Rev. Rul. 74-521

Advice has been requested whether, under the circumstances described below, a domestic corporate shareholder which elected to treat a distribution received from a controlled foreign corporation as a minimum distribution from a chain of controlled foreign corporations under section 963(c)(2) of the Internal Revenue Code of 1954 and also applied the special rules under section 1.963-4(b) and (c) of the Income Tax Regulations is precluded from claiming a foreign tax credit under section 902(b) with respect to such distribution for taxes paid by a second tier controlled foreign corporation not in the chain.

X, a domestic corporation, owns all of the stock of Y, a controlled foreign corporation within the meaning of section 957 of the Code. Y, in turn, wholly owns controlled foreign corporations, R and T. For its taxable year ending with or within X's taxable year 1970, T had no subpart F income or non-subpart F income invested in U.S. property that would be includible in X's gross income under section 951(a). For its taxable year 1970, X made a chain election under section 963 to receive a minimum distribution with respect to the earnings and profits of Y and R but not with respect to T. The special rules under sections 1.963-4(b) and (c) of the regulations were also applied for determining earnings and profits, foreign income taxes and foreign tax credits for purposes of determining the minimum over-all tax burden. For such tax year X received distributions in excess of the minimum distributions required. In determining the earnings and profits and foreign income taxes of Y for purposes of section 963, the earnings and profits and foreign income taxes were computed as including dividends received by Y from T and withholding taxes paid by Y thereon but not including taxes paid by T. X, in determining its foreign tax credit with respect to the portion of the distribution not treated under the special rules, included in the foreign taxes paid by Y the taxes deemed paid by Y as a result of the receipt of dividends from T.

Section 316 of the Code defines the term "dividend" to mean any distribution of property made by a corporation to its shareholders out of its earnings and profits and provides in part, that except as otherwise provided by law, every distribution is made out of earnings and profits to the extent thereof, and from the most recently accumulated earnings and profits.

Sections 902(a) and (b) of the Code provide, in effect, that if a domestic corporation which owns all of the voting stock of a foreign corporation which owns all of the voting stock of a second foreign corporation, receives distributions of the earnings and profits of the second-tier foreign corporation through the first-tier corporation, the domestic corporation is entitled to a foreign tax credit for the income taxes paid by the second-tier corporation with respect to such distribution.

Section 963(a)(2) of the Code provides for an election by a United States shareholder which is a domestic corporation to exclude from its gross income for its taxable year the otherwise includible subpart F income as determined under section 951(a)(1)(A)(i) of a chain of controlled foreign corporations for those taxable years of such controlled foreign corporations ending with or within the taxable year of the United States shareholder, subject to receipt of a minimum distribution with respect to the consolidated earnings and profits for the taxable year of all the controlled foreign corporations in the chain.

Section 963(c)(2) of the Code provides, in effect, that section 963(a)(2) applies to amounts which would otherwise be included in the gross income of the United States shareholder as subpart F income as determined under section 951(a)(1)(A)(i) by reason of its direct stock ownership of a controlled foreign corporation and by reason of its ownership within the meaning of section 958(a)(2) of stock of another controlled foreign corporation.

Section 1.963-1(b)(7) of the regulations provides, in part, that for purposes of section 963 of the Code and section 1.963-1 through 1.963-8, except in determining the foreign tax credit under section 901, the term "foreign income tax" shall not include any tax which is deemed paid by a foreign corporation under section 902(b).

Section 1.963-4(c)(1) of the regulations provides, in effect and in part, that, in determining the minimum overall tax burden under the special rules, the foreign tax credit of the United States shareholder with respect to a minimum distribution received for a taxable year from a chain shall be determined under the provisions of sections 901 through 905 of the Code as modified by section 1.963-3 of the regulations except that under section 1.963-4(c)(2) of the regulations, taxes of a second-tier corporation making a distribution through a first-tier corporation shall not be averaged with taxes of the first-tier corporation or with taxes of the first-tier corporation on its other income.

Section 1.963-4(c)(2)(i)(a) of the regulations provides with respect to taxes deemed paid by a first-tier corporation and taxes actually paid by such corporation in the year of the minimum distribution, that if, by successive distributions through a chain or group, a United States shareholder receives for a taxable year a distribution of the earnings and profits for such year of any corporation in such chain or group, and if both section 902(a) and section 902(b) of the Code apply with respect to such distribution, all the taxes deemed paid under section 902(b) by the first-tier corporation with respect to such distribution of such earnings and profits shall be deemed paid by the United States shareholder for such taxable year under section 902(a) with respect to the earnings and profits so distributed and, notwithstanding the rules otherwise applicable under section 902, no part of the taxes so deemed paid by such first-tier corporation shall be attributed to other earnings and profits of such first-tier corporation for such year and no part of the taxes paid or accrued with respect to such other earnings and profits shall be attributed to the earnings and profits so received as a distribution.

Section 1.963-4(c)(2)(i)(a) of the regulations is limited in its application to taxes paid by corporations in a chain or group. This, however, does not preclude a United States corporate shareholder from claiming a foreign tax credit under section 902(b) of the Code for taxes paid by second-tier corporations not in the chain or group with respect to the minimum distribution. The purpose of excluding the deemed paid taxes incurred by a controlled foreign corporation included in a chain election from the term "foreign income tax" defined in section 1.963-1(b)(7) of the regulations, except in determining the foreign tax credit under section 901 of the Code, is simply to avoid such taxes being counted twice. Where the controlled foreign corporation incurring the taxes is not included in the chain election, the purpose of excluding such deemed paid taxes would be to avoid an inflated effective foreign tax rate. Therefore, in determining the foreign tax credit under section 901, as modified by the regulations under section 963 in applying the special rules, the term "foreign income taxes" includes taxes deemed paid under section 902(b) by a controlled foreign corporation not included in a chain or group election under section 963 with respect to the distribution to which they are attributable.

In the instant case, the distributions out of earnings and profits by Y to X are dividends within the meaning of section 316 of the Code whether or not they are minimum distributions under section 963.

Accordingly, X's chain election under section 963 of the Code to receive a minimum distribution by applying the special rules under section 1.963-4(b) and (c) of the regulations with respect to the earnings and profits of Y and R but not with respect to T does not preclude X from claiming a foreign tax credit under section 902(b) with respect to such a distribution for taxes paid by T.