Rev. Rul. 55-392

Advice has been requested whether a corporation is entitled to a net capital addition for the purposes of computing its excess profits credit based on income where there has been a decrease in inadmissible assets in conjunction with an increase in operating assets, the decrease in inadmissibles resulting when stock in a wholly-owned subsidiary was distributed by the corporation to its controlling stockholders as a dividend.

In the instant case, the corporation distributed to its two controlling corporations as a dividend all of its stock in a wholly-owned subsidiary. The distribution resulted in a net decrease in inadmissible assets of the distributing corporation for the taxable year in the amount of 1.5 x dollars. During the same taxable year, there was a net increase of .3 x dollars in the corporation's operating assets which came about by reasons other than the stock distribution, since no additional funds were obtained by the corporation as a result of the stock dividend.

Section 435(g)(9) of the Internal Revenue Code of 1939 provides that the excess of the decrease in inadmissible assets for the taxable year over the net capital reduction for the taxable year shall be considered the net capital addition (or shall be added to the net capital addition otherwise determined), subject to the exceptions and limitations provided in paragraph (10) of that section. One of the limitations in paragraph (10) is that such excess of the decrease in inadmissibles shall not be greater than the excess of the increase in operating assets for the taxable year over the net capital addition (determined without certain limitations that are not pertinent here) for that year.

The purpose of paragraph (9) of section 435(g) of the Code is that `reductions in inadmissible assets subsequent to the base period are to be allowed a credit as capital additions provided that the additional capital is invested in operating assets.' Senate Report No. 781, 82d Cong., C.B. 1951-2, 458 at 515. Operating assets, as defined in paragraph (10) of section 435(g), supra , means property used in the taxpayer's trade or business, stock in trade or other property of a kind which would properly be includible in the inventory of the taxpayer, and property held by the taxpayer primarily for sale to customers in the ordinary course of the taxpayer's trade or business. It is apparent that the intent of section 435(g)(9) of the Code is that a capital addition under that section should result where additional funds were obtained from the disposal of inadmissible assets and such funds are used to finance expanding manufacturing operations, facilities, or inventories. While in some instances an increase in operating assets could come about by reasons other than by the sale of inadmissible assets, as, for example, from indebtedness incurred which constituted borrowed capital, a decrease in inadmissible assets for the purpose of section 435(g)(9) would not appear pertinent where no additional capital was made available to the taxpayer. In the instant case, no additional funds were obtained as a result of the taxpayer distributing stock in a wholly-owned subsidiary as a dividend.

Accordingly, it is held that in determining a net capital addition section 435(g) of the Code for the purposes of the excess profits credit based on income, a distribution by a corporation of the stock of a wholly-owned subsidiary as a dividend, which distribution reduces the corporation's inadmissible assets and does not provide funds used in increasing its operating assets, does not result in a net capital addition within the meaning of section 435(g)(9) of the Code