Rev. Rul. 87-75

1987-2 C.B. 152, 1987-32 I.R.B. 15.

PERSONAL HOLDING COMPANIES; AFFILIATED GROUPS

Published: August 10, 1987

SECTION 542. - DEFINITION OF PERSONAL HOLDING COMPANY, 26 CFR 1.542-4: Corporations filing consolidated returns.

(Also Section 1504; 1.1504-1.)

  Personal holding companies; affiliated groups. In deciding whether an affiliated group of corporations may determine its status as a personal holding company on a consolidated basis under section 542(b)(1) of the Code, the dividend exclusion provisions of section 542(b)(4) apply only to dividends received by the common parent corporation from another corporation of which the common parent owns more than 50 percent of the outstanding stock, but which is not a member of the affiliated group and is not a personal holding company.

ISSUE

  This ruling addresses two issues in connection with the determination of whether an affiliated group of corporations filing a consolidated return may determine its status as a personal holding company on a consolidated basis under section 542(b)(1) of the Internal Revenue Code. First, does the dividend exclusion provision of section 542(b)(4) apply to dividends from all corporations (other than a personal holding company) of which the common parent owns more than 50 percent of the outstanding voting stock? Second, does section 542(b)(4) apply to otherwise excludible dividends received by affiliated corporations other than the parent corporation?

FACTS

  In January 1987, corporation P acquired 100 percent of the voting stock and value of the stock of corporation S1. S1 owns 60 percent of the outstanding voting stock of corporation Y. Following P's acquisition of S1, S1 acquired 100 percent of the voting stock and value of the stock of corporation S2. Both S1 and S2 own shares of stock in other corporations, but none of these ownership interests constitutes more than 50 percent of the outstanding voting stock of the corporations involved. P also owns 60 percent of the outstanding voting stock of corporation X, which is not a personal holding company, and less than 50 percent ownership of the outstanding voting stock of several other corporations. All of the corporations are domestic corporations.

  At the time of the above transactions and throughout all of 1987, all of P's capital stock was owned by three individuals. P's income for 1987 consisted solely of dividends received from all its stock holdings. S1 and S2 are actively engaged in the conduct of a trade or business that does not generate personal holding company income.

  During 1987, P, S1, and S2 received dividends on all of the shares of stock that they own. Those dividends and income received by S1 and S2 from their normal operations were the only income received by members of the group during 1987. The following table shows a partial income statement for the members of the consolidated group:

Corporation                   P     S1    S2
Dividend from S1             $ 95     -     -
Dividend from S2                -  $ 95     -
Dividend from X                50     -     -
Dividend from Y                 -    50     -
Dividend from less-than-50%
owned corporations              5     5  $  5
Operating income                -    10    95
Gross income                 $150  $160  $100

  Prior to 1987, P, S1, and S2 had always filed separate federal income tax returns. P, S1, and S2 elected to file a consolidated return for 1987.

LAW AND ANALYSIS

  Section 1504(a)(1) of the Code defines an affiliated group as one or more chains of includible corporations connected through stock ownership with a common parent corporation that is an includible corporation if (i) the common parent owns directly stock meeting the requirements of section 1504(a)(2) in at least one of the other includible corporations, and (ii) stock meeting the requirements of section 1504(a)(2) in each of the includible corporations (except the common parent) is owned directly by one or more of the other includible corporations.

  Section 1504(a)(2) of the Code provides that the ownership of stock of any corporation meets the requirements of section 1504(a)(2) if it (A) possesses at least 80 percent of the total voting power of the stock of such corporation and (B) has a value equal to at least 80 percent of the total value of the stock of such corporation.

  Section 541 of the Code imposes a tax equal to 28 percent (38.5 percent in the case of tax years beginning in 1987) of the undistributed personal holding company income (as defined in section 545) of every personal holding company (as defined in section 542).

  Section 542(a) of the Code defines the term 'personal holding company' as any corporation (other than a corporation described in section 542(c)) which meets certain stock ownership requirements and of which at least 60 percent of the adjusted ordinary gross income (as defined in section 543(b)(2)) for the tax year is personal holding company income (as defined in section 543(a)).

  Section 543(a)(1) of the Code provides that the term 'personal holding company income' includes the portion of the adjusted ordinary gross income that consists of dividends.

  Section 542(b)(1) of the Code provides that, in the case of an affiliated group of corporations filing a consolidated return, the adjusted ordinary gross income requirement of section 542(a)(1) shall generally be applied 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 section 542(b)(1) shall not apply to an affiliated group of corporations if:

    (A) any member of the affiliated group of corporations (including the common parent corporation) derived 10 percent or more of its adjusted ordinary gross income for the tax year from sources outside the affiliated group, and

    (B) 80 percent or more of the amount described in section 542(b)(2)(A) consists of personal holding company income (as defined in section 543).

  Thus, if section 542(b)(2) rather than section 542(b)(1) applies, the adjusted ordinary gross income requirement of section 542(a)(1) is applied separately to each member of the affiliated group. An affiliated group to which section 542(b)(2) applies is referred to as an 'ineligible affiliated group.'

  Section 542(b)(4) of the Code provides that, in applying sections 542(b)(2)(A) and (B), personal holding company income and adjusted ordinary gross income shall not include dividends received by a common parent corporation from another corporation if the common parent corporation owns, directly or indirectly, more than 50 percent of the outstanding voting stock of that other corporation and the other corporation is not a personal holding company is not a personal holding company for the tax year in which the dividends are paid.

  Section 1.542-4(b)(1) of the Income Tax Regulations provides that for purposes of the 10 percent test of section 542(b)(2)(A) of the Code, intercorporate dividends received by members of the affiliated group (including the common parent) are to be included in the gross income from all sources.

  Section 1.542-4(d)(1) of the regulations provides that, for purposes of section 542(b)(2), gross income of a common parent corporation shall not include dividends received from a corporation that is not a member of the affiliated group if the conditions of section 542(b)(4) are met with respect to the dividend paying corporation.

  In the present situation, P, S1, and S2 constitute an affiliated group of corporations. See section 1504(a) of the Code. X and Y are not part of the group because less than 80 percent of their stock is owned by members of the affiliated group.

  In general, in the case of an affiliated group of corporations filing a consolidated return, the adjusted ordinary gross income test of section 542(a)(1) of the Code for determining a corporation's potential status as a personal holding company is to be applied on a consolidated basis, rather than to each corporation separately. See section 542(b)(1). However, section 542(b)(2) provides an exception in that consolidated treatment is denied to an affiliated group if any member of the affiliated group derived 10 percent or more of its adjusted ordinary gross income for the tax year from sources outside the affiliated group and if 80 percent or more of such income from sources outside the affiliated group consists of personal holding company income.

  The exception to consolidated treatment contained in section 542(b)(2) of the Code is itself qualified by section 542(b)(4), which provides that, in applying the tests of section 542(b)(2), dividends received by a common parent corporation are not included in computing adjusted ordinary gross income and personal holding company income if the common parent owns 50 percent or more of the outstanding voting stock of the corporation paying the dividends and if the other corporation is not a personal holding company. The first issue addressed in this revenue ruling is whether the provisions of section 542(b)(4) apply to all dividend paying corporations of which the common parent corporation owns 50 percent or more of the outstanding voting stock (including subsidiaries that are members of the affiliated group) or whether the provisions apply only to non-affiliated, but majority-owned, dividend paying corporations (that is, corporations that are more than 50 percent owned, but either less than 80 percent owned or excepted from the definition of includible corporation in section 1504(b)). Consistent with the legislative history, the regulations under section 542 provide that only dividends received from corporations not members of the affiliated group are excluded in applying the test of section 542(b)(2). See sections 1.542-4(b)(1) and 1.542-4(d)(1) of the regulations; see also Senate Committee on Finance, Summary of Finance Committee Amendments to H.R. 8300, 83d Cong., 2d Sess., 27 (1954).

  In the present situation, P had $100 of adjusted ordinary gross income for purposes of section 542(b)(2) of the code. Under section 542(b)(4), section 1.542-4(b)(1) of the regulations, and section 1.542-4(d)(1), the $50 dividend received by P from x is not included in the section 542(b)(2) computation. This $100 consisted of $95 from S1 and $5 from a less-than-50 percent-owned corporation. Thus, only 5 percent ($5) of the $100 was from sources outside the affiliated group. The dividend received by P from § is not eliminated. Thus, consolidated treatment is not denied as a result of the income received by P for the tax year.

  The second issue addressed in this revenue ruling is whether section 542(b)(4) of the Code excludes dividends received from controlled but non- affiliated corporations by lower-tier members of the affiliated group. Section 542(b)(4) and section 1.542-4(d)(1) of the regulations exclude dividends received from certain subsidiaries only in the case of dividends received by the common parent corporation of an affiliated group. In the case of lower-tier members of the affiliated group, all dividend income received from corporations outside the affiliated group is included in computing the gross income and personal holding income of such lower-tier members.

  Thus, in the present situation S1 had $160 of adjusted ordinary gross income. This $160 consisted of $10 from operating income, $95 dividend income from S2, $50 dividend income from Y and $5 dividend income from a less-than-50 percent- owned corporation. Approximately 35 percent ($55) of the $160 was from sources outside the affiliated group. The $55 consisted of $50 dividend income from Y and $5 dividend income from a less-than-50 percent-owned corporation. Approximately 35 percent ($55) of the $160 was from sources outside the affiliated group. The $55 consisted of $50 dividend income from Y and $5 dividend income from a less-than-50 percent-owned corporation. Because more than 10 percent of S1's adjusted ordinary gross income is from outside the affiliated group and all of that income is personal holding company income under section 543(a)(1), the affiliated group of which P is the common parent is an 'ineligible affiliated group' under section 542(b)(2).

HOLDING

  For purposes of determining whether an affiliated group of corporations may determine its status as a personal holding company on consolidated basis under section 542(b)(1) of the Code, the dividend exclusion provisions of section 542(b)(4) apply only to dividends received by the common parent corporation from another corporation of which the common parent owns more than 50 percent of the outstanding voting stock but which is not a member of the affiliated group and is not a personal holding company.

Rev. Rul. 87-75, 1987-2 C.B. 152, 1987-32 I.R.B. 15