Rev. Rul. 78-62

The Internal Revenue Service has been asked to reconsider a number of its published revenue rulings and acquiescences relating to the creditability of certain foreign taxes under section 901 of the Internal Revenue Code of 1954. Accordingly, the purpose of the instant Revenue Ruling is to review those prior published positions of the Service and to indicate what the position of the Service is with respect to those prior published revenue rulings and acquiescences.

Whether a foreign tax qualifies as an income tax within the meaning of section 901 of the Code depends on whether that tax constitutes an "income tax" as determined from an examination of the Federal income tax laws of the United States. Biddle v. Commissioner, 302 U.S. 573 (1938), 1938-1 C.B. 309, and Bank of America Nat'l T. & S. Ass'n v. United States, 459 F.2d 513, 515, 518 (Ct. Cl. 1972), cert. denied, 409 U.S. 949 (1972). Thus, the courts have often said that a foreign tax will be considered to be an income tax within the meaning of section 901 only if that tax is the substantial equivalent of an income tax in the United States sense. See, e.g., Commissioner v. American Metal Co., 221 F.2d 134 (2d Cir. 1955); F. W. Woolworth Co. v. Commissioner, 54 T.C. 123 (1970), nonacq. on another issue, 1971-2 C.B. 4.

To qualify as an income tax in the United States sense, a foreign tax must satisfy certain requirements. See Rev. Rul. 78-61, 1978-1 C.B. The first requirement relevant to this Revenue Ruling is that the gain on which the foreign tax is levied must be realized in the United States sense. The United States Federal income tax, a tax of general application, does tax in certain limited situations the constructive or deemed receipt of income. However, as a whole, the Federal income tax is imposed on gain actually realized. Eisner v. Macomber, 252 U.S. 189 (1920), 3 C.B. 25. A substantially equivalent degree of realization is required with respect to foreign taxes. Commissioner v. American Metal Co., 221 F.2d 134 (2d Cir. 1955); Keasbey & Mattison Co. v. Rothensies, 133 F.2d 894, 898 (3d Cir. 1943); and Lanman & Kemp-Barclay & Co. of Colombia v. Commissioner, 26 T.C. 582 (1956).

In addition to realization, the second requirement relevant to the instant case is that a foreign tax will not be considered to be an income tax in the United States sense unless its purpose is to reach net gain and it is so structured as to be almost certain of doing so. Bank of America Nat'l T. & S. Ass'n. v. United States; Bank of America Nat'l T. & S. Ass'n. v. Commissioner, 61 T.C. 752 (1974). Generally, a foreign tax is almost certain to fall on net gain if levied on income computed in such a manner that it is very unlikely that taxpayers generally subject to that tax will have to pay it when they have no net gain. See the United States Court of Claims decision in Bank of America Nat'l T. & S. Ass'n. v. United States, at 524, wherein it was stated that the ". . . only question is whether it is very unlikely or highly improbable that taxpayers subject to the impost would make no profit or would suffer a loss." See also, Allstate Ins. Co. v. United States, 419 F.2d 409 (Ct. Cl. 1969).

The final requirement relevant to the instant case is that in order for a foreign tax to qualify as an income tax in the United States sense, the tax in question must be imposed on the receipt of income by the taxpayer rather than on transactions such as sales or the exercise of a privilege or a franchise, such as exploiting natural resources. Commissioner v. American Metal Co.; Keasbey & Mattison Co. v. Rothensies; and Rev. Rul. 57-62, 1957-1 C.B. 241.

Herbert Ide Keen v. Commissioner, 15 B.T.A. 1243 (1929), acq., VIII-2 C.B. 27 (1929), involved a French tax imposed solely on the French source income of individuals who maintain a residence in France but are not domiciled there (non-domiciliaries). These non-domiciliaries pay the aforementioned tax on estimated income fixed at a sum equal to seven times the presumed rental value of their respective residences in France, unless their actual French source income exceeds their estimated income. If so, the tax will be computed on their actual income.

The tax paid by non-domiciliaries is separate from the tax paid by individuals who are domiciled in France. The latter pay a tax on their actual income from all sources and not some form of estimated income.

The United States Board of Tax Appeals held this French tax on estimated income to be a creditable income tax principally because it was an income tax under French standards. Relying on the decision in the Keen case, the Board reaffirmed the creditability of that French tax in James R. Hatmaker v. Commissioner, 15 B.T.A. 1044 (1929) (decided for the Commissioner on other grounds). However, subsequent to the Keen and Hatmaker decisions, the Supreme Court of the United States held in the Biddle case that in order for a foreign tax to qualify as a creditable income tax, it must satisfy the United States standard and not the foreign standard of an income tax.

It is apparent that the aforementioned French tax on estimated income does not satisfy any of the United States standards of an income tax discussed above. Such tax is imposed on estimated income fixed at seven times the presumed rental value of a residence even if the non-domiciliary has not realized any gain from French sources or even if such gain as may have been realized is less than such estimated income. Thus, the Service is withdrawing its acquiescence in the Keen case and substituting a nonacquiescence therefor, see page 2 of this Bulletin. Accord, Commissioner v. American Metal Co., wherein the court stated that Keen is in conflict with the later decision of Biddle. In addition, the Service will not follow the conclusion expressed in the Hatmaker case that the French tax is a creditable income tax.

Also decided prior to the Biddle case was Burk Bros. v. Commissioner, 20 B.T.A. 657 (1930) (decided for the Commissioner on other grounds). In that case the taxpayer, a domestic corporation that manufactured goat skins into leather, purchased some goat skins in India through its Indian office. As a result, India levied a tax on the income deemed to be derived by the taxpayer from the goat skins. This income was determined by multiplying the number of goat skins purchased by the difference between the average sales price of goat skins in Philadelphia and their average sales price in Calcutta. The resulting figure was reduced by certain transportation and skin preservation expenses. The Board of Tax Appeals held the Indian tax to be creditable. However, because the tax in Burk Bros. was triggered by a purchase and was levied without reference to the amount of income, if any, actually realized by the taxpayer during the year, it does not satisfy the first and third requirements of an income tax discussed above. Accordingly, the Service will not follow the holding in the Burk Bros. decision that the Indian tax is a creditable income tax.

Rev. Rul. 272, 1953-2 C.B. 56, involved a Haitian tax imposed at progressive rates under chapters III, IV, and V of the Haitian statute. Chapter III taxed the business income of associations, companies, corporations, except stock companies, individual or partnership enterprises, manufacturers, merchants and professional people. Income for purposes of chapter III was computed on a fixed-rate basis by multiplying by five the yearly rental value of the buildings and land occupied by the aforementioned taxpayers.

Chapter IV of the Haitian statute taxed the net profit of all partnership or individual enterprises, companies, and stock corporations conducting a business. For purposes of chapter IV, net profit was actual receipts less the ordinary and necessary expenses incurred in producing these receipts. Taxpayers who were subject both to the tax on net profits under chapter IV and the tax on income computed on a fixed-rate basis under chapter III were required to pay the net profits tax only on that portion of the net profit, if any, which exceeded the income computed on a fixed-rated basis under chapter III. Moreover, even if a taxpayer with this dual liability had no net profit, it still had to pay a tax on income computed on a fixed-rate basis.

Relying on the decision in the Keen case, Rev. Rul. 272 held that the tax imposed by chapter III on income computed on a fixed-rate basis qualified as a creditable income tax. The Revenue Ruling also concluded that the tax imposed by chapter IV was a creditable income tax. The tax imposed by chapter III is not triggered by a realization event in the United States sense and is levied on a base that is not computed from actual receipts. Therefore, the chapter III tax fails to qualify as a creditable income tax. Moreover, insofar as the chapter IV tax is concerned, the only creditable portion of such tax is that portion that exceeds the tax imposed under chapter III. Accordingly, Rev. Rul. 272 is modified to eliminate the holding thereof that the tax imposed by chapter III of the Haitian tax is a creditable tax and to provide that a taxpayer may treat as a creditable income tax only that portion of the chapter IV tax that exceeds the taxpayer's tax under chapter III. However, the holding in Rev. Rul. 272 that the tax imposed by chapter V of the Haitian statute is creditable is reaffirmed because it is the substantial equivalent of an income tax in the United States sense.

Rev. Rul. 59-192, 1959-1 C.B. 191, and Rev. Rul. 56-658, 1956-2 C.B. 501, dealt with certain Cuban Taxes on unrealized net income expected to be derived by sugar mill owners from processed sugar. The event that triggered the imposition of the taxes was the manufacture of the sugar and not its subsequent sale. Moreover, the net income of the sugar mill owners was computed by multiplying the amount of sugar produced in the mill by the average market price of sugar produced in the mills for the past three years and then reducing this figure by an arbitrary 60 percent figure to cover processing costs. Because the Cuban taxes in Rev. Rul. 59-192 and Rev. Rul. 56-658 were imposed independently of any realized gain, they do not satisfy the United States realization standard. Moreover, if a sugar mill subject to the Cuban taxes had a loss for any year by United States standards, it would still pay the tax because net income by Cuban standards is 40 percent of the average market price of sugar produced by the mill for the past three years. Therefore, the taxes fail to meet the second United States standard that the foreign tax must be almost certain of falling on net gain. For these reasons the Cuban taxes are not creditable income taxes. Accordingly, Rev. Rul. 59-192 and Rev. Rul. 56-658 are revoked.

In Santa Eulalia Mining Co. v. Commissioner, 2 T.C. 241 (1943), acq., 1946-1 C.B. 4, the United States Tax Court held that a Mexican tax of 10 percent imposed by Articles 26(I) and 27, Chapter IV, Third Schedule, of the "Ley del Impuesto sobre la Renta" is a creditable income tax under a predecessor of section 901 of the Code. The "Ley del Impuesto sobre la Renta" (Law) imposed a series of schedular taxes on various classes of taxpayers. The First Schedule of the Law imposed a tax on taxpayers engaged in commerce, industry, and agriculture and thus would include taxpayers actively engaged in the conduct of a mining business in Mexico.

Article 26(I) of the Third Schedule of the Law imposed a modified gross income tax on "(t)axpayers who . . . receive participations, whether in the form of rentals or otherwise, from the exploitation of the subsoil or concessions granted by the Federal or state Governments or Municipalities." The amount of participations subject to tax are the gross amount received, less a limited number of deductions as set forth in regulations issued under Article 27. However, persons who are actively engaged in the mining business in Mexico, ". . . taxpayers whose income consists of a participation in the profits of the exploiting concern . . .," are specifically excluded from Article 26(I) of the Third Schedule of the Law because they pay tax under the First Schedule of the Law. Thus, only taxpayers not engaged in the conduct of a mining business in Mexico who receive participations are subject to the tax imposed by Article 26(I).

Though the tax imposed by Article 26(I) falls on the gross amount of participations received by the above taxpayers as reduced by a limited number of deductions, the tax does not violate the third requirement of an income tax discussed above. Because the above taxpayers are not engaged in the conduct of a mining business in Mexico, it is presumed that the expenses ordinarily connected with such participations and incurred by such taxpayers will almost never exceed the income from such participations. Therefore, the foreign tax imposed on such participations as reduced by the aforementioned deductions will be almost certain of reaching net gain. Bank of America Nat'l T. & S. Ass'n v. United States, and Rev. Rul. 73-106, 1973-1 C.B. 343, holding a Mexican tax imposed on the gross amount of royalties received by nonresident aliens and foreign legal entities not established in Mexico to be a creditable income tax. Additionally, similar taxes have long been imposed by the United States on dividends, interest, and royalties paid to nonresident aliens and foreign corporations (that are not effectively connected with the conduct of a trade or business in the United States) as a basic part of the United States income tax system. See sections 871(a)(1)(A) and 881(a)(1) of the Code. The thrust of these United States tax provisions is realistically directed against net gain or profit. See Bank of America Nat'l T. & S. Ass'n v. Commissioner, 61 T.C. 752 (1974).

Accordingly, because the tax imposed by Article 26(I) and 27 of the Third Schedule of the Law is the substantial equivalent of an income tax in the United States sense, the Service reaffirms its acquiescence in the decision in Santa Eulalia Mining Company.

Pursuant to the authority contained in section 7805(b) of the Code, this Revenue Ruling will not be applied to taxable years beginning before January 16, 1978, with respect to taxpayers who have relied on Rev. Rul. 59-192, Rev. Rul. 56-658, and Rev. Rul. 272, but only insofar as the specific taxes discussed in those Revenue Rulings are concerned.

Rev. Rul. 272 is modified. Rev. Rul. 59-192 and Rev. Rul. 56-658 are revoked.