section 1291 as an excess distribution received on the 
qualification date. The excess distribution determined under this 
paragraph (a) is allocated under section 1291(a)(1)(A) only to those 
days in the shareholder's holding period during which the foreign 
corporation qualified as a PFIC. For purposes of the preceding 
sentence, the holding period of the PFIC stock with respect to which 
the election is made ends on the day before the qualification date. For 
the definitions of PFIC, QEF, unpedigreed QEF, and pedigreed QEF, see 
paragraph (j)(1) and (2) of this section.
    (2) Post-1986 earnings and profits defined--(i) In general. For 
purposes of this section, the term post-1986 earnings and profits means 
the undistributed earnings and profits, within the meaning of section 
902(c)(1), as of the day before the qualification date, that were 
accumulated and not distributed in taxable years of the PFIC beginning 
after 1986 and during which it was a PFIC, but without regard to 
whether the earnings relate to a period during which the PFIC was a 
CFC.
    (ii) Pro rata share of post-1986 earnings and profits attributable 
to shareholder's stock--(A) In general. A shareholder's pro rata share 
of the post-1986 earnings and profits of the PFIC attributable to the 
stock held by the shareholder on the qualification date is the amount 
of post-1986 earnings and profits of the PFIC accumulated during any 
portion of the shareholder's holding period ending at the close of the 
day before the qualification date and attributable, under the 
principles of section 1248 and the regulations under that section, to 
the PFIC stock held on the qualification date.
    (B) Reduction for previously taxed amounts. A shareholder's pro 
rata share of the post-1986 earnings and profits of the PFIC does not 
include any amount that the shareholder demonstrates to the 
satisfaction of the Commissioner (in the manner provided in paragraph 
(d)(2) of this section) was, pursuant to another provision of the law, 
previously included in the income of the shareholder, or of another 
U.S. person if the shareholder's holding period of the PFIC stock 
includes the period during which the stock was held by that other U.S. 
person.
    (b) Who may make the election. A shareholder of an unpedigreed QEF 
that is a CFC for the taxable year of the PFIC for which the 
shareholder makes the section 1295 election may make the deemed 
dividend election provided the shareholder held stock of that PFIC on 
the qualification date. A shareholder is treated as holding stock of 
the PFIC on the qualification date if its holding period with respect 
to that stock under section 1223 includes the qualification date. A 
shareholder may make the deemed dividend election without regard to 
whether the shareholder is a United States shareholder within the 
meaning of section 951(b). A deemed dividend election may be made by a 
shareholder whose pro rata share of the post-1986 earnings and profits 
of the PFIC attributable to the PFIC stock held on the qualification 
date is zero.
    (c) Time for making the election. The shareholder makes the deemed 
dividend election in the shareholder's return for the taxable year that 
includes the qualification date. If the shareholder and the PFIC have 
the same taxable year, the shareholder makes the deemed dividend 
election in either the original return for the taxable year for which 
the shareholder makes the section 1295 election, or in an amended 
return for that year. If the shareholder and the PFIC have different 
taxable years, the deemed dividend election must be made in an amended 
return for the taxable year that includes the qualification date. If 
the deemed dividend election is made in an amended return, the amended 
return must be filed by a date that is within three years of the due 
date, as extended under section 6081, of the original return for the 
taxable year that includes the qualification date.
    (d) Manner of making the election--(1) In general. A shareholder 
makes the deemed dividend election by filing Form 8621 and the 
attachment to Form 8621 described in paragraph (d)(2) of this section 
with the return for the taxable year of the shareholder that includes 
the qualification date, reporting the deemed dividend as an excess 
distribution pursuant to section 1291(a)(1), and paying the tax and 
interest due on the excess distribution. A shareholder that makes the 
deemed dividend election after the due date of the return (determined 
without regard to extensions) for the taxable year that includes the 
qualification date must pay additional interest, pursuant to section 
6601, on the amount of the underpayment of tax for that year.
    (2) Attachment to Form 8621. The shareholder must attach a schedule 
to Form 8621 that demonstrates the calculation of the shareholder's pro 
rata share of the post-1986 earnings and profits of the PFIC that is 
treated as distributed to the shareholder on the qualification date 
pursuant to this section. If the shareholder is claiming an exclusion 
from its pro rata share of the post-1986 earnings and profits for an 
amount previously included in its income or the income of another U.S. 
person, the shareholder must include the following information:
    (i) The name, address, and taxpayer identification number of each 
U.S. person that previously included an amount in income, the amount 
previously included in income by each such U.S. person, the provision 
of the law pursuant to which the amount was previously included in 
income, and the taxable year of inclusion of each amount; and
    (ii) A description of the transaction pursuant to which the 
shareholder acquired, directly or indirectly, the stock of the PFIC 
from another U.S. person, and the provisions of law pursuant to which 
the shareholder's holding period includes the period the other U.S. 
person held the CFC stock.
    (e) Qualification date--(1) In general. Except as otherwise 
provided in this paragraph (e), the qualification date is the first day 
of the PFIC's first taxable year as a QEF (first QEF year).
    (2) Elections made after March 31, 1995, and before January 27, 
1997--(i) In general. The qualification date for deemed dividend 
elections made after March 31, 1995, and before January 27, 1997 is the 
first day of the shareholder's election year. The shareholder's 
election year is the taxable year of the shareholder for which it made 
the section 1295 election.
    (ii) Exception. A shareholder who made the deemed dividend election 
after May 1, 1992, and before January 27, 1997 may elect to change its 
qualification date to the first day of the first QEF year, provided the 
periods of limitations on assessment for the taxable year that includes 
that date and for the shareholder's election year have not expired. A 
shareholder changes the qualification date by filing amended returns, 
with revised Forms 8621 and the attachments described in paragraph 
(d)(2) of this section, for the shareholder's election year and the 
shareholder's taxable year that includes the first day of the first QEF 
year, and making all appropriate adjustments and payments.
    (3) Examples. The rules of this paragraph (e) are illustrated by 
the following examples:

    Example 1--(i) Eligibility to make deemed dividend election. A 
is a U.S. person who files its income tax return on a calendar year 
basis. On January 2, 1994, A purchased one percent of the stock of 
M, a PFIC with a taxable year ending November 30. M was both a CFC 
and a PFIC, but not a QEF, for all of its taxable years. On December 
3, 1996, M made a distribution to its shareholders. A received $100, 
all of which A reported in its

[[Page 68153]]

1996 return as an excess distribution as provided in section 
1291(a)(1). A decides to make the section 1295 election in A's 1997 
taxable year to treat M as a QEF effective for M's taxable year 
beginning December 1, 1996. Because A did not make the section 1295 
election in 1994, the first year in its holding period of M stock 
that M qualified as a PFIC, M would be an unpedigreed QEF and A 
would be subject to both sections 1291 and 1293. A, however, may 
elect under section 1291(d)(2) to purge the years M was not a QEF 
from A's holding period. If A makes the section 1291(d)(2) election, 
the December 3 distribution will not be taxable under section 
1291(a). Because M is a CFC, even though A is not a U.S. shareholder 
within the meaning of section 951(b), A may make the deemed dividend 
election under section 1291(d)(2)(B).
    (ii) Making the election. Under paragraph (e)(1) of this 
section, the qualification date, and therefore the date of the 
deemed dividend, is December 1, 1996. Accordingly, to make the 
deemed dividend election, A must file an amended return for 1996, 
and include the deemed dividend in income in that year. As a result, 
M will be a pedigreed QEF as of December 1, 1996, and the December 
3, 1996, distribution will not be taxable as an excess distribution. 
Therefore, in its amended return, A may report the December 3, 1996, 
distribution consistent with section 1293 and the general rules 
applicable to corporate distributions.
    Example 2. X, a U.S. person, owned a five percent interest in 
the stock of FC, a PFIC with a taxable year ending June 30. X never 
made the section 1295 election with respect to FC. X transferred her 
interest in FC to her granddaughter, Y, a U.S. person, on February 
14, 1996. The transfer qualified as a gift for federal income tax 
purposes, and no gain was recognized on the transfer (see Regulation 
Project INTL-656-87, published in 1992-1 C.B. 1124; see 
Sec. 601.601(d)(2)(ii)(b) of this chapter). As provided in section 
1223(2), Y's holding period includes the period that X held the FC 
stock. Y decides to make the section 1295 election in her 1996 
return to treat FC as a QEF for its taxable year beginning July 1, 
1995. However, because Y's holding period includes the period that X 
held the FC stock, and FC was a PFIC but not a QEF during that 
period, FC will be an unpedigreed QEF with respect to Y unless Y 
makes a section 1291(d)(2) election. Although Y did not actually own 
the stock of FC on the qualification date (July 1, 1995), Y's 
holding period includes that date. Therefore, provided FC is a CFC 
for its taxable year beginning July 1, 1995, Y may make a section 
1291(d)(2)(B) election to treat FC as a pedigreed QEF.

    (f) Adjustment to basis. A shareholder that makes the deemed 
dividend election increases its adjusted basis of the stock of the PFIC 
owned directly by the shareholder by the amount of the deemed dividend. 
If the shareholder makes the deemed dividend election with respect to a 
PFIC of which it is an indirect shareholder, the shareholder's adjusted 
basis of the stock or other property owned directly by the shareholder, 
through which ownership of the PFIC is attributed to the shareholder, 
is increased by the amount of the deemed dividend. In addition, solely 
for purposes of determining the subsequent treatment under the Code and 
regulations of a shareholder of the stock of the PFIC, the adjusted 
basis of the direct owner of the stock of the PFIC is increased by the 
amount of the deemed dividend.
    (g) Treatment of holding period. For purposes of applying sections 
1291 through 1297 to the shareholder after the deemed dividend, the 
shareholder's holding period of the stock of the PFIC begins on the 
qualification date. For other purposes of the Code and regulations, 
this holding period rule does not apply.
    (h) Coordination with section 959(e). For purposes of section 
959(e), the entire deemed dividend is treated as included in gross 
income under section 1248(a).
    (i) Election inapplicable to shareholder of former PFIC-- (1) 
Coordination with section 1297(b)(1). The rules of this section do not 
apply to an election made under section 1297(b)(1).
    (2) Former PFIC. A shareholder may not make the section 1295 and 
deemed dividend elections if the foreign corporation is a former PFIC 
(as defined in paragraph (j)(2)(iv) of this section) with respect to 
the shareholder. For the rules regarding the election by a shareholder 
of a former PFIC, see Sec. 1.1297-3T.
    (j) Definitions--(1) Passive foreign investment company (PFIC). A 
passive foreign investment company (PFIC) is a foreign corporation that 
satisfies either the income test of section 1296(a)(1) or the asset 
test of section 1296(a)(2). A corporation will not be treated as a PFIC 
with respect to a shareholder for those days included in the 
shareholder's holding period when the shareholder, or a person whose 
holding period of the stock is included in the shareholder's holding 
period, was not a United States person within the meaning of section 
7701(a)(30).
    (2) Types of PFICs--(i) Qualified electing fund (QEF). A PFIC is a 
qualified electing fund (QEF) with respect to a shareholder that has 
elected, under section 1295, to be taxed currently on its share of the 
PFIC's earnings and profits pursuant to section 1293.
    (ii) Pedigreed QEF. A PFIC is a pedigreed QEF with respect to a 
shareholder if the PFIC has been a QEF with respect to the shareholder 
for all taxable years during which the corporation was a PFIC that are 
included wholly or partly in the shareholder's holding period of the 
PFIC stock.
    (iii) Unpedigreed QEF. A PFIC is an unpedigreed QEF for a taxable 
year if--
    (A) An election under section 1295 is in effect for that year;
    (B) The PFIC has been a QEF with respect to the shareholder for at 
least one, but not all, of the taxable years during which the 
corporation was a PFIC that are included wholly or partly in the 
shareholder's holding period of the PFIC stock; and
    (C) The shareholder has not made an election under section 
1291(d)(2) and this section or Sec. 1.1291-10 with respect to the PFIC 
to purge the nonQEF years from the shareholder's holding period.
    (iv) Former PFIC. A foreign corporation is a former PFIC with 
respect to a shareholder if the corporation satisfies neither the 
income test of section 1296(a)(1) nor the asset test of section 
1296(a)(2), but whose stock, held by that shareholder, is treated as 
stock of a PFIC, pursuant to section 1297(b)(1), because at any time 
during the shareholder's holding period of the stock the corporation 
was a PFIC that was not a QEF.
    (3) Shareholder. A shareholder is a U.S. person that is a direct or 
indirect shareholder as defined in Regulation Project INTL-656-87 
published in 1992-1 C.B. 1124; see Sec. 601.601(d)(2)(ii)(b) of this 
chapter.
    (k) Effective date. The rules of this section are applicable as of 
April 1, 1995.


Sec. 1.1291-9T  [Removed]

    Par. 5. Section 1.1291-9T is removed.
    Par. 6. Section 1.1291-10 is added to read as follows:


Sec. 1.1291-10  Deemed sale election.

    (a) Deemed sale election. This section provides rules for making 
the election under section 1291(d)(2)(A) (deemed sale election). Under 
that section, a shareholder (as defined in Sec. 1.1291-9(j)(3)) of a 
PFIC that is an unpedigreed QEF may elect to recognize gain with 
respect to the stock of the unpedigreed QEF held on the qualification 
date (as defined in paragraph (e) of this section). If the shareholder 
makes the deemed sale election, the PFIC will become a pedigreed QEF 
with respect to the shareholder. A shareholder that makes the deemed 
sale election is treated as having sold, for its fair market value, the 
stock of the PFIC that the shareholder held on the qualification date. 
The gain recognized on the deemed sale is taxed under section 1291 as 
an excess

[[Page 68154]]

distribution received on the qualification date. In the case of an 
election made by an indirect shareholder, the amount of gain to be 
recognized and taxed as an excess distribution is the amount of gain 
that the direct owner of the stock of the PFIC would have realized on 
an actual sale or other disposition of the stock of the PFIC indirectly 
owned by the shareholder. Any loss realized on the deemed sale is not 
recognized. For the definitions of PFIC, QEF, unpedigreed QEF, and 
pedigreed QEF, see Sec. 1.1291-9(j) (1) and (2).
    (b) Who may make the election. A shareholder of an unpedigreed QEF 
may make the deemed sale election provided the shareholder held stock 
of that PFIC on the qualification date. A shareholder is treated as 
holding stock of the PFIC on the qualification date if its holding 
period with respect to that stock under section 1223 includes the 
qualification date. A deemed sale election may be made by a shareholder 
that would realize a loss on the deemed sale.
    (c) Time for making the election. The shareholder makes the deemed 
sale election in the shareholder's return for the taxable year that 
includes the qualification date. If the shareholder and the PFIC have 
the same taxable year, the shareholder makes the deemed sale election 
in either the original return for the taxable year for which the 
shareholder makes the section 1295 election, or in an amended return 
for that year. If the shareholder and the PFIC have different taxable 
years, the deemed sale election must be made in an amended return for 
the taxable year that includes the qualification date. If the deemed 
sale election is made in an amended return, the amended return must be 
filed by a date that is within three years of the due date, as extended 
under section 6081, of the original return for the taxable year that 
includes the qualification date.
    (d) Manner of making the election. A shareholder makes the deemed 
sale election by filing Form 8621 with the return for the taxable year 
of the shareholder that includes the qualification date, reporting the 
gain as an excess distribution pursuant to section 1291(a), and paying 
the tax and interest due on the excess distribution. A shareholder that 
makes the deemed sale election after the due date of the return 
(determined without regard to extensions) for the taxable year that 
includes the qualification date must pay additional interest, pursuant 
to section 6601, on the amount of the underpayment of tax for that 
year. A shareholder that realizes a loss on the deemed sale reports the 
loss on Form 8621, but does not recognize the loss.
    (e) Qualification date--(1) In general. Except as otherwise 
provided in this paragraph (e), the qualification date is the first day 
of the PFIC's first taxable year as a QEF (first QEF year).
    (2) Elections made after March 31, 1995, and before January 27, 
1997--(i) In general. The qualification date for deemed sale elections 
made after March 31, 1995, and before January 27, 1997, is the first 
day of the shareholder's election year. The shareholder's election year 
is the taxable year of the shareholder for which it made the section 
1295 election.
    (ii) Exception. A shareholder who made the deemed sale election 
after May 1, 1992, and before January 27, 1997 may elect to change its 
qualification date to the first day of the first QEF year, provided the 
periods of limitations on assessment for the taxable year that includes 
that date and for the shareholder's election year have not expired. A 
shareholder changes the qualification date by filing amended returns, 
with revised Forms 8621, for the shareholder's election year and the 
shareholder's taxable year that includes the first day of the first QEF 
year, and making all appropriate adjustments and payments.
    (f) Adjustments to basis--(1) In general. A shareholder that makes 
the deemed sale election increases its adjusted basis of the PFIC stock 
owned directly by the amount of gain recognized on the deemed sale. If 
the shareholder makes the deemed sale election with respect to a PFIC 
of which it is an indirect shareholder, the shareholder's adjusted 
basis of the stock or other property owned directly by the shareholder, 
through which ownership of the PFIC is attributed to the shareholder, 
is increased by the amount of gain recognized by the shareholder. In 
addition, solely for purposes of determining the subsequent treatment 
under the Code and regulations of a shareholder of the stock of the 
PFIC, the adjusted basis of the direct owner of the stock of the PFIC 
is increased by the amount of gain recognized on the deemed sale. A 
shareholder shall not adjust the basis of any stock with respect to 
which the shareholder realized a loss on the deemed sale.
    (2) Adjustment of basis for section 1293 inclusion with respect to 
deemed sale election made after March 31, 1995, and before January 27, 
1997. For purposes of determining the amount of gain recognized with 
respect to a deemed sale election made after March 31, 1995, and before 
January 27, 1997, by a shareholder that treats the first day of the 
shareholder's election year as the qualification date, the adjusted 
basis of the stock deemed sold includes the shareholder's section 
1293(a) inclusion attributable to the period beginning with the first 
day of the PFIC's first QEF year and ending on the day before the 
qualification date.
    (g) Treatment of holding period. For purposes of applying sections 
1291 through 1297 to the shareholder after the deemed sale, the 
shareholder's holding period of the stock of the PFIC begins on the 
qualification date, without regard to whether the shareholder 
recognized gain on the deemed sale. For other purposes of the Code and 
regulations, this holding period rule does not apply.
    (h) Election inapplicable to shareholder of former PFIC. A 
shareholder may not make the section 1295 and deemed sale elections if 
the foreign corporation is a former PFIC (as defined in Sec. 1.1291-
9(j)(2)(iv)) with respect to the shareholder. For the rules regarding 
the election by a shareholder of a former PFIC, see 1.1297-3T.
    (i) Effective date. The rules of this section are applicable as of 
April 1, 1995.


Sec. 1.1291-10T  [Removed]

    Par. 7. Section 1.1291-10T is removed.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 8. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


Sec. 602.101  [Amended]

    Par. 9. In Sec. 602.101, paragraph (c) is amended by removing the 
entries for 1.1291-9T and 1.1291-10T from the table and adding entries 
in numerical order to the table to read as follows:


Sec. 602.101  OMB Control numbers.

* * * * *
    (c) * * *
* * * * *

------------------------------------------------------------------------
                                                            Current OMB 
   CFR part or section where identified and described       Control No. 
------------------------------------------------------------------------
                                                                        
                      *      *      *      *      *                     
1.1291-9................................................       1545-1507
1.1291-10...............................................       1545-1507
                                                                        
                      *      *      *      *      *                     
------------------------------------------------------------------------


[[Page 68155]]

Margaret Milner Richardson,
Commissioner of Internal Revenue.
    Approved: December 12, 1996.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 96-32246 Filed 12-26-96; 8:45 am]
BILLING CODE 4830-01-U