Rev. Rul. 84-72
1984-1 C.B. 182, 1984-20 I.R.B. 4.
Internal Revenue Service
Revenue Ruling
GAIN FROM SALE OF STOCK IN FOREIGN CORPORATION
Published: May 14, 1984
Section 351. - -Transfer to Corporation Controlled by Transferor, 26 CFR 1.351- 1: Transfer to corporation controlled by transferor.
Section 368. - -Definitions Relating to Corporate Reorganizations, 26 CFR 1.368- 2: Definitions of terms.
Section 958. - -Rules for Determining Stock Ownership, 26 CFR 1.958-1: Direct and indirect ownership of stock.
Section 1248. - -Gain from Certain Sales or Exchanges of Stock in Certain Foreign Corporations, 26 CFR 1.1248-1: Treatment of gain from certain sales or exchanges of stock in certain foreign corporations.
(Also Section 958; 1.958-1.)
Gain from sale of stock in foreign corporation. The earnings and profits of FS2, a foreign subsidiary of FS1, a foreign corporation, that were accumulated from 1964 to the date of FS1's sale by P, the domestic parent of FS1, are deemed to be included with all the earnings and profits of FS1 for purposes of applying section 1248(a) and (c)(2) of the Code to P's gain on the sale of FS1.
ISSUE
Under the facts described below, whether upon the sale by P, a domestic corporate parent, of FS1, a first tier foreign subsidiary, all or only part of the earnings of FS2, a second tier foreign subsidiary owned by FS1, should be included in computing the earnings and profits of FS1 for purposes of applying the ordinary income provisions of section 1248(a) of the Internal Revenue Code to P's gain on the sale of FS1.
FACTS
P, a domestic corporation, has owned directly all the stock of FS1 since its incorporation in 1964 under the laws of a foreign country. Until 1980, P had owned all the stock of FS2 since its incorporation in 1964 under the laws of a foreign country. In 1980, P transferred the stock of FS2 to FS1 for FS1 nonvoting stock in an exchange for which favorable rulings were obtained from the Commissioner pursuant to sections 367(a) and 351 of the Code. This transaction was not a reorganization as defined in section 368(a)(1)(B) of the Code. FS1 and FS2 have had earnings and profits in every year of their existence. Both FS1 and FS2 are controlled foreign corporations within the meaning of section 957(a) of the Code. In 1982, in an unrelated transaction, P sold all the FS1 stock at a gain for an amount that exceeded the earnings and profits of FS1 and FS2 accumulated from 1964 through the date of the sale of FS1.
LAW AND ANALYSIS
Section 1248(a) of the Code provides that if a United States person who meets certain ownership requirements sells or exchanges stock in a foreign corporation, the gain recognized on the sale or exchange will be included in the gross income of that person as a dividend to the extent of the earnings and profits of the foreign corporation attributable to the stock that were accumulated in taxable years of the foreign corporation beginning after December 31, 1962, and during the period or periods the stock sold or exchanged was held by the person while the foreign corporation was a controlled foreign corporation as defined in section 957.
Section 1248(c) of the Code, which provides rules for the determination of earnings and profits of the foreign corporation, states:
(1) IN GENERAL--Except as provided in section 312(k)(4), for purposes of this section, the earnings and profits of any foreign corporation for any taxable year shall be determined according to rules substantially similar to those applicable to domestic corporations, under regulations prescribed by the Secretary.
(2) EARNINGS AND PROFITS OF SUBSIDIARIES OF FOREIGN CORPORATIONS. - -If--
(A) subsection (a) or (f) applies to a sale, exchange, or distribution by a United States person of stock of a foreign corporation and, by reason of the ownership of the stock sold or exchanged, such person owned within the meaning of section 958(a)(2) stock of any other foreign corporation; and
(B) such person owned, within the meaning of section 958(a), or was considered as owning by applying the rules of ownership of section 958(b), 10 percent or more of the total combined voting power of all classes of stock entitled to vote of such other
foreign corporation at any time during the 5- year period ending on the date of the sale or exchange when such other foreign corporation was a controlled foreign corporation (as defined in section 957),
then, for purposes of this section, the earnings and profits of the foreign corporation the stock of which is sold or exchanged which are attributable to the stock sold or exchanged shall be deemed to include the earnings and profits of such other foreign corporation which--
(C) are attributable (under regulations prescribed by the Secretary) to the stock of such other foreign corporation which such person owned within the meaning of section 958(a)(2) (by reason of its ownership within the meaning of section 958(a)(1)(A) of the stock sold or exchanged) on the date of such sale or exchange (or on the date of any sale or exchange of the stock of such other foreign corporation occurring during the 5-year period ending on the date of the sale or exchange of the stock of such foreign corporation, to the extent not otherwise taken into account under this section but not in excess of the fair market value of the stock of such other foreign corporation sold or exchanged over the basis of such stock (for determining gain) in the hands of the transferor); and
(D) were accumulated in taxable years of such other corporation beginning after December 31, 1962, and during the period or periods--
(i) such other corporation was a controlled foreign corporation, and
(ii) such person owned within the meaning of section 958(a)(2) the stock of such other foreign corporation.
Section 958(a)(1) of the Code provides that, for purposes of Subpart F, stock owned means (A) stock owned directly, and (B) stock owned with the application of section 958(a)(2).
Section 958(a)(2) of the Code provides that, for purposes of section 958(a)(1)(B), stock owned, directly or indirectly, by or for a foreign corporation, foreign partnership, or foreign trust or foreign estate shall be considered as being owned proportionately by its shareholders, partners, or beneficiaries.
Section 1248 of the Code was enacted to prevent the repatriation by a shareholder, at a capital gains tax rate instead of an ordinary income tax rate, of earnings accumulated by a foreign corporation. This objective is to be accomplished, in the case of taxable liquidations and sales or exchanges of stock of a controlled foreign corporation by a U.S. person, by taking such accumulated earnings as dividends (to the extent of any gain) at the time of the liquidation, sale, or exchange by a U.S. person. S.Rep. No. 1881, 87th Cong., 2d Sess. (1962), 1962-3 C.B. 707, 813. In 1976, Congress amended section 1248 of the Code in order to ensure that repatriated earnings and profits of a controlled foreign corporation are taxed to a U.S. person on a liquidation, sale, or exchange even if certain gains otherwise would qualify for non-recognition treatment. S.Rep. No. 94-938, 94th Cong., 2d Sess. 264 (1976), 1976-3 (Vol.3) C.B. 57, 302.
The language of section 1248(c)(2)(D)(ii), when read literally, provides that only the earnings and profits of FS2 that were accumulated while FS2 was a subsidiary of FS1 should be aggregated with those of FS1 for purposes of section 1248(a). However, section 1248(c)(2) does not really address a situation in which there is a sequential mixture of direct and indirect ownership of FS2 by P. Certainly section 1248(c)(2)(D)(ii) expressly covers the period of P's indirect ownership of FS2, when FS2 was a subsidiary of FS1. But the omission of any prior periods of P's direct ownership of FS2 from the express language of the section 1248(c)(2)(D)(ii) coverage is not dispositive of the present issue.
To fail to aggregate all the earnings and profits of FS2 (from 1964 through 1982) with those of FS1 in this case is clearly unwarranted. There is nothing about the pre-1980 earnings and profits of FS2 that suggests they should be differentiated (for section 1248(a) purposes) from the post-1979 earnings and profits of FS2 except for the nature of P's ownership interest, and that distinction between direct and indirect ownership has no relevance to the purpose of Congress in enacting section 1248. If the pre-1980 earnings and profits of FS2 has been accumulated while it was a wholly-owned subsidiary of FS3, which in turn was wholly-owned by P, and FS2 had then been transferred to FS1 in 1980, as in this case, there would be no question that all of FS2's earnings and profits would be aggregated with those of FS1 upon the sale of FS1 for purposes of section 1248. That result is clear because all of FS2's earnings and profits would have been accumulated while P had an indirect ownership interest in FS2 (either through FS3 or FS1) within the scope of section 1248(c)(2)(D)(ii). To reach a contrary conclusion here simply because there was no intermediary corporation between P and FS2 during the pre-1980 taxable years when P owned FS2 directly is unwarranted and inconsistent with the Congressional purpose in enacting section 1248.
Likewise, if FS2 had been sold by P prior to 1980 (that is, before FS2 was transferred to FS1), all of FS2's accumulated earnings and profits would have been included for purposes of section 1248(a). Because the sale of FS1 necessarily involves the sale of its subsidiary, FS2, the earnings and profits considered under section 1248(a) for purposes of the FS1 sale must now include those of FS2 that were derived during P's direct and indirect ownership of FS2. That is, to give proper effect to section 1248(a) and (c)(2), all the earnings and profits of FS2 from 1964 through the date of the sale of FS1 must be taken into account on P's sale of FS1 without regard to the intervening transfer of FS2 to FS1 in 1980.
HOLDING
The earnings and profits of FS2 that were accumulated from 1964 to the ate of P's sale of FS1 are deemed to be included with all the earnings and profits of FS1 for purposes of the application of section 1248(a) and (c)(2) of the Code to P's gain on the sale of FS1.
Rev. Rul. 84-72, 1984-1 C.B. 182, 1984-20 I.R.B. 4.