IRS EXAMINES FOREIGN TAX CREDIT TRANSITION ISSUES.

Rev. Rul. 92-62

PURPOSE

This revenue ruling provides guidance relating to transition issues that arise when a foreign country ceases to be described in section 901(j) of the Internal Revenue Code.

LAW

Section 901(a) of the Code allows a foreign tax credit against United States taxes for foreign income taxes paid or accrued by a taxpayer and for taxes deemed paid or accrued by a corporation under sections 902 and 960. Section 901(j)(1)(A) disallows a foreign tax credit for taxes paid or accrued to certain countries if the taxes are with respect to income attributable to a period during which the country is described in section 901(j)(2) ("sanction period"). Section 901(j)(1)(B) applies sections 904(a), (b), and (c), 902, and 960 separately with respect to income attributable to the sanction period from sources within the sanctioned countries. Section 952(a)(5) provides that in the case of a controlled foreign corporation ("CFC") all income derived from such a country during the sanction period shall be treated as subpart F income.

Rev. Rul. 89-44, 1989-1 C.B. 237, provided certain rules for taxpayers with operations in South Africa subject to the provisions of section 901(j)(2)(C) of the Code.

QUESTIONS AND ANSWERS

QUESTION 1.

When a country ceases to be described in section 901(j) of the Code during a person's taxable year, what taxes paid or accrued for that year are creditable?

ANSWER 1.

The date on which the Secretary of State certifies to the Secretary of the Treasury that a country is no longer described in section 901(j)(2)(A) or (C) of the Code is the final day of the period for which section 901(j) applies with respect to such country ("certification date"). Accordingly, a United States taxpayer must determine what income for the taxable year is attributable to, or derived during, the period ending on that date. Credits for foreign taxes paid or accrued to the foreign country with respect to that income are denied. However, foreign tax credits are allowed for taxes with respect to income attributable to the period beginning after that date. In the case of taxes deemed paid under section 902 or 960, credits are denied for foreign taxes allocated to income in a section 901(j) separate category under the rules of section 1.904-6. (For guidance on the effective date of the provisions discussed in this revenue ruling, see Rev. Rul. 92-63, page , this bulletin.) For example, foreign tax credits are denied for South African taxes with respect to income attributable to the period January 1, 1988 through July 10, 1991. However, foreign tax credits are allowed for South African taxes with respect to income attributable to the period beginning after July 10, 1991. Similarly, Yemeni taxes with respect to income attributable to the period beginning after May 22, 1990, are creditable.

QUESTION 2.

When a sanction period ends during a person's taxable year, how does the person determine the amount of income for that taxable year that is attributable to the sanction period?

ANSWER 2.

For purposes of applying section 901(j) of the Code to a taxable year that includes but does not end on the certification date, the principles of section 1.1502-76(b)(4) of the Income Tax Regulations shall apply. Taxpayers who have items that substantially affect taxable income, but whose amounts cannot be accurately determined as of the certification date, may make a reasonable estimate from existing data. Examples of these items are the last in, first out (LIFO) index for taxpayers using the dollar-value LIFO inventory method, the deferred gross profit for taxpayers with revolving charge accounts, intercompany adjustments for taxpayers that file consolidated returns, and the liquidation of a LIFO layer at the installment date that the taxpayer reasonably believes would be replaced at the end of the year.

QUESTION 3.

A country formerly described in section 901(j) of the Code imposes a withholding tax on a distribution after the sanction period. Is the tax creditable under section 901(a)?

ANSWER 3.

Yes, the withholding tax is creditable under section 901(a) of the Code. In the case of a distribution of previously taxed earnings and profits ("PTI"), the allocation of the distribution to the appropriate separate limitation category under section 904(d) and the determination of the amount of the increase in limitation with respect to the PTI under section 960(b) shall be made as if section 901(j)(1)(B) had not applied when the PTI was initially taken into income.

QUESTION 4.

Assume that under section 904(f)(5)(B) of the Code a United States taxpayer allocated a separate limitation loss from one separate category ("loss category") to a section 901(j) separate category for Country X, reducing the amount of income in that category. After the sanction period, the taxpayer has income in the loss category. Is that income recharacterized as income from the section 901(j) separate category to the extent otherwise provided in section 904(f)(5)(C)?

ANSWER 4.

Yes. Section 904(f)(5) of the Code provides, in part, that separate limitation losses for any taxable year (to the extent the losses do not exceed the separate limitation incomes for that year) shall be allocated proportionately among (and operate to reduce) amounts of income in other separate categories. Thus, the taxpayer's original allocation of separate limitation loss to the section 901(j) separate category was proper.

Section 904(f)(5)(C) of the Code requires that if a separate limitation loss from a loss category was allocated to income in any other category and the loss category has income in a subsequent taxable year, then that income shall be recharacterized as income in the other category in proportion to the prior reduction. However, the amount of income recharacterized and allocated to the other category must not exceed the aggregate separate limitation losses from the loss category not previously recharacterized. Accordingly, a United States taxpayer that allocated a separate limitation loss from a loss category to a section 901(j) separate category must recharacterize and allocate, under section 904(f)(5), subsequent income in that loss category to the section 901(j) separate category. Section 904(f)(5) requires a taxpayer to allocate subsequent income to the section 901(j) separate category even if such a category is not otherwise applicable because the country for which the section 901(j) separate category was established has ceased to be described in that section.

QUESTION 5.

Assume that a United States corporation owns 100% of the stock in FC, a corporation engaged in business in Country X, which is a country described in section 901(j) of the Code. During year 1, FC has earnings and profits ("E&P") in excess of its taxable income (computed under United States tax principles) because of the operation of section 312(n)(4), (5), or (6). Section 952(c)(1)(A), in general, limits the amount of income to be included currently as subpart F income to the amount of the E&P for that taxable year. The United States shareholder's Year 1 subpart F inclusion is therefore less than FC's Year 1 E&P. In Year 2, the foreign country ceases to be described in section 901(j). FC has no additional E&P in years 2 and 3. In Year 3, FC distributes all of its Year 1 E&P to its United States shareholder. The portion of such E&P included in the shareholder's income in Year 1 is excluded from Year 3 income under section 959. The remainder is included in the shareholder's income as a dividend. For purposes of section 904(d)(3), into what separate category or categories does the shareholder place this income?

ANSWER 5.

The income is allocated to the section 904(d) category in which it would have been placed had section 901(j) not applied to FC. No foreign tax credit is permitted for any Country X taxes deemed paid with respect to this distribution, as provided in Answer 1. If the distribution of the E&P in excess of the subpart F inclusion in year 1 had been distributed during the sanction period, the income from such distribution would have been allocated to the section 901(j) basket.

QUESTION 6.

In year 1, CFC recognized income from sources within a country described in section 901(j) of the Code but had no E&P for the year. The section 901(j) income was not taxed to the CFC's United States shareholder as subpart F income under section 952(a)(5) in Year 1 because section 952(c)(1)(A) limits subpart F income to the amount of E&P for that year. In year 2, the country ceased to be described in section 901(j). How do sections 952(c)(2) and 904 apply to E&P accumulated by the CFC in a subsequent year?

ANSWER 6.

Section 951(a) of the Code provides that a pro rata share of subpart F income of a CFC must be included currently in the gross income of a United States shareholder. Section 952(c)(1)(A) provides that subpart F income of a CFC in a particular taxable year may not exceed the CFC's E&P for the year. Accordingly, it is possible that a CFC will have income from sources within a country subject to section 901(j) that is not subpart F income by virtue of section 952(c)(1)(A). However, section 952(c)(2) requires that if the subpart F income of a CFC for any taxable year was reduced because of the limitation in section 952(c)(1)(A), any excess E&P of the corporation in a subsequent year over the subpart F income of the corporation for the taxable year shall be recharacterized as subpart F income under rules similar to the rules in section 904(f)(5). Therefore, it is necessary to recharacterize the excess E&P in the subsequent year as subpart F income, and to allocate an appropriate portion of the subpart F income to the section 901(j) separate category for purposes of section 904, even if that excess E&P is accumulated after the sanction period.

QUESTION 7.

Is the former United States-South Africa Income Tax Convention, 3 U.S.T. 3821, in force after July 10, 1991?

ANSWER 7.

No. The United States terminated the treaty on October 15, 1986, effective July 1, 1987. The removal of other economic sanctions against South Africa does not revive the treaty.

DRAFTING INFORMATION

The principal author of this revenue ruling is Thomas L. Ralph of the Office of Associate Chief Counsel (International). For further information regarding this revenue ruling contact Mr. Ralph at (202) 622-3880 (not a toll-free call).