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A number of provisions in the tax and budget plan that President Clinton signed on August 5 of this year will affect the project finance community.
CFC VERSUS PASSIVE FOREIGN INVESTMENT COMPANY
Starting in 1998, a foreign corporation that is a CFC cannot also be a passive foreign investment company (PFIC). This will eliminate PFIC issues in most foreign projects.
The taxpayer must be a "U.S. shareholder" in order for this rule to apply. Therefore, a foreign corporation in which a U.S. investor owns less than 10% of the voting stock can still be a PFIC, notwithstanding that the foreign corporation is a CFC.
It is probably still a good idea routinely to file protective qualified electing fund (QEF) elections for all foreign corporations, even foreign corporations that are CFCs. This is because if some U.S. shareholders in a foreign corporation sell their shares -- causing the foreign corporation to lose CFC status - it is not clear that any U.S. taxpayer still holding an interest will be able to file a "pedigreed" QEF election at that time. Better to be safe than sorry.
The Senate Finance Committee report says, If a shareholder of a PFIC is subject to the rules applicable to nonqualified funds before [1998 when a CFC can no longer be a PFIC], the stock held by such shareholder continues to be treated as PFIC stock unless the shareholder makes an election to pay tax and interest charge with respect to the unrealized appreciation in the stock or the accumulated earnings of the corporation.
In other words, any foreign corporation that is already trapped in the PFIC regime will not be able to get out without making a "purge" election.
SIX TIERS FOR FTCs
Most U.S. companies try not to have more than three foreign corporations in an ownership chain. There is a "three-tier rule" that taxes paid by foreign corporations below the third tier cannot be claimed as foreign tax credits in the U.S.
The new law allows up to six foreign corporations in an ownership chain. However, foreign corporations four through six must be be CFCs. Thus, in order for foreign taxes paid by corporations four through six to pass up the ownership chain as credits, ultimate ownership of...