Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 72-1

1972-1 C.B. 52

Sec. 165
Sec. 166
Sec. 172
Sec. 1231

IRS Headnote

The tax treatment of foreign expropriation losses incurred by domestic corporations in three factual situations is explained.

Full Text

Rev. Rul. 72-1

The purpose of this Revenue Ruling is to state the income tax treatment under the Internal Revenue Code of 1954 of expropriations by foreign countries of properties in such countries owned by domestic corporations in the situations described below. Situation (1). X, a domestic corporation, owned a mining business in foreign country A that consisted of a mine, storage buildings and dwellings for personnel. In 1967, this business was intervened by officials of country A who took over its management. There was no reasonable prospect for recovery of the property or for indemnification by insurance or otherwise in 1967. In 1969, country A expropriated X's assets without promise of indemnification.

Situation (2). For years prior to 1970, Y, a domestic corporation, had owned 49 percent of the capital stock of corporation T. T was incorporated under the laws of foreign country B and has been engaged in the business of owning and operating a mine in country B. In 1970, T was nationalized under the laws of country B and continued to operate under the control of country B. Such laws provide that former shareholders of companies nationalized have no rights other than to assert a right to their proportional share of compensation. There was no reasonable prospect for payment of such compensation, nor of recovery of Y's interest in T, or indemnification by insurance or otherwise. At the time of nationalization substantially all of T's assets were located in country B.

Situation (3). Z, a domestic corporation using the calendar year as its taxable year, owned 70 percent of the stock of S, a corporation incorporated in foreign country C. In 1969, country C threatened to expropriate S if Z did not agree to sell its 70 percent interest in S in exchange for country C's obligation evidenced by a written contract to pay a fixed and determinable amount. The debt was to be reflected by country C's guaranteed interest-bearing bonds payable in equal installments due quarterly over a 20-year period, serially numbered but without interest coupons and not in registered form. The bonds were to be issued periodically commencing with the date of acceptance of the offer and continuing at agreed intervals until the entire amount of the purchase price had been covered by outstanding bonds. On December 31, 1969, Z accepted the offer and reasonably believed that the bonds would be paid when due. Country C issued some of the bonds and paid the first installment thereon, but on June 30, 1970, when the second installment was due, country C refused to pay and denied any further obligations under its agreement.

In the foregoing situations, it is assumed that the property in question owned by the domestic corporations did not represent and was not purchased with unreported taxable income, as might have been the case, for example, if such income had been blocked and the domestic corporations had elected to defer the reporting of blocked currency. See Mim. 6475, C.B. 1950-1, 50.

Section 165(a) of the Internal Revenue Code of 1954 provides, in general, for the deductibility of losses that are not compensated for by insurance or otherwise. Section 1.165-1(b) of the Income Tax Regulations provides, in part, that a loss, to be allowable as a deduction under section 165(a) of the Code, must be evidenced by a closed and completed transaction, fixed by identifiable events, and actually sustained during the taxable year. Section 1.165-1(d)(1) of the regulations provides, in part, that a loss shall be allowed as a deduction under section 165(a) of the Code only for the taxable year in which the loss is sustained.

In regard to the timing of the loss, section 1.165-1(d)(2)(i) of the regulations provides, in part, that if an event occurs that may result in a loss and, in the year of such event, there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery, no portion of the loss with respect to which reimbursement may be received is sustained for purposes of section 165 of the Code until it can be ascertained with reasonable certainty whether or not such reimbursement will be received. Whether a reasonable prospect of recovery exists with respect to a claim for reimbursement of a loss is a question of fact to be determined upon an examination of all facts and circumstances.

In the case of United States v. S. S. White Dental Manufacturing Co. of Pennsylvania, 274 U.S. 398 (1927), T.D. 4059, C.B. VI-2, 198 (1927), the Supreme Court of the United States ruled deductible a loss suffered by the taxpayer when its wholly-owned German corporation was sequestered by Germany in 1918. The Court held that a loss may become complete enough for deduction even though the taxpayer cannot establish that there is no possibility of eventual recoupment. In the case of Commissioner v. Jacob F. Brown, 54 F. 2d 563 (1931), certiorari denied, 286 U.S. 556 (1931), the taxpayer was allowed a deduction for a loss in 1918, even though the bonds seized by Germany in that year were restored to the taxpayer in 1920. In both the White Dental and Brown cases, it was pointed out that the taxpayer is not required to be unreasonably optimistic about his chances for recovery.

Section 166(a)(1) of the Code provides that there shall be allowed as a deduction any debt that becomes worthless within the taxable year.

Section 1.166-1(c) of the regulations provides, in part, that only a bona fide debt qualifies for purposes of section 166 of the Code. A bona fide debt is a debt that arises from a debtor-creditor relationship based upon a valid and enforceable obligation to pay a fixed or determinable sum of money.

Section 166(e) of the Code provides that a debt that is evidenced by a security as defined in section 165(g)(2)(C) of the Code shall not be considered a bad debt under section 166 of the Code. Section 165(g)(2)(C) of the Code defines a security to mean a bond, debenture, note, or certificate, or other evidence of indebtedness, issued by a corporation or by a government or political subdivision thereof, with interest coupons or in registered form.

Section 172(k)(1) of the Code and section 1.172-11(b)(1) of the regulations define "foreign expropriation loss" to mean, in part, the sum of the losses sustained by reason of the expropriation, intervention, seizure, or similar taking of property by a foreign from, or which under section 165(g) government. It does not include losses of the Code or section 1231(a) of the Code are treated or considered as losses from, sales or exchanges of capital assets and losses described in section 165(i)(1) of the Code relating to certain property confiscated by Cuba. A debt that becomes worthless in whole or in part, to the extent of any deduction allowed under section 166(a) of the Code, is considered a loss for purposes of section 172(k)(1) of the Code.

Section 172(b)(1)(D) and section 172(b)(3)(C)(i) of the Code, read together, provide that in the case of a taxpayer that has a foreign expropriation loss that equals or exceeds 50 percent of the net operating loss for any taxable year ending after 1958, the portion of the net operating loss for such year attributable to such foreign expropriation loss shall not be a net operating loss carryback and shall be a net operating loss carryover to each of the 10 taxable years following the taxable year of such loss. Section 172(b)(3)(C)(ii) of the Code (applicable for taxable years ending after December 31, 1963) requires an election by the taxpayer to apply the foregoing provision, and section 1.172-11(c) of the regulations sets forth the time and manner of making the election.

Section 1231(a) of the Code requires the aggregating of all recognized gains and losses on sales, exchanges, and involuntary conversions of property used in the trade or business (as defined in section 1231(b) of the Code) and the recognized gains and losses from involuntary conversions of capital assets held for more than six months. If the aggregated gains exceed the aggregated losses, then all such gains and losses are considered as gains and losses from sales or exchanges of capital assets held for more than six months. If the aggregated losses exceed the aggregated gains, then such gains and losses shall not be considered as gains and losses from sales or exchanges of capital assets. Instead, such gains and losses constitute ordinary gains and losses. In Revenue Ruling 62-197, C.B. 1962-2, 66, the Internal Revenue Service discussed the principles that would be used to determine when a loss by confiscation had been sustained by United States taxpayers whose property had been seized by the government of Cuba. That revenue ruling, in pertinent part, states:

* * * [I]t is the position of the Service that acts of confiscation, whether by way of seizure, intervention in, expropriation, or similar taking of property, by the Cuban Government constitute identifiable events which, in the light of all of the circumstances, have resulted in closed and completed transactions notwithstanding promise of indemnification. An act of confiscation has occurred when the taxpayer has been deprived of ownership of property or the normal attributes of ownership, such as receipt of income and control over the operation or use of the property, with little or no chance of being compensated therefor.

In determining when a loss through confiscation has been sustained for Federal income tax purposes, the Service will recognize as the identifiable event evidencing a closed and completed transaction whichever of the acts of confiscation occur first. The burden of proof is upon the taxpayer to establish by whatever evidence is available the occurrence of the act and the date thereof to support a deduction for a loss. An officially published expropriation decree (or similar document) will in general be considered prima facie evidence of Cuban confiscation as of the date of the decree. Naturally, all other evidence which is available to the taxpayer or the Service will be used, to the extent material, in establishing loss and the date thereof.

In situations in which there has been seizure, intervention in, or similar taking of property by Cuban officials followed by expropriation evidenced by an officially published expropriation decree (or similar document), the loss will be considered to have been sustained at the time of the seizure, intervention, or taking rather than at the later date of the decree, provided that there is evidence sufficient to establish that the confiscation took place on the date of seizure, intervention, or taking. In situations in which there is not sufficient evidence to establish that the confiscation took place at a date prior to the date of the officially published expropriation decree (or similar document), the date of the decree will be considered as the date of the loss. In situations in which there has been no officially published expropriation decree (or similar document), the date of loss may be established by whatever evidence is available, including evidence of a circumstantial nature.

The issue in Situation (1) is whether a loss was sustained within the meaning of section 165(a) of the Code and, if so, the timing of such loss. With respect to Situation (2) the issue is whether there has been a compulsory or involuntary conversion of the foreign corporation's stock owned by the domestic corporation as the result of the nationalization of the foreign corporation by the country of incorporation. The issue in Situation (3) is whether the unpaid portion of the foreign country's outstanding bonds and the amount of the bonds to be issued under the contract were wholly worthless debts within the meaning of section 166(a)(1) of the Code and whether they fall within the term "foreign expropriation loss" pursuant to section 172(k)(1) of the Code.

The conclusions set forth below apply the foregoing rules and court decisions to the factual situations presented above.

Situation (1). A loss from foreign expropriation is deductible under section 165(a) of the Code for any taxable year when, by reason of the confiscation, intervention, seizure, or similar taking of property, or any other act, whether formal or informal, the taxpayer is deprived of the normal attributes of ownership of property with little or no chance of being compensated therefor. The principles set forth in Revenue Ruling 62-197 for determining when a loss has been sustained for Federal income tax purposes in the Cuban situation are equally applicable to the instant case. When in 1967 X's property was intervened by officials of country A, X was deprived, without reasonable prospect of any compensation therefor or indemnification by insurance or otherwise, of the normal attributes of ownership of the property, such as the right to receive income therefrom, to control its operation, or to sell or otherwise dispose of it.

Accordingly, the intervention by officials of country A in 1967 in X's business in such country gave rise to a loss allowable to X in 1967 under section 165(a) of the Code. If there had been no intervention in 1967, the loss would have arisen in 1969 at the time of the official expropriation of X's property and would have been allowable to X in 1969 under section 165(a) of the Code.

The confiscation of property by a foreign government qualifies as a compulsory or involuntary conversion for purposes of section 1231 of the Code. See Situation (3) of Revenue Ruling 62-197. Since section 1231 of the Code is thus applicable to the expropriation loss sustained in the instant situation, if the aggregated section 1231 gains exceed the aggregated section 1231 losses, the expropriation loss sustained is considered a loss from the sale or exchange of a capital asset held for more than six months. If the aggregated section 1231 losses exceed the aggregated section 1231 gains, the expropriation loss sustained is not considered a loss from the sale or exchange of a capital asset, but instead, is considered an ordinary loss.

Situation (2). In the instant case, T, itself, was nationalized, as opposed to the seizure of its assets, by country B. The laws of country B that accomplished this nationalization had the effect of vesting ownership of Y's T stock in country B. Such stock was confiscated by virtue of such nationalization just as if country B had physically seized the stock certificates. Compare Situations (2) and (6) of Revenue Ruling 62-197, in which corporate assets were seized, with Luis P. Garrigo v. United States, 296 F. Supp. 1110 (1968), in which a share of stock was apparently confiscated by Cuba while the taxpayer was in the United States. Also see Erwin de Reitzes-Marienwert v. Commissioner, 21 T.C. 846 (1954).

Accordingly, the nationalization of T by country B in 1970 resulted in a compulsory or involuntary conversion of Y's stock in T, a capital asset held for more than six months. Since there was no reasonable prospect for compensation by country B or for indemnification by insurance or otherwise at the time of nationalization, the full loss (exclusive of amounts that Y may reasonably expect to realize with respect to assets of T located outside country B) sustained by Y in respect of such involuntary conversion constitutes an ordinary loss in 1970 if it, together with Y's other section 1231 losses, exceed Y's section 1231 gains in 1970. If the prospect for compensation is favorable but Y is required, as a condition to receiving compensation, to enter into a formal contract of sale in 1970 with country B in respect of Y's stock in T, such a "sale" will be viewed by the Service as merely an agreement as to the amount of compensation to be paid for the involuntary conversion of Y's stock in T and the gain or loss in 1970 due to the involuntary conversion will be measured by the difference between the "sale" price and Y's adjusted basis of its stock in T. Situation (3). In 1969 when Z accepted country C's offer to pay Z a fixed amount for Z's stock in S and country C began issuing bonds covering that amount with respect to which Z reasonably expected payment, a bona fide debt came into existence. The fact that the debtor was a foreign country does not preclude classification of the obligation as a debt for purposes of section 166 of the Code. See Anna Bissell v. Commissioner, 23 B.T.A. 572 (1931). Country C's denial in 1970 of any further obligation under its agreement with Z combined with the futility, in the instant case, of suing country C for payment, sufficiently established the complete worthlessness of the debt for purposes of a deduction under section 166(a)(1) of the Code. Since the bonds were not in registered form and were without interest coupons, they were not "securities" as defined in section 165(g)(2)(C) of the Code and, therefore, section 166(e) of the Code does not apply.

Accordingly, the entire amount of the obligation reflected in bonds issued and to be issued under the contract less the payment of the first installment is a wholly worthless debt in 1970 within the meaning of section 166(a)(1) of the Code. Under section 172(k)(1) of the Code, such loss is considered a foreign expropriation loss.

Any recoveries by the domestic corporation in the aforementioned situations must be taken into account in accordance with section 111 or section 1351 of the Code and the regulations thereunder.