Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 58-56

1958-1 C.B. 335

Sec. 863
Sec. 904
Sec. 921
Sec. 922
Sec. 1502

IRS Headnote

In an affiliated group of corporations, those members of the group which operate in the Western Hemisphere outside of the United States and whose only source of income is from dividends, interest, and capital gains shall, for the purpose of the consolidated section 922 deduction, be excluded in determining the consolidated taxable income attributable to members of the group which are Western Hemisphere trade corporations.

In computing the limitation under section 904(a) of the Internal Revenue Code of 1954, to determine the allowable foreign tax credit, the Western Hemisphere trade corporation deduction provided by section 922 of the Code should be apportioned or allocated between income from sources within and income from sources without the United States as required by section 863 of the Code.

Revenue Ruling 56-316, C.B. 1956-2, 597, amplified.

Full Text

Rev. Rul. 58-56

Advice has been requested (1) concerning the applicability of the consolidated section 922 deduction provided for in section 1.1502-31(a)(15) of the Income Tax Regulations where some members of an affiliated group of corporations, which operate in the Western Hemisphere but outside the United States, have gross income only from dividends, interest, and capital gains; and (2) whether the Western Hemisphere trade corporation deduction may be apportioned or allocated between income from sources within and income from sources without the United States in computing the limitation under section 904(a) of the Internal Revenue Code of 1954.

The taxpayer is a member of an affiliated group of corporations, some of which qualify as Western Hemisphere trade corporations within the meaning of section 921 of the Code. The affiliated group also includes several members whose sole operations consist of exploration activities conducted in the Western Hemisphere outside the United States, and have gross income solely from dividends, interest, and capital gains. The affiliated corporations filed consolidated income tax returns for several years and, in computing the limitation on foreign tax credits, allocated the Western Hemisphere trade corporation deduction between income from sources within and income from source without the United States.

Section 1.1502-31 of the Income Tax Regulations provides, in part, as follows:

(a) DEFINITIONS.- * * *

*

`(15) Consolidated Section 922 Deduction .-The consolidated section 922 deduction, relating to Western Hemisphere trade corporations, shall be that portion of the consolidated taxable income attributable to those members of the affiliated group which are Western Hemisphere trade corporations (computed without regard to the consolidated section 922 deduction) multiplied by the fraction specified in section 922(2).'

The special deduction allowed by section 922 of the Code is a fraction of the taxable income of a Western Hemisphere trade corporation computed without regard to the deduction allowed by that section. Section 921 of the Code defines the term `Western Hemisphere trade corporation' as a domestic corporation all of whose business (other than incidental purchases) is done in any country or countries in North Central, or South America, or in the West Indies, if 95 percent or more of the corporation's gross income for the three-year period immediately preceding the close of the taxable year was derived from sources without the United States, and if 90 percent or more of its gross income for such period was derived from the active conduct of a trade or business.

Corporations in similar circumstances, but having no gross income of any kind, may not be classified as Western Hemisphere trade corporations. See Revenue Ruling 56-316, C.B. 1956-2, 597. It is stated in I.T. 1785, C.B. II-2, 258 (1923), and I.T. 2318, C.B. V-2, 76 (1929), that dividends are not income derived from the active conduct of a trade or business. See also section 1.921-1(a)(3) of the Income Tax Regulations. Interest received on money loaned and gains from the sale of capital assets as defined in section 1221 of the Code are likewise not regarded as income derived from the active conduct of a trade or business. However, gains from the sale of property used in the trade or business, which are treated as capital gains under section 1231 of the Code, are considered as income derived from the active conduct of a trade or business, unless such sales are made in connection with a complete or partial liquidation of the corporation. Accordingly, it is held that those members of an affiliated group of corporations, which operate in the Western Hemisphere outside the United States and whose only source of income is from dividends, interest, and capital gains, shall, for the purpose of the consolidated section 922 deduction, be excluded in determining the consolidated taxable income attributable to members of the group which are Western Hemisphere trade corporations.

In determining the allowance of the foreign tax credit, section 904 of the Internal Revenue Code of 1954 places a limitation thereon, as follows:

(a) LIMITATION.-The amount of the credit in respect of the tax paid or accrued to any country shall not exceed the same proportion of the tax against which such credit is taken which the taxpayer's taxable income from sources within such country (but not in excess of the taxpayer's entire taxable income) bears to his entire taxable income for the same taxable year.

Section 863 of the Code, pertaining to items not specified as income from sources within or without the United States, provides, in part, as follows:

(a) ALLOCATION UNDER REGULATIONS.-Items of gross income, expenses, losses, and deductions, other than those specified in sections 861(a), 862(a), shall be allocated or apportioned to sources within or without the United States, under regulations prescribed by the Secretary or his delegate. Where items of gross income are separately allocated to sources within the United States, there shall be deducted (for the purpose of computing the taxable income therefrom) the expenses, losses, and other deductions properly apportioned or allocated thereto and a ratable part of other expenses, losses, or other deductions which cannot definitely be allocated to some item or class of gross income. * * *

Where the tax liability is based on income from sources within and without the United States, the special deduction allowed corporations by section 922 of the Code, relating to Western Hemisphere trade corporations, should be taken into account in the computation of taxable income from such sources. Inasmuch as the Western Hemisphere trade corporation deduction is computed on the taxable income of the corporation, including any income from sources within as well as without the United States, such deduction should be apportioned or allocated pursuant to the provisions of section 863 of the Code.

Accordingly, it is held that the Western Hemisphere trade corporation deduction should be allocated between income from sources within and income from sources without the United States in computing the limitation under section 904(a) of the Code.