QUESTION: On the topic of passive foreign investment companies
(PFICs), wouldn't it be possible to avoid the draconian PFIC
regulations by holding these vehicles in an IRA?

REPLY: As far as I know, there are no tax prohibitions or penalties
against investing in a passive foreign investment company by a self
directed IRA. IRS Regulations appear to recognize that a tax exempt
entity may own shares of a PFIC and do not appear to prohibit such an
arrangement. (See http://www.irs.gov/pub/irs-regs/td8750.txt ) Without
spending many hours searching for other regulations, rulings or expert
commentary, I have not been able to locate any additional authority.

Apart from the tax issues, there are two obstacles.

First, it can be difficult for a U.S. investor to buy any kind of
foreign security without doing so through a foreign corporation. The
reason is because the foreign bank or fund doesn't want to get into
any disputes with the U.S. SEC or with the securities department of
the state where the investor resides. Thus, the first step for most
U.S. investors who want to invest in foreign mutual funds is to form a
foreign IBC or corporation that is owned 100% by the self directed
IRA. Then the foreign IBC or corporation purchases the foreign mutual
funds.

The second obstacle is the problem of finding an IRA/401k custodian
that will agree to transfer funds to a foreign corporation. In a
search with Google, I did not locate any web sites of organizations
that are promoting this kind of service. There are only two people I
know of who can assist with this process. One is my colleague J. Ben
Vernazza (see http://www.itcgpros.com/JBV.htm). The other is Larry
Grossman. (See http://www.siamsite.com)

However, the use of an IRA is not the only way to avoid the onerous
PFIC tax and interest on deferred distributions or on gains from
dispositons of fund shares. If the fund is controlled by U.S.
investors, it could provide the investors with the information needed
to make an election as a qualified fund (QEF) so that the income and
losses of the PFIC pass through as if the PFIC were a U.S. mutual fund
or a partnership. Another option if the PFIC is traded on a major
national exchange is to make an election to report the gain in market
value as ordinary income on an annual basis. A charitable entity such
as a charitable remainder trust could be used, although that would be
far more complicated and expensive than using an IRA.

For some additional information on this subject see
http://www.offshorepress.com/offshoretax/otpfic.htm. Additional
background on PFIC tax rules is available in my book "Offshore Tax
Strategies." (http://www.offshorepress.com/offshoretax/index.htm)

Vern

IRS Regulations require that I include the following statement with
any written explanation of the tax law unless the written explanation
is a covered opinion.

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