Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 71-65

1971-1 C.B. 212

Sec. 301

Sec. 312

Sec. 902

IRS Headnote

Effect of distributions of appreciated property by a foreign subsidiary to its domestic corporate shareholder on the computation, under section 902(a)(2) of the Code, of the credit for foreign taxes deemed paid by the domestic corporation.

Full Text

Rev. Rul. 71-65

Advice has been requested concerning the effect on computations under section 902(a)(2) of the Internal Revenue Code of 1954 of distributions of appreciated property by a foreign corporation to its domestic corporate shareholder under the circumstances described below.

X, a domestic corporation, owns all of the stock of Y, a foreign corporation, incorporated in 1966. In all years since its inception Y was a less developed country corporation as defined in section 902(d) of the Code and did not engage in trade or business within the United States. Both corporations use the calendar year as the taxable year.

For the purpose of computing the taxable status of distributions, Y had accumulated earnings and profits at January 1, 1967, of 12,000x dollars, and for the year 1967 had current earnings and profits of 2,000x dollars. It distributed to X on December 31, 1967, property in kind having an adjusted basis to it of 1,000x dollars but a fair market value of 1,500x dollars. For the year 1968, Y had current earnings and profits of 3,000x dollars and distributed to X on December 31, 1968, property in kind having an adjusted basis to it of 5,000x dollars but a fair market value of 10,000x dollars. For the year 1969, Y had no current earnings and profits or deficit in earnings and profits and made a cash distribution of 7,500x dollars to X on December 31, 1969. In each of the taxable years in issue X elected to claim a foreign tax credit for the amount of foreign income taxes it was deemed to have paid under section 902(a)(2) of the Code.

Section 301(b)(1)(C) of the Code provides, in pertinent part, that if the shareholder is a corporation and the distributing corporation is a foreign corporation, the amount taken into account with respect to property (other than money) shall be the fair market value of such property. Under section 301(c)(1) of the Code, the fair market value of the property distributed is included in the shareholder's gross income provided that the earnings and profits of the corporation are adequate to permit the distribution to constitute a dividend under section 316 of the Code.

Section 312(a)(3) of the Code provides, in part, that on the distribution of property by a corporation with respect to its stock, the earnings and profits of the corporation shall be decreased by the adjusted basis of the other property so distributed.

Applying section 312(a)(3) of the Code to the facts herein, Y's accumulated earnings and profits on December 31, 1967, are 13,000x dollars (12,000x dollars plus 2,000x dollars less 1,000x dollars), and its accumulated earnings and profits on December 31, 1968, are 11,000x dollars (13,000x dollars plus 3,000x dollars less 5,000x dollars).

Applying sections 301(b)(1)(C) and 301(c) of the Code to the facts herein, the distribution of property in kind to X in 1967 and 1968 in the amount of the fair market values of 1,500x dollars and 10,000x dollars, respectively, and the cash distribution to X in 1969 in the amount of 7,500x dollars are dividends as defined in section 316 of the Code and accordingly are included in X's gross income.

Under the holdings of Central Aguirre Sugar Company, et al. v. Commissioner, 24 T.C. 630 (1955), acquiescence, C.B. 1965-2, 4, and National Carbon Company, Inc. v. Commissioner, 2 T.C. 57 (1943), acquiescence, C.B. 1965-2, 6, a distribution by a foreign corporation to a domestic corporation of appreciated property constituting a dividend is included in the section 902 computation as a dividend at the same value as it is included in gross income. Under section 301(b)(1)(C) of the Code the gross income figure is the fair market value of the property to the extent it constitutes a dividend under section 316 of the Code. However, under section 312(a)(3) of the Code the earnings and profits of the distributing corporation are reduced only by the adjusted basis of the property rather than by the fair market value. As a result of this difference between the amount of the dividend and the amount by which earnings and profits are reduced, a foreign corporation can distribute dividends under section 316 of the Code in amounts exceeding the total amounts of annual earnings and profits for all years before reduction for distributions. For example, on the facts herein, although the aggregate of Y's annual earnings and profits for the years 1966, 1967, 1968, and 1969 is only 17,000x dollars, at the close of the taxable year 1969 it has distributed dividends in the amount of 19,000x dollars. The potential effect on computations under section 902 of the Code is that the domestic corporate shareholder might claim credit for amounts of foreign taxes deemed paid in excess of the amount of taxes actually paid or accrued by the foreign corporation.

Section 902(a)(2) of the Code provides that a domestic corporation which owns at least 10 percent of the voting stock of a foreign corporation from which it receives dividends in any taxable year shall, to the extent such dividends are paid by such foreign corporation out of accumulated profits (as defined in section 902(c)(1)(B) of the Code) of a year for which such foreign corporation is a less developed country corporation, be deemed to have paid the same proportion of any income, war profits, or excess profits taxes paid or deemed to be paid by such foreign corporation to any foreign country or to any possession of the United States, on or with respect to such accumulated profits, which the amount of such dividends bears to the amount of such accumulated profits.

The general intent of section 902 of the Code and the underlying assumption of the regulations thereunder is that the amount of the foreign tax deemed paid is to be calculated separately for each year in which a foreign tax was paid or accrued on the basis of the relationship between the accumulated profits for that year and the amount of dividends attributable to the accumulated profits of that year. That principle was established in General Foods Corp. v. Commissioner, 4 T.C. 209 (1944), acquiescence, C.B. 1946-1, 2.

Section 1.902-3(c)(2) of the Income Tax Regulations provides that the accumulated profits for any taxable year of a less developed country corporation shall be the amount of the earnings and profits of such corporation for such year. In both the Central Aguirre and National Carbon cases, the total annual earnings and profits of the distributing corporation for the year of distribution and preceding years were in excess of the fair market value of the distribution in kind. Each case allowed a foreign tax credit when the dividend was supported by accumulated profits which had been subjected to a foreign tax not previously credited. Neither case held that a distribution constituting a dividend under the applicable statutory provision corresponding to section 316 of the Code could be utilized to secure a foreign tax credit when the total amount of the dividend and prior dividends was in excess of the aggregate amount of the annual accumulated profits before reduction for any distributions.

The legislative history relating to the effect of section 301(b)(1)(C) of the Code, added by the Revenue Act of 1962 C.B. 1962-3, 126, insofar as it affects the computation of the amount of foreign taxes deemed paid under section 902 of the Code, indicates that the Congress intended to do no more than adopt the rule of Central Aguirre and National Carbon. The general purpose in requiring that the amount of a distribution be the fair market value was to preclude the United States parent from exercising an option (through its control of the foreign subsidiary) of distributing property from the foreign subsidiary with an adjusted basis lower than fair market value, rather than cash, and thus "* * * realiz[ing] on the earnings and profits of the foreign corporation at a minimum U.S. tax." Calculation of United States tax on the basis of the fair market value of the distribution "* * * is believed appropriate since the increase in value of the parent's assets is the same whether it receives the cash or the property." Senate Report No. 1881, Eighty-seventh Congress, C.B. 1962-3, 707, at 744 and 745.

The statutory purpose of avoidance of double taxation is fulfilled when credit has been taken, or could have been taken if all shareholders had qualified for and claimed the credit, for the full amount of foreign taxes allocable to the accumulated profits of a particular year. The fact that a distribution is subject to Federal income tax as a dividend does not require or justify a foreign tax credit when the full amount of the foreign taxes attributable to the accumulated profits which form the source of the dividend has been allocated to dividends paid in prior years in computations of the allowable tax credit for those years. Therefore, it is proper to limit the amount of taxes deemed paid for a particular year under section 902 of the Code to the amount of foreign taxes paid or accrued on or with respect to the accumulated profits of that year. The total amount of taxes deemed paid for all years as of the close of any taxable year cannot exceed the total of taxes actually paid or accrued for all years prior to that date.

Accordingly, for purposes of section 902 of the Code, the dividend figures used in the numerator of the apportioning fractions applied to the foreign creditable taxes of a given year may not exceed the denominator used in the apportioning fractions for such year. Thus, on the facts herein, for 1967, 1,500x dollars of dividends are considered paid out of accumulated profits of 2,000x dollars for such year, leaving a balance of 500x dollars that may be used for distributions in subsequent years. The dividend in the numerator in the fraction used in the section 902(a)(2) computation for 1968 will be limited to 3,000x dollars, the amount of the accumulated profits for 1968. The balance of the dividend for 1968 of 7,000x dollars (10,000x dollars representing the fair market value of the 1968 distribution of property in kind less 3,000x dollars, the amount of the accumulated profits for such year) must be treated as having been paid out of (1) accumulated profits of 500x dollars for 1967 and (2) accumulated profits of 6,500x dollars for taxable year 1966. Likewise, 5,500x dollars of the cash dividend of 7,500x dollars in 1969 must be treated as having been paid out of remaining accumulated profits of taxable year 1966 (12,000x dollars less 6,500x dollars) since there are no accumulated profits for 1969 and none remaining for 1968 or 1967. Since there are no remaining accumulated profits to which the remaining amount of the cash dividend, 2,000x dollars (7,500x dollars less 5,500x dollars), distributed in 1969 can be attributed, and the total amount of income taxes paid or accrued by Y with respect to its accumulated profits for the taxable years 1966, 1967, and 1968 has been taken into account in computation of the amount of foreign taxes deemed paid by X with respect to the accumulated profits for those years, no further credit is available with respect to such taxes as taxes deemed paid by the shareholder under a section 902(a)(2) computation.

The principle of the holding herein is equally applicable to a foreign corporation that is not a less developed country corporation.