Rev. Rul. 72-337

Advice has been requested concerning the interest equalization tax and certain Federal income tax consequences of the transaction described below.

P, a domestic corporation, formed S, a wholly owned domestic international finance subsidiary. In addition to its common stock, S also had authorized capital consisting of 200x shares of convertible preferred stock having a par value of $1.00 per share which it sold to underwriters, one or more of which were United States persons. The underwriters offered and sold such stock to foreign persons. The preferred stock was not registered with the United States Securities and Exchange Commission.

Dividend paid on the preferred stock of S was at a rate per share equal to 6 cents above the amount paid on the common stock of P during the immediately preceding six months. Such dividend payment was guaranteed by P to the extent of 10 cents per share and was paid in the United States.

The holders of S's preferred stock (representing equity in the corporation) had no preemptive rights and no voting rights except in limited situations where a class vote is required by law. Such stock was preferred as to distributions in liquidation and were convertible into the common stock of P, at the option of the holder, at any time on or after six months from the date of issuance on a one for one basis and was callable thereafter by S in accordance with certain stipulated conditions and prices.

S used the proceeds of its sale of stock for the purpose of acquiring and investing in the stock or debt obligations of foreign corporations in which P, or members of its affiliated group, at the time of investment or within 12 months thereafter, owned, directly or indirectly, 10 percent or more of the total combined voting power of all classes of stock of such corporations. Pending these investments, S deposited the proceeds for a period of less than one year with foreign banks or foreign branches of United States banks, or invested the funds in foreign government or corporate debt obligations having periods to maturity of less than one year.

The Internal Revenue Service has ruled that S was formed or availed of for the principal purpose of obtaining funds (directly or indirectly) for foreign issuers or obligors.

S, at all times, derived less than 20 percent of its gross income from sources within the United States and its investments, at all times, produced enough net income to meet the dividend payments on its preferred stock.

Section 4911 of the Internal Revenue Code of 1954 imposes the interest equalization tax on each acquisition by a United States person of stock of a foreign issuer, or a debt obligation of a foreign obligor, if such obligation has a period remaining to maturity of one year or more.

Section 4912(b)(3) of the Code provides, in part, that the acquisition of stock or debt obligation of a domestic corporation, formed or availed of for the principal purpose of obtaining funds (directly or indirectly) for a foreign issuer or obligor, shall be deemed an acquisition (from such foreign issuer or obligor) of stock or debt obligations of such foreign issuer or obligor.

Section 4918(a) of the Code provides, in relevant part, that the interest equalization tax shall not apply to an acquisition of stock of a foreign issuer or a debt obligation of a foreign obligor if it is established in the manner provided in that section that the person from whom such stock or debt obligation was acquired was a United States person throughout the period of his ownership continuously since July 18, 1963, and was not ineligible to dispose of such stock or debt obligation as a United States person and such person had paid the tax imposed by section 4911 of the Code with respect to acquisition of such stock or debt obligation by such person or acquired such stock or debt obligation without liability for payment of such tax.

Since S was formed or availed of for the principal purpose of obtaining funds for a foreign issuer or obligor pursuant to section 4912(b)(3) of the Code, the stock issued by S is deemed to be the stock of such foreign issuer. Therefore, the acquisition by United States persons of S's stock is subject to the interest equalization tax unless one or more specific statutory exemptions is applicable.

Section 4915(a) of the Code provides, in relevant part, that except as provided in subsection (c) and (d) the interest equalization tax imposed by section 4911 of the Code shall not apply to the acquisition by a United States person of stock or debt obligations of a foreign corporation, if immediately after the acquisition such person (or one or more includible corporations in an affiliated group, as defined in section 1504 of the Code, of which such person is a member) owns (directly or indirectly) 10 percent or more of the total combined voting power of all classes of stock of such foreign corporation.

Section 1504(a) of the Code provides that the term "affiliated group" means one or more chains of includible corporations connected through stock ownership with a common parent corporation which is an includible corporation if: (1) stock possessing at least 80 percent of the voting power of all classes of stock and at least 80 percent of each class of the non-voting stock of each of the includible corporations (except the common parent corporation) is owned directly by one or more of the common parent corporations; and (2) the common parent corporation owns directly stock possessing at least 80 percent of the voting power of all classes of stock and at least 80 percent of each class of the non-voting stock of at least one of the other includible corporations.

Section 4915(c)(1) of the Code provides that section 4915(a) of the Code shall be inapplicable in any case where the foreign corporation is formed or availed of by the United States person for the principal purpose of acquiring, through such foreign corporation, an interest in stock or debt obligations of one or more other foreign issuers or obligors direct acquisition of which by the United States person would be subject to the interest equalization tax imposed by section 4911 of the Code.

Section 4915(d) of the Code provides that section 4915(a) of the Code shall be inapplicable in any case where the acquisition of stock or debt obligations of the foreign corporation is made with intent to sell, or to offer to sell, any part of the stock or debt obligations acquired to United States persons.

Accordingly, under section 4915(a) of the Code, subject to the exceptions set forth in sections 4915(c) and 4915(d) of the Code, the interest equalization tax does not apply to the acquisition by S of the stock or debt obligations of a foreign corporation, if S (or one or more includible corporations in an affiliated group, as defined in section 1504 of the Code, of which S is a member) owns (directly or indirectly) 10 percent or more of the total combined voting power of all classes of stock of such foreign issuer or obligor immediately after such acquisition by S. Further, under section 4915(a)(1) of the Code, P will not be subject to interest equalization tax on the acquisition by P of common or preferred stock of S if, under section 4915(c)(1) of the Code, S does not acquire stock or debt obligations which would be subject to the interest equalization tax.

A United States person acting as a dealer or underwriter with respect to the preferred stock of S may avail himself of the credit or refund provisions of section 4919 of the Code (relating to sales by underwriters and dealers to foreign persons) provided the requirements of such section and the Temporary Regulations thereunder are satisfied.

Section 862(a)(2) of the Code provides that dividends other than those derived from sources within the United States as provided in section 861(a)(2) of the Code shall be treated as income from sources without the United States.

Section 861(a)(2)(A) of the Code provides, in relevant part, that an amount of gross income received as dividends from a domestic corporation other than a corporation less than 20 percent of whose gross income is shown to the satisfaction of the Secretary of the Treasury or his delegate to have been derived from sources within the United States for the 3 year period ending with the close of the taxable year of such corporation preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence) shall be treated as income from sources within the United States.

Accordingly, since less than 20 percent of S's gross income is derived from sources within the United States at all times, the amount of gross income received as a dividend from S is not treated as income from sources within the United States.

Section 1441(a) of the Code provides, in relevant part, that all persons, in whatever capacity acting, having the control, receipt, custody, disposal, or payment of any of the items of income specified in section 1441(b) of the Code (which includes dividends) to the extent that any of such items constitute gross income from sources within the United States, of any nonresident alien individual, or of any foreign partnership, shall deduct and withhold from such items a tax equal to 30 percent thereof.

Section 1442 of the Code provides, in relevant part, that in the case of foreign corporations, subject to income taxation under the Code, there shall be deducted and withheld at the source in the same manner and on the same items if income as is provided in section 1441 of the Code a tax equal to 30 percent thereof.

Accordingly, since the amount of gross income received as a dividend from S is not treated as income from sources within the United States, no withholding of United States income tax on its preferred stock dividends is required, if paid to holders who are nonresident alien individuals, nonresident alien fiduciaries, foreign partnerships or foreign corporations.

Section 1.1441-3(b)(1)(ii) of the Income Tax Regulations provides, in pertinent part, that the tax shall not be withheld at the source under section 1.1441-1 on the gross amount of any distribution which is treated as a distribution in part or full payment in exchange for stock.

Accordingly, if the conversion of S's preferred stock into the common stock of P is a distribution that qualifies as a distribution in part or full payment in exchange for stock, no withholding of United States income tax is required with respect to any gain realized by preferred stock holders of S upon such conversion who are nonresident alien idividuals, nonresident alien fiduciaries, foreign partnerships or foreign corporations.