Rev. Rul. 56-658

Advice has been requested whether certain Cuban taxes, as set forth below, which were paid by a Cuban sugar company may be claimed as a foreign tax credit for Federal income tax purposes by a company and its subsidiary incorporated under the laws of the United States which own the entire voting stock of the Cuban company.

The Cuban taxes considered for credit are:

(1) MUNICIPAL TAXES.--Decree No. 568 of May 19, 1908 (Organic Municipal Law), Article 216 thereof providing, inter alia, for a tax on the net income (renta liquide) of rural property which will not exceed eight percent in the case of farms grinding sugar from cane grown on their own lands and two percent where mill owners grind cane grown by others. In addition, a surcharge of 15 percent of the amount of the foregoing tax (eight percent or two percent rate) is imposed by Law No. 11 of December 4, 1942.

(2) PROVINCIAL TAXES.--Organic Law of the Provinces, Article 63 thereof providing for a surcharge of 15 percent on the net income, as above computed. Law No. 11 of December 4, 1942, imposes a further surcharge of 15 percent on this provincial tax.

(3) NATIONAL TAX.--A tax of two percent imposed by the Law of July 15, 1925, on net income, Article XVIII thereof, providing that the tax was not applicable to rural properties that did not produce any income. The National tax was increased to four percent by Law No. 7 of April 5, 1943.

(4) SO-CALLED "BAG-TAX".--A tax at a flat rate of ten cents per bag of sugar is imposed by the Laws of July 31, 1917, and July 1, 1920.

In order for a tax paid to a foreign country to be allowable as a credit against United States income tax under section 901 of the Internal Revenue Code of 1954, it must be shown that the tax imposed by the foreign law is a tax on income within the United States concept thereof, or is a tax paid in lieu of an income tax under section 903.

Article 39 of the Municipal Tax Law, which embodies the provisions for the collection of the taxes imposed by the Organic Municipal Law, item (1) above, establishes the manner of determining the net income of a sugar mill. Where the mill owner buys sugar cane from farmers and produces raw sugar therefrom, the amount of the net income of the Cuban sugar mill is determined by an empirical formula which starts by finding the amount of sugar produced from the cane ground by the mill. The farmer who delivers his cane to the mill to be ground receives as his price for such cane approximately one-half of the sugar yielded therefrom or generally the equivalent cash payment, based on the average price of sugar for the last three years. The farmer's net income for the purpose of the municipal tax is determined by deducting from this amount 35 percent representing costs of cultivation, and this net income is taxable at the rate of 6 percent. The remaining one-half of the sugar, converted into dollars on the same basis as the farmer's share, represents the gross income of the mill. From this amount is deducted 60 percent, representing the cost of processing the cane. The net income thus arrived at is subject to the municipal tax of two percent, and also the municipal and provincial surcharges and the national tax.

The Cuban taxes outlined above are intended, in the case of sugar mills, to be imposed only if sugar is manufactured and then only on the "net income" derived therefrom as determined under Cuban law. The fact that under Cuban law the taxable income is determined in a manner different from that under the Internal Revenue Code does not change the nature of the Cuban taxes.

The taxes imposed by Cuba by reason of extraordinary war profits of ten cents per bag of sugar were imposed by a Law of July 31, 1917, on sugar producers; that is, an ordinary tax of ten cents per bag, and an extraordinary tax, consisting of the ordinary tax of 10 cents and an additional tax of 10 cents per bag, imposed when sugar was quoted and sold in Havana at three cents per pound or over. The Law of July 1, 1920, continued the ordinary tax of ten cents per bag and raised the extraordinary tax to 30 cents, payable when the price of raw sugar in Cuba reached six cents or more a pound. The Law of July 31, 1917, had also specifically extended to sugar companies the eight percent national profits tax of Military Order 463, from which they had previously been exempted. Article II of this Law also provided that such taxpayers could deduct this bag tax and export taxes in computing taxable net profit, which thus reduces the national profits tax.

Section 903 of the Internal Revenue Code of 1954 (formerly section 131(h) of the 1939 Code) provides in part:

* * * the term "income, war-profits, and excess-profits taxes" shall include a tax paid in lieu of a tax on income, war profits, or excess-profits otherwise generally imposed by any foreign country or by any possession of the United States.

Section 39.131(h)-1(b) of Regulations 118, applicable to the 1954 Code by T. D. 6091, C. B. 1954-2, 47, provides in part:

* * * the term "income, war-profits, and excess-profits taxes" includes a tax imposed * * * by a foreign country * * * if (1) such country or possession has in force a general income tax law, (2) the taxpayer claiming the credit would, in the absence of a specific provision applicable to such taxpayer, be subject to such general income tax, and (3) such general income tax is not imposed upon the taxpayer thus subject to such substituted tax. * * *

In view of the above, it is held that the Cuban taxes imposed under the provisions of the Organic Municipal Law, the Municipal Tax Law, the Organic Law of the Provinces, and the Law of July 15, 1925, as amended by Law No. 7 of April 5, 1943, constitute income taxes for which a credit is allowable under sections 901 and 902 of the 1954 Code. It is further held that since Cuba imposes the general profits tax as well as the bag taxes the bag taxes cannot be considered an income tax or tax in lieu of an income, war-profits, or excess profits tax and, consequently, no credit is allowable under sections 901 or 902 of the Code. See O. D. 372, C. B. 2, 115 (1920), wherein it is held that a domestic corporation may deduct from gross income in its return to the United States Government the amount of the bag tax paid to the Cuban Government but may not claim the amount as a credit against the total tax due to the United States.