Computation under section 1.902-3 of the regulations Y Corporation Gains, profits, and income-- Foreign income taxes paid---- Accumulated profits in excess of foreign taxes.. Dividends paid to X during 1967-- Foreign income taxes of Y deemed paid by X for 1967 ($30/$70/$70) -- X Corporation Gains, profits, and income (Dividends from Y). Foreign income taxes paid----- Accumulated profits in excess of foreign taxes-- Foreign income taxes paid and deemed to be paid by X for 1967 on or with respect to its accumulated profits ($30+$14). Dividends paid to M during 1967 M Corporation Amount of distribution from X__. Gross-up under section 78 of the Code ($44/$56×$40). Taxable income_-_. U.S. tax before foreign tax credit ($71.43X .48) ----. Less: Foreign tax credit (as determined under gross-up above). U.S. tax payable‒‒‒‒‒ $40.00 31. 43 71.43 34.29 31.43 $2.86 Situation 3.-Domestic corporation M makes a chain election for 1967 under section 1.963-1 of the regulations with respect to controlled foreign corporation X which is wholly owned directly by M, and with respect to controlled foreign corporation Y which is wholly owned directly by X. Each corporation uses the calendar year as the taxable year. In 1967, X and Y are subject to income tax at the rates of 25 percent and 45 percent, respectively; deduction is allowed for dividends received by X in computing its income subject to tax; X and Y have pretax and predistribution earnings and profits of $20 and $200, respectively; X is not a less developed country corporation; M complies with the special rules of section 1.963-4(b) and (c) of the regulations; I' distributes all of its earnings and profits to X; and M receives a distribution of $110 from X. The United States income tax payable by M for 1967 assuming a tax rate of 48 percent, is as follows: Computation under section 1.963–4 (b) and (c) of the regulations Computation under section 1.902-3 of the regulations Y Corporation Gains, profits, and income.. Foreign income taxes paid ($200 ×.45)---- Accumulated profits in excess of foreign taxes___ Dividends paid to X during 1967 Foreign income taxes of Y deemed paid by X for 1967 ($90-$110/$110) - Foreign income taxes paid and deemed to be paid by X for 1967 on or with respect to its accumulated profits ($90+$5). Dividends paid to M during 1967-- M Corporation $200 90 110 $110 90 $20 110 130 5 125 95 110 Dividends from X... Gross-up under section 78 of the Code ($95/$125×$110). Taxable income--- U.S. tax ($193.60X.48)‒‒‒‒‒‒ Foreign tax credit (gross-up above)--. U.S. tax payable----- $110.00 83. 60 193. 60 92.93 83.60 9. 33 It should be noted that by reason of the amendment to section 963 (b) of the Code by section 102(b) of the Revenue and Expenditure Control Act of 1968, Public Law 90-364 page 715, this Bulletin, the statutory percentages under section 963 (b) of the Code have been increased from those effective in the above situations. A domestic corporation that is a member of an affiliated group filing consolidated returns may elect or take actions under section 1.964–1(c)(3) of the regulations with respect to a foreign corporation which it controls. SECTION 964.-MISCELLANEOUS PROVISIONS 26 CFR 1.964-1: Determination of the earn- Rev. Rul. 68-641 Advice has been requested as to who may elect or take an action under section 1.964-1(c)(3) of the Income Tax Regulations, with respect to a foreign corporation controlled by a domestic corporation that is a member of an affiliated group filing consolidated returns under section 1501 of the Internal Revenue Code of 1954. 334-533°-69--23 An affiliated group of domestic corporations has elected to file consolidated returns under section 1501 of the Code. X corporation, a member of the affiliated group of corporations, is the controlling United States shareholder, within the meaning of section 1.964-1 (c) (5) of the regulations, of a controlled foreign corporation Z. Y corporation, the parent corporation of the affiliated group has not elected, under section 963 (e) (3) of the Code, that the group be treated as a single United States shareholder for purposes of applying the minimum distribution provisions of section 963 of the Code, nor has Y, under section 964 of the Code, made any election or taken any action with respect to Z. The question presented is whether X may elect or take an action under section 1.964-1 (c) (3) of the regulations on behalf of Z, the foreign corporation of which X is the controlling United States shareholder. Section 1.1502-77 (a) of the regulations provides, in general, that the common parent corporation, shall, in all matters relating to the tax liability for the consolidated return year, be the sole agent for each subsidiary in the group. For example, any election available to a subsidiary corporation in the computation of its separate taxable income must be made by the common parent. Section 1.964-1(c)(3) of the regulations provides, in general, that an election shall be deemed made, or an adoption or change in method of accounting deemed effectuated, on behalf of a controlled foreign corporation, only by a controlling United States shareholder. Section 1.963-1(a) (4) of the regulations provides that an affiliated group of domestic corporations which makes a consolidated return under section 1501 of the Code for the taxable year shall be treated as a single United States shareholder for purposes of applying section 963 of the Code for such year if the common parent corporation in its return for such affiliated group makes any first-tier election, chain election, or group election under section 963 of the Code for such affiliated group. In such case, no member of such affiliated group may separately make any first-tier election, chain election, or group election under section 963 of the Code for the taxable year. Section 1.963-1(a) (4) of the regulations also provides that if the common parent of such an affiliated group making a consolidated return under section 1501 of the Code makes no first-tier election, chain election, or group election for such affiliated group, then any member of such group may make a first-tier election, chain election, or group election to the same extent that it could so elect if the affiliated group had not filed a consolidated return. In such case, the affiliated group will not be treated as a single United States shareholder. On the basis of section 1.1502-77 (a) of the regulations and because of the relationship between, and hence the need for consistent treatment under sections 963 and 964 of the Code, in any case where an affiliated group is treated as a single United States shareholder on the basis of any election, with respect to a controlled foreign corporation, made under section 1.963-1 (a) (4) of the regulations by the common parent corporation, any election or action under section 1.964-1 (c) (3) of the regulations with respect to the same controlled foreign corporation must also be made by the common parent corporation. On the basis of section 1.1502-77 (a) of the regulations, in any case where an affili ated group makes a consolidated return under section 1501 of the Code (whether or not such group is treated as a single United States shareholder under section 1.963-1 (a) (4) of the regulations) the common parent corporation of such group has the prerogative of making any election or taking any action under section 1.964-1(c)(3) of the regulations with respect to a controlled foreign corporation of a member of the group. However, consistent with section 1.963-1 (a) (4) of the regulations, if in any such case no election is made or action is taken by the common parent corporation, under sections 963 or 964 of the Code or regulations thereunder, then the member of the affiliated group that is a controlling United States shareholder with respect to a foreign corporation may make any election or take any action permitted under section 1.964–1(c) (3) of the regulations. Accordingly, under the facts in this case, X may make elections or take actions under section 1.964-1 (c) (3) of the regulations with respect to Z, the foreign corporation of which it is the controlling United States shareholder. SUBCHAPTER O.-GAIN OR LOSS ON DISPOSITION OF PROPERTY PART L-DETERMINATION OF AMOUNT OF AND RECOGNITION OF GAIN OR LOSS The "formula" approach may be used in determining the fair market value of intangible assets of a business only if there is no better basis available for making the determination; A.R.M. 34, A.R.M. 68, O.D. 937, and Revenue Ruling 65–192 superseded. SECTION 1001.-DETERMINATION OF AMOUNT OF AND RECOGNITION OF GAIN OR LOSS 26 CFR 1.1001-1: Computation of gain or loss. (Also Section 167; 1.167 (a)-3.) Rev. Rul. 68-6091 The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the currently outstanding portions of A.R.M. 34, C.B. 2, 31 (1920), A.R.M. 68, Č.B. 3, 43 (1920), and O.D. 937, C.B. 4, 43 (1921). The question presented is whether the "formula" approach, the capitalization of earnings in excess of a fair rate of return on net tangible assets, may be used to determine the fair market value of the intangible assets of a business The "formula" approach may be stated as follows: A percentage return on the average annual value of the tangible assets used in a business is determined, using a period of years (preferably not less than five) mmediately prior to the valuation date. The amount of the percentage return on tangible assets, thus determined, is deducted from the average earnings of the business for such period and the remainder, if any, is considered to be the amount of the average annual earnings from the intangible assets of the business for the period. This amount (considered as the average annual earnings from intangibles), capitalized at a percentage of, say, 15 to 20 percent, is the value of the tangible assets of the business determined under the "formula" approach. 1 Prepared pursuant to Rev. Proc. 67-6, C.B. 1967-1, 576. The percentage of return on the average annual value of the tangible assets used should be the percentage prevailing in the industry involved at the date of valuation, or (when the industry percentage is not available) a percentage of 8 to 10 percent may be used. The 8 percent rate of return and the 15 percent rate of capitalization are applied to tangibles and intangibles, respectively, of businesses with a small risk factor and stable and regular earnings; the 10 percent rate of return and 20 percent rate of capitalization are applied to businesses in which the hazards of business are relatively high. The above rates are used as examples and are not appropriate in all cases. In applying the "formula" approach, the average earnings period and the capitalization rates are dependent upon the facts pertinent thereto in each case. The past earnings to which the formula is applied should fairly reflect the probable future earnings. Ordinarily, the period should not be less than five years, and abnormal years, whether above or below the average, should be eliminated. If the business is a sole proprietorship or partnership, there should be deducted from the earnings of the business a reasonable amount for services performed by the owner or partners engaged in the business. See Lloyd B. Sanderson Estate v. Commissioner, 42 F. 2d 160 (1930). Further, only the tangible assets entering into net worth, including accounts and bills receivable in excess of accounts and bills payable, are used for determining earnings on the tangible assets. Factors that influence the capitalization rate include (1) the nature of the business, (2) the risk involved, and (3) the stability or irregularity of earnings. The "formula" approach should not be used if there is better evidence available from which the value of intangibles can be determined. If the assets of a going business are sold upon the basis of a rate of capitalization that can be substantiated as being realistic, though it is not within the range of figures indicated here as the ones ordinarily to be adopted, the same rate of capitalization should be used in determining the value of intangibles. Accordingly, the "formula" approach may be used for determining the fair market value of intangible assets of a business only if there is no better basis therefor available. See also Revenue Ruling 59-60, C.B. 1959-1, 237, as modified by Revenue Ruling 65-193, C.B. 1965-2, 370, which sets forth the proper approach to use in the valuation of closely-held corporate stocks for estate and gift tax purposes. The general approach, methods, and fac tors, outlined in Revenue Ruling 59-60, as modified, are equally applicable to valuations of corporate stocks for income and other tax purposes as well as for estate and gift tax purposes. They apply also to problems involving the determination of the fair market value of business interests of any type, including partnerships and proprietorships, and of intangible assets for all tax purposes. A.R.M. 34, A.R.M. 68, and O.D. 937 are superseded, since the positions set forth therein are restated to the extent applicable under cur rent law in this Revenue Ruling. Revenue Ruling 65-192, C.B. 1965-2, 259, which contained restatements of A.R.M. 34 and A.R.M. 68, is also superseded. |