Rev. Rul. 76-67

Advice has been requested whether, under the circumstances described below, foreign income taxes paid by a controlled foreign corporation that is a member of a chain and that has a deficit in earnings and profits under United States standards for the taxable year involved are includable in computing the "effective tax rate" of the chain for purposes of section 963 of the Internal Revenue Code of 1954.

P, a domestic corporation, owns directly all of the outstanding stock of S, a controlled foreign corporation. S, in turn, owns directly all of the outstanding stock of X and Y, which also qualify as controlled foreign corporations.

In filing its 1973 Federal income tax return, P elected to receive a minimum distribution under section 963 of the Code and further elected to receive the distribution described in section 963(c)(2) with respect to a chain of corporations.

In 1973 S, X, and Y had the following pre-tax income (deficit), as computed under sections 1.952-2 and 1.964-1 of the Income Tax Regulations, and paid the following foreign income taxes:

                     S          X           Y             Total

Section 963(d)(2) of the Code provides, in part, that the term "effective foreign tax rate" means with respect to two or more foreign corporations, the percentage that (A) the total income, war profits, or excess profits taxes paid or accrued to foreign countries or possessions of the United States by such foreign corporations for the taxable year on or with respect to the consolidated earnings and profits of such foreign corporations for the taxable year, is of (B) the sum of (i) the consolidated earnings and profits of such foreign corporations described in (A) and (ii) the taxes described in (A).

Section 1.963-2(c)(2) of the regulations provides, in part, that for purposes of section 963 of the Code, the term "effective foreign tax rate" for a taxable year means, with respect to a chain, the percentage that (i) the consolidated foreign income taxes (as determined under section 1.963-2(e)(2)) of such chain with respect to the United States shareholder for such taxable year is of (ii) the sum of (a) the consolidated earnings and profits (as determined under section 1.963-2(d)(3)) of such chain with respect to such United States shareholder for such taxable year, and (b) the amount referred to in (i).

Section 1.963-2(d)(3) of the regulations provides, in relevant part, that the consolidated earnings and profits of a chain with respect to any United States shareholder for the taxable year shall be the sum of such shareholder's proportionate shares of the earnings and profits, and of the deficit in earnings and profits, determined under section 1.963-2(d)(2), for such year of all foreign corporations, whether or not controlled foreign corporations, in such chain.

Section 1.963-2(e)(2) of the regulations provides, in relevant part, that the consolidated foreign income taxes of a chain with respect to a United States shareholder for the taxable year of such chain shall be the sum of such shareholder's proportionate shares (as determined under section 1.963-2(e)(1)) of the foreign income tax of all foreign corporations, whether or not controlled foreign corporations, in such chain.

Section 1.963-2(e)(1) of the regulations provides, in general, that in computing the shareholder's proportionate share of taxes of a foreign corporation, the foreign tax of a foreign corporation for a taxable year shall consist, in part, of the foreign income tax referred to in section 1.963-2(d)(1)(ii).

Section 1.963-2(d)(1)(ii) of the regulations provides, in part, that the amount referred to therein is, in the case of every foreign corporation, the amount of foreign income tax paid or accrued by such corporation during its taxable year other than certain foreign income tax not herein relevant.

Section 1.963-1(b)(7) of the regulations provides that the term "foreign income tax" means income, war profits, and excess profits taxes, and taxes included in the term "income, war profits, and excess profits taxes" by reason of section 903 of the Code, paid or accrued to a foreign country or possession of the United States and taken into account for purposes of sections 901 through 905. Section 1.963-1(b)(7) further provides that except in determining the foreign tax credit under section 901, the term shall not include any tax that is deemed paid by a foreign corporation under section 902(b).

The reference in section 1.963-1(b)(7) of the regulations to sections 901 through 905 of the Code in defining the term foreign income tax for purposes of section 963 is for the purpose of determining whether a foreign tax is an income, war profits or excess profits tax under United States concepts and does not prevent amounts paid for foreign taxes paid by a chain member, which cannot be claimed as a credit under sections 901 through 905 because of the operation of the rules of section 902 or 904 from being included in the term foreign income tax for purposes of section 963.

Examples (7) and (8) of section 1.963-2(f) of the regulations take into account the foreign income taxes of a third-tier controlled foreign corporation, notwithstanding the fact that at the time of promulgation of that section of the regulations, the foreign income taxes paid by a third-tier corporation could not be credited to a shareholder as deemed paid under section 902 of the Code because of a dividend received.

Thus, the phrase "and taken into account for purposes of sections 901 through 905 of the Code" as used in section 1.963-1(b)(7) of the regulations indicates that the tax must be classifiable as an income tax for purposes of the foreign tax credit, but does not imply a restriction on the amount of that tax for purposes of section 963 depending upon the amount that would have been creditable under the provisions of sections 901 through 905.

Accordingly, in computing the effective foreign tax rate of the chain for 1973, P may include the foreign income taxes paid by Y. Therefore, the effective tax rate of the chain for 1973 is 581/3 percent, which is computed as follows:

          70 (Total foreign income