US Tax Cuts Provide No Respite for US Based Aussie Expats Holding PFIC’s
The recent tax cuts that have been passed by the Trump administration in the United States unfortunately has provided no respite for US based Aussie expats holding PFIC’s.
The below briefly summarises the effect the recent tax cuts legislation has on PFICs or Passive Foreign Investment Companies. The short answer is that not too much has changed, particularly for US based Australian expats holding PFIC’s. PFIC’s are still just as bad as they previously were and you should try and mitigate your risk where you can in holding such pecuniary tax attracting investments.
What Is A Passive Foreign Investment Company (PFIC)?
To recap, a PFIC is a foreign (non-US) company or trust that meets one of the following tests:
- 75% or more of its gross income is passive. OR
- 50% or more of its Assets produce passive income.
These PFICs can include but are not limited to Australian managed funds, Australian listed investment companies (LIC’s) and Australian domiciled exchange-traded funds (ETF’s).
One of the advertised features of the tax cuts is that corporations are now taxed on a domicile basis, which means profits earned abroad are not taxed. Unfortunately, it is not that straightforward and requires key criteria to be met, and we will save this for a more in-depth post.
The new domicile system works when a US corporation owns more than 10% of a specified foreign corporation. It gets to deduct dividends received from the foreign corporation that can be attributed to foreign profits (IRC 245A(a)). This domicile system only works for corporations and not for individuals, and therefore US citizens or US based Aussie expats holding PFIC’s don’t get the benefit of this legislation change.
What Should US based Aussie Expats Holding PFIC’s Do?
One of the options for an US based Aussie expats holding PFIC’s in their investment portfolio is to make a qualifying electing fund (QEF) election under s1295. This election must be made in the first year of acquiring the interest in the PFIC. The person must include a pro-rata share of the earnings (capital growth and/or income) from the PFIC each income year. The downside of this election is that you are declaring earnings, which you might not have received yet, and tax is levied on it.
The tax cut eliminated the indirect tax credit for income taxes that foreign corporations pay(s14301(a)). This has eliminated the indirect tax credit that US corporations used to get if they own 10% or more of a PFIC, and the PFIC paid foreign taxes(s1291(2)(2)). However, if you made the QEF election and you own more than 10%, then you get the indirect tax credit for the foreign tax that the QEF paid(s1293(f)).
Whilst there have been no dramatic impacts on the treatment of PFICs from an Australian expats point of view, it is very important that you seek qualified financial advice to help mitigate the risks of investing in such investments which will attract pecuniary taxes from the IRS. A US expat or US based Aussie expat can still hold the same investment strategy with some necessary tweaks to there underlying investments both in their superannuation or their investment portfolios.
Disclaimer – The above commentary is general in nature and should not be construed as tax or financial advice. Please consult a licensed tax accountant and financial adviser to determine whether the above information is suitable for you.