Rev. Rul. 72-599

Advice has been requested whether, under the circumstances described below, a United States shareholder may change a group election made under section 963(c)(3) of the Internal Revenue Code of 1954 to a single controlled foreign corporation election under section 963(c)(1) of the Code.

P, a domestic corporation, keeps its books and files its Federal income tax return using an accrual method of accounting. On September 10, 1968, P filed with its Federal income tax return for its taxable year ended June 30, 1968, an election to exclude from its gross income the subpart F income of its controlled foreign corporations and to receive a minimum distribution of the earnings and profits of such controlled foreign corporations, pursuant to section 963 of the Code and the regulations thereunder. All of the controlled foreign corporations had taxable years ending on June 30 and reported their income using an accrual method of accounting. The election included S, a corporation organized under the laws of country Y. Prior to 1968, S had a fiscal year ended June 30 for country Y as well as for United States tax purposes.

When P made its group election under section 963 of the Code for its taxable year ended June 30, 1968, it calculated that the consolidated foreign income taxes of the group for P's taxable year ended June 30, 1968, would satisfy the minimum overall tax burden limitation contained in section 1.963-4 of the Income Tax Regulations and, accordingly, that no minimum distribution was required in order for P to be able to exclude the subpart F income of the controlled foreign corporations in the group. In making this calculation, P used the country Y income taxes as accrued on S's books on June 30, 1968.

On September 16, 1968, country Y tax authorities approved a change in S's taxable year from a fiscal year ending June 30 to a calendar year. The application to change S's accounting period for country Y purposes had been approved by S's stockholders before June 30, 1968 and was filed by S in April, 1968. S changed its taxable year in order that its annual accounting period for country Y purposes would coincide with country Y's annual accounting period. Country Y required S to file a single income tax return for S's 18-month period ending December 31, 1968. For United States tax purposes, however, S did not change its taxable year pursuant to the procedures set forth in Rule 4 of Revenue Procedure 63-7, C.B. 1963-1, 485.

S's operations during the period July-December, 1968, were conducted at a loss in contrast to the profitable operations during July 1967 through June 1968.

On audit by country Y, S's income tax for the 18-month period ending December 31, 1968, was determined by country Y to be an amount substantially less than the amount accrued by S on June 30, 1968. P then calculated that a portion of the adjusted tax paid by S to country Y was allocable to the 12-month period ended June 30, 1968, and that such allocated amount caused a failure by the group to satisfy the limitation in section 1.963-4 of the regulations as a result of which, under the provisions of section 963 of the Code, a minimum distribution was required to be made to P.

P thereupon sought to eliminate S from P's election under section 963 of the Code by changing P's group election under section 963(c)(3) of the Code for the taxable year ended June 30, 1968, to a single controlled foreign corporation election under section 963(c)(1) of the Code.

Section 1.963-1(c)(3)(ii) of the regulations provides, in pertinent part, that if a United States shareholder establishes to the satisfaction of the Commissioner that reasonable cause exists to revoke or modify a group election, it may modify the election by eliminating corporations or change from a group election to first-tier elections. Further, reasonable cause shall be deemed to exist for such modification only if, after the making of such election, a material or substantial change in circumstances affecting the election occurs which reasonably could not have been anticipated when the election was made and which, to a significant degree, was beyond the control of the electing United States shareholder. For example, reasonable cause would exist if the minimum distribution was computed on the basis of a contested foreign income tax asserted by a foreign tax authority which, as a consequence of litigation occurring after the filing of the United States shareholder's return, is refunded with the result that the United States shareholder is not entitled, under the election which was made, to an exclusion under section 963 of the Code.

In the instant case, S's taxable year for United States tax purposes, including section 963 of the Code, ended on June 30, 1968.

In the instant case S's foreign tax liability to country Y was determined by reference to S's taxable year for country Y tax purposes, and, by reason of the change approved by country Y, S's foreign tax liability to country Y was determined on the basis of an 18-month period ended December 31, 1968. Consequently, S could not determine the fact of its liability for income taxes payable to country Y until December 31, 1968, when all events requisite for their accrual occurred. Since S could not accrue such taxes until December 31, 1968, P was not in a position to take such taxes into account on its Federal income tax return for its taxable year ended June 30, 1968, in computing the required minimum distribution for such taxable year. Further, the change in S's taxable year for country Y tax purposes was not an event which could not have been reasonably anticipated when the election was made or which was beyond P's control within the meaning of section 1.963-1(c)(3) of the regulations.

Accordingly, P may not modify its group election made under section 963(c)(3) of the Code for the taxable year ended June 30, 1968.