Conflict over PTI.

• Author: Smith, Annette B.
• Position: Previously taxed income

In Letter Ruling (TAM) 200141003, the IRS treated the entire previously taxed income (PTI) pool of a controlled foreign corporation (CFC) as a distribution to a fractional U.S. shareholder on the shareholder's sale of its interest in the CFC's to its wholly owned foreign subsidiary in a Sec. 304 transaction. The TAM may have implications for taxpayers engaging in international restructuring transactions.

PTI Rules--In General

Under the subpart F and other rules, certain CFC earnings are taxed to the CFC's U.S. shareholders, whether or not distributed. To prevent double taxation on the actual receipt of the CFC'S earnings, Sec. 959 allows the U.S. shareholders to exclude such earnings from gross income. Although the purpose of the PTI rules (the avoidance of double taxation) is plain, their application can be difficult, such as when applied to Sec. 304 transactions.

Sec. 304 Transactions

Sec. 304 prevents a taxpayer from using a sale of stock of one related corporation to another related corporation to withdraw corporate earnings as capital gains and return of capital, thereby avoiding the ordinary income tax on dividends. To achieve its anti-bailout purpose, Sec. 304 recasts such sales into another fictional transaction, which typically gives rise to dividend treatment.

For example, if a U.S. corporation sells, under Sec. 304, all the shares of its wholly owned foreign subsidiary to another wholly owned foreign subsidiary, the sale would be treated as (1) a Sec. 351 contribution by the U.S. corporation of all of the first subsidiary's shares to the acquiring corporation, in exchange for additional shares of that corporation and (2) a cash distribution by the acquiring corporation to the U.S. corporation in redemption of the acquiring corporation's shares. Because the distribution qualifies as a distribution of property under Secs. 301 and 302(d), the U.S corporation will be treated as receiving a dividend distribution from the acquiring corporation to the extent of (1) the acquiring corporation's earnings and profits (E&P) and (2) the first subsidiary's E&P.

If the distribution exceeds the acquiring corporation's and the first subsidiary's available E&P, the excess will apply against and reduce the basis of the acquiring corporation's stock deemed issued to the selling corporation (although some tax practitioners believe that it may be applied against and reduce the selling corporation's legacy basis in the acquiring corporation as well)...