Rev. Proc. 65-31

SECTION 1. BACKGROUND AND PURPOSE.

Section 3 of Revenue Procedure 64-54, C.B. 1964-2, 1008, prescribes the policy and procedure of the internal Revenue Service for the treatment of United States controlling taxpayers who are subjected to "economic double taxation" for their taxable years beginning prior to January 1, 1963, arising from the application of section 482 of the Internal Revenue Code of 1954 (section 45 of the Internal Revenue Code of 1939) to the United States controlling taxpayers and one or more of their controlled foreign entities. Requests have been received for more complete instructions and guidelines on the manner in which such relief is to be determined. This Revenue Procedure provides such guidelines. It also suggests that taxpayers desiring relief from "economic double taxation" under Revenue Procedure 64-54 should determine whether to elect the benefits provided by Revenue Procedure 65-17, C.B. 1965-1, 833, which governs the adjustment of accounts and the transfer of amounts as the result of section 482 allocations. Finally, the Revenue Procedure sets forth certain consequences of a section 482 allocation if Revenue Procedure 65-17 is not availed of or applicable.

SEC. 2. MITIGATION OF ECONOMIC DOUBLE TAXATION.

.01 Section 3 of Revenue Procedure 64-54 provides relief from economic double taxation by the allowance of an offset against the United States tax attributable to the adjustment under section 482 of the Code. The amount of this relief will hereinafter be referred to as the "offset." Section 3.01 of Revenue Procedure 64-54 states:

"For its taxable years beginning prior to January 1, 1963 (subject to the other provisions of this Revenue Procedure), a United States controlling taxpayer will be granted relief from economic double taxation resulting from allocations under section 482 of the Code. Such a taxpayer will be allowed by the Service to offset against the United States tax attributable to the section 482 allocation an amount equal to the amount by which the controlled foreign entity's foreign income tax liability as actually determined exceeded the amount which would have been determined to be such liability if the controlled foreign entity had originally treated the transactions giving rise to the section 482 allocation in a manner consistent with the section 482 allocations. The amount of the relief shall be limited to that portion of the United States controlling taxpayer's tax liability which is attributable to the section 482 allocation."

(1) The computation of the amount of offset shall be made by the taxpayer and will be subject to review and approval of the Director of International Operations. In reviewing the computation of the offset, the Director of International Operations will not modify or question the amount of the section 482 allocation. The material covered in this section and the examples set forth in Section 3, below, will provide taxpayers with a working knowledge of the manner of computing the offset and its effect upon the foreign tax credit attributable to dividend distributions made by the foreign entity.

(2) The amount of the offset is computed as follows:

(a) Compute the amount of the section 482 allocation in United States currency, and, where applicable, in the currency used by the foreign entity in reporting its income and expenses on tax returns prepared for the particular countries involved. See section 1.964- 1(d) of the Income Tax Regulations for appropriate exchange rates.

(b) Determine, in the foreign currency, the amount by which the foreign income tax liability of the controlled foreign entity of the United States controlling taxpayer, computed BEFORE giving effect to the section 482 allocation, exceeded the hypothetical foreign income tax of such controlled foreign entity, computed AFTER giving effect to the section 482 allocation.

(c) Convert the amount determined to be such excess tax of the controlled foreign entity (as determined in (b) above) into United States currency. The exchange rate used shall be the same rate used to determine the allocation.

(d) The amount determined in (c) above is the offset to be used to reduce the United States income tax liability of the United States controlling taxpayer affected by the section 482 allocation. The reduction shall be made to the liability determined after the section 482 allocation but before the allowance of any foreign tax credits. The offset may not exceed the taxpayer's additional federal income tax attributable to the section 482 allocation.

(3) For purposes of this section the foreign income tax liability includes any tax that would be recognized as an income, war profits, or excess profits tax for foreign tax credit purposes.

(4) Relief for the purpose of this section can be granted only when there is double taxation which would have been avoided if the transaction had been handled initially in a manner consistent with the section 482 allocation. Section 482 allocations may at times have no effect on the tax liability of the controlled foreign entity. In such situations there will be no relief by way of offset. Some examples are:

(a) EXAMPLE. -- A section 482 adjustment allocating a capital gain from a controlled foreign entity, where the foreign country does not tax capital gains, would not entitle the United States controlling taxpayer to relief as no economic double taxation resulted.

(b) EXAMPLE. -- A section 482 allocation results in the shifting of certain expenses from the United States controlling taxpayer P, to the controlled foreign entity X. If such expenses would not have been deductible under the income tax laws of the particular foreign country, no relief will be allowed.

(5) The fact that the United States controlling taxpayer owns less than 100 percent of the stock of the controlled foreign entity shall not serve to reduce the amount of the offset to be allowed.

.02 In order for a United States controlling taxpayer to obtain relief from economic double taxation the conditions listed in section 3.02 of Revenue Procedure 64-54 must be met for each taxable year.

SEC. 3. ILLUSTRATIVE EXAMPLES.

.01 The following examples will illustrate the methods to be used in determining the tax offset to be allowed under section 3 of Revenue Procedure 64-54. Some of the examples illustrate the effect of the allocation and the offset on dividend distributions but do not cover the dividend exclusion provisions of section 4.01 of Revenue Procedure 65-17.

EXAMPLE 1. -- A United States controlling taxpayer reported taxable income of $300,000 in 1961, all of which was from United States sources. The controlled foreign entity reported taxable income of $200,000 on which foreign tax was paid at a rate of 40 percent. The foreign entity paid no dividends in 1961 or the first 60 days of 1962. Expenses of $100,000 are allocated under section 482 of the Code from the taxpayer to the foreign entity. These expenses would have been deductible under the laws of the foreign country. The amount of the offset and the resulting effect on earnings and profits of both entities are computed as follows:

             OFFSET -- IN YEAR OF NO DIVIDEND DISTRIBUTION

              OFFSET -- IN YEAR OF DIVIDEND DISTRIBUTION

                                                            Rate

             OFFSET -- IN YEAR OF NO DIVIDEND DISTRIBUTION

             OFFSET -- IN YEAR OF NO DIVIDEND DISTRIBUTION

              OFFSET -- IN YEAR OF DIVIDEND DISTRIBUTION

EXAMPLE 6. -- Assume the income tax returns of United States Corporation M and Foreign Corporation Z provide the following information for the year 1962. The examiner determines that $100,000 royalty is to be allocated from Z to M. The tax effect of the allocation and offset is as follows:

                                             Domestic       Foreign

      Foreign tax credit claimed before

.01 Taxpayers desiring relief from economic double taxation under section 3 of Revenue Procedure 64-54 should at the same time determine whether to elect the benefits provided by Revenue Procedure 65-17. Revenue Procedure 65-17, among other things, permits a qualifying United States taxpayer whose taxable income has been increased by reason of an allocation under section 482 of the Code, to receive payment from the related entity from, or to which, the allocation of income, or deduction, was made, of an amount determined in accordance with the revenue procedure, without having the receipt of such amount considered as a taxable distribution for Federal income tax purposes. As indicated hereinafter, failure to request the benefits provided by Revenue Procedure 65-17, prior to the granting of relief under section 3 of Revenue Procedure 64-54, will preclude a later attempt to take advantage of such provisions.

.02 Under Revenue Procedure 65-17, the United States taxpayer must file a request for the treatment provided by that Revenue Procedure in writing with the District Director before closing action (as defined in section 4.03 below) is taken on the section 482 issue. However, Revenue Procedure 64-54 requires that, as a condition of obtaining relief from economic double taxation, the taxpayer must enter into a closing agreement with respect to the section 482 allocation. Thus, a closing agreement under Revenue Procedure 64-54 or other action listed in section 4.03 below, will constitute closing action on the section 482 issue, and foreclose availability of Revenue Procedure 65-17. Accordingly, if a taxpayer desires the benefits provided by Revenue Procedure 64-54 and Revenue Procedure 65-17, he must file his request under Revenue Procedure 65-17 before any closing action on the section 482 issues is taken.

.03 For purposes of this Revenue Procedure and Revenue Procedure 65-17, the first occurring of the following shall constitute "closing action":

(1) Execution and acceptance of Form 870-AD, Offer of Waiver of Restrictions on Assessment and Collection of Deficiency in Tax and of Acceptance of Overassessment, or execution of a closing agreement relative to the section 482 allocation.

(2) Stipulation of a section 482 allocation in the Tax Court of the United States.

(3) Expiration of the statute of limitations for the year to which the allocation applies.

(4) Final determination of tax liability for the year to which the allocation relates by offer-in-compromise, closing agreement, or court action.

.04 Where a taxpayer requests relief under section 3 of Revenue Procedure 64-54, but does not desire the treatment provided by Revenue Procedure 65-17 or fails to make timely request for such treatment, the amount of the allocation, reduced by the offset granted, will be considered as of the last day of the taxpayer's taxable year for which the allocation is made as follows:

(1) If the United States taxpayer directly controls the foreign entity which was a party to the section 482 allocation, such amount will be considered as being a contribution to the capital of the controlled foreign entity.

(2) If the foreign entity (a second or lower tier subsidiary) which was a party to the allocation is directly controlled by another entity, and such other entity (a first tier subsidiary) is directly controlled by the United States taxpayer, such amount will be considered as being a contribution by such taxpayer to the capital of its first tier subsidiary.

(3) Where the allocation is between two corporate entities (sister-brother corporations) controlled by the same shareholder, such amount will be treated as a distribution to the controlling shareholder with respect to the stock of the entity whose income is increased and as a capital contribution to the entity whose income is reduced by the allocation.

.05 A taxpayer may elect to establish an account receivable in an amount less than the maximum amount which could have been established as an account receivable. The difference between the amount which could have been established and the amount actually established will be treated in the same manner as prescribed in the applicable paragraph of section 4.04, above.

SEC. 5. EFFECT ON OTHER DOCUMENTS.

This Revenue Procedure amplifies section 3 of Revenue Procedure 64-54, C.B. 1964-2, 1008, and discusses its relationship to Revenue Procedure 65-17, C.B. 1965-1, 833.