Redemption distributions of PTE.

• Author: Bacon, Jordan W.
• Position: Previously taxed earnings

Letter Ruling 9802018 could have broad implications for common restructuring techniques and, in certain cases, result in double taxation of previously taxed earnings (PTE) of a controlled foreign corporation (CFC). The ruling involved a Sec. 302 redemption by a CFC of shares held by another CFC; the redeeming CFC was wholly owned indirectly by two U.S. corporations that were members of the same U.S. consolidated group. The ruling held that only a portion of the redeeming CFC's PTE distributed (as a dividend) in the redemption will be excluded from the recipient CFC's gross income under Sec. 959.

The simplified facts in the letter ruling are as follows: U.S. Parent A owns 100% of domestic corporation B, which owns 100% of domestic corporation C. A files a consolidated tax return with B and C. B and C together own 100% percent of the shares of CFC H, which owns 100% percent of the shares of CFC I. In addition, C owns 100% CFCs of G and J. Together G, J and I own 100% of CFC L. All of L's earnings and profits (E&P) have been previously taxed under Sec. 951(a).

Prior to a redemption of L shares held by G, J will increase its percentage ownership of L through a capital contribution. Accordingly, the percentage ownership of L held by G and I will be reduced. This transaction will have the effect of shifting a portion of the indirect ownership of L from B to C. Under Secs. 302, 301 and 316, the subsequent redemption distribution from L to G will be characterized as a dividend to the extent of L's E&P. All of L's E&P will be distributed to G in the redemption distribution.

Holding

The ruling held that the portion of the redemption distribution attributable to amounts previously included in C's gross income under Sec. 951 (a) is determined based on the percentage of C's indirect ownership of L stock under Sec. 958(a), measured at the time of the redemption distribution. As a consequence, only a portion of the total distribution, to the extent characterized as a dividend, will be excluded from G's gross income, even though all of L's E&P were previously taxed. The ruling does not state how the remainder of the distribution to G should be treated.

Comments: The ruling seems to recharacterize a portion of L's PTE as untaxed E&P, the amount of which would be determined based on C's indirect ownership of L at the time of the redemption distribution. The amount included in G's gross income presumably would be treated as a dividend and constitute subpart F...