Internal Revenue Service
Revenue Ruling

TaxLinks.com   sm

 Rev. Rul. 76-39

1976-1 C.B. 206

Section 960

IRS Headnote

Foreign tax credit; Swiss National Defense Tax. For purposes of section 960(a)(1) of the Code, the proper method of accrual of the Swiss National Defense Tax, assessed on corporate net profits for the two-year period preceding the first year of a biennial assessment period, is set forth for the first 5 years of existence of a Swiss subsidiary of a domestic corporation.

Full Text

Rev. Rul. 76-39

Advice has been requested as to the amount of the Swiss National Defense Tax that is creditable under section 960 of the Internal Revenue Code of 1954 under the circumstances described below.

The taxpayer is a domestic corporation that owns 100 percent of the stock of S, a foreign corporation incorporated in Switzerland. S qualifies as a controlled foreign corporation within the meaning of section 957 of the Code, and as a result, the taxpayer includes in its gross income under section 951(a), certain amounts earned by S. S is not a less developed country corporation as defined in section 902(d). Both the taxpayer and S use the accrual method of accounting and are on the calendar year basis for book and Federal income tax purposes.

The Swiss National Defense Tax is levied on an annual basis for each calendar year of an assessment period, which consists of two consecutive calendar years. The Swiss National Defense Tax is an income tax. Rev. Rul. 69-446, 1969-2 C.B. 150. The tax is not assessed (officially computed) on the net profits earned during each of those years. Instead, the tax is computed on the average of the net profits of the computational period, the two consecutive calendar years immediately preceding the first calendar year of the assessment period. Thus, if the assessment period consists of the calendar years 1967 and 1968, the net profits upon which the tax was computed for each of those years was the average of the net profits of 1965 and 1966.

To facilitate the assessment process, S must file biennially a tax return, containing its net profits for each calendar year of the computational period. The return is usually due three months after the end of the computational period (March 31st of the first year of the assessment period). No payment of tax is submitted with this return. Rather, from this return Switzerland assessed S's tax for each calendar year of the assessment period after averaging S's net profits for each year of the computational period. S then paid its tax for each calendar year of the assessment period on the March 15th, following the close of each such calendar year of the assessment period.

S commenced operation in Switzerland on January 1, 1965. However, assessment at the commencement of a corporation's existence is an exception to the above rule as no normal computation period exists. In this regard the tax levied for the first calendar year of S's existence, 1965, was computed on its net profits earned during that year. The tax levied for 1966 was computed on the average of S's net profits earned during 1965 and 1966. Since a normal two-year computational period now exists, the tax levied for the third and fourth calendar years of S's existence, 1967 and 1968, with respect to the profits earned during those years was computed on the average of S's net profits of 1965 and 1966. Since the computational period for the fifth year (1969) is the third and fourth years (1967 and 1968) the tax levied for 1969, with respect to the profits earned during that year was assessed on the average of the net profits of 1967 and 1968.

S earned net profits during each calendar year between 1965 and 1969, as follows: 1965--$4,000,000; 1966--$3,000,000; 1967--$4,000,000; 1968--$5,000,000; and 1969--$4,000,000. The rate of tax for those years was 8 percent. All of S's income is subpart F income taxable to the taxpayer under section 951 of the Code. In accordance with the foregoing discussion, S's tax for each of those years is computed as follows:

                  Applicable
Assessment        average income  Year(s) in          Total tax
year for          against which   which such          owing for
which tax   Tax   the tax         average income      the assess-
levied      rate  is applied      earned              ment year
-----------------------------------------------------------------
1965        8%     $4,000,000     (income of 1965)     =$320,000
1966        8%     $3,500,000     (average of
                                  income of 1965
                                  and 1966)            =$280,000
1967        8%     $3,500,000     (average of
                                  income of 1965
                                  and 1966)            =$280,000
1968        8%     $3,500,000     (average of
                                  income of 1965
                                  and 1966)            =$280,000
1969        8%     $4,500,000     (average of
                                  income of 1967
                                  1967 and 1968)       =$360,000

The issue presented is what amount of Swiss National Defense Tax should S have accrued for each of the years 1965 through 1969, for purposes of computing the taxpayer's deemed paid foreign tax credit in accordance with section 960(a)(1) of the Code.

Section 960(a)(1)(A) and (C) of the Code states in relevant part that if there is included under section 951(a) in the gross income of a domestic corporation any amount attributable to earnings and profits for any year of a foreign corporation other than a less developed country corporation, at least 10 percent of the voting stock of which is owned by such domestic corporation, then under the regulations prescribed by the Secretary, such domestic corporation shall be deemed to have paid the same proportion of the total income taxes paid or accrued by such foreign corporation to a foreign country for the taxable year on, or with respect to, the earnings and profits of such foreign corporation which the amount of earnings and profits of such foreign corporation so included in gross income of the domestic corporation bears to the entire amount of the earnings and profits of such foreign corporation for such taxable year.

In resolving this issue, it must be determined when the Swiss National Defense Tax for a particular year accrued.

In United States v. Anderson, 269 U.S. 442 (1926), V-1 C.B. 179, the Supreme Court of the United States held that a taxpayer accrues a liability for tax when all events have occurred that determine the fact of his legal liability and the amount thereof can be determined with reasonable accuracy.

Since the tax levied for the first two years of S's existence, 1965 and 1966, is computed in whole or in part on the total profits earned during each of those years, respectively, S accrues the tax assessed for each of those years on the last day of each of those years.

Though a normal computational period now exists for all calendar years subsequent to 1966, S does not accrue income tax assessed for the calendar years 1967 and 1968 on the last day of the second calendar year of the computational period, December 31, 1966, even though those taxes are based on the profits earned in 1965 and 1966. Instead, S accrues such tax in each calendar year for which the tax is assessed. That S accrues that tax at such time is demonstrated by an example whereby S conducted business during a full calendar year, 1966, and then liquidated that business on December 31, 1966. S did not engage in business during 1967 or 1968. S would not therefore be assessed any tax for 1967 or 1968, computed on the average of the net profits of the computational period, 1965 and 1966. Upon liquidation, S was liable for tax on any untaxed extraordinary gains arising from the realization of capital gains or the release of hidden reserves. However, this tax applies only to such extraordinary gains and hidden reserves and cannot be considered a substitute for any assessed tax on net profits that is attributable to the portions of the calendar year or years of the assessment period expiring after S is liquidated.

Because the amount of tax for 1965 is computed on the net profits of that year, S accrued a tax of $320,000 on December 31, of that year. S accrued the tax on that date since all events had then occurred to fix the fact and amount of S's liability. Though S's future tax for 1966, 1967, and 1968, would be computed, in part, on the profits of 1965, S accrued no additional tax for 1965 on account of that fact since it could not be known whether S would be engaged in business during those future years. See Columbian Carbon Co., 25 B.T.A. 456, 470-71 (1932), acq., XI-1 C.B. 2. See also Rev. Rul. 68-305, 1968-1 C.B. 213; and Rev. Rul. 71-212, 1971-1 C.B. 145. Applying the same analysis for 1966, S accrued an income tax of $280,000 for that year.

The taxpayer accrued an income tax of $280,000 for the years 1967 and 1968 and $360,000 for 1969 even though those taxes were based on profits earned in the preceding years. This is because, under the principles and precedents cited, S did not accrue those taxes until each of the assessment years.

Accordingly, the taxpayer, pursuant to section 960 of the Code, will be deemed to have paid the following amounts of foreign income taxes on or with respect to the profits taxable to the taxpayer under section 951:

                                        Tax deemed paid
             Year                         for the year
             1965                          $320,000
             1966                          $280,000
             1967                          $280,000
             1968                          $280,000
             1969                          $360,000