FOREIGN TAX REDUCTION REQUIRED BY INCLUSION OF WESTERN HEMISPHERE TRADE CORPS. IN AFFILIATED GROUP QUALIFIES FOR FOREIGN TAX CREDIT CARRYBACK AND CARRYOVER

Rev. Rul. 85-55

ISSUE

Whether the amount of the foreign tax credit reduction determined under former section 1503(b)(1) of the Internal Revenue Code qualifies for the carryback and carryover provisions of former section 904(d)?

FACTS

The taxpayer is the common parent of an affiliated group of corporations, some of which qualify as Western Hemisphere trade corporations within the meaning of former section 921 of the Code. The affiliated group filed consolidated Federal income tax returns and elected the overall limitation under section 904(a)(2) in determining the foreign tax credit under section 901. Although the group's foreign taxes did not exceed the foreign tax credit limitation for the tax year, certain of the foreign taxes paid by the Western Hemisphere trade corporations could not be used due to the credit reduction required by former section 1503(b)(1).

LAW AND ANALYSIS

Former section 922 of the Code allowed a Western Hemisphere trade corporation, as defined in former section 921, a special deduction designed to reduce the United States income tax imposed on such corporations.

Section 1503(a) of the Code provides that in any case in which a consolidated Federal income tax return is made, the tax shall be determined, computed, assessed, collected and adjusted in accordance with the regulations under section 1502.

Former section 1503(b)(1) of the Code provided that if the affiliated group includes one or more Western Hemisphere trade corporations, and if for the tax year an election under section 904(b)(1) (relating to election of overall limitation on foreign tax credit) is in effect, the amount of taxes paid or accrued to foreign countries and possessions of the United States by such Western Hemisphere trade corporations which may be taken into account for purposes of section 901 shall be reduced by the amount by which the amount of such taxes exceeds the amount of the tax computed under section 1503(a) with respect to the portion of the consolidated taxable income attributable to such corporations.

Section 901(a) of the Code provides that the foreign tax credit allowed by the section is subject to the limitations of section 904. Section 904(a)(2) (now section 904(a)) provided that the total amount of the credit taken under section 901(a) shall not exceed the same proportion of the tax against which such credit is taken which the taxpayer's taxable income from sources without the United States bears to the entire taxable income for the same tax year.

Former section 904(d) of the Code (now section 904(c)) provided that if taxes paid or accrued to foreign countries for any tax year exceed the limitation on the foreign tax credit under section 904(a), the excess may be carried back to the two preceding years and carried over to the five succeeding years as a credit.

Rev. Rul. 74-72, 1974-1 C.B. 253, held that the amount of the foreign tax reduction required by former section 1503(b)(1) did not qualify for the carryback and carryover provisions. Generally, section 901 of the Code allows a credit for foreign taxes subject to the limitations of section 904(a), which restricts the amount of those foreign taxes otherwise eligible for allowance as credits under section 901. Section 904(d), in turn, provides for the carryback and carryover of those taxes disallowed as credits for the specific year paid or incurred under section 904(a). Because former section 1503(b)(1) specially limited the credit initially available under section 901, the carryover provisions in section 904(d) were never reached.

This literal reading of the applicable provisions resulted in disparity of treatment between a Western Hemisphere trade corporation that joined in the filing of a consolidated Federal income tax return and a Western Hemisphere trade corporation that filed a separate return. Because former section 1503(b)(1) applied only to consolidated returns, a Western Hemisphere trade corporation filing separately could avail itself of any foreign tax credit carryover otherwise denied under section 1503(b)(1).

The Service has reconsidered Rev. Rul. 74-72 and has determined that the carryover and carryback provisions of former section 904(d) apply to the amount of the foreign tax credit reduction determined under former section 1503(b)(1). See S. Rep. No. 1393, 86th Cong., 2d Sess., 6 (1960), 1960-2 C.B. 874, 878. See also Eastman Kodak Company v. United States 1 Cl. Ct. 173 (1983); Texas Instruments, Inc. v. United States, 551 F.2d 599 (5th Cir. 1977). Therefore, any foreign tax credit of a Western Hemisphere trade corporation disallowed under former section 1503(b)(1) may be carried over with respect to such corporations, but may not be used to offset tax on foreign source income of corporations in the affiliated group that do not qualify as Western Hemisphere trade corporations under section 921. This result achieves parity of treatment between a Western Hemisphere trade corporation filing a consolidated return and a similar corporation filing separately.

HOLDING

The amount of the foreign tax reduction required under former section 1503 by reason of the inclusion of Western Hemisphere trade corporations in an affiliated group filing consolidated returns and using the overall limitation in determining the foreign tax credit qualifies for the foreign tax credit carryback and carryover provisions of section 904(d) (now section 904(c)) of the Internal Revenue Code. Foreign tax credits of Western Hemisphere trade corporations reduced under former section 1503(b)(1) may not be used to offset tax on foreign source income of non-Western Hemisphere trade corporations either in the current year or in the years to which the unused credits may be carried.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 74-72 is revoked.