QUESTION: I have a client who is setting up an investment fund in
Bulgaria, which will have some US shareholders, and will definitely
meet the definition of a PFIC (passive foreign investment company) but
will not be a CFC (<50% US shareholders). He wants to use a Bulgarian
corporation as the vehicle.

My first instinct is that the "best" structure for what would otherwise
be a PFIC is to disregard the entity which would result in a foreign
partnership for US tax purposes (reported on Form 8865 / K-1's). This
removes the PFIC implications and also allows for a flow through of
foreign taxes paid by the partnership. Does this sound like the most
tax efficient structure?

REPLY: A flow through entity is generally the most tax efficient for
U.S. investors in foreign investment companies. But I'm told that most
foreign investment funds don't want to be burdened by the cost of
providing the kind of information that is required for a foreign
partnership or even for a PFIC qualified electing fund. So unless your
client has effective control over the foreign entity, the manager of
the entity may not be willing to provide the required information.

And, in some cases, a foreign corporation may not be eligible to be
treated as a foreign partnership by U.S. investors. A list of
non-eligible entities is included in IRS Reg. 301.7701-2 but I don't
see any Bulgarian entities listed in my copy of the Regs. You might
want to take a look at the countries surrounding Bulgaria and then see
if any entities are listed for those countries that are the same type
as the one being used in Bulgaria. Also, an election by a U.S.
shareholder must be made within 75 days of the formation of the
entity. Unless your client is organizing the fund and is waiting on
you for an answer, it may be too late to make an election to treat the
entity as a partnership. However, the instructions to Form 8832 do
include some information about making a late election on the due date
of the first tax return -- which would be March 15th. (Extensions are
not available.)

If it's too late to make an election to be treated as a partnership,
or if the entity is not eligible, similar results can be obtained with
a "Qualified electing fund" (QEF) of a PFIC. A QEF election results in
pass-through tax treatment for the U.S. shareholders.

Vern

The comments in this memorandum are not intended to constitute an
opinion regarding any specific tax issues because additional tax
issues may exist that could affect the tax treatment of the tax issues
addressed in this memo. This memorandum does not consider or reach a
conclusion with respect to those additional issues and was not written
and cannot be used for the purpose of avoiding penalties under code
section 6662(d). For further details see
http://www.offshorepress.com/vkjcpa/disclosurerules.htm