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Revenue Ruling

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 Rev. Rul. 78-63

1978-1 C.B. 228

Section 901 -- Foreign Tax Credit

IRS Headnote

Foreign tax credit; Libya and Saudi Arabia. The "surtax" imposed on oil companies by Article 14(1)(a) of the Libyan Petroleum Law and the taxes imposed by Saudi Arabia under Royal Decree No. 17/2/28/3321 and Royal Decree No. 17/2/28/7634 are neither the substantial equivalent of income taxes in the United States sense as required by section 901 of the Code nor taxes in lieu of income taxes within the meaning of section 903; Rev. Ruls. 55-296 and 68-552 revoked.

Full Text

Rev. Rul. 78-63

The purpose of this Revenue Ruling is to reconsider Rev. Rul. 68-552, 1968-2 C.B. 306, and Rev. Rul. 55-296, 1955-1 C.B. 386. Rev. Rul. 68-552 held the "surtax" paid to Libya under Article 14(1)(a) of Libyan Petroleum Law No. 25 of 1955, as amended through Nov. 20, 1965, to be a creditable income tax under section 901 of the Internal Revenue Code of 1954. Rev. Rul. 55-296 held that amounts received by Saudi Arabia under Royal Decree No. 17/2/28/3321, dated November 4, 1950, and under Royal Decree No. 17/2/28/7634, dated December 27, 1950, are creditable income taxes.

Rev. Rul. 68-552

Article 1(1) of Libyan Petroleum Law No. 25 of 1955, as amended through January 1, 1975 (hereinafter "Petroleum Law") provides that all underground oil and gas in Libya is the property of the Libyan government.

Article 1(2) of the Petroleum Law provides, in part, that no person shall mine or produce petroleum unless authorized by a concession issued under that Law.

Article 14(1) of the Petroleum Law and Clause 8(1) of the Second Schedule (Standard Form Deed of Concession) to that Law, specify that an oil company or other concession holder under the Petroleum Law shall pay such income tax and other taxes and imposts as are payable under the laws of Libya.

All companies engaged in business in Libya must pay a company income tax. See Articles 1 and 93-104 of Part II of Law No. 64 of 1973, effective Oct. 1, 1973, as amended through December 1975 (hereinafter "Company Tax"). Prior to the effective date of this law such companies were subject to a company income tax substantially similar to the above law. See, Articles 1 and 89-99 of Income Tax Law No. 21 of 1968.

In addition, Article 14(1)(a) of the Petroleum Law, and Clause 8(1)(a) of the Second Schedule to the Petroleum Law, require that if the total annual amount of fees, rents, income tax, and other direct taxes except royalties equal to 16.67 percent of the value of crude oil exported, paid or payable by a petroleum concession holder to Libya, falls short of 65 percent of its profits from all its Libyan petroleum concessions, such concession holder must pay Libya such sum by way of "surtax" as will make the total of its payments equal 65 percent of its profits. Thus, this provision guarantees Libya at least a 65 percent share of each concessionaire's profits.

"Profits" are defined as the income resulting from the operations of the concession holder in Libya after deducting (1) operating expenses and overhead, (2) depreciation of all physical assets in Libya, (3) amortization for all other capital expenditures in Libya, (4) exploration and prospecting expenses, (5) intangible drilling costs, and (6) royalties not mentioned in Article 14(1)(a) of the Petroleum Law, Article 14(2), (3), and (4) of the Petroleum Law, and Clause 8(2), (3), and (4) of the Second Schedule to that Law. No deduction is allowed for interest or expenses incurred in organizing and initiating petroleum operations in Libya prior to receiving a concession from the government and for fees, rents, income tax, and other direct taxes mentioned in Article 14(1)(a).

Article 14(5)(a) and (b) of the Petroleum Law, and Clause 5(a) and (b) of the Second Schedule to that Law, further define "income resulting from the operations of the concession holder in Libya" as follows:

(a) In relation to crude oil exported by the concession holder from Libya: total gross receipts realized by the concession holder from such export, and such receipts shall not be less than the amount which results from multiplying the number of barrels of such crude oil exported by the applicable posted price per barrel of such crude oil less [certain marketing allowances as discussed below] . . . .

(b) In relation to other operations of the concession holder in Libya the income to be ascertained in a manner to be agreed between the concession holder and the Ministry of Petroleum.

The value of petroleum and natural gasoline taken as a royalty in kind under Article 13 of the Petroleum Law shall be deemed to form part of such income. [Emphasis added.]

The term "posted price" is defined as . . . the price f.o.b. Seaboard Terminal for Libyan crude oil of the gravity and quality concerned arrived at by reference to free market prices for individual commercial sales of full cargoes and in accordance with the procedures to be agreed between the concession holder and the Ministry of Petroleum or if there is no free market for commercial sales of full cargoes of Libyan Crude Oil, then posted price shall mean a fair price fixed by agreement between the concession holder and the Ministry of Petroleum. . . . [Article 14(5) of the Petroleum Law.]

Prior to 1965, Libya permitted oil companies to reduce the posted price by certain marketing discounts in computing their "surtax" under Article 14(1)(a) of the Petroleum Law. See Article 15 of Petroleum Reg. No. 6, dated December 21, 1961. The resulting net price figure was approximately equal to the actual price that an unrelated purchaser would ordinarily pay for a barrel of Libyan crude oil (hereinafter "market price"). However, in 1965, Libya began to eliminate these discounts, thereby assuring that the "surtax" would be computed on the basis of posted prices set in excess of actual market price. See, Clause 8(5)(a) of the Second Schedule to the Petroleum Law. Thereafter, Libya exercised increasing control over the level of posted prices and subsequently assumed total responsibility for fixing those prices. The posted price is an arbitrary value placed on a barrel of crude oil for the purpose of computing a foreign oil concessionaire's tax under Article 14(1)(a) of the Petroleum Law.

Except for some differences not here relevant, the "surtax" imposed by Article 14(1)(a) of Libyan Petroleum Law is essentially identical to the "surtax" imposed by Article 14(1)(a) of Libyan Petroleum Law No. 25 of 1955, as amended through Nov. 20, 1965. Some foreign oil concessionaires sell Libyan oil directly to unrelated parties at the market price even though under either version of the Petroleum Law they are required to pay the above "tax" on a base measured from the posted price. Others sell the oil to purchasing affiliates at the posted price. These affiliates then resell the oil at the market price and regularly suffer losses equal to the difference between the posted and market price.

Foreign oil concessionaires must also pay Libya a per barrel royalty currently fixed at 16.67 percent of the value of crude oil exported as determined from the posted price.

Subject to certain limitations, section 901 of the Code permits domestic corporations to claim a credit for income taxes paid or accrued to foreign countries.

Whether a payment made to a foreign government qualifies as an income tax under section 901 of the Code depends on whether it is the substantial equivalent of an "income tax" as determined from an examination of the Federal income tax laws of the United States. E.g., Biddle v. Commissioner, 302 U.S. 573, 578 (1938), 1938-1 C.B. 309, and Bank of America Nat'l T. & S. Ass'n v. United States, 459 F.2d 513, 518 (Ct. Cl. 1972), cert. denied, 409 U.S. 949 (1972).

To qualify as an income tax in the United States sense, amounts received by a foreign government must satisfy certain requirements. See generally, Rev. Rul. 78-61, page 221. Among these requirements, the amounts must constitute a tax that is paid or accrued. The tax must be based upon gain or profit realized by the taxpayer. The tax must be structured to be almost certain of falling on net gain.

An income tax in the United States sense is not one that is intentionally structured to tax artificial or fictitious income. F. W. Woolworth v. Commissioner, 54 T.C. 1233 (1970), nonacq. on another issue, 1971-2 C.B. 4. The Woolworth case considered the creditability of Schedule A of the British Income Tax Act of 1952. Under that schedule a tax was levied on the rent derived from real property. However, if the property was owner-occupied or otherwise not rented, the tax fell not on actual income but on a fictitious amount, the imputed rental value of the property. The court denied credit for the tax stating that: [t]he United States concept of "income" is based upon gain or profit realized by the taxpayer (i.e., net income as opposed to gross income, gross sales, or some other basis) . . . By no stretch of the imagination could it be said that the tax under Schedule A on the ownership of property as measured by its annual rental value, which may be an estimated figure, falls within the scope of this concept. F. W. Woolworth Co. v. Commissioner, at 1260. [Emphasis added.]

As previously stated, the income subject to the "surtax" is defined under Article 14(5) of the Libyan Petroleum Law, and Clause 5(a) of the Second Schedule to that Law, as total gross receipts with the further requirement that such receipts shall not be less than the number of barrels exported multiplied by the posted price less marketing allowances. Because the "surtax" imposed by Article 14(1)(A) of the Libyan Petroleum Law is levied on a base measured from an arbitrarily determined value (the posted price), the base on which the "surtax" is levied is artificial or fictitious. For example, when a concessionaire sells Libyan oil directly to unrelated parties at the market price, the concessionaire must pay the "surtax" on a base measured from the posted price even though the sales proceeds are less than the posted price. The Libyan "tax" base is not made any less fictitious or artificial by the fact that (1) some concessionaires actually sell the Libyan oil to their affiliates at the posted price, and (2) the affiliates then dispose of the oil at the lower market price, claiming losses equal to the difference. Although the purchasing affiliate makes a payment equal to the posted price in this situation, it does so only because it is required to do so by the persons who control both it and the concessionaire.

Gain on which the foreign tax is levied must be realized in the United States sense. Since the income subject to the "surtax" cannot be less than the number of barrels exported multiplied by the posted price less marketing allowances, the "surtax" may be triggered by the export of crude oil regardless of whether a sale has taken place. Thus, the requirement that the tax be imposed on realized income is not satisfied. See, Motland v. Commissioner, 192 F. Supp. 358, 361 (N.D. Iowa 1961), denying a credit for a Cuban tax triggered by the export of capital, and Keasbey & Mattison Co. v. Rothensies, 133 F.2d 894, 895, n. 1 and 898 (3rd Cir. 1943).

In Keasbey, the court denied a credit for the Quebec Mining Tax which was imposed on the gross value of mineral output, less allowable deductions, and which was triggered by shipment, use, or sale of that output. Gross value was computed from the ruling market prices of the minerals whether or not sold and, if sold, without regard to whether the sales proceeds were greater or lesser than the ruling market prices.

For these reasons, the "surtax" imposed by Article 14(1)(a) of the Libyan Petroleum Law is not the substantial equivalent of an income tax in the United States sense as required by section 901 of the Code. F. W. Woolworth; Motland; Keasbey.

The next question is whether the "surtax" is a tax in lieu of an income tax within the meaning of section 903 of the Code.

Section 903 of the Code provides, in part, that income taxes as used in section 901 shall include a tax paid in lieu of a tax on income otherwise generally imposed.

Section 1.903-1(a) of the Income Tax Regulations provides, in part, that the term "income tax" includes a tax imposed by statute or decree by a foreign country or by a possession of the United States if (1) such country or possession has in force a general income tax law, (2) the taxpayer claiming the credit would, in the absence of a specific provision applicable to such taxpayer, be subject to such general income tax, and (3) such general income tax is not imposed upon the taxpayer thus subject to such substituted tax.

An oil concessionaire is subject to both the Company Tax and the "surtax" with respect to the profits it derives from its operations in Libya. Thus, the "surtax" cannot qualify as a tax imposed in lieu of the Company Tax within the meaning of section 903 of the Code. See, sections 1.903-1(a)(2) and (3) of the regulations; Allstate Ins. Co. v. United States, 419 F.2d 409 (Ct. Cl. 1969); Rev. Rul. 58-3, 1958-1 C.B. 263.

Accordingly, the "surtax" imposed by Article 14(1)(a) of the Libyan Petroleum Law is neither an income tax in the United States sense nor a tax in lieu of an income tax. Therefore, it is not creditable under section 901 of the Code.

Rev. Rul. 68-552 is revoked. Pursuant to the authority contained in section 7805(b) of the Code this Revenue Ruling will be applied only to amounts paid or accrued to Libya for taxable years beginning on or after July 1, 1978, provided the taxpayer does not change the taxpayer's accounting period.

Rev. Rul. 55-296

Chapter I of Royal Decree No. 17/2/28/3321, dated November 4, 1950, as amended through September 2, 1970 (the November Decree), levies a tax at progressive rates on the combined Saudi source "personal income" and "income earned by investment of capitals," derived by individuals. Articles 1, 2, 3, 4, and 6 of the November Decree. Chapter I of the November Decree has been cancelled with respect to income earned by individuals after May 14, 1975.

Chapter II of the November Decree levies a tax at progressive rates currently set as high as 45 percent on the Saudi source "net profits" derived by all companies engaged in business in Saudi Arabia whose capital is non-Saudi (foreign companies). Article 11 of the November Decree.

In addition, under Royal Decree No. 17/2/28/7634, dated December 27, 1950, as amended through November 27, 1974 (the December Decree), foreign companies engaged in the production of oil and gas in Saudi Arabia and owned in whole or in part by non-Saudis (foreign oil companies) must also pay a so-called "additional income tax" on their "net operating income."

Articles 1 and 3 of the December Decree provide that if the total amount of duties, rents, income tax, Chapter II tax, other direct taxes, and that amount of royalties which exceeds 20 percent of the value of crude oil produced and sold for export does not equal 85 percent of an oil company's net operating income, then such company must pay Saudi Arabia "additional income tax" sufficient to make its total payments equal 85 percent of its net operating income. Thus, the December Decree assures that Saudi Arabia will receive at a minimum 85 percent of a foreign oil company's net operating income.

Except for differences not here relevant, the statutory provisions of both Chapter II of the November Decree and the December Decree are essentially identical to the statutory provisions of the December Decree, and Chapter II of the November Decree, respectively, in effect when Rev. Rul. 55-296 was issued.

No United States company engaged in producing oil and gas in Saudi Arabia computes the levies imposed, respectively, by the December Decree and by Chapter II of the November Decree exactly as provided by the above decrees. Instead, both the December Decree and Chapter II of the November Decree, as they apply to such companies, have been modified by individual agreements and understandings between each of the companies and the Saudi Government and, since 1973, by directives issued to each of the oil companies by that Government. It is understood that these agreements are not contractual agreements in the ordinary sense, but rather are imposed upon the oil companies by the Saudi Government.

Under the individual agreements and understandings discussed above, United States oil companies engaged in producing oil and gas in Saudi Arabia pay "Chapter II tax" calculated at a flat 20 percent rate. By contrast, companies engaged in other business activities in Saudi Arabia are required to pay such tax at progressive rates as high as 45 percent.

Also, a United States company engaged in producing oil and gas in Saudi Arabia is required by the above agreements and understandings to sell in Saudi Arabia all oil destined for export. Additionally, for the purposes of such sales and for the computation of "net profits" under Chapter II of the November Decree, and thus "net operating income" under the December Decree, the oil companies have been required, at least up until 1977, to use a posted price established by the Saudi Government. Posted price is a fixed price generally in excess of the actual price (market price) that an unrelated purchaser would ordinarily pay such companies for a barrel of Saudi crude oil.

Posted price is an arbitrary value placed on a barrel of crude oil which has been used for the purpose of computing a foreign oil company's "income tax" under Chapter II of the November Decree and its "additional income tax" under the December Decree, each as modified by the aforementioned agreements, understandings, and directives.

Foreign oil companies must also pay Saudi Arabia a per barrel royalty currently fixed at 20 percent of the posted price.

Neither the "income tax" nor the "additional income tax" imposed, respectively, on foreign oil companies by Chapter II of the November Decree, and by the December Decree, each as modified by the aforementioned agreements, understandings, and directives, has been imposed upon income in the United States sense. As is stated above, an income tax in the United States sense is not one that is intentionally structured to tax artificial or fictitious income. Accordingly, these Saudi "taxes" are not substantial equivalents of income taxes in the United States sense as required by section 901 of the Code.

The next question is whether amounts received by Saudi Arabia from foreign oil companies under Chapter II of the November Decree, as modified, and under the December Decree, as modified, respectively, are taxes in lieu of income taxes within the meaning of section 903 of the Code.

Saudi Arabia has no generally imposed income tax. Instead, it imposes a series of separate taxes restricted to limited classes of taxpayers. Companies wholly owned by Saudis are required to pay the Islamic religious tax known as the Zakat. Article 2 of Royal Decree No. 17/2/28/8634, dated April 24, 1951, as implemented by Royal Decree No. 17/2/28/8799, dated June 15, 1951. Only foreign companies engaged in activities in Saudi Arabia other than the production of oil and gas are required to pay the income tax imposed by Chapter II of the November Decree. Only foreign companies engaged in the production of Saudi oil and gas are required to pay the "taxes" imposed, respectively, by Chapter II of the November Decree, as modified, and the December Decree, as modified.

Since there is no generally imposed Saudi income tax in the United States sense for which the "taxes" on foreign oil companies imposed, respectively, by Chapter II of the November Decree, as modified, and the December Decree, as modified, are substitutes, such "taxes" cannot qualify as in lieu of "taxes" within the meaning of section 903 of the Code.

Accordingly, the levies imposed on oil companies by Chapter II of the November Decree, as modified, and by the December Decree, as modified, respectively, have been neither income taxes in the United States sense nor taxes in lieu of such income taxes in the United States sense.

Rev. Rul. 55-296 is revoked. However, pursuant to the authority contained in section 7805(b) of the Code, this Revenue Ruling will be applied only to amounts paid or accrued to Saudi Arabia for taxable years beginning on or after July 1, 1978, provided the taxpayer does not change the taxpayer's accounting period.

The holdings of this Revenue Ruling with respect to section 901 of the Code are limited to the questions discussed herein and no opinion is expressed as to whether the amounts received by Libya and Saudi Arabia might fail to qualify as creditable income taxes for any other reasons.

Rev. Rul. 68-552 is revoked. Rev. Rul. 55-296 is revoked.