Rev. Rul. 83-80

1983-1 C.B. 130.

                       Internal Revenue Service
                                 Revenue Ruling

             ADJUSTMENT OF EARNINGS AND PROFITS;  CLAIM FOR REFUND

                            Published: May 23, 1983

SECTION 905. - -APPLICABLE RULES, 26 CFR 1.905-3: Redetermination of tax when credit proves incorrect

(Also Sections 6501, 6511; 301.6501(a)-1, 301.6511(d)-3.)

  Adjustment of earnings and profits;  claim for refund.  The earnings and profits of a foreign subsidiary corporation may be adjusted by the Service to reduce or offset the amount of a claim for refund made by the corporation's domestic parent under the 10-year statute of limitations in section 6511(d)(3)(A) of the Code even though the parent corporation's normal 3-year statute of limitations under section 6501(a) has expired.  Rev. Rul. 72-525 clarified.

ISSUE

  Under the circumstances described below, may the earnings and profits of a foreign subsidiary corporation be adjusted in connection with a claim for a United States income tax refund by the corporation's domestic parent after the normal 3-year period of limitations provided by section 6501(a) of the Internal Revenue Code has expired but within the 10-year period of limitations provided by section 6511(d)(3)(A)?

FACTS

  X, a United States corporation, owns all of the stock of S, a Country A foreign corporation.  Both X and § are accrual basis taxpayers and have as their taxable year the calendar year.  In 1975, § paid a dividend to X out of earnings and profits that were taxed under the Country A income tax law (a creditable income tax under section 901 of the Code).  On its 1975 United States income tax return, X claimed a section 901 foreign tax credit based on calculations it had made under section 902.  In 1980, S's 1975 taxable year was audited by Country A and certain claimed deductions were disallowed because Country A authorities determined that the expenditures for which the deductions had been claimed were capital in nature rather than deductible expenses. Accordingly, § was assessed additional Country A income tax in 1980 after pursuing and exhausting all effective and practical remedies with respect to the foreign audit adjustments.  In 1980 (after the expiration of the normal 3- year period of limitations on assessment provided by section 6501(a) of the Code, but within the 10-year limitations period for claims for refund of foreign taxes in section 6511(d)(3)(A)), X filed a claim for a United States income tax refund for 1975, alleging that additional foreign taxes had accrued with respect to the 1975 dividend paid by S.  In processing this claim, the Internal Revenue Service increased S's 1975 earnings and profits (thereby increasing S's accumulated profits under section 902) because the Service determined that, under United States standards, the deductions disallowed by Country A were capital expenditures. The earnings and profits (and the accumulated profits) adjustment had the effect of decreasing the United States refund claimed by X.

LAW AND ANALYSIS

  Section 6501(a) of the Code provides in general that the amount of any tax imposed by the Code must be assessed within 3 years after the taxpayer's return is filed.

  Section 6501(c)(5) of the Code provides that the special rules of section 905(c) are applicable when the adjustment of certain taxes allowed as a credit against income taxes results in additional tax.

  Under section 905(c) of the Code, the taxpayer must notify the Secretary, who must redetermine the amount of the tax for the year or years affected, (1) if accrued foreign taxes when paid differ from the amounts claimed as credits by the taxpayer, or (2) if the taxes have been partially or fully refunded to the taxpayer.  If any tax is due upon redetermination, the taxpayer must pay the amount upon notice and demand.  If the Secretary determines that an overpayment exists, the amount must be credited or refunded to the taxpayer in accordance with subchapter B of chapter 66 of the Code (section 6511 and following).

  Section 6511(a) of the Code provides that a taxpayer must file a claim for credit or refund of an overpayment of any tax for which a return is required within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever is later.  If the taxpayer did not file a return, the claim must be filed within 2 years from the time the tax was paid.

  Under section 6511(d)(3)(A) of the Code, the taxpayer may file a claim for credit or refund within 10 years from the last date prescribed for filing the return for the year with respect to which the claim is made when the claim relates to an overpayment of income tax attributable to foreign taxes that are creditable under section 901 or under a treaty.  The 10-year period is in place of the 3-year period prescribed in section 6511(a).

  In Pacific Metals Corp. v. Commissioner, 1 T.C. 1028 (1943), the Tax Court held that the predecessor of section 905(c) of the Code indefinitely postponed the period of limitations on assessment during the time that the taxpayer had not ascertained the correct amount of the foreign tax owed and had not informed the Service of the correct amount.  See also Rev. Rul. 71-454, 1971-2 C.B. 294.

  In Texas Co. (Caribbean) Ltd. v. Commissioner, 12 T.C. 925 (1949), acq., 1949-2 C.B. 3, the Tax Court noted that public policy generally requires a fixed period of limitations on assessment of tax and held that the Service's power to recompute tax liability under the predecessor of section 905(c) of the Code should be limited to the two general situations covered by the statute: (1) when the amount of foreign tax paid differs from the amount claimed as a credit, and (2) when the taxpayer receives a refund of foreign tax that the taxpayer previously claimed as a credit.  Thus, the Service may assess an additional United States income tax liability after the expiration of the normal 3-year period of limitations in section 6501(a) with respect to substantive foreign tax adjustments, but not with respect to computational errors associated with the taxpayer's United States income tax return.

  In Rev. Rul. 72-525, 1972-2 C.B. 443, a domestic parent corporation had claimed a credit on its 1964 return under sections 901 and 902 of the Code for foreign income taxes deemed paid by it with respect to its foreign subsidiary. In ascertaining the correct amount of the credit, the taxpayer made a computational error that went unchallenged by the Service throughout the normal period of limitations on assessment.  In 1971, after the normal period of limitations under section 6501(a) had expired, the subsidiary received a refund of a portion of the foreign income taxes it had paid in 1964.  This foreign tax refund resulted from a loss carryback to 1964.

  In discussing the holding in Texas Co. (Caribbean), Rev. Rul. 72-525, at page 444, states:

    Thus, additional assessments permitted under section 905(c) of the Code are limited to adjustments of foreign tax credits caused by factors which are not ascertainable either at the time of the computation of the credit originally claimed or within the period of limitations provided by section 6501(a) of the Code.

Thus, Rev. Rul. 72-525 holds, in part, that the Service was prohibited in 1971 from assessing additional United States income taxes as the result of the computational error by a domestic parent corporation on its 1964 return, although the Service was allowed to assess additional United States income taxes as the result of the foreign tax refund.

  Rev. Rul. 72-525 indicates that the Service's statutory power to assess additional tax under section 905(c) of the Code after the normal period of limitations in section 6501(a) has expired is generally inapplicable in the case of mere computational errors made on a United States income tax return. Thus, even though the correct amount of foreign tax deemed paid by the domestic parent under sections 901 and 902 was different from the amount claimed as a credit on the domestic parent's United States income tax return for 1964, section 905(c) could not be used to assess additional United States income taxes based upon the computational error.  This should not be construed, however, as applying to adjustments by a foreign country in the amount of foreign taxes paid or accrued by the foreign subsidiary of a domestic corporation.

  Thus, where a taxpayer notifies the Service within or after the 3-year period set forth in section 6501(a) of the Code of a foreign tax adjustment resulting in a refund of foreign taxes for a particular year, section 905(c) would nevertheless permit the Service to assess additional United States income tax based upon the substantive foreign tax adjustment.

  In the present case, the domestic parent is claiming a United States income tax refund under section 6511(d)(3)(A) of the Code based on the increased foreign tax payment by its foreign subsidiary.  The application of section 905(c) is not the same in the case of claims for refund as it is in the case of additional assessments. Rev. Rul. 71-454, 1971-2 C.B. 294, explains the difference as follows:

    Section 905(c) of the Code provides in effect that there is no statute of limitations for the redetermination of the amount of Federal income taxes due upon adjustment of foreign income taxes by foreign tax authorities if the taxpayer overpaid the foreign tax and as a consequence received a refund, but there is a 10-year period of limitations for such redetermination if the taxpayer has underpaid the foreign tax and desires to increase the amount of the foreign tax credit.

See also Rev. Rul. 68-150, 1968-1 C.B. 564, and Rev. Rul. 77-54, 1977-1 C.B. 400.  In substance, the Service's use of section 905(c) of the Code to determine the correct amount of a United States income tax refund as a result of a foreign tax adjustment is limited only by the taxpayer's 10-year period of limitations under section 6511(d)(3)(A).

  Thus, the Service may redetermine a taxpayer's United States income tax liability for purposes of a refund claim under section 6511(d)(3)(A) of the Code, by making whatever adjustments are necessary, including an adjustment to earnings and profits, to determine the proper amount of the foreign tax credit available to a taxpayer.

HOLDING

  The earnings and profits of the foreign subsidiary may be adjusted in connection with a claim for refund filed by the subsidiary's domestic parent after the 3-year period of limitations provided by section 6501(a) of the Code has expired, but within the 10-year period provided by section 6511(d)(3)(A).

  Further, this adjustment to the earnings and profits of the foreign subsidiary can also be made under the offset doctrine of Lewis v. Reynolds, 284 U.S. 281, XI C.B. 130 (1932).  In that case the U.S. Supreme Court held that although the United States was barred by the statute of limitations from assessing and collecting additional taxes, this did not preclude the United States from offsetting or reducing a claimed tax refund by retaining payments already received when they do not exceed the amount which might have been properly assessed and demanded.  Thus, the taxpayer is not entitled to a refund unless the taxpayer has actually overpaid the tax.

EFFECT ON OTHER REVENUE RULINGS

  Rev. Rul. 72-525 is clarified.

Rev. Rul. 83-80, 1983-1 C.B. 130.