Internal Revenue Service
Revenue Ruling

TaxLinks.com   sm

 Rev. Rul. 79-60

1979-1 C.B. 211

Section 542
Section 543
Section 545
Section 1502

IRS Headnote

Personal holding company income; consolidated return; intra group dividends. A personal holding company, a member of an affiliated group treated as an ineligible group by reason of section 542(b)(2) of the Code, paid dividends to its parent, which was not a personal holding company, during a taxable year for which the group filed a consolidated return, and took a dividends paid deduction for the dividends in order to avoid the personal holding company tax. The dividends are included in computing the recipient corporation's separate personal holding company income. Dividends the recipient corporation subsequently paid to its personal holding company parent in the same year are excluded from the common parent's computation of separate personal holding company income and separate undistributed personal holding company income.

Full Text

Rev. Rul. 79-60

ISSUES

(1) Whether dividends paid by a member of an affiliated group to another member of the group during the taxable year for which the affiliated group files consolidated federal income tax returns are eliminated for purposes of determining the recipient's separate personal holding company income under section 543 of the Internal Revenue Code of 1954 and its separate undistributed personal holding company income under section 545.

(2) Whether the subsequent dividend paid by the recipient corporation, to its common parent corporation is eliminated for purposes of determining the common parent's separate personal holding company income under section 543 and its separate undistributed personal holding company income under section 545.

FACTS

P is a domestic corporation that owns all the outstanding stock of its subsidiary, S-1. S-1 owns all the outstanding stock of its subsidiary, S-2. P, S-1 and S-2 filed consolidated federal income tax returns for 1977.

During its 1977 taxable year, more than 50 percent in value of P's outstanding stock was owned, directly or indirectly, by four individuals. P's income from outside of the affiliated group in 1977 exceeded 10 percent of its adjusted ordinary gross income and 80 percent of this outside income is personal holding company income. S-2 was a personal holding company as defined in section 542 of the Code for its taxable year 1977. In 1977, S-2 paid to S-1 a dividend of 20x dollars. With respect to this dividend, S-2 availed itself of a dividends paid deduction under section 562(d) in order to avoid the personal holding company tax. Subsequently in 1977, S-1 (which was not a personal holding company in 1977) paid a dividend of 30x dollars to P.

By reason of section 542(b)(2) of the Code, the affiliated group of P, S-1 and S-2 is treated as an ineligible group. Therefore, P, S-1 and S-2 are required to compute their personal holding company tax on a separate basis. As a result, this affiliated group computes its liability for personal holding company tax, if any, by reference to the aggregate of the personal holding company taxes separately computed.

LAW AND ANALYSIS

The applicable sections of the Code and the Income Tax Regulations thereunder are 61 and 1.61-9(a), relating to dividends that are included in gross income; 542 and 1.542-4, relating to the definition of a personal holding company for corporations filing consolidated federal income tax returns; 543 and 1.543-1, relating to personal holding company income; and 1.1502-2 and 1.1502-14(a)(1), relating to intercompany distributions with respect to stock.

Section 542(b)(1) of the Code provides that an affiliated group of corporations filing a consolidated return shall apply the adjusted ordinary gross income requirement of section 542(a)(1) with respect to the consolidated adjusted ordinary gross income and the consolidated personal holding company income of the affiliated group.

Section 542(b)(2) of the Code provides that affiliated groups are not eligible to apply the adjusted ordinary gross income requirement on a consolidated basis if any member of the group derived 10 percent or more of its adjusted ordinary gross income from sources outside the group and 80 percent or more of the amount so derived is personal holding company income.

Section 1.1502-2 of the regulations provides that if the affiliated group is not eligible to compute its personal holding company income on a consolidated basis, the federal income tax liability of the group will be determined by adding together the tax imposed by section 541 of the Code on the separate undistributed personal holding company income of the members of the group that are personal holding companies.

Section 1.1502-14(a)(1) of the regulations provides that a dividend distributed by one member of an affiliated group to another member of the group during a consolidated return year shall be eliminated in computing the separate taxable income of a member of the affiliated group.

Rev. Rul. 71-531, 1971-2 C.B. 242, holds that if the parent of an affiliated group must determine liability for the personal holding company tax separately solely because a member of the group is a bank, which is an excluded corporation for personal holding company purposes, dividends received by the parent from the bank during a consolidated return year are eliminated for purposes of determining the parent's separate personal holding company income. Such treatment of dividends is effective while the bank remains within the exclusion of section 542(b)(3) of the Code and the bank is not required to avail itself of a dividends paid deduction under section 562(d) in order to avoid the personal holding company tax.

Rev. Rul. 74-131, 1974-1 C.B. 145, provides that the parent of an affiliated group that includes a bank subsidiary and files a consolidated return determines whether and to what extent it is liable for the personal holding company tax based on its separate personal holding company income excluding dividends received from the bank subsidiary.

In Rev. Rul. 74-432, 1974-2 C.B. 175, the dividends received by a holding company from its subsidiary, a bank, were eliminated from the holding company's personal holding company income pursuant to Rev. Rul. 71-531. Because the holding company had no source of income other than these dividends, it was not a personal holding company as defined in section 542(a) of the Code. As a result, the holding company did not have to avail itself of a dividends paid deduction under section 562(d) in order to avoid the personal holding company tax. Therefore, the dividends paid by the holding company to its parent corporation, during the consolidated year, were eliminated for purposes of determining the parent corporation's separate personal holding company income and its separate undistributed personal holding company income.

The Congressional intent that is reflected in section 542(b)(1) of the Code is that as a general rule earnings of a non-personal holding company should not be converted into personal holding company income when distributed to members of the same affiliated group. See H. R. Rep. No. 1337, 83rd Cong. 2d Sess. 55 (1954); S. Rep. No. 93-1061, 93rd Cong., 2d Sess. 4-5 (1974), 1974-2 C.B. 442, 443. The inequity which Congress sought to correct by enacting section 542(b)(1) would still exist if such dividends were to subject the parent to the personal holding company tax in the section 542(b)(2) and section 542(b)(3) situations; consequently, the policy underlying section 542(b)(1) is applicable in these situations as well. Rev. Rul. 71-531, Rev. Rul. 74-131, and Rev. Rul. 74-432 reflect the application of this policy.

However, the Congressional intent and these Revenue Rulings do not protect any dividends paid by a member of the affiliated group in order to avail itself of a dividends paid deduction under sections 561 and 562(d) of the Code. Such dividends will be taken into account in determining the personal holding company income and the undistributed personal holding company income of the recipient. If the recipient member is the subsidiary of another member of the affiliated group, the inclusion of the personal holding company's dividend into the recipient's test of personal holding company income terminates the "taint" on the amount of the sections 561 and 562(d) dividends and does not affect any dividends from the recipient member to its parent.

HOLDINGS

(1) Because S-2 availed itself of a dividends paid deduction under sections 561 and 562(d) of the Code with respect to the dividend of 20x dollars that it paid to S-1 in the taxable year in which a consolidated federal income tax return is filed by the affiliated group, such a dividend is not eliminated in determining S-1's separate personal holding company income under section 543 and its separate undistributed personal holding company income under section 545.

(2) The dividend paid by S-1 to P is eliminated for purposes of determining P's separate personal holding company income under section 543 and its separate undistributed personal holding company income under section 545 since S-1 did not avail itself of a dividends paid deduction under sections 561 and 562(d) of the Code.