Retroactive QEF Election Granted in PLR 201120009
May 25, 2011Administrative Actions
This ruling does not present any new law, but is the most recent one in the retroactive qualified electing fund (QEF) line of authorities, so I decided to use it as a platform to cover the issue on this blog. Investment fund participants ought to be familiar with the passive foreign investment company (PFIC) and QEF rules. These are anti-deferral rules that could cause the investor to have reporting obligations and more importantly, convert capital gains to ordinary income. Like many other Internal Revenue Code provisions, these rules are overly-complex and not always clear or intuitive. On top of that, there are extensive proposed regulations that have been proposed since 1992. This in my opinion is always a sign of trouble because it tells me that Treasury itself has not made up its mind on some of these issues.
That said, investment fund participants (particularly those that have not received competent counsel at the onset of the investment) often find out after the fact that the PFIC rules may apply to them and that could cause adverse tax consequences. They find out that some of these issues (for example, the conversion of capital gain to ordinary income) might have been prevented if they had filed a QEF election when they first acquired an interest in the fund. Naturally, the consequential question that comes up is, what can I do to mitigate this issue? The unfortunate thing is that there is no magic wand solution that can solve the predicament. The easiest thing is to file a late QEF election. That causes the foreign fund to be something called an unpedigreed QEF. In other words, this is a fund to which both the PFIC and QEF rules apply simultaneously. As the reader would surmise, this is not necessarily a perfect solution to the problem. The other thing that a private equity, venture capital, or hedge fund participant can do is to file for something called a consent election. This is what the person in this ruling did. The consent election is something similar to the late filing relief available under Regulations Sections 301.9100-1, -2, and -3 (“9100 relief”). If the relief is granted, the taxpayer is allowed to make a retroactive QEF election, thus, treating the foreign fund as a QEF from day one and avoiding the more adverse PFIC regime. Just as with 9100 relief, the taxpayer has to show that the investor reasonably relied on a qualified tax professional and the government’s interest is not prejudiced. Often, however, the government interest is prejudiced. In those instances, the government may agree to still approve the request, but the investor may have to pay some additional charges so that the prejudice is mitigated. Obtaining the consent is usually a straight-forward but lengthy process that can span from 6 months to a few years. It is nonetheless a process that is worth exploring and may present the best option of the investment fund participant. Again, obtaining a consent QEF ruling is not a replacement for seeking and receiving competent advice upfront, but may mitigate to certain extent the failure to obtain such advice. There are many consent rulings that the reader can find on Westlaw, Lexis or any of the reporting services. The latest ruling mentioned in this post can be found below