Rev. Rul. 82-16

ISSUE

To what extent is a dividend received by a controlled foreign corporation from its wholly owned foreign subsidiary, under the circumstances described below, excluded from the controlled foreign corporation's "subpart F income" under section 959(b) of the Internal Revenue Code for purposes of applying section 951(a) to its United States shareholder?

FACTS

P, a domestic corporation, owns 70 percent of the only class of stock of S. S, a corporation formed under the laws of country X, is a "controlled foreign corporation" under section 957(a) of the Code, and P is a "United States shareholder" under section 951(b). The remaining 30 percent of the stock of S is held by non-United States shareholders.

S-1, a corporation formed under the laws of country Y, is a wholly owned subsidiary of S. S-1 is a "controlled foreign corporation" under section 957(a) of the Code by reason of the direct and indirect ownership rules of section 958(a), and P is a "United States shareholder" of S-1 under sections 951(b) and 958(a). During its tax year ending September 30, 1980, S-1 had "subpart F income" of 100x dollars and other income of 50x dollars. S-1's accumulated earnings and profits exceed 250x dollars, none of which are attributable to amounts previously included in P's gross income under section 951(a). On September 30, 1980, S-1 distributed 200x dollars in cash to S.

LAW AND ANALYSIS

Section 951(a)(1)(A)(i) of the Code provides that if a foreign corporation is a controlled foreign corporation for an uninterrupted period of 30 days or more during any tax year, every person who is a United States shareholder (as defined in section 951(b)) of the corporation and who owns (within the meaning of section 958(a)) stock in the corporation on the last day in the year on which the corporation is a controlled foreign corporation shall include in its gross income, for its tax year in which or with which the tax year of the corporation ends, its pro rata share of the corporation's "subpart F income" for that year.

Section 952(a)(2) of the Code provides that "subpart F income" includes, for any controlled foreign corporation, the foreign base company income as determined under section 954.

Section 954(a)(1) of the Code provides that "foreign base company income" for any tax year includes the foreign personal holding company income for the tax year determined under section 954(c) and reduced as provided in section 954(b)(5).

Section 954(c)(1) of the Code provides that the term "foreign personal holding company income" means the foreign personal holding company income as defined in section 553, with certain modifications and adjustments not relevant here.

Section 553(a)(1) of the Code provides that the term "foreign personal holding company income" includes that portion of gross income that consists of dividends.

Section 959(b) of the Code provides that, for purposes of section 951(a), the earnings and profits for a tax year of a controlled foreign corporation attributable to amounts that are, or have been, included in the gross income of a United States shareholder under section 951(a) shall not, when distributed through a chain of ownership described under section 958(a), be also included in the gross income of another controlled foreign corporation in the chain for purposes of applying section 951(a) to the other controlled foreign corporation with respect to the United States shareholder.

The 100x dollars of income constitutes "subpart F income" to S-1 as defined in section 952(a) of the Code because under section 1.952-1(c)(1) of the Income Tax Regulations "subpart F income" for a tax year is computed as of the close of the tax year without diminution for any distributions made during the tax year. As a result, under section 951(a)(1)(A)(i), P must include in its gross income for its tax year in which or with which the tax year of S-1 ends its pro rata share of S-1's "subpart F income" for the year ending September 30, 1980, which amounts to 70x dollars (70 percent X 100x dollars).

Under sections 952(a)(2), 954(a)(1) and (c), and 553(a)(1) of the Code, the dividends received by S from S-1 constitute "subpart F income" to S except to the extent the exclusion provisions of section 959(b) apply to the distribution. Section 959(b) was enacted for the specific purpose of preventing the income of a controlled foreign corporation, having once been included in the gross income of a United States shareholder, from being included in the gross income of the United States shareholder a second time when the income is distributed to another controlled foreign corporation. See Technical Explanation of S. Rep. No. 1881, 87th Cong., 2d Sess. 137, 256 (1962) 1962-3 C.B. 841, 960.

However, the question exists whether the provisions of section 959(b) of the Code apply to exclude only 70x dollars (P's pro rata portion of S-1's income included in P's income) from S's gross income or whether the exclusion applies to the entire 100x dollars of S-1's earnings and profits that are attributable to the 70x dollars included in P's gross income. The exclusionary language of section 959(b) looks to the total amount of earnings and profits of the controlled foreign corporation that caused the United States shareholder to be in receipt of gross income under section 951(a). The amount of S-1's earnings and profits that caused P to be in receipt of 70x dollars of gross income is 100x dollars. Further, if the exclusion of section 959(b) were limited to that portion of the distribution included in P's income (70x dollars) under section 951(a)(1)(A)(i), it would result in the inclusion in P's gross income of more than its pro rata share of S-1's income. This results because the 30x dollars not excluded would be considered "subpart F income" in the hands of S and P's pro rata share of 21x dollars (70 percent X 30x dollars) would be required to be included in P's income in addition to the 70x dollars of "subpart F income" already included from the S-1 level. Therefore, only by excluding 100x dollars from S's "subpart F income" can the stated purpose of section 959(b) of preventing the inclusion of previously taxed "subpart F income" (based on the amount of S-1's earnings and profits attributable thereto) be achieved.

Because section 959(b) of the Code excludes 100x dollars from S's "subpart F income" of 200x dollars, P also must include in its gross income for the same tax year its pro rata share of the remaining 100x dollars of S's "subpart F income," which is 70x dollars (70 percent X 100x dollars).

HOLDING

A portion of the dividend received by a controlled foreign corporation from its wholly owned foreign subsidiary, under the circumstances described above, is excluded from the controlled foreign corporation's "subpart F income" under section 959(b) of the Code for purposes of apply section 951(a) to its United States shareholder.