Passive Foreign Investment Company

As if the Controlled Foreign Corporation designation isn't bad enough, there is one that is even worse. It is the "Passive Foreign Investment Company" (PFIC) label. Passive income seems to be a particular target for the tax man. This designation was created by Congress to appease the mutual fund industry which had to compete with passive investments made in non-Controlled Foreigh Corporations. To be ruled a PFIC, anything organized as a corporation that (1) receives 75% or more of its income from passive investment sources or (2) has invested 50% or more of its assets in passive investments as distinguished from investments in a trade or business.

Any US shareholder who owns ANY interest in a PFIC is required to file form 8621, however no filing for tax year 2010 was required which means the first required year is 2011.
The CFC tax rules and the PFIC rules overlap so the law was modified in 1997 to relieve U.S. shareholders of compliance with the PFIC rules if the same income was subject to tax under the subpart f rules for CFCs. BUT the "fine print" indicates that this relief is only available for taxpayers who elect to treat their portion of the PFIC as a "Qualified Electing Fund" (QEF) in which the taxpayer pays taxes on his or her share of the fund's current earnings. This election would only apply to U.S. persons who own 10% or more of the PFIC shares and where more than 50% of the stock is owned by five or fewer U.S. shareholders.

See how nutty this all is? A foreign partnership that is organized to make passive investments will not get the PFIC designation because it's not a corporation and that may be an option. Please note that the IRS may impute CFC designation to partnerships (even though they are not corporations) and those rules should be considered carefully.