Rev. Rul. 87-14

1987-1 C.B. 181, 1987-6 I.R.B. 14.

REDUCTION OF EARNINGS AND PROFITS; TAX DEEMED PAID

Published: February 9, 1987

Section 902.-Credit for Corporate Stockholder In Foreign Corporation, 26 CFR 1.9002-1(e): Determination of accumulated profits of foreign corporation

(Also Section 964; 1.964-1.)

  Reduction of earnings and profits; tax deemed paid. Accumulated profits of a foreign corporation are not reduced to the amount of earnings and profits attributable to the interests of U.S shareholders upon which the foreign income tax is actually imposed.

ISSUE

  For purposes of computing the foreign income taxes deemed paid by a domestic corporation pursuant to section 902 of the Internal Revenue Code, do the accumulated profits of a foreign corporation include only the amount of accumulated profits attributable to the interests held by U.S. shareholders, in situations in which only profits of the foreign corporation attributable to the interests of non-local shareholders are subject to foreign income tax?

FACTS

  X is a domestic corporation which owns 50 percent of the voting stock of FS, a foreign corporation incorporated under the laws of Saudi Arabia. The remaining 50 percent of the FS voting stock is owned by Saudi nationals. X and FS both have a calendar taxable year.

  FS is engaged in business in Saudi Arabia and, for the 1986 taxable year, has pre-tax earnings and profits of 200x as computed under U.S. tax rules after reduction for any taxes which are the legal liability of FS, but are not income taxes under section 901 or 903. FS paid a current dividend of 55x to X after the first 60 days of 1986.

  In situations in which a Saudi corporation is owned by Saudi and non-Saudi interests, Saudi law imposes an income tax on Saudi corporations of 45 percent of the earnings and profits of such corporation attributable to the ownership interests of non-Saudi shareholders. Saudi Arabia Royal Decree No. 17/2/28/3321 (1950), as amended. The tax is paid by the Saudi Corporation and it is assumed that the income tax is a creditable tax for foreign tax credit purposes.

  The bylaws of FS provide that its non-Saudi shareholders will bear the cost of the Saudi income tax liability of FS. Thus, the Saudi income tax reduce the amount of earnings and profits of FS available for distribution to X, but does not reduce the amount of earnings and profits of FS available for distribution to the Saudi shareholders.

LAW AND ANALYSIS

  Section 901 of the Code provides, in general, for a direct credit for creditable income taxes paid by a domestic corporation to a foreign country. The person entitled to the credit under section 901 is the person who bears legal liability under foreign law for the tax. Section 1.902-2(f)(1) of the Income Tax Regulations; Biddle v. Commissioner, 302 U.S. 573 (1938). Although the economic burden of the Saudi income tax is passed on to X in the form of reduced earnings available for distribution to X, the Saudi income tax is the legal liability of FS. Accordingly, X may not claim a credit for the Saudi income tax under section 901. However, X may claim a credit for foreign taxes deemed paid to Saudi Arabia under section 902.

  Under section 902(a)(1) of the Code, a domestic corporation which owns at least 10 percent of the voting stock of a foreign corporation from which it receives dividends shall be deemed to have paid the same proportion of foreign income taxes imposed upon the foreign corporation for a particular taxable year, which the amount of such dividends (determined without regard to section 78) paid from earnings and profits for that taxable year bears to the amount of accumulated profits in excess of foreign income taxes for that taxable year. Expressed in algebraic terms, the credit for taxes deemed paid by a domestic corporate shareholder of a foreign corporation pursuant to section 902 is determined as follows:

Foreign taxes     Foreign taxes       Dividend received by the
deemed paid    =  imposed for the  x  domestic corporation from
                  taxable year        earnings and profits for the taxable year
                                      -----------------------------------------
                                      Accumulated profits of the foreign
                                      corporation less foreign taxes
                                      imposed for the taxable year

  Accumulated profits for purposes of section 902 of the Code means all of a foreign corporation's earnings and profits for the taxable year plus the foreign taxes imposed on such earnings and profits. Section 902(c) and section 1.902-1(e) of the regulations. Earnings and profits for this purpose are computed under U.S. tax rules. Section 1.902-1(g) and section 1.964-1(f)(1). There is nothing in either the Code or regulations limiting the calculation of earnings and profits to the earnings and profits attributable to the interests of U.S. shareholders. See section 1.902-1(e).

  The Saudi income tax deemed to have been paid by X (rounded to the nearest whole number) with respect to the dividend received by it during the taxable year is 16x computed as follows:

FC income tax      FC tax (45x)     Dividend (55x)
deemed paid by  =                x  Accumulated profits (200x) less
X(16x)                              taxes (45x)
HOLDING

  Accordingly, the accumulated profits of FS are not reduced to the amount of earnings and profits attributable to the interests of U.S. shareholders upon which the foreign income tax is actually imposed.

Rev. Rul. 87-14, 1987-1 C.B. 181, 1987-6 I.R.B. 14