Sec. 304: IRS reconsiders "foreign subsidiary stock transfer" rulings.

• Author: Andrews, Jim

Recently, an IRS official informally stated that thought has been given to reconsidering the Service's position on Rev. Ruls. 91-5 and 92-86 (both dealing with Sec. 304 cross-chain transfers) and Letter Rulings 9131059 and 9325040, which expanded on the revenue rulings. The Service is concerned about the availability of Sec. 902 foreign tax credits (FTCs) in certain Sec. 304 cross-chain transfers of stock in a foreign subsidiary by a U.S. subsidiary of a foreign parent to a foreign subsidiary of the same foreign parent. In the meantime, the two revenue rulings remain in effect; however, the official indicated that the IRS will no longer issue rulings on Sec. 959 (distributions of previously taxed income) or Sec. 961 (basis adjustments of previously taxed income) within the parameters of Sec. 304.

Although Sec. 304 was originally enacted to prevent the conversion of ordinary income into capital gain from the sale of stock to a related party, in the international area Sec. 304 has become a popular vehicle for repatriating cash from a foreign subsidiary back into the United States without incurring any foreign withholding tax. This is important because when earnings are repatriated in the form of dividends, they generally bear a withholding tax of 5% or more. When these taxes are added to the foreign corporate tax rate, the combined taxes generally amount to more than 35% (the current top U.S. corporate rate). Furthermore, as the U.S. FTC system allows an offset for foreign taxes only up to the U.S. rate on the foreign-source income, the withholding tax in effect becomes a bottom line cost to the company. In addition, if the total amount of foreign taxes imposed exceeds the creditable amount allowed by the U.S. FTC system, the benefit of the excess credits can be carried forward or carried back.

Generally, Sec. 304 applies to recast a sale of shares of one controlled (acquired) corporation to an affiliated (acquiring) corporation as a redemption of shares by the acquiring corporation from the controlling (selling) corporation.

Example: A domestic parent (P) owns all the shares of a domestic corporation (Dx) and a foreign corporation (Fx). Dx owns all the shares of a second foreign corporation (Fy). P and Dx file a consolidated return. Dx sells all its Fy shares to Fx at their fair market value, such price also being equal to the combined earnings and profits (E&P) of the two foreign corporations.

The sale is a transaction described in Sec...