Rev. Rul. 80-40

                       Internal Revenue Service
                                 Revenue Ruling

                  U.S. CORPORATION; VIRGIN ISLANDS INHABITANT

                          Published: February 19, 1980

SECTION 934.--LIMITATION ON REDUCTION IN INCOME TAX LIABILITY INCURRED TO THE VIRGIN ISLANDS, 26 CFR 1.934-1: Limitation on reduction in income tax liability incurred to the Virgin Islands

(Also Sections 243, 864, 881, 882, 7701; 1.243-1, 1.864-2, 1.881-1, 1.882-1, 301.7701-1.)

  U.S. corporation; Virgin Islands inhabitant. A situation is described in which a U.S. corporation that has its principal office in the Virgin Islands and qualifies for certain Virgin Islands tax incentives is treated as a Virgin Islands inhabitant so that it satisfies its U.S. income tax obligation by paying tax on its income from all sources to the Virgin Islands. The same corporation is a domestic corporation for purposes of the dividends received deduction.

ISSUES

  (1) Is a United States corporation that has its principal office in the Virgin Islands and qualifies for certain Virgin Islands tax incentives treated as a Virgin Islands inhabitant so that it satisfies its United States income tax obligation by paying tax on its income from all sources to the Virgin Islands?

  (2) Is such a United States corporation a 'domestic corporation' for purposes of the dividends received deduction of section 243 of the Internal Revenue Code?

FACTS

  P, a corporation organized in state X, is engaged in manufacturing in state X.  In order to take advantage of certain income tax incentives offered by the Virgin Islands, P organized S to carry out part of P's manufacturing operations in the Virgin Islands.  S is incorporated in state Y.

  S conducts all of its manufacturing operations in the Virgin Islands and derives 80 percent or more of each taxable year's gross income from Virgin Islands sources, and 50 percent or more of each taxable year's gross income from the active conduct of its business in the Virgin Islands.  S maintains its principal office in the Virgin Islands.  Management and control of S is in the Virgin Islands and all policy is made there.  Board of directors and shareholders' meetings are held in the Virgin Islands, and all officers and some directors of S are Virgin Islands residents. S's corporate receipts are received in the Virgin Islands and deposited in Virgin Islands bank accounts. All disbursements are made from the Virgin Islands and the corporate books and records are maintained and audited there.

LAW AND ANALYSIS--ISSUE (1)

  Section 934(a) of the Code prevents the Virgin Islands from reducing by subsidy its income tax on United States source income of a United States corporation.  However, section 934(b) provides that in the case of a domestic corporation, subsection (a) shall not apply to the extent such corporation derived its income from sources without the United States:  (1) if 80 percent or more of the gross income of such corporation for the 3-year period immediately preceding the close of the taxable year (or for such part of such period immediately preceding the close of such taxable year as may be applicable) was derived from sources within the Virgin Islands; and (2) if 50 percent or more of the gross income of such corporation for such period or such part thereof was derived from the active conduct of a trade or business within the Virgin Islands.

  Section 1.934-1(b)(3) of the Income Tax Regulations explains how to compute income tax liability incurred to the Virgin Islands and attributable to income derived from sources without the United States by a United States corporate inhabitant of the Virgin Islands.  Section 1.934-1(b)(5) explains how to make a similar computation for a United States corporation which is not an inhabitant of the Virgin Islands.  Section 934(d) of the Code provides that section 934(b) will only apply to corporations who supply the information required by section 1.934-1(d) and (e) of the regulations.

  Section 1.901-1(g)(5) of the regulations states that a United States foreign tax credit is not allowable to persons who are inhabitants of the Virgin Islands.

  Authority for income taxation in the Virgin Islands is derived from the Naval Appropriations Act, approved into the Treasury of the Virgin Islands' mirrors the income tax laws of the United States into the Virgin Islands as if the Virgin Islands legislature had adopted the Internal Revenue Code and applied it to United States persons in the same way the United States applies the Code to foreigners.

  Under the mirror system the United States and the Virgin Islands are separate and distinct taxing jurisdictions even though their income tax laws arise from an identical statute applicable to each (the Code).  See Rev. Rul. 73-315, 1973-2 C.B. 225.  Thus, the effect of this mirror system of taxation is to require all persons including United States corporations incurring income tax obligations to both the United States and the Virgin Islands under Chapter 1 of the Code (as applicable in each jurisdiction) to file tax returns and pay income tax to both jurisdictions.

  Section 28(a) of the Revised Organic Act of the Virgin Islands (R.O.A.), 48 U.S.C. section 1642 (Supp. 1979), makes substantial changes in this system as it affects 'inhabitants of the Virgin Islands.'  Section 28(a) requires inhabitants to satisfy their United States and Virgin Islands income tax obligations arising under Chapter 1 of the Code (as applicable in each jurisdiction) by filing a single return with, and paying to, the Virgin Islands the Virgin Islands territorial income tax (the Code as mirrored into the Virgin Islands) on their income from all sources.  See Rev. Rul. 60-291, 1960-2 C.B. 407.

  Section 28(a) of the R.O.A. defines 'inhabitants of the Virgin Islands' as all persons whose permanent residence is the Virgin Islands.'

  A United States corporation can qualify as an inhabitant of the Virgin Islands because (1) under section 7701(a)(1) of the Code, the term 'person' includes a corporation, and (2) in adopting section 28(a), Congress rejected an attempt to limit the definition of 'inhabitants of the Virgin Islands' to-- 'U.S. citizens' instead of 'all persons.'  See Conf. Rept. No. 2105, 83rd Cong., 2d Sess. 22 (1954).  Also, section 934 of the Code and section 1.934- 1(b)(3) of the regulations operate on the assumption that a United States corporation can qualify as an inhabitant of the Virgin Islands. See S. Rept. No. 1767, 86th Cong., 2d Sess. 3 (1960).

  In the present situation, all of the officers and some directors of S are Virgin Islands residents.  All significant business operations, shareholder meetings, and Board of Directors meetings are conducted in the Virgin Islands, and S meets the percentage tests of section 934(b) of the Code.  In addition, S is carrying on a trade or business in the Virgin Islands within the meaning of section 864(a).  This is sufficient to constitute S a permanent resident, and therefore an inhabitant, of the Virgin Islands for purposes of section 28(a) of the R.O.A.

  The United States does not tax a foreign corporation on its non-United States source income that is not effectively connected with the corporation's conduct of a trade or business within the United States.  See sections 881(a) and 882. Therefore, under an exact mirror system, non-Virgin Islands source income that is not effectively connected with a United States corporate inhabitant's conduct of a Virgin Islands trade or business would escape territorial income tax since the inhabitant is considered a foreign corporation by the Virgin Islands.  However, Congress, in section 28(a) of the R.O.A., made it clear that such income of inhabitants of the Virgin Islands would not escape taxation by using the words 'paying their tax on income derived from all sources both within and outside the Virgin Islands into the Treasure of the Virgin Islands' (emphasis added).  Thus, in effect, S is taxed as if it were a Virgin Islands corporation and satisfies both its United States and Virgin Islands income tax obligations by paying the Virgin Islands territorial income tax on its income from all sources.  If S fails to file a return or pay tax on its income from all sources to the Virgin Islands, then S does not satisfy its U.S. tax obligations.

LAW AND ANALYSIS--ISSUE (2)

  Under section 243 of the Code, a deduction is allowed for dividends received from a domestic corporation that is subject to taxation under Chapter 1 of the Code.

  As a domestic corporation, S is still subject to taxation under Chapter 1 of the Code as applicable in the United States. Section 28(a) of the R.O.A. merely requires S to satisfy this obligation by paying income tax to the Virgin Islands on S's income from all sources.  Thus dividends paid by S are not excluded from qualifying for treatment under section 243 when received by P.

HOLDINGS

  (1) S is treated as an inhabitant of the Virgin Islands and must satisfy its United States and Virgin Islands income tax obligations by paying tax on its income from all sources to the Virgin Islands.

  (2) S is a domestic corporation for purposes of the dividends received deduction of section 243 of the Code.

Rev. Rul. 80-40, 1980-1 C.B. 175, 1980-7 I.R.B. 12.