Rev. Rul. 76-192

Advice has been requested whether, under the circumstances described below, a loan by a foreign subsidiary to its domestic parent was an investment by an affiliated foreign subsidiary in "United States property" as defined in section 956 of the Internal Revenue Code of 1954.

Y, a domestic corporation, owned all of the outstanding stock of X, a controlled foreign corporation. X was engaged in providing working capital and funds for expansion of Y's business both in the United States and abroad through its other affiliates. To obtain additional funds for such financing, X, on January 1, 1971, sold debt obligations to underwriters for offer and sale to the public outside the United States. The proceeds from the sale of these debt obligations were deposited by X with an unrelated foreign financial institution.

On January 31, 1971, Z, a newly organized wholly owned foreign subsidiary of Y, borrowed at an arm's length interest rate for a term of two years from the same financial institution the same amount as had been deposited by X. The proceeds of the borrowing by Z were loaned to Y, also for a term of two years and at an arm's length interest rate. Payments of the principal and interest on the loan to Z was guaranteed by Y. At December 31, 1971, Z had no earnings and profits.

The deposit by X with the financial institution was denominated a demand deposit and was not under any formal agreement collateral or security for repayment of the loan made by the financial institution to Z. The funds deposited by X were not withdrawn by X until Z repaid the amount it had borrowed. The difference in the rate between the interest the financial institution paid X on its deposit and the interest the institution charged Z on its loan was a fraction of one percent.

The specific question is whether the loan by Z to Y was an investment by X in United States property within the meaning of 956 of the Code.

Section 951(a)(1)(B) of the Code provides, in part, that if a foreign corporation is a controlled foreign corporation for an uninterrupted period of 30 days or more during any taxable year beginning after December 31, 1962, every person who is a United States shareholder of such corporation and who owns stock in such corporation on the last day, in such year, on which such corporation is a controlled foreign corporation shall include in his gross income, for his taxable year in which or with which such taxable year of the corporation ends, his pro rata share (determined under section 956(a)(2)) of the corporation's increase in earnings invested in United States property for such year.

Section 956(a)(1) of the Code provides that the amount of earnings of a controlled foreign corporation invested in United States property at the close of any taxable year is the aggregate amount of such property held, directly or indirectly, by the controlled foreign corporation at the close of the taxable year, to the extent such amount would have constituted a dividend if it had been distributed.

Section 956(b)(1)(C) of the Code provides, in part, that for purposes of section 956(a) the term "United States property" means any property acquired after December 31, 1962, which is an obligation of a United States person. Under section 7701(a)(30)(C), a domestic corporation is a United States person. Therefore, X invested earnings in United States property within the meaning of Section 956 if X held, directly or indirectly, Y's obligation.

For purposes of determining the amount of a controlled foreign corporation's earnings invested at the close of its taxable year in United States property, section 1.956-1(b)(3) of the Income Tax Regulations provides that a controlled foreign corporation will be considered to hold indirectly the investments in United States property held on its behalf by another foreign corporation which is controlled by the controlled foreign corporation and which is created or availed of by it principally for the purpose of holding United States property.

Section 957(a) of the Code provides that for purposes of Subpart F a foreign corporation is "controlled" if more than fifty percent of the total combined voting power of all classes of stock entitled to vote is owned (within the meaning of section 958(a)) or is considered as owned by applying the rules of ownership of section 958(b).

In general, section 958(b) of the Code provides that section 318(a) (relating to constructive ownership of stock) shall apply to the extent that the effect is to treat a foreign corporation as a controlled foreign corporation under section 957. Specifically, section 1.958-2(d)(1)(iii) of the regulations restates the attribution rule contained in section 318(a)(3)(C) that if fifty percent or more in value of the stock of a corporation is owned, directly or indirectly, by or for any person, such corporation shall be considered as owning stock owned, directly or indirectly, by or for such person. Thus, since X is wholly owned by Y, X is considered as owning the Z stock owned by Y and is considered to control Z for purposes of section 957(a) and section 1.956-1(b)(3) of the regulations.

The facts of this case indicate that Z was availed of by X principally for the purpose of holding Y's obligation and that Z held Y's obligation on X's behalf. Each of the described steps from the January 1, 1971, sale by X of debt obligations to the loan to Y was undertaken as part of an overall plan to enable Y to obtain funds from its foreign subsidiaries. Although the deposit by X in the foreign financial institution is nominally a demand deposit, the sale by X of debt obligations and deposit of the proceeds in the foreign financial institution as part of this overall plan to enable Y to obtain funds from its foreign subsidiaries indicates that the financial institution would not have made the loan to Z without the deposit by X. Similarly, the fractional difference in interest rates, referred to above, indicates that the financial institution is acting in this transaction as a mere conduit and that it would not have made the loan to Z without X's deposit.

Accordingly, it is held that under section 1.956-1(b)(3) of the regulations the deposit in the foreign financial institution by X of the proceeds of the sale of the debt obligations and the loan to Y by Z of funds borrowed by Z from such institution constituted an investment of the earnings of X in United States property to the extent such loan to Y did not exceed the earnings and profits of X available for distribution as a dividend.