Rev. Rul. 58-618

Advice has been requested with respect to the method of computing the limitation on foreign tax credits of an affiliated group of corporations filing a consolidated income tax return, where some members of the affiliated group are Western Hemisphere trade corporations having profits, while some others are Western Hemisphere trade corporations sustaining operating losses.

An affiliated group of corporations filed a consolidated income tax return for the calendar year 1955. The affiliated group includes a number of member companies qualifying as Western Hemisphere trade corporations. One of such companies is engaged in marketing operations in two Central American republics which impose income taxes, and another such company operates in a South American republic which also imposes an income tax. These companies reported net income for the calendar year 1955. The remaining members of the group qualifying as Western Hemisphere trade corporations sustained net losses for 1955.

Section 1.1502-31(a)(1) of the Income Tax Regulations provides that the consolidated taxable income of an affiliated group of corporations shall be the combined taxable income of the several affiliated corporations, minus, among other items, the sum of any consolidated section 922 deduction.

Section 1.1502-31(a)(15) of the regulations provides as follows:

(15) Consolidated Section 922 Deduction .-The consolidated section 922 deduction, relating to Western Hemisphere trade corporations, shall be that portion of the consolidated taxable income attributable to those members of the affiliated group which are Western Hemisphere trade corporations (computed without regard to the consolidated section 922 deduction) multiplied by the fraction specified in section 922(2).

Section 922 of the Internal Revenue Code of 1954 provides as returns due to be filed after the date

In the case of a Western Hemisphere trade corporation there shall be allowed as a deduction in computing taxable income an amount computed as follows-

(1) First determine the taxable income of such corporation computed without regard to this section.

(2) Then multiply the amount determined under paragraph (1) by the fraction-

(A) the numerator of which is 14 percent, and

(B) the denominator of which is that percentage which equals the sum of the normal tax rate and the surtax rate for the taxable year prescribed by section 11.

Section 1.1502-43 of the regulations provides that the credit allowed to an affiliated group of corporations for taxes paid or accrued, and for such taxes deemed to have been paid, during the consolidated return period to any foreign country or to any possession of the United States shall be computed and allowed as if the affiliated group were the taxpayer and as if the aggregate taxes paid or deemed to have been paid by the several members of the group and the credits allowed with respect to such payments were payments made and deemed to have been made by, and credits allowed to, the group.

Section 904(a) of the Code provides that the amount of the credit in respect of the tax paid or accrued to any country shall not exceed the same proportion of the tax against which such credit is taken which the taxpayer's taxable income from sources within such country (but not in excess of the taxpayer's entire taxable income) bears to his entire taxable income for the same taxable year. Taxable income from a foreign country and the entire taxable income for the purpose of this limiting fraction are to be computed according to the provisions of sections 861 and 862 of the Code.

The problem in this case is whether, in determining the limiting fraction under section 904(a) of the Code, the section 922 deduction allowable to the affiliates who qualify as Western Hemisphere trade corporations is computed on a separate company basis, or whether the consolidated section 922 deduction is to be allocated on the basis of some ratio. No problem arises on this point where all the Western Hemisphere trade members have profits. Where, however, one or more of such members have operating losses, resulting in either a reduced consolidated section 922 deduction, or in no consolidated section 922 deduction, the foreign tax credit is substantially reduced unless only an allocated portion of the consolidated section 922 deduction is used in determining the taxable income in the foreign country. If, in those cases where there is a reduced consolidated section 922 deduction, or no such deduction, the section 922 deduction is computed on a separate company basis, the deduction is invariably greater and therefore the taxable income in the foreign country ( i.e. , the numerator of the limiting fraction) is reduced to a greater extent than is the entire taxable income ( i.e. , the denominator of the limiting fraction) which has been determined by applying a smaller deduction or no deduction at all against entire income. This results in less foreign tax credit than if the taxable income within the foreign country were determined by applying an allocated portion of the consolidated section 922 deduction.

There appears to be no authority to determine the section 922 deduction on a separate company basis since, if one of the Western Hemisphere trade corporations has a loss, the total of the section 922 deductions for the other Western Hemisphere trade corporations would be greater than the section 922 deduction as computed for the affiliated group.

Accordingly, it is held that in computing the limitation on foreign tax credits of an affiliated group of corporations filing a consolidated income tax return where some members of the affiliated group are Western Hemisphere trade corporations having profits while others are Western Hemisphere trade corporations having operating losses, taxable income from sources within a foreign country means income from such country computed without the section 922 deduction minus the allocable portion of the consolidated section 922 deduction. Such allocation is made only among the profit companies qualifying as Western Hemisphere trade corporations on the basis of the ratio of their respective net incomes to their combined net income. Where a portion of the consolidated section 922 deduction is allocated to a profit company operating in several countries, such portion may be further allocated to the separate countries on the basis of the ratio of the net income within each country to its total net income. In a case where there is no consolidated section 922 deduction allowable to the group, there exists no section 922 deduction to be taken into account by the profit companies qualifying as Western Hemisphere trade companies in determining their taxable income for the purposes of section 904(a) of the Code.