Rev. Rul. 70-426

Advice has been requested whether, under the circumstances described below, a foreign corporation is a controlled foreign corporation within the meaning of section 957 of the Internal Revenue Code of 1954.

Y, a foreign corporation, has two classes of capital stock outstanding, as follows: 100 shares of no par value class A stock and 100 shares of $1.00 par value class B stock. Each class of outstanding stock has the same voting rights. The class B stock has a preference as to assets on dissolution of the corporation to the extent of its par value and a preference to annual dividends equal to the greater of a small fixed amount or a minor percentage of Y's annual income. X, a domestic corporation, owns all shares of class A stock. All the shares of class B stock are owned equally by two individuals who are citizens and residents of the foreign country in which Y is incorporated. The corporate charter of Y is for one year with an annual renewal requiring the approval of the shareholders owning 75 percent of the combined voting power of all classes of stock entitled to vote.

Section 957(a) of the Code provides, in general, that the term "controlled foreign corporation" means any foreign corporation of which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned by United States shareholders on any day during the taxable year of such corporation.

Section 1.957-1(b)(1) of the Income Tax Regulations provides that in determining whether United States shareholders own the requisite percentage of total combined voting power of all classes of stock entitled to vote, consideration will be given to all the facts and circumstances of each case. In all cases, however, United States shareholders of a foreign corporation will be deemed to own the requisite percentage of total combined voting power with respect to such corporation--

(i) if they have the power to elect, appoint, or replace a majority of that body of persons exercising the powers ordinarily exercised by the board of directors of a domestic corporation;

(ii) if any persons elected or designated by such shareholders have the power, where such shareholders have the power to elect exactly one-half of the members of such governing body of such foreign corporation, either to cast a vote deciding an evenly divided vote of such body or, for the duration of any deadlock which may arise, to exercise the powers ordinarily exercised by such governing body; or

(iii) if the powers which would ordinarily be exercised by the board of directors of a domestic corporation are exercised with respect to such foreign corporation by a person whom such shareholders have the power to elect, appoint, or replace.

Section 1.957-1(b)(2) of the regulations provides that any arrangement to shift formal voting power away from United States shareholders of a foreign corporation will not be given effect if in reality voting power is retained. The mere ownership of stock entitled to vote does not by itself mean that the shareholder owning such stock has the voting power of such stock for purposes of section 957 of the Code. This section of the regulations further provides that if there is any agreement, whether express or implied, that any shareholder will not vote his stock or will vote it only in a special manner, or that shareholders owning stock having not more than 50 percent of the total combined voting power will exercise voting power normally possessed by a majority of stockholders, then the nominal ownership of the voting power will be disregarded in determining which shareholders actually hold such voting power, and this determination will be made on the basis of such agreement.

Section 1.957-1(b)(2) of the regulations also provides that where United States shareholders own shares of one or more classes of stock of a foreign corporation which has another class of stock outstanding, the voting power ostensibly provided such other class of stock will be deemed owned by any person on whose behalf it is exercised or, if not exercised, will be disregarded if the percentage of voting power of such other class of stock is substantially greater than its proportionate share of the corporate earnings, if the facts indicate that the shareholders of such other class of stock do not exercise their voting rights independently or fail to exercise such voting rights, and if a principal purpose of the arrangement is to avoid the classification of such foreign corporation as a controlled foreign corporation under section 957 of the Code.

Y's charter has a one year life and the annual renewal of the charter requires the approval of 75 percent of the combined voting power of all classes of stock entitled to vote. Thus, X, owning 50 percent of the total combined voting power of Y, has the power to readily force Y into liquidation. X is therefore, deemed to own the requisite percentage of the total combined voting power with respect to Y under section 1.957-1(b)(1) of the regulations.

Accordingly, under the circumstances noted above, X is deemed to own the voting power ostensibly attached to the class B stock owned by the foreign stockholders, and Y is a controlled foreign corporation under section 957 of the Code.