Internal Revenue Service
Revenue Ruling
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smRev. Rul. 59-71
1959-1 C.B. 194
Sec. 902
IRS Headnote
Determination of the amount of foreign tax deemed to have been paid by a domestic corporation, under section 902(d) of the Internal Revenue Code of 1954, where the amounts received by the domestic corporation, from its wholly-owned foreign subsidiary, were allowed as a deduction to the subsidiary in computing its income subject to tax in the foreign country.
Full Text
Rev. Rul. 59-71
Advice has been requested relating to the determination of the foreign tax credit, under the special rules provided in section 902(d) of the Internal Revenue Code of 1954, with respect to distributions (in lieu of dividends) made by a wholly-owned foreign subsidiary corporation to its domestic parent corporation under the circumstances described below.
A wholly-owned foreign subsidiary corporation has, for a period of years, paid both dividends and certain other service fees in substantial amounts to its domestic parent corporation. In 1954, under section 902(d)(2) of the Internal Revenue Code of 1954, the domestic parent entered into a `contractual arrangement' with its foreign subsidiary under which the fees were accepted in lieu of dividends, and no dividends, as such, were thereafter paid by the subsidiary. In 1955, the domestic parent corporation received 50 x dollars in service fees from its wholly-owned foreign subsidiary, the amount of which was allowed as a deduction for income tax purposes by the foreign country in which the subsidiary was located and, thus, no foreign tax was paid on such amount. The total profits of the foreign subsidiary were 500 x dollars and the foreign taxes paid were 300 x dollars. Cost of the service fees to the domestic parent was 2 x dollars.
Section 902(d) of the Code provides as follows:
SPECIAL RULES FOR CERTAIN WHOLLY-OWNED FOREIGN CORPORATIONS.-For the purposes of this subtitle, if-
(1) a domestic corporation owns, directly or indirectly, 100 percent of all classes of outstanding stock of a foreign corporation engaged in manufacturing, production or mining,
(2) such domestic corporation receives property in the form of a royalty or compensation from such foreign corporation pursuant to any form of contractual arrangement under which the domestic corporation agrees to furnish services or property in consideration for the property so received, and
(3) such contractual arrangement provides that the property so received by such domestic corporation shall be accepted by such domestic corporation in lieu of dividends and that such foreign corporation shall neither declare nor pay any dividends of any kind in any calendar year in which such property is paid to such domestic corporation by such foreign corporation, then the excess of the fair market value of such property so received by such domestic corporation over the cost to such domestic corporation of the property and services so furnished by such domestic corporation shall be treated as a distribution by such foreign corporation to such domestic corporation, and for the purposes of section 301, the amount of such distribution shall be such excess, in lieu of any amount otherwise determined under section 301 without regard to this subsection; and the basis of such property so received by such domestic corporation shall be the fair market value of such property, in lieu of the basis otherwise determined under section 301(d) without regard to this subsection.
The essential problem involved in the instant case is the proper determination of the `accumulated profits' of the foreign subsidiary for the purpose of applying the formula under section 902(a) of the Code, since, even in a case to which the special rules of section 902(d) of the Code apply, the computation of the tax deemed paid must be made as provided in section 902(a) of the Code.
Section 902(d) of the Code provides a limitation of the amount which will be treated as a dividend and does not make inapplicable the provisions of section 902(a) of the Code. Thus, in computing the amount of foreign tax deemed to have been paid with respect to a section 902(d) `dividend,' such amount of foreign tax deemed to have been paid shall be the same proportion of taxes paid by the foreign corporation to a foreign country on or with respect to its accumulated profits from which the dividend was paid, which the amount of such dividend bears to the amount of such accumulated profits. Further, section 1.902-2(b) of the Income Tax Regulations provides that the amount which may be treated as a distribution subject to the special rules under section 902(d) of the Code cannot exceed the amount which would constitute a dividend for the purposes of subtitle A of the Internal Revenue Code of 1954 relating to income taxes and thus as if, for the purpose of section 902(a) of the Code, such excess (of the fair market value of the property received in lieu of dividends by the domestic corporation over the cost to it of the property and services furnished) had been declared and paid as a dividend by the foreign corporations.
Regardless of the fact that the service fees, in the instant case, are treated as deductions in computing the income of the foreign subsidiary that is subject to tax in the foreign country, such fees, for Federal income tax purposes (in the instant case, for the purpose of the foreign tax credit), must be treated in the manner prescribed in section 902(a) of the Code.
In Mary D. Biddle v. Commissioner , 302 U.S. 573, Ct. D. 1303, C.B. 1938-1, 309, the Supreme Court of the United States, in analyzing the credit for taxes under section 131 of the Internal Revenue Code of 1939 (the counterpart of sections 901-905 of the 1954 Code), stated:
Section 131 does not say that the meaning of its words is to be determined by foreign taxing statutes and decisions, and there is nothing in its language to suggest that in allowing the credit for foreign tax payments, a shifting standard was adopted by reference to foreign characterizations and classifications of tax legislation. * * *.
Therefore, in cases where the service fees (like any other item of expense) are allowed as a deduction to the foreign corporation in computing its taxable income for the purposes of the foreign income tax, the amount of such fees cannot, at one and the same time, be a deductible expense and also a distribution from accumulated earnings and profits when applying the provisions of section 902(d) of the Code. In the instant case, the domestic parent corporation is deemed to have paid, to the extent provided in section 902(a) of the Code, foreign taxes imposed on its foreign subsidiary on or with respect to the subsidiary's accumulated profits from which the dividend of 48 x dollars was paid (50 x dollars minus 2 x dollars). Since 48 x dollars of the service fees is treated as a dividend distribution under section 902(d) of the Code, such amount must be added back to the amount of 500 x dollars (profits of the subsidiary before taxes) in order to arrive at the correct amount of accumulated profits under section 902(a) of the Code. Based upon the facts in the instant case, the computation of the foreign subsidiary's accumulated profits under United States Law, that is, for the application of section 902 of the Code, is as follows:
Total profits of the foreign subsidiary before taxes
(500x dollars plus 48x dollars)_____________________ 548x dollars
Foreign income taxes paid_____________________________ 300x dollars
----
Accumulated profits of the foreign subsidiary for the
purpose of applying section 902 of the Code_________ 248x dollars
The formula for computing the foreign tax deemed to have been paid by the domestic parent corporation with respect to the "dividend" of 48x dollars would therefore be:
48x dollars 248x dollars
(dividend) (accumulated profits) 300x dollars (foreign
------------- x --------------------- x income tax paid)
248x dollars 548x dollars (total
(accumulated profits before
profits) foreign taxes)
See section 902(a) and 902(c) of the Code. Also, see American Chicle Co. v. United States , 316 U.S. 450, Ct. D. 1561, C.B. 1942-1, 161. Subject to the limitation of section 904, the amount, thus computed, of foreign tax deemed to have been paid by the domestic parent is allowable as a credit.
One of the conditions for qualifying for the special rule under section 902(d) of the Code is that, where a domestic parent corporation accepts property in the form of a royalty or compensation from its foreign subsidiary under some form of contractual arrangement, the foreign corporation shall neither declare nor pay any dividend of any kind in any calendar year in which such property is paid to the domestic parent. The lack of this condition would preclude the allowance of a foregn tax credit with respect to a section 902(d) `dividend' but would not affect the regular dividends pursuant to section 902(a) of the Code.