Ruling highlights mismatch between Subchapter C and Subpart F for deemed dividend of previously taxed income arising from redemption of CFC stock.

In Letter Ruling 9802018, the ruled on a Sec. 959(b) that goes to the heart of an incongruity between the corporate (subchapter C) and the subpart F rules. In the ruling, a third-tier controlled foreign corporation (CFC), L, with two related U.S. shareholders, proposes to make a redemption distribution to a foreign company (G) that is a CFC with respect to only one of the two U.S. shareholders. The distribution will be characterized under Sec. 302(d) as a distribution of all of L's earnings and profits (E&P). All of Us E&P was previously included, under Sec. 951 (a), in the income of the two US. shareholders as previously taxed income (PTI); see, e.g., Regs. Secs. 1.902-1 (f), Examples 4 and 5; 1.904-4(c)(6); and 1.954-2(b)(1)(i)..

The Service ruled that the deemed dividend would be excluded from G's gross income under Sec. 959(b), to the extent that the underlying earnings had been previously included under subpart F in the income of G's U.S. shareholder. In effect, the extent to which the underlying earnings had previously been included under subpart F in the income of the other U.S. shareholder was ignored for Sec. 959(b) purposes. The deemed dividend apparently would not be excluded from Gs gross income under Sec. 959(b), to the extent the underlying earnings had been previously included under subpart F in the income of that other U.S. shareholder.

As shown by this ruling, the PTI "protection" associated with L's E&P is not an attribute of the earnings considered in isolation; it is also partially tied to the particular shares of stock held by the U.S. shareholder in whose income the earnings were included under Sec. 951. By contrast, the rules of subchapter C generally do not link earnings of a corporation to particular shares of stock issued by it.

The ruling suggests that in some cases, the interaction of Secs. 951, 302 and 959 can result in double taxation, or possibly even double Sec. 902 or 960 credits, if a CFC has multiple U.S. shareholders. As demonstrated by the ruling, these consequences may apply even if the multiple U.S. shareholders are related persons. Thus, in appropriate cases, taxpayers may have the flexibility to plan into or out of the "doubling up" resulting from these rules.