Rev. Rul. 85-3

ISSUE

Whether an affiliated group of domestic corporations filing a consolidated return is entitled to a credit under section 902 of the Internal Revenue Code for foreign income taxes paid by a foreign corporation under the circumstances described below.

FACTS

P is a domestic corporation that owns all of the stock of four domestic subsidiary corporations. P and its subsidiaries are an affiliated group within the meaning of section 1504(a) of the Code and P filed a consolidated income tax return for the tax year 1984.

P and its four subsidiaries each own 2.5 percent of the voting stock of FX, a foreign corporation incorporated under the laws of foreign country FC. During the 1984 tax year P and its subsidiaries each received a cash dividend from FX with respect to each corporation's voting stock interest in FX. FX paid a creditable foreign income tax to FC with respect to its accumulated profits from which the dividend distributions were made.

LAW AND ANALYSIS

Subject to certain limitations, section 901 of the Code permits domestic corporations to claim a credit for foreign income taxes paid to foreign countries. Section 902(a) provides that a domestic corporation that owns at least 10 percent of the voting stock of a foreign corporation from which it receives dividends paid out of the accumulated profits of the foreign corporation shall be deemed to have paid a specified portion of any creditable income tax paid or deemed paid by the foreign corporation to any foreign country on or with respect to such accumulated profits.

Section 902(a) of the Code does not provide that a domestic corporation may satisfy the stock ownership requirement indirectly by ownership of domestic subsidiaries which, in turn, own in the aggregate 10 percent of the voting stock of the foreign corporation making the dividend distribution. Indirect stock ownership for purposes of the foreign tax credit is provided for only in section 902(b)(1) which provides, in general, that a 10 percent owned foreign subsidiary will be deemed to have paid a certain percentage of foreign income taxes paid by its 10 percent owned foreign subsidiary. Section 902(b)(2) extends the provision for indirect ownership to third tier foreign subsidiary corporations.

Section 1502 of the Code provides, in general, that the Secretary shall prescribe such regulations as he may deem necessary in order that the tax liability of any affiliated group of corporations may be determined in such a manner as clearly to reflect the income tax liability. Section 1.1502-4(c) provides that the foreign tax credit for the consolidated return year shall be determined on a consolidated basis under the principles of sections 901 through 905 and section 960.

Section 1.502-34 of the regulations provides, in part, that for purposes of sections 1.1502-1 through 1.1502-80, in determining the stock ownership of a member of the group in another corporation (the `issuing corporation`) for purposes of determining the application of section 165(g)(3)(A), 332(b)(1), 333(b), 351(a), or 904(f), in a consolidated return year, there shall be included stock owned by all other members of the group in the issuing corporation.

Section 1.1502-80 of the regulations provides that the Code, or other law, shall be applicable to an affiliated group to the extent the regulations do not exclude its application.

To be applicable, section 902(a) requires that the domestic corporation receiving the dividend be one which `owns` at least 10 percent of the voting stock of the foreign corporation. Generally, when the income tax laws require a person to own a certain percentage of voting stock, they mean `own` in the ordinary, common sense understanding of the term; that is, actual or outright ownership. See, for example, Trotz v. Commissioner, 361 F.2d 927 (10th Cir. 1966). Section 902(a) does not contain any indirect ownership provisions that make indirect ownership a part of actual or direct ownership. Indirect ownership is dealt with in section 902(b), but only in terms of attributing foreign taxes paid by indirectly owned foreign corporations to a domestic corporation, and not in terms of attributing one domestic corporation's ownership of a foreign corporation to another domestic corporation.

Section 1502 of the Code and the regulations thereunder do not provide for an exception to the requirement provided for in section 902(a) that a domestic corporation own directly 10 percent or more of the voting stock of a foreign corporation in order to be deemed to have paid foreign income taxes paid by the foreign corporation. Section 1.1502-34 of the regulations does not provide for the aggregation of all of the voting stock of a foreign corporation owned by the domestic members of the group for the purpose of determining the application of section 902(a) of the Code. Neither P nor any of its four subsidiaries owns directly 10 percent of the voting stock of FX.

HOLDING

The affiliated group of corporations consisting of P and its domestic subsidiaries is not entitled to a credit under section 902 of the Code for foreign income taxes paid by FX with respect to its accumulated profits.