Rev. Rul. 74-6

Advice has been requested as to the treatment under section 963 of the Internal Revenue Code of 1954 of dividends received by a first-tier controlled foreign corporation (a member of a chain election) from the previously taxed subpart F income of a second-tier foreign corporation which is not included in the chain election.

Specifically, it has been requested whether for purposes of section 963 of the Code (1) the earnings and profits of Y, a wholly-owned first-tier foreign subsidiary of a United States corporation (included in a chain election), for the taxable year to which the election relates are determined by excluding dividends (together with any foreign income taxes paid in respect thereto) received from Z, a wholly-owned second-tier foreign subsidiary (not included in the chain election), and which were paid out of previously taxed subpart F income, (2) the amount of the minimum distribution, the earnings and profits, and the effective foreign tax rate for the chain is determined without regard to such dividends and the foreign income taxes applicable thereto, and (3) a minimum distribution by Y is considered to be first out of earnings and profits other than earnings and profits attributable to the previously taxed subpart F income received from Z.

Z has no earnings and profits attributable to investments in United States property and both Y and Z are not less developed country corporations.

Section 1.963-3(c)(2) of the Income Tax Regulations provides, in relevant part, that in the case of a chain or group election a distribution received by a foreign corporation in the chain or group from another foreign corporation in such chain or group shall be taken into account as earnings and profits of the recipient corporation for the taxable year of the recipient to which the election relates, but only to the extent that (1) the distribution is received by the recipient corporation during the distribution period for the taxable year of such recipient corporation to which the election relates, (2) if the distribution had been received by the United States shareholder, it would have constituted a distribution qualifying as counting toward a minimum distribution, i.e., not a distribution excludable from gross income, and (3) the distribution is made from the earnings and profits of the distributing corporation for the taxable year of such distributing corporation to which the election relates.

Thus, for purposes of section 963 of the Code, if Y had received a distribution from one of its subsidiaries included in the chain election, and such distribution, if received by the United States shareholder, would be excluded from its gross income, such distribution would not be taken into account as earnings and profits of Y for the taxable year of Y to which the election relates.

Based on this principle of exclusion from earnings and profits, the earnings and profits for the taxable year of election of Y (included in a chain election) should be determined by excluding the distribution of previously taxed subpart F income received from Z (not included in the chain election) which was included in the United States shareholder's gross income.

Accordingly, it is held that for purposes of section 963 of the Code the earnings and profits of Y for the taxable year of election shall be determined by excluding dividends consisting of previously taxed subpart F income received from Z. It follows that any foreign income taxes paid with respect to such dividends should also be excluded for such purposes.

Since the dividend received by Y from Z consisted entirely of subpart F income previously taxed to the United States shareholder and is therefore excludable by Y from its earnings and profits for purposes of section 963 of the Code, and since the foreign income tax paid on such dividend does not reduce the earnings and profits of Y, neither the dividend nor the tax is included in determining the minimum distribution, the earnings and profits, or the effective foreign tax rate for the chain.

Section 1.963-3(a) of the regulations provides, in part, that a distribution to a United States shareholder by a foreign corporation included in a chain shall count toward a minimum distribution for the taxable year of such shareholder to which the section 963 election relates only to the extent it is a distribution of the type described in section 1.963-3(b).

Section 1.963-3(b) of the regulations excludes from distributions counting toward a minimum distribution, any distribution to the extent it is excludable from gross income (except distributions from earnings and profits for the taxable year attributable to amounts required to be included in gross income of such shareholder as an increase in United States property for such year). See also section 1.963-3(e).

The dividend received by Y from the previously taxed subpart F income of Z is excludable from the gross income of both the United States shareholder and Y. Section 959(a) and (b) of the Code. Therefore, such distribution will not count toward a minimum distribution by Y to the United States shareholder under section 963 and section 1.963-3(b) and (e) of the regulations.

Accordingly, for purposes of section 963 of the Code, a minimum distribution by Y to the United States shareholder is considered to be first out of current earnings and profits of the type described in section 959(c)(1), then out of current earnings and profits of the type described in section 959(c)(2), and last out of other earnings and profits. Therefore, such minimum distribution would not include (because of the exclusion from gross income under section 1.963-3(b) of the regulations) the distribution of previously taxed subpart F income to Y by Z. Such minimum distribution is considered to be first out of earnings and profits other than earnings and profits attributable to the previously taxed subpart F income received by Y from Z.