Rev. Rul. 74-550

Advice has been requested, under the circumstances described below, as to the determination of the taxable year out of which dividends are paid for the purpose of computing the foreign tax deemed paid by a domestic corporate shareholder under section 902 of the Internal Revenue Code of 1954, where the foreign corporation has deficits in earnings and profits in certain taxable years.

M, a domestic corporation, wholly owns S, a foreign corporation. S is not a less developed country corporation as defined in section 902 (d) of the Code. The applicable foreign country's income tax law has no loss carryback or carryover rules and subjects S to tax on a calendar year basis. S's accumulated profits in excess of foreign income taxes and deficits in accumulated profits, and foreign income taxes paid for the years involved are as follows:

                          Accumulated Profits         Foreign Income

Section 902(a)(1) of the Code provides, in part, that a domestic corporation which owns at least 10 percent of the voting stock of a foreign corporation from which it receives dividends in any taxable year to the extent such dividends are paid out of accumulated profits of a year in which the foreign corporation was not a less developed country corporation, is deemed to have paid the same proportion of income taxes paid or deemed to be paid by such foreign corporation to any foreign country or possession of the United States on or with respect to such accumulated profits, which the amount of such dividends (determined without regard to section 78 of the Code) bears to the amount of such accumulated profits in excess of such income taxes (other than those deemed paid).

Section 1.902-3(f) of the Income Tax Regulations refers to section 316 of the Code for the definition of the term "dividend" for purposes of applying section 902 of the Code.

Section 316 of the Code defines "dividend," in pertinent part, to mean any distribution of property made by a corporation to its shareholders out of its earnings and profits accumulated after February 28, 1913, or out of its earnings and profits of the taxable year. Generally, every distribution is made out of the most recently accumulated earnings and profits.

Section 1.902-3(c)(6) of the regulations provides, in part, that the district director in whose district is filed the income tax return of the domestic shareholder claiming a credit under section 902 of the Code shall have full power to determine from the accumulated profits of what year or years such dividends were paid, treating dividends as having been paid from the most recently accumulated gains, profits, or earnings.

Section 1.902-3(c)(1) of the regulations provides that the accumulated profits for any taxable year is the sum of the earnings and profits for such year and the foreign income taxes imposed upon the income to which such earnings and profits are attributable.

Section 1.243-4(a)(6) of the regulations provides an ordering rule for purposes of section 243(a)(3) of the Code (relating to qualifying dividends) for determining from what year's earnings and profits a dividend is treated as having been distributed. Generally, a dividend shall be considered to be distributed, first, out of the earnings and profits of the taxable year, second, out of the earnings and profits accumulated for the immediately preceding taxable year, third, out of the earnings and profits accumulated for the second preceding taxable year, etc. A deficit in earnings and profits for any taxable year shall reduce the most recently accumulated earnings and profits for a prior year.

Applying the aforementioned provisions of the Code and regulations to the facts in the instant case, the following results:

           Earnings and       Foreign

As a result of the above computation, the $18,000 foreign taxes paid in 1968 would not constitute taxes paid on or with respect to accumulated profits out of which a dividend is paid. Accordingly, a deemed paid foreign tax credit under section 902 of the Code is not available to M with respect to such taxes.

If a dividend were paid in 1968, a deemed paid foreign tax credit would be allowed based upon the accumulated profits at that time. The deficit in earnings and profits in 1969 would not require recomputation of the deemed paid foreign tax credit with respect to such 1968 dividend. A deficit in earnings and profits for a taxable year does not carry back or carry over to compute the earnings and profits for another taxable year, although such deficit will reduce the accumulated profits available for distribution as a dividend.

The holdings in the instant case are for computing the foreign tax deemed paid under section 902 of the Code for the years of dividend distribution and not for computing the actual earnings and profits of the years involved.