Rev. Rul. 70-312

Advice has been requested whether a foreign corporation qualified as a "less developed country corporation" within the meaning of section 4916(c) of the Internal Revenue Code of 1954, and, if so, whether certain acquisitions of the foreign corporation's debt obligations by X, a domestic corporation, were entitled to the exclusion under section 4916(a)(2) of the Code from the interest equalization tax imposed by section 4911 of the Code.

M is a foreign corporation whose only business has been, and is, the extraction and sale of oil from the area of the Kuwait-Saudi Arabia Neutral Zone pursuant to oil concession agreements with the Governments of Kuwait and Saudi Arabia.

During the period from October 1965, through March 1966, X made three loans to M. The loans, evidenced by M's interest bearing promissory notes each in the amount of 100x dollars, were made in October 1965, December 1965, and March 1966, respectively. Each loan had a period remaining to maturity of 2 years.

Section 4911 of the Code, in relevant part, imposes an interest equalization tax on the acquisition by a United States person of a debt obligation of a foreign obligor, if the obligation has a period remaining to maturity of one year or more.

Section 4916(a)(2) of the Code provides that the interest equalization tax will not apply to the acquisition by a United States person of the stock or debt obligation of a less developed country corporation. Under section 4916(c)(1), a "less developed country corporation" is defined as, among others, a foreign corporation which, for its annual accounting period in which the acquisition was made and for the annual accounting period immediately before and immediately after such period, meets the requirements set forth in section 955(c)(1) of the Code. Under the latter requirements, in general, the foreign corporation must be engaged in the active conduct of a trade or business and must (1) derive at least 80 percent of its gross income from sources within less developed countries, and (2) have at least 80 percent of its assets on each day of the taxable year composed of, among other, property used in its trade or business and located in less developed countries.

M met the requirements of section 955(c)(1) of the Code with respect to the active conduct of a trade or business, the sources of its income, and the character of its assets for the annual accounting periods immediately prior to the ones in which the acquisitions in question occurred, for the annual accounting periods in which the acquisitions occurred, and for the annual accounting periods immediately thereafter.

Section 4916(b) of the Code, in relevant part, defines a "less developed country" as any foreign country (other than an area within the Sino-Soviet bloc) with respect to which, as of the date of an acquisition for which an exclusion is sought under section 4916(a) of the Code, there is in effect an Executive Order issued by the President of the United States designating such country as an economically less developed country for purposes of the interest equalization tax. Section 4916(b) of the Code further provides, however, that once the President so designates a foreign country as a less developed country, he cannot terminate such designation (either directly or indirectly by a subsequent Executive Order) unless, at least 30 days prior to such termination, he notifies Congress of his intention to do so. For purposes of section 4916(b), a territory, department, province, or possession of a foreign country may be designated as a separate foreign country.

The President has issued two Executive Orders pursuant to section 4916(b) of the Code. Under Executive Order 11224, C.B. 1965-1, 507, dated May 14, 1965, the Kuwait-Saudi Arabia Neutral Zone was designated a less developed country for purposes of the interest equalization tax. On December 7, 1965, the President gave the required notice of his intention to terminate the status of the Kuwait-Saudi Arabia Neutral Zone and certain other areas as less developed countries, but no formal termination of such status was made until the issuance of Executive Order 11285, C.B. 1966-2, 480, dated June 10, 1966.

Section 3 of Executive Order 11285, entitled "Prior commitments to acquire," sets forth a special rule with respect to the application of sections 1 and 2 of that Order (which, in effect, terminate the status of several areas--including the Kuwait-Saudi Arabia Neutral Zone--as less developed countries) in the case of certain acquisitions made on or after the effective date of that Order. In general, section 3 of Executive Order 11285 permits a foreign country which had the status of a less developed country prior to the effective date of that Order (but which status is being terminated by that Order) to be considered a less developed country with respect to an acquisition made (i.e., completed) on or after the effective date of that Order if the acquisition was made pursuant to a binding commitment to acquire that existed prior to December 7, 1965. According to section 5 of Executive Order 11285, that Order is effective as of the time of its filing for publication in the Federal Record, which was 12:23 p.m. on June 10, 1966. Accordingly, section 3 of Executive Order 11285 does not apply to acquisitions completed prior to that time.

Section 4916 of the Code does not clearly prescribe the treatment to be afforded acquisitions of stock or debt obligations of a less developed country corporation where the status of the less developed country in question is terminated prior to the corporation's annual accounting period following the one in which the acquisition occurs. However, section 4916 of the Code has remained substantially unchanged from its original enactment as part of the Interest Equalization Tax Act (Public Law 88-563, C.B. 1964-2, 615) and, pertinent to the question at hand, the legislative history of that Act (House Report 1046, 88th Congress, 1st Session, C.B. 1964-2, 708 at 746) states:

The designation of a country as a less developed country under section 4916 can be terminated . . . only by a further Executive Order after 30 days' notice to the Congress. Any such termination will not affect the treatment of acquisitions occurring prior to the issuance of the terminating Executive Order. [Emphasis supplied.]

Based on the foregoing, it is held that M, with respect to each of the acquisitions in question (which were prior to June 10, 1966) met the qualifications for a less developed country corporation as defined by section 4916(c)(1) of the Code. Accordingly, such acquisitions are entitled to the exclusion from interest equalization tax provided by section 4916(a)(2) of the Code.