Rev. Rul. 71-340

Advice has been requested whether the exemption from the interest equalization tax provided by section 4914(b)(3) of the Internal Revenue Code of 1954 is applicable under the circumstances described below.

The taxpayer is a domestic corporation engaged in the sale and distribution of travelers checks. It maintains branches in the United Kingdom and other countries through which travelers checks are sold and distributed. Such checks are also sold by banks and travel agencies in the United Kingdom and other foreign countries. These checks are payable in pound sterling.

The excess of the proceeds from the sale of checks not needed to cover current redemptions of the checks are sent to the taxpayer's main office in London and credited to an account which the United Kingdom Exchange Control Authorities have designated as an internal account for exchange control purposes. Funds in the internal account may not be invested in other than sterling securities except with the consent of the Bank of England. If consent is granted for the investment of the funds in dollar securities, the conversion of pound sterling into dollars usually carries a high premium. The taxpayer invested the internal account funds in debt obligations of the United Kingdom government; 50 percent in short-term (less than one year) obligations and 50 percent in long-term (one year or more) obligations.

Section 4911(a) of the Code imposes the interest equalization tax on each acquisition by a United States person of stock of a foreign issuer, or of a debt obligation of a foreign obligor (if such obligation has a period remaining to maturity of one year or more). Conversely, debt obligations having a period remaining of less than one year are not subject to interest equalization tax.

Section 4914(b)(3) of the Code exempts from the interest equalization tax the direct acquisition by a United States person doing business in a foreign country of stock or debt obligations of foreign issuers or obligors to the extent that such acquisitions is reasonably necessary to satisfy minimum requirements relating to holdings of stock or debt obligations of foreign issuers or obligors imposed by the laws of such foreign country. House Report No. 1046, Eighty-eighth Congress, First Session, C.B. 1964-2, 708, at page 721, states that the exemption provided by section 4914(b)(3) of the Code is intended to apply to acquisitions of foreign securities which arise from business necessity and are not influenced by interest rate differentials.

Section 4916 of the Code provides, in part, an exemption from interest equalization tax with respect to the acquisition by a United States person of stock or debt obligation of a less developed country or of a less developed country corporation.

Revenue Ruling 69-11, C.B. 1969-1, 293, holds that the exemption provided by section 4914(b)(3) of the Code applies in the case where, under the laws of the foreign country, a United States corporation doing business in that country is required to deposit cash or bonds of that foreign country with the government of that foreign country as a condition to doing business there. The fact that the corporation acquired bonds for purposes of meeting the deposit requirement was considered reasonably necessary to satisfy the minimum requirements of the foreign country as a condition to doing business in that country.

In the instant case, the taxpayer was not restricted to the acquisition of United Kingdom long-term bonds only. It could have invested all of its internal account funds in short-term debt obligations of the United Kingdom government or it could have invested the 50 percent of its internal account funds that had been invested in long-term United Kingdom debt obligations in short-term sterling debt obligations of other foreign countries. In either case these short-term debt obligations would not be subject to interest equalization tax. It could also have invested such 50 percent of its internal account funds in short-term or long-term sterling debt obligations of less developed countries, or in short-term or long-term sterling debt obligations or stock of less developed country corporations. These acquisitions would have been exempt from interest equalization tax under section 4916 of the Code. In addition, it could have converted such 50 percent of its internal account funds into United States dollar securities at a high premium with the consent of the Bank of England. Therefore, the restriction to purchase sterling securities is not a restriction within the meaning of section 4914(b)(3) of the Code.

Accordingly, the investment by the taxpayer of 50 percent of its internal account funds in long-term United Kingdom debt obligations is not exempt from the interest equalization tax pursuant to section 4914(b)(3) of the Code.

Revenue Ruling 69-11, C.B. 1969-1, 293, distinguished.