Rev. Rul. 71-582

Advice has been requested whether, under the circumstances described below, the fact that payment of a foreign income tax by a controlled foreign corporation not incorporated in the county to which payment is made is the same tax that any other foreign corporation not incorporated in such foreign country would have paid to such country is sufficient to satisfy the requirements of section 1.954-1(b)(3)(v) of the Income Tax Regulations.

Corporation X, a foreign corporation incorporated in country S, is wholly owned by a domestic corporation. X uses the calendar year as its taxable year. For its taxable 1968, X performed construction services in country T on behalf of a related person within the meaning of section 954(e) of the Internal Revenue Code of 1954. For such taxable year X did not meet certain tests described in section 1.954-1(b)(3)(iii) of the regulations which, if they were met, would result in the organization of the corporation being considered not to have the effect of substantially reducing income or similar taxes with respect to foreign base company services income. Also, for such year, X was subjected by country T to a progressive income tax on its income source within country T. Country T also imposes the same tax upon income from sources within country T of other individuals, corporations, and local business entities, foreign to country T.

Section 954(b)(4) of the Code provides, for taxable years ending on or before October 9, 1969, that for purposes of section 954(a) of the Code, pertaining to definition of foreign base company income, foreign base company income does not include any item of income received by a controlled foreign corporation if it is established with respect to such item that the creation or organization of such corporation under the laws of the foreign country in which it is incorporated does not have the effect of substantial reductions of income, war profits, excess profits, or similar taxes.

Section 1.954-1(b)(3)(iii) of the regulations provides, in part, that organization of a controlled foreign corporation will be considered not to have the effect of substantially reducing income or similar taxes with respect to an item of foreign base company services income if certain percentage tests described therein are met.

Section 1.954-1(b)(3)(v) of the regulations provides, in effect, that although a failure to meet the tests described in section 1.954-1(b)(3)(iii) of the regulations with respect to an item or foreign base company services income will be regarded as a significant factor, foreign base company income will not include such item if, on the basis of other facts and circumstances, it is established to the satisfaction of the district director that the creation or organization of the controlled foreign corporation receiving such item does not have the effect of substantially reducing income or similar taxes with respect to such item.

The specific issue in this case is whether the fact that payment of a foreign income tax by a controlled foreign corporation not incorporated in the country to which payment is made is the same tax that any other foreign corporation not incorporated in such foreign country would have paid to such country is sufficient to satisfy the "other facts and circumstances" test of section 1.954-1(b)(3)(v) of the regulations.

The determination of whether the creation or organization of a controlled foreign corporation has the effect of substantially reducing taxes depends upon all the facts and circumstances including the effective rate of tax and the extent to which it has been reduced. See Senate Report No. 1881, Eighty-seventh Congress, C.B. 1962-3, 707, at 948. The controlled foreign corporation must establish that it was not created or organized to substantially reduce taxes with respect to each item of foreign base company income. The burden of proof is on the taxpayer to furnish the necessary information to determine whether the controlled foreign corporation was availed of to reduce taxes and section 1.954-1(b)(3) of the regulations provides the tests.

Section 954(b)(4) of the Code for taxable years ending on or before October 9, 1969, does not inquire as to the motive behind the organization of a controlled foreign corporation but rather whether the organization of the corporation had the effect of reducing taxes.

Accordingly, it is held in the instant case that the fact that the payment by X of the foreign income tax imposed by country T is the same tax that any other foreign corporation not incorporated in country T would have paid to country T is not sufficient to satisfy the requirements of section 1.954-1(b)(3)(v) of the regulations.