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The Tax Trap: What VC Funds Need to Know About Passive Foreign Investment Companies
- VC funds investing in foreign corporations have to consider if such investment comes under Passive Foreign Investment Company (PFIC) rules.
- Regarding PFIC, the tax consequences are different than the ones for foreign corporations that are not PFIC.
- QEF election can mitigate the negative tax consequences in caseof a PFIC.
- VC funds typically make QEF election instead of the domestic investors.
- A VC fund alone makes the QEF election, as per the current regulations, the first US owner in a chain of ownership.
- VC funds must consult with tax advisors before making foreign investments and communicating with investors as well.
- VC funds should ensure that a QEF election, when applicable, is made on the fund’s return and shareholder's share of PFIC earnings are classified in income tax.
- Yearly, PFIC status and potential income inclusion are something that needs to check with a tax advisor.
- VC funds need to consider all the PFIC rules which could result in punitive tax treatment if not identifying the PFICs.
- Venture capital funds can maintain tax benefits and avoid costly pitfalls by being attentive towards the PFIC regime.
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