PROCEDURES ARE SET FORTH FOR ADJUSTMENTS AND RECLASSIFICATION OF DISC DISTRIBUTIONS WHERE INTERCOMPANY PRICES HAVE BEEN REDETERMINED BY IRS

Rev. Proc. 85-45

SECTION 1. PURPOSE AND SCOPE

The purpose of this revenue procedure is to modify and supersede Rev. Proc. 84-3, 1984-1 C.B. 361, in order to conform it to section 1.994-1(e)(5)(v) of the Income Tax Regulations.

Rev. Proc. 84-3 prescribes the conditions and the procedures to be followed in cases in which intercompany prices paid by a domestic international sales corporation (DISC) to its related supplier or commissions paid by a related supplier to a DISC, as originally determined by the parties under section 994 of the Internal Revenue Code, are redetermined by the Internal Revenue Service in a manner that results in an increase of the intercompany prices or reduction of the commissions. Procedures are prescribed below by which the DISC's related supplier and/or shareholder may request an adjustment of accounts and a reclassification of actual distributions previously made with respect to all or a part of the amount of the pricing or commission redetermination.

SECTION 2. BACKGROUND

Section 995(b) of the Code treats a portion of a DISC's taxable income for each taxable year as a deemed distribution to its shareholder, which is taxable to the shareholder as a dividend. Under section 996(a)(3), actual distributions by a DISC out of previously taxed income (PTI), which consists of amounts taxed to a DISC's shareholder under section 995(b), are excluded from the shareholder's gross income. Actual distribution by a DISC out of its accumulated DISC income (ADI) or other earnings and profits (not constituting either PTI or ADI) are taxable to the DISC's shareholder as ordinary dividends.

Redeterminations by the Service of intercompany prices or commissions determined under the section 994(a) pricing rules generally have the effect of reducing a DISC's PTI and ADI for the taxable year of the redetermination. As a result of such a reduction in PTI, a portion of any nontaxable distribution previously made by a DISC out of PTI as originally computed by the parties is reclassified as a taxable distribution out of ADI or other earnings and profits.

SECTION 3. CASES IN WHICH ADJUSTMENT OF ACCOUNTS WILL BE PERMITTED

01 The treatment provided in this revenue procedure will be available with respect to all transactions for any taxable year of a DISC to which intercompany prices paid by the DISC to its related supplier, or commissions paid by the related supplier to the DISC, as originally determined by the parties under section 994 of the Code, are subsequently redetermined by the Service in a manner that results in an increase of the intercompany prices or reduction of the commissions, provided it is determined by the Service that the arrangements or transactions, or the terms thereof, giving rise to the redetermined intercompany prices or commissions did not have as one of their principal purposes the avoidance of Federal income tax. The determination as to whether one of the principal purposes was avoidance of Federal income tax will be based upon all the facts and circumstances of the case.

02 The treatment provided in this revenue procedure will not be available if any part of any underpayment of tax by the related supplier and/or shareholder for any taxable year affected by the Service's redetermination is due to fraud.

SECTION 4. ADJUSTMENT TO BE MADE OR ALLOWED

01 In a case qualifying under section 3 above in which the DISC's shareholder complies with the requirements of section 5 below, in lieu of establishing an account receivable in accordance with section 1.994-1(e)(5)(i) of the regulations for all or part of an amount due a related supplier, the related supplier and DISC are permitted to treat all or part of any distribution which was made by the DISC out of its PTI with respect to the year to which the Service's determination or redetermination relates as an additional payment of transfer price or repayment of commission (and not as a distribution) made as of the date the distribution was made. To the extent that a distribution is so treated under section 1.994-1(e)(5)(v), it shall cease to qualify as a distribution for any Federal income tax purpose, and the DISC's PTI account shall be adjusted accordingly.

02 Any additional amount arising on the determination or redetermination due the related supplier after the treatment under section 4.01 above shall be represented by an account receivable established under section 1.994-1(e)(5)(i) of the regulations. Such account receivable and any interest attributable thereto shall be paid in the time and manner set forth in section 1.994-1(e)(5).

03 If all or part of any distribution made to a shareholder other than the related supplier is recharacterized under section 1.994-1(e)(5)(v) of the regulations, the related supplier shall establish an account receivable from that shareholder for the amount so recharacterized. Such account receivable and any interest attributable thereto shall be paid in the time and manner set forth in section 1.994-1(e)(5).

04 The election of a DISC's shareholder to invoke this revenue procedure in no way affects the redetermination by the Service of the intercompany prices payable by the DISC or the commissions payable to the DISC. Such election shall, however, affect the taxable income of the shareholder, the DISC, and the DISC's related supplier to the extent indicated by sections 4.01, 4.02, and 4.03 above.

SECTION 5. PROCEDURES TO BE FOLLOWED

01 Cases pending with the Internal Revenue Service

1 If a DISC's shareholder desires to invoke this revenue procedure, it must file a request in writing with the District Director of Internal Revenue or the Appeals Office having jurisdiction of the case before closing action is taken on the redetermination of DISC taxable income. The request shall be signed by a person having the authority to sign the shareholder's Federal income tax returns, and shall contain the following:

(a) a request that the shareholder be granted the treatment provided by section 4 of this revenue procedure for the years indicated; and

(b) an offer to enter into a closing agreement under section 7121 of the Code as provided in section 5.013 below.

2 The Service will determine whether the affected parties qualify under section 3 above for the requested treatment and inform the shareholder of its decision. If the request is rejected, the shareholder may pursue the matter through established channels of administrative appeal.

3 If the Service concludes that section 4 above properly applies and if the amount of the redetermination of DISC taxable income has been agreed upon, the shareholder will be requested to enter into a closing agreement, binding itself, the DISC, and any affected related supplier, establishing for each year involved:

(a) the amount of the redetermination of DISC taxable income;

(b) the amount of any actual distributions received by the shareholder which it elects to exclude from income under section 4.01 above;

(c) the amount of the account receivable from the DISC established by the DISC's related supplier under section 1.994-1(e)(5) of the regulations;

(d) the amount of the account receivable from the DISC's shareholder established by the related supplier under section 4.03 above; and

(e) the parties' rights to receive payment of the accounts receivable referred to in (c) and (d) above free of further Federal income tax consequences, provided such payments are made within the time and in the manner prescribed by section 1.994-1(e)(5) of the regulations.

02 Cases pending before the United States Tax Court.--If a case has reached trial status in the Tax Court and it is determined that the taxpayer is entitled to the benefits of the provisions of section 4 above, the parties may stipulate or otherwise arrange with the Court so that any adjustment in tax for the years before the Court will reflect the application of section 4 above, provided the DISC's shareholder executes the required closing agreement.

03 Closed cases.--In any closed case involving a redetermination of DISC income, the DISC's shareholder may file a request for the treatment provided by section 4 above, if such treatment will not change any taxpayer's liability for a year which is barred by the statute of limitations, or a year for which the tax liability has been finally determined by offer in compromise, closing agreement, or court action. Such request must be filed within 180 days after September 9, 1985, with the District Director for the District in which the shareholder filed its tax return for the year to which such redetermination relates, and shall contain the information required by section 5.011 above. The request will then be processed in the same manner as in a pending case described in sections 5.012 and 5.013 above.

04 Cases within the jurisdiction of the Department of Justice.--If a taxpayer files a request for treatment under section 4 above with the appropriate District Director, with respect to a case within the jurisdiction of the Department of Justice, the Service, through its Chief Counsel, will recommend to the Department of Justice the action to be taken with respect to the taxpayer's request.

SECTION 6. EFFECTIVE DATE

This revenue procedure will be effective as of October 12, 1984, the date on which section 1.994-1(e)(5)(v) of the regulations was adopted in final form and was published in the Federal Register.

SECTION 7. EFFECT ON OTHER REVENUE PROCEDURES

Rev. Proc. 84-3 is modified and superseded.