IRS RULES ON TIMING OF DEEMED-PAID FOREIGN TAX CREDIT.

UIL Number(s) 0902.00-00

                                             Date: March 15, 1994

When a domestic corporate shareholder, with a calendar year as its taxable year, receives from its foreign subsidiary, with a fiscal year as its taxable year, a dividend paid out of pre-1987 accumulated profits, with respect to which foreign income taxes were paid, from a fiscal year of the payor ending after the calendar year of the recipient, should the domestic corporate shareholder claim a deemed paid credit under sections 901 and 902 of the Internal Revenue Code ("Code") ¹ for foreign taxes associated with the dividend in its calendar year in which the dividend was received, or in its next calendar year within which the foreign subsidiary's fiscal taxable year ended?

FACTS

Taxpayer, a domestic corporation, wholly owns a domestic subsidiary, P. Both Taxpayer and P are calendar year taxpayers using the accrual method of accounting and filing consolidated returns. During the years at issue, 1983 to 1985, P owned more than 10% of the voting stock of FS, a Country X corporation, with a U.S. and foreign taxable year end of February 28. In each of its calendar years, P received dividends from FS. For the tax years at issue, Taxpayer filed an income tax return claiming foreign tax credits under section 902 of the Code for the calendar year in which P received the dividends.

Taxpayer has requested technical advice to confirm its interpretation that deemed paid credits associated with a dividend were properly claimed in the calendar year in which the dividend was received. The International Examiner's position is that the deemed paid credits associated with the dividends paid out of the accumulated profits should have properly been claimed in Taxpayer's (and P's) next calendar year when the foreign taxes associated with the dividend were paid.

LAW

Section 901 of the Code generally provides a credit against Federal income taxes for the amount of any income taxes paid or deemed paid to a foreign country or U.S. possession.

Section 902(a) of the Code provides that a corporate taxpayer shall be deemed to have paid a proportionate share of the foreign income taxes paid or deemed paid by its foreign subsidiary, from which it receives a dividend in any taxable year, on the accumulated profits to which the dividends are attributable.

Section 78 of the Code and Treas. Reg. section 1.78-1(a) provide that, if a domestic corporation chooses to credit a foreign tax for any taxable year, an amount equal to the taxes deemed to be paid by such corporation under section 902(a) for such taxable year shall be treated for purposes of the Code as a dividend received by such domestic corporation from the foreign corporation.

Treas. Reg. section 1.902-1(b)(1)(i) provides that, when a domestic corporate shareholder receives a dividend, the foreign income tax credit allowed by section 901 includes the foreign income taxes deemed to be paid by much domestic shareholder for such year.

Treas. Reg. section 1.902-1(b)(2) provides that the domestic shareholder shall be deemed to have paid any foreign taxes paid, accrued or deemed paid by a first-tier corporation on or with respect to that portion of such accumulated profits that is actually distributed to the domestic parent in the form of a taxable dividend. The fraction resulting therefrom is meant to disseminate the full credit among the shareholders, and to allocate the credit in proportion to the available profits which are in fact distributed. Treas. Reg. sections 1.902-1(c)(2) and 1.902-1(d)(2) provide the same treatment with respect to second- and third-tier corporations, respectively.

Treas. Reg. section 1.902-1(f) provides that the foreign income taxes paid or accrued on or with respect to the accumulated profits of a foreign corporation for any taxable year shall be the entire amount of foreign income taxes paid or accrued for such year on or with respect to such gains, profits, and income.

The courts have long held that, in order to truly reflect the income of a given year, all the events must occur in that year which fix the amount of that income and the fact of the taxpayer's liability for income tax. See Dixie Pines Products Co. v. Commissioner, 320 U.S. 516, 519 (1944); United States v. Anderson, 269 U.S. 422, 441 (1926). The holding of these cases has been adopted in Treas. Reg. sections 1.446-1(c)(1)(ii) and 1.461-1(a)(2).

ANALYSIS

Section 902(a) of the Code and the regulations thereunder clearly provide that a domestic corporation which owns 10 percent or more of a foreign corporation is entitled to the deemed paid foreign tax credit when it receives a dividend from its foreign subsidiary for the amount of foreign income taxes paid, accrued or deemed to be paid to any foreign country on the amount of accumulated profits represented by the dividend. There are no other statutory or regulatory requirements for associating a dividend with a foreign tax paid or accrued. The only requirement for obtaining the benefit of section 902 is that the parent corporation must receive a dividend from the accumulated profits of a foreign subsidiary upon which a foreign income tax was paid.

The rule that the credit for the amount of foreign taxes deemed paid is associated with the year dividends are received also is found in Treas. Reg. sections 1.902-1(b)(1)(i) and 1.902-1(b)(2). Treas. Reg. section 1.902-1(b)(1)(i) provides that if a domestic shareholder --

RECEIVES DIVIDENDS IN ANY TAXABLE YEAR from its first-tier corporation, THE CREDIT FOR FOREIGN INCOME TAXES ALLOWED BY SECTION 901 INCLUDES . . . THE FOREIGN INCOME TAXES DEEMED, in accordance with paragraph (b)(2) of this section, TO BE PAID BY SUCH DOMESTIC SHAREHOLDER FOR SUCH YEAR. (emphasis added)

Treas. Reg. section 1.902-1(b)(2) provides that --

TO THE EXTENT DIVIDENDS ARE PAID by a first-tier corporation to its domestic shareholder out of accumulated profits . . . FOR ANY TAXABLE YEAR, the DOMESTIC SHAREHOLDER SHALL BE DEEMED TO HAVE PAID THE SAME PROPORTION OF ANY FOREIGN INCOME TAXES PAID, ACCRUED OR DEEMED . . . TO BE PAID BY SUCH FIRST-TIER CORPORATION ON OR WITH RESPECT TO SUCH ACCUMULATED PROFITS FOR SUCH YEAR. (emphasis added)

The regulations also associate the foreign taxes deemed paid with the dividend payments for dividends from second- and third- tier corporations in Treas. Reg. sections 1.902-1(c)(2) and 1.902-1(d)(2).

The Tax Court has emphasized the importance of linking a dividend with the accumulated profits that have been taxed by a foreign jurisdiction for purposes of the foreign income tax credit. in H.H. Robertson Co. v. Commissioner, 59 T.C. 53, 79 (1972), the Tax Court stated:

It is of critical importance to determine the "accumulated profits" of each year, so that they can be matched against the foreign taxes paid for THAT year, and so that when dividends are paid "out of" or "from" such "accumulated profits," a foreign tax credit may properly be computed as a portion (in accordance with the statutory formula) of the foreign taxes paid in respect of the "accumulated profits" of THAT year. (emphasis in the original.)

Additional support for associating paid, accrued or deemed paid foreign taxes with the payment of a dividend is found in section 78. Section 78 provides that a domestic corporate taxpayer that receives a dividend from a foreign corporation and chooses the benefit of the foreign tax credit is required to "gross-up" or include in income the amount of the creditable foreign taxes deemed paid as a section 78 dividend. The full inclusion in income of the section 78 dividend is for the taxable year in which the actual foreign dividend is received. Treas. Reg. section 1.78-1(d) provides in part that --

A section 78 dividend SHALL BE CONSIDERED RECEIVED IN THE TAXABLE YEAR OF A DOMESTIC CORPORATION IN WHICH -- . . . [THE] CORPORATION RECEIVES THE DIVIDEND BY REASON OF WHICH THERE ARE DEEMED PAID UNDER 902(a) IN ACCORDANCE WITH SECTIONS 1.902-1 AND 1.902-2 THE FOREIGN INCOME TAXES which gave rise to such section 78 dividend. . . . (emphasis added)

Both the amount of the accumulated profits and the amount of the foreign taxes deemed paid are determined for the entire taxable year of the payor-foreign subsidiary. Both the International Examiner and the Taxpayer rely on Rev. Rul. 69-447, 1969-2 C.B. 153, in finding that the taxes on the accumulated profits from which a dividend is distributed are determined from the payor's earnings and profits. Treas. Reg. section 1.902-1(f) provides that deemed paid foreign taxes are determined for the foreign subsidiary's entire taxable year.

Foreign taxes should be deemed paid by the domestic corporate shareholder in the same taxable year the dividend is received, although the foreign taxes may not have actually accrued to, and been paid by, the foreign subsidiary until the corporate-shareholder's next calendar year which is when the foreign subsidiary's fiscal year ends. The courts have acknowledged a statutory "link" in section 902 between accumulated profits and dividends received and between the deemed paid credit and the dividends. See U.S. v. Goodyear Tire and Rubber Co. 493 U.S. 132, 138-139 and 143-144 (1989); Champion International Corp. v. Commissioner, 81 T.C. 424, 432-433 (1983); H.H. Robertson Co. v. Commissioner, 59 T.C. 53, 79-80 (1972); General Foods Corp. v. Commissioner, 4 T.C. 209, 216 (1944). The amount of the foreign taxes deemed paid on a dividend (i.e. the credit) and the dividend itself (including section 78 dividends) are "linked" to the amount of accumulated profits determined for the entire taxable year of the payor. Therefore, section 902 presumes that the corporate shareholder may account for the dividends received (including section 78 dividends) and included in its income during its calendar year with the amount of deemed paid foreign taxes on that dividend that it may claim as a credit in that same calendar year. To properly match income and credits, the foreign income taxes paid or accrued at the end of FS section fiscal year must be deemed paid for the taxable year in which P receives the dividend.

Further, in describing the operation of section 902 prior to the Tax Reform Act of 1986, the Senate Finance Committee explained:

U.S. corporations owning at least 10 percent of the voting stock of a foreign corporation are TREATED AS IF THEY HAD PAID A SHARE OF THE FOREIGN INCOME TAXES paid by the foreign corporation IN THE YEAR IN WHICH THAT FOREIGN CORPORATION'S EARNINGS AND PROFITS BECAME SUBJECT TO U.S. TAX AS DIVIDEND INCOME OF THE U.S. SHAREHOLDER. S. Rep. No. 313, 99th Cong., 2d Sess., 298 (1986). (emphasis added)

Additional support for the proposition that a foreign tax credit associated with a dividend is appropriately credited in the year received even if foreign taxes are accrued or paid after the recipient's taxable year is found in Elisabeth Owens' treatise, The Foreign Tax Credit: A Study of the Credit for Foreign Taxes Under United States Income Tax Law, Harvard Law School, 1961. Owens reasons that because the foreign tax may not be credited until it has accrued "on or with respect to" accumulated profits from which dividends were paid, the foreign tax credit must reflect all taxes paid or accrued in the taxable year of the payor even if accrued after the close of the recipient's tax year. Accordingly, Owens concludes that, if the foreign tax is accrued after the shareholder's tax year in which the dividend is received, the credit for that tax must then relate back to the shareholder's year in which the dividend was received. Owens at 340. See also section 902(a) of the Code.

The recipient of the dividend may not, of course, claim the credit on its return for the year in which the dividend is received until the foreign taxes on which the credit is based are actually paid or accrued. The foreign subsidiary determines its ultimate tax liability at the end of its fiscal year when its foreign tax liability becomes fixed and determinable. See Treas. Reg. sections 1.446-1(c)(1)(ii) and 1.461-1(a)(2); see also Dixie Pines Products, supra; United States v. Anderson, supra. Only after the foreign subsidiary's final foreign tax liability is fixed and determinable under the "all events" test may the domestic corporate shareholder claim the credit. For purposes of the "all events" test, the shareholder may claim credits associated with the dividends it receives in the calendar year on its return for that year only after the tax liability of the subsidiary can be determined with reasonable accuracy, that is, at the later end of the subsidiary's fiscal year.

If, contrary to the facts of this case, the foreign subsidiary's U.S. tax year were to end before the end of its foreign tax year, such as when its U.S. tax year was conformed under section 898 of the Code to its U.S. shareholder's tax year, and its foreign tax year was unchanged, foreign taxes accrued at the end of the foreign year may, under Prop. Treas. Reg. section 1.898-4, be claimed as a credit only at the end of the U.S. tax year during which the foreign taxes accrued.

CONCLUSION

Under the Code and the regulations, in the event a domestic corporate shareholder has a calendar year and its foreign subsidiary paying dividends has a later ending fiscal year, the domestic shareholder may claim a foreign tax credit under section 902 in its calendar year in which the dividends are received for the foreign taxes associated with the dividends that may be paid or accrued in its next calendar year. The domestic corporate shareholder, however, may claim the deemed paid credit only after its foreign subsidiary has paid or accrued its foreign taxes at the later end of its fiscal year. Therefore, the corporate shareholder may claim the deemed paid credit on its original return for the calendar year in which it received the dividend, when that return is filed after the payment or accrual of foreign taxes at the close of its foreign subsidiary's year. A domestic corporate shareholder may not claim a deemed paid credit for foreign taxes that have not been paid or accrued. If the corporate shareholder files its return before the end of the foreign subsidiary's fiscal year, the domestic corporate shareholder may later file an amended income tax return for its earlier calendar year to claim the deemed paid credit for that earlier calendar year in which it received the dividends.

P is entitled to a deemed paid foreign income tax credit for dividends paid by FS, upon which foreign income taxes were paid or accrued, in the year the dividends were received. If P filed its original income tax return which included the dividend after the end of FS's fiscal year, then P would be entitled to claim the deemed paid credit on its original return for the year in which it received the dividend. P may not claim on its return the deemed paid credits on the dividends received before FS had paid or accrued the foreign taxes associated with the dividends paid at the close of its fiscal year. Once the foreign income taxes have been paid or accrued, however, the credits associated with the paid or accrued taxes appropriately relate back to the taxable year of the recipient of the dividends in which the dividends were received. If P included the dividends in income on a return filed before-he end of FS's fiscal year, (when foreign income taxes are paid and accrued for federal income tax purposes by the foreign subsidiary), P may file an amended federal income tax return for the year in which the dividend was received to claim the later accruing section 902 deemed paid tax credits.

Our conclusion renders moot a second issue in this case of the proper computation of foreign taxes with respect to the accumulated profits of a foreign subsidiary for a short taxable year since the appropriate year in which to allow the credit on the dividends paid by FS is the year in which the dividends were received.