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By: Kris Hatch, Idan Netser, Fenwick & West LLP

U.S.-based venture capital and other funds that invest in foreign companies must be careful to avoid the passive foreign investment company (PFIC) rules, which could substantially increase the tax owed on exit for U.S. taxpaying investors. U.S. persons who are limited partners (LPs) of funds must also be aware of the PFIC rules, as they are liable for their own tax reporting and payment of taxes.

Failure to adhere to the PFIC rules could result in significant tax consequences for U.S. taxpayers. Ignorance of the rules could result in taxes, interest and penalties significantly greater than the potential tax liability of an adequately monitored and managed PFIC.

The PFIC rules are not new; they have been around for many years. However, in light of substantial changes to the U.S. tax law by the Tax Cuts and Jobs Act, and newly issued proposed PFIC regulations (discussed in greater detail below), we are witnessing a growing trend of funds that require foreign incorporated startup companies to invert to become a Delaware C corporation, thereby avoiding PFIC issues. If a startup remains a foreign corporation, funds now require the inclusion of certain robust tax provisions in the financing documents. These tax provisions may impose liability upon the startup if it is not careful to avoid becoming a PFIC, to timely inform the fund that the startup has or will become a PFIC, or to provide the fund with the much-needed finan......................

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