RULINGS MADE PUBLIC SINCE BULLETIN 1952-14 SPECIAL ATTENTION is directed to the cautionary notice on page II that pub- ANNOUNCEMENT RELATING TO DECISIONS OF THE TAX COURT OF THE UNITED STATES The Commissioner does NOT acquiesce in the following decisions: 1 Estate tax decision. 2 Acquiescence published in Cumulative Bulletin 1943, page 8, insofar as it relates to the issue whether $1,000 expended for legal services in connection with the dissolution of The First National Corporation of Portland in 1938 constituted an allowable deduction, withdrawn. 3 Acquiescence published in Cumulative Bulletin 1943, page 18, insofar as it relates to the issue whether $1,000 expended for legal services in connection with the dissolution of The First National Corporation of Portland in 1938 constituted an allowable deduction, withdrawn. 4 Acquiescence published in Cumulative Bulletin 1943, page 23, insofar as it relates to the issue whether $1,000 expended for legal services in connection with the dissolution of The First National Corporation of Portland in 1938 constituted an allowable deduction, withdrawn. 5 Acquiescence published in Cumulative Bulletin 1943, page 24, insofar as it relates to the issue whether $1,000 expended for legal services in connection with the dissolution of The First National Corporation of Portland in 1938 constituted an allowable deduction, withdrawn. (1) INCOME TAX.-PART I INTERNAL REVENUE CODE SECTION 22 (b).-GROSS INCOME: EXCLUSIONS INTERNAL REVENUE CODE 1952-15-13871 I. T. 4088 For Federal income tax purposes, the tax-exempt status of disability retirement pay of a retired officer of the Regular Army, which pay is suspended during his employment as a civilian with the Federal Government, will not be affected when payment thereof is resumed upon termination of such civilian employment. The compensation received by the taxpayer during such civilian employment is includible in gross income under section 22(a) of the Internal Revenue Code. Advice is requested as to the tax-exempt status of disability retirement pay received by a retired officer of the Regular Army where such pay is suspended during his employment as a civilian with the Federal Government but is to be resumed upon termination of such civilian employment. In the instant case, an officer of the Regular Army was retired from active service under section 1251 of the Revised Statutes (section 933, Title 10, U. S. C. A.) which provides as follows: When a retiring board finds that an officer is incapacitated for active service, and that his incapacity is the result of an incident of service, and such decision is approved by the President, said officer shall be retired from active service and placed on the list of retired officers. Section 1251 of the Revised Statutes, supra, was repealed, effective October 1, 1949, by section 531 (b) (2) of the Career Compensation Act of 1949 (63 Stat. 802, 838), and section 402 of such Act was enacted in lieu thereof but not limited to section 1251 of the Revised Statutes. (See I. T. 4017, C. B. 1950-2, 12, relating to the taxable status of disability retirement pay received by members of the "uniformed services" who retire under section 402 (f) of the Career Compensation Act.) I. T. 3641 (C. B. 1944, 70) holds that the retirement pay or allowances received by officers of the Regular Army who have been retired from active service under section 1251 of the Revised Statutes, supra, for personal injuries or sickness resulting from active service in the United States Army, are not subject to Federal income tax for the year 1942 and subsequent years. It is held that, for Federal income tax purposes, the tax-exempt status of disability retirement pay of a retired officer of the Regular Army, which pay is suspended during his employment as a civilian with the Federal Government, will not be affected when payment thereof is resumed upon termination of such civilian employment. The compensation received by the taxpayer during such civilian employment is includible in gross income under section 22(a) of the Internal Revenue Code. SECTION 131.-TAXES OF FOREIGN COUNTRIES AND POSSESSIONS OF THE UNITED STATES SECTION 29.131-7: Taxes of subsidiary corpo ration. INTERNAL REVENUE CODE 1952-15-13872 I. T. 4089 For the purposes of section 131 (b) and (f) of the Internal Revenue Code, all income of a foreign subsidiary of a domestic parent, or of a foreign subsidiary of the foreign subsidiary, as therein contemplated, shall be deemed to have been derived from sources within the foreign country or possession of the United States in which the first subsidiary is incorporated; and all income, war-profits, and excess-profits taxes paid or deemed to have been paid to any foreign country or possession of the United States shall be deemed to have been paid to the government of the country or possession under whose laws the first subsidiary is incorporated. Advice is requested whether a domestic corporation which is entitled to the benefits of section 131 (f) of the Internal Revenue Code may receive a credit, under section 131 (a) (1) of the Code, for income taxes paid by its foreign subsidiary to a foreign country other than that in which the subsidiary is incorporated. This inquiry also raises the questions as to what portion of the taxes will be recognized by section 131 (f) as having been (or deemed to have been) paid, and to what extent the limitations of section 131 (b) will be applied to that portion of the tax recognized for credit. In the instant case, a domestic corporation has a wholly owned Panamanian subsidiary, which subsidiary owns more than 50 percent of the stock in a Brazilian corporation from which it receives dividends. The Brazilian corporation is subject to the income tax imposed by Brazil upon the profits earned therein, but the dividends paid by it are taxed to the recipients, such tax being collected by withholding. (See I. T. 4013, C. B. 1950-1, 65.) The Panamanian subsidiary is subject to the tax imposed by Panama upon its operating income, but no tax is imposed by Panama upon its dividend income or upon the dividends paid by it to its parent company. Section 131 of the Internal Revenue Code provides in part as follows: * * * (a) ALLOWANCE OF CREDIT.-If the taxpayer chooses to have the benefits of this section, the tax imposed by this chapter [chapter 1 of the Code] shall be credited with: (1) CITIZENS AND DOMESTIC CORPORATIONS.-In the case of a citizen of the United States and of a domestic corporation, the amount of any income, war-profits, and excess-profits taxes paid or accrued during the taxable year to any foreign country or to any possession of the United States; * * * * * * (b) LIMIT ON CREDIT.-The amount of the credit taken under this section shall be subject to each of the following limitations: * (1) The amount of the credit in respect of the tax paid or accrued to any country shall not exceed, * * in the case of a corporation, the same 214336-52——2 * proportion of the tax against which such credit is taken, which the taxpayer's normal-tax net income from sources within such country bears to its entire normal-tax net income for the same taxable year; and (2) The total amount of the credit shall not exceed, * * in the case of a corporation, the same proportion of the tax against which such credit is taken, which the taxpayer's normal-tax net income from sources without the United States bears to its entire normal-tax net income for the same taxable year; * (f) TAXES OF FOREIGN CORPORATION.— (1) TREATMENT OF TAXES PAID BY FOREIGN CORPORATION.-For the purposes of this section, a domestic corporation which owns at least 10 per centum of the voting stock of a foreign corporation from which it receives dividends in any taxable year shall be deemed to have paid the same proportion of any income, war-profits, or excess-profits taxes paid or deemed to be paid by such foreign corporation to any foreign country or to any possession of the United States, upon or with respect to the accumulated profits of such foreign corporation from which such dividends were paid, which the amount of such dividends bears to the amount of such accumulated profits. ** * * (2) FOREIGN SUBSIDIARY OF FOREIGN CORPORATION.-If such foreign corporation owns 50 per centum or more of the voting stock of another foreign corporation from which it receives dividends in any taxable year it shall be deemed to have paid the same proportion of any income, war-profits, or excess-profits taxes paid by such other foreign corporation to any foreign country or to any possession of the United States, upon or with respect to the accumulated profits of the corporation from which such dividends were paid, which the amount of such dividends bears to the amount of such accumulated profits. In view of the provisions of section 131 (f) of the Code, and in view of the fact that the Brazilian tax in question has been recognized (I. T. 4013, supra) as an income tax for the purposes of section 131, the Brazilian income tax is appropriate for the purposes of the credit under section 131. * * *99 * * Section 119 (a) (2) (B) of the Code provides in part that: "* dividends from a foreign corporation shall, for the purposes of section 131 (relating to foreign tax credit), be treated as income from sources without the United States In the instant case, the dividends received by the domestic corporation from its Panamanian subsidiary are, therefore, income from sources without the United States. To the extent that the amount of the dividends is includible in the domestic corporation's normal-tax net income, such amount is also includible in the numerator of the credit-limiting fraction to be applied pursuant to section 131 (b) (2) of the Code. Section 131 (b) (1) further limits the amount of the credit in the case of a corporation by providing that the tax paid or accrued to any country shall not exceed the same proportion of the tax against which the credit is taken which the taxpayer's normal-tax net income from sources within such country bears to its entire normal-tax net income for the same taxable year. The question thus presented is whether that portion of the dividends received by the domestic corporation which was paid ultimately out of accumulated profits derived from Brazil should, for the purposes of section 131, be viewed as constituting net income from sources within Panama, or should be considered as from sources within Brazil. It is the position of the Bureau that, for the purposes of section 131 of the Code, the geographical source of the dividends paid by a foreign subsidiary to a domestic parent is the country in which the foreign subsidiary is organized, unless otherwise expressly provided by law. (Cf. section 119(a) (2) (B) of the Code.) Furthermore, since in many instances it would be administratively difficult, if not impossible, to determine the source of the accumulated profits from which dividends were paid by foreign subsidiaries, or foreign subsidiaries of such subsidiaries, the Bureau has adopted a practical rule of treating foreign taxes paid or deemed to have been paid by a foreign subsidiary of a domestic parent as having been paid to the foreign country in which the first subsidiary is incorporated. Summarizing, it is the position of the Bureau that, for the purposes of section 131 (b) and (f) of the Internal Revenue Code, all income of a foreign subsidiary of a domestic parent, or of a foreign subsidiary of the foreign subsidiary, as therein contemplated, shall be deemed to have been derived from sources within the foreign country or possession of the United States in which the first subsidiary is incorporated; and all income, war-profits, and excess-profits taxes paid or deemed to have been paid to any foreign country or possession of the United States shall be deemed to have been paid to the government of the country or possession under whose laws the first subsidiary is incorporated. Application of the above-stated conclusion may be illustrated by the following example, which is based on assumed facts: The domestic corporation and its Panamanian subsidiary keep their accounts and file their returns on the calendar-year basis. On January 1, 1951, the beginning of the subsidiary's taxable year, it had no accumulated profits. During the calendar year 1951, its profits from Panamanian operations were $90,000, and the gross amount of its dividends from the Brazilian corporation was $10,000. With respect to these amounts, the subsidiary paid an income tax of $6,574 to Panama and an income tax of $1,500 to Brazil. During 1951 (including the first 60 days thereafter), it paid a dividend of $91,926 to its parent (that being the amount of its net profits after payment of the foreign income taxes thereon). The taxes assumed to have been paid to Panama with respect to this dividend would be $8,074 ($6,574 plus $1,500). Under the formula provided by section 131 (f) of the Code, the tax available for credit by the parent (subject, however, to the additional limitations provided by section 131(b)) would be $7,422.11, i. e., 91,926/100,000 × $8,074. It next becomes necessary to apply. the limitations provided by section 131 (b) (1) and by section 131 (b) (2) to the tax available for credit. In the case of a corporation, the limitation of section 131(b) (1) is the ratio of the taxpayer's normal tax net income from sources within the country imposing the tax for which credit is claimed to its entire normal-tax net income, whereas the limitation of section 131 (b) (1) is the ratio of the taxpayer's normal-tax net income from sources outside the United States to its entire normal-tax net income. The tax available for credit, as thus limited, will be the lesser of the amounts computed under section 131 (b) (1) or section 131(b) (2). For the purpose of illustrating these limitations, it will be assumed that the parent's normal-tax net income for 1951 from all sources was |