Rev. Rul. 75-174

Advice has been requested whether amounts paid to the taxpayer, under the circumstances described below, by its wholly owned foreign subsidiary will be treated as a dividend and count towards the taxpayer's minimum distribution requirements under section 963 of the Internal Revenue Code of 1954.

P, a domestic manufacturing corporation, acquired 100 percent of the outstanding capital stock of T, a foreign corporation, for 100,000x dollars during the current taxable year. T is engaged in manufacturing products sold outside the United States.

P also owned 100 percent of the total combined voting power of all classes of stock entitled to vote of foreign corporation S. S is engaged in the merchandising of various products outside the United States and is a controlled foreign corporation within the meaning of section 957 of the Code. For each year since 1964, P has made an election to secure an exclusion of S's subpart F income under section 963. P filed its election for the current taxable year to exclude S's subpart F income pursuant to the provisions of section 963(c)(1). Under this election dividends totaling 125,000x dollars would be paid to P during the current taxable year.

In a transaction that otherwise is subject to the tax consequences of and meets the requirements of section 367 of the Code and the regulations thereunder P, during the current taxable year, transferred to S all the stock interest it had acquired in T for a total purchase price of 125,000x dollars.

S had earnings and profits for the current taxable year sufficient in amount to cover the payment made to P during the current taxable year.

Section 304(a)(1) of the Code provides, in part, that for purposes of section 302, if one or more persons are in control of each of two corporations, and in return for property, one of the corporations acquires stock in the other corporation from the person (or persons) solely in control, then such property shall be treated as a distribution and redemption of the stock of the corporation acquiring such stock. In any such case, the stock so acquired shall be treated as having been transferred by the person from whom aquired, and as having been received by the corporation acquiring it, as a contribution to the capital of such corporation.

Section 302(a) of the Code provides, in part, that if a corporation redeems its stock and if paragraph (1), (2), (3), or (4) of section 302(b) applies, such redemption shall be treated as a distribution in part or full payment in exchange for stock.

Section 302(d) of the Code provides that except as provided in subchapter C of the Code, if a corporation redeems its stock (within the meaning of section 317(b)), and if section 302(a) does not apply, such redemption shall be treated as a distribution of property to which section 301 applies.

Section 963(a)(1) of the Code provides, generally, that subpart F income will not be taxed to the United States corporate shareholder if a minimum distribution of the earnings and profits is made to the United States shareholder by the controlled foreign corporation earning the subpart F income. Section 1.963-3 of the Income Tax Regulations describes those distributions that count toward a minimum distribution.

Section 1.963-3(b)(1) of the regulations provides that no distribution received by a United States shareholder shall count towards a minimum distribution for the taxable year with respect to such shareholder to the extent the distribution is excludible from gross income, to the extent gain on the distribution is not recognized, or to the extent that the distribution is treated as a distribution in part or full payment in exchange for stock. Undistributed amounts required to be included in gross income under section 551 of the Code as undistributed foreign personal holding company income or under section 951 as undistributed amounts of a controlled foreign corporation shall not count toward a minimum distribution under section 963. An amount received by a United States shareholder as a distribution that under section 302 or section 331 is treated as a distribution in part or full payment in exchange for stock shall not count toward a minimum distribution even though such amount is includible in gross income under section 1248 as a dividend.

P controlled S and T prior to the transfer of T's stock to S for cash. Control for the purpose of section 304 of the Code is defined in section 304(c) as meaning the ownership of stock possessing at least 50 percent of the total combined voting power of all classes of stock entitled to vote, or at least 50 percent of the total value of shares of all classes of stock.

Accordingly, the acquisition of T's stock by S from P was an acquisition of stock by a related corporation within the meaning of section 304(a)(1) of the Code. The transaction will be treated as a distribution in redemption of a portion of S's stock. Pursuant to the provisions of section 304(a) P is deemed to have made a capital contribution of the stock of T to S.

Under section 1.304-2(a) of the regulations the amount received by P is treated as a distribution of property under section 302(d) of the Code, unless the distribution is to be treated as received in exchange for stock pursuant to section 302(a).

Section 304(b)(1) of the Code provides that the applicability of section 302(b) is made by reference to the stock of the issuing corporation, T. In the instant case, there was no complete termination of P's interest is T within the meaning of section 302(b)(3) nor was there a substantially disproportionate redemption within the meaning of section 302(b)(2), since P owned 100 percent of the stock of T before the transaction and, by reason of section 318(a), P also is considered as owning 100 percent of the stock of T after the transaction (see section 1.318-4(c) of the regulations).

The "not essentially equivalent to a dividend" test of section 302(b)(1) of the Code was not met since there has not been a meaningful reduction of P's interest in T. See United States v. Davis, 397 U.S. 301 (1970), Ct. D. 1937, 1970-1 C.B. 62.

Thus, as provided by section 302(d) of the Code, the inapplicability of section 302(a) results in the amount received by P being treated as a distribution under section 301, and is a dividend from S to P to the extent of S's earnings and profits as provided in section 964.

Accordingly, the amount of the payment made by S to P of the purchase price of 125,000x dollars for the stock of T, to the extent it otherwise meets the test and conditions of section 963 of the Code and the regulations thereunder, will count towards P's minimum distribution requirements under section 963 to the same extent and under the same conditions as if such amount had been declared and paid by S to P as a formal dividend.