Rev. Rul. 68-351

Advice has been requested whether a domestic corporate shareholder of a foreign subsidiary corporation that survived a merger with a sister foreign corporation is entitled to the credit for foreign income taxes paid by such subsidiaries under the circumstances set forth below.

X , a domestic corporation, owned all of the outstanding voting stock of its first-tier foreign subsidiary corporations, Y and Z. X effected the acquisition of all the assets of Z by Y in a transaction described in section 381(a)(2) of the Internal Revenue Code of 1954. As required by section 367 of the Code, it was established that the acquisition by Y of the assets of Z was not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income tax. Subsequent to such acquisition and unrelated thereto, a dividend was paid to X from the accumulated earnings and profits of subsidiary Y that included earnings and profits subsidiary Z had accumulated prior to the date of acquisition. One of the subsidiary corporations originally owned by X was not a less developed country corporation for purposes of section 902(a)(1) of the Code during the taxable years in which its earnings and profits were accumulated.

Section 381(c)(2) of the Code requires an acquiring corporation (such as Y ) in a transaction to which section 381(a) of the Code applies to succeed to and take into account that the earnings and profits of the transferor corporation (such as Z ) as of the close of the date of the transfer. See also section 1.381(c)(2)-1 of the Income Tax Regulations. Further, if a domestic shareholder (such as X corporation) receives dividends in any taxable year from its first-tier corporation, the credit for foreign income taxes allowed by section 901 of the Code includes the foreign taxes deemed to be paid by such domestic shareholder for such year under section 902 of the Code and section 1.902-3 of the regulations. Section 902 of the Code and section 1.902-3 of the regulations provide, among other things, one rule with respect to dividends attributable to the accumulated profits of a first-tier corporation that is not a less developed country corporation and another rule with respect to dividends attributable to the accumulated profits of a first-tier corporation that is a less developed country corporation. In the first instance the dividend to the domestic corporation is increased by a `gross up' of the foreign tax deemed paid by it, whereas in the latter instance there is no such requirement. See section 78 of the Code and paragraphs (a)(2) and (3) and (b)(1), (2), and (3) of section 1.902-3 of the regulations. In addition, section 1.902-3(a)(5) of the regulations provides that if dividends are received by a domestic shareholder from more than one first-tier corporation, the taxes deemed to be paid by such shareholder under section 902(a) of the Code shall be computed separately with respect to the dividends received from each of such first-tier corporations.

Accordingly, with respect to the dividend paid to X , subsequent to the acquisition of Z by Y , from the profits accumulated by such subsidiaries prior to the date of such acquisition, X will be deemed to have paid a proportionate part of the foreign income taxes paid by both Y and Z on their accumulated profits. For purposes of determining the taxes thus deemed to have been paid by X under section 902(a) of the Code, and in order to give effect to the different rules provided in paragraphs (1) and (2) of section 902(a), a separate computation is required to be made with respect to the portion of such dividend attributable to the accumulated profits of Y and the portion of such dividend attributable to the accumulated profits of Z . The dividend paid will be attributable to the accumulated earnings and profits of Y and Z determined on a pro-rata basis by reference to the respective balances of the earnings and profits of Y and Z for each year for which a computation under section 902(a) of the Code is made.