IRS Chief Counsel - Remove foreign taxes from a foreign corporation’s post-1986 foreign tax pool when earnings are eliminated from the post-1986 undistributed earnings pool in a non-dividend equivalent transaction 

November 1:  The IRS posted a memorandum of Chief Counsel Advice* concluding that when a foreign corporation’s post-1986 undistributed earnings are reduced under section 312(a) as a result of a section 302(a) redemption, a corresponding reduction of the foreign corporation’s post-1986 foreign income taxes is also required. AM2013-006 (dated September 30, 2013, and release date October 25, 2013)

AM2013-006 [PDF 73 KB] addressed the following factual situation:


  • U.S. parent (USP) owns 60% of the stock of a controlled foreign corporation (CFC).
  • Unrelated foreign party (FP) owns the other 40%.
  • CFC does not earn any subpart F income.
  • In Year 1, CFC redeems all stock owned by FP through a cash distribution. Pursuant to section 302(b)(3), the redemption is treated as a section 302(a) distribution in full payment in exchange for the stock.
  • After the redemption, USP owns 100% of the CFC stock.
  • The distribution of cash in the redemption results in a reduction of the post-1986 undistributed earnings of CFC (pursuant to section 312(a)). Section 312(n)(7) limits this reduction to an amount equal to FP’s pro-rata share of CFC’s post-1986 undistributed earnings.

The question presented was whether the CFC’s post-1986 foreign income taxes must also be reduced to prevent taxes associated with the earnings and profits reduction from being claimed as credits with respect to subsequent distributions.

KPMG observation

The conclusion reached in the Chief Counsel Advice reads the phrase “otherwise removed” in isolation and disregards the fact that it is in fact used in a parallel construction as illustrative of situations described in the prior sentence which speaks to “dividends distributed to, or earnings otherwise included … in the income of a foreign or domestic shareholder.” In other words, the regulation appears to be focused on dividend equivalent transactions, rather than on any transactions that might have the effect of reducing earnings and profits. Viewed in this light, because a section 302(a) transaction is a sale and not a dividend equivalent, regulation would not apply.


There is even evidence that the Treasury Department may agree that the IRS position is incorrect. The Obama Administration’s Fiscal Year 2013 budget proposal includes a provision that would require a reduction in post-1986 foreign taxes when a transaction results in a reduction in a foreign corporation’s earnings and profits other than by reason of a dividend or deemed dividend. There is no indication in Treasury’s “Green Book” (General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals) that the Treasury Department views this change as a clarification rather than a change to current law. If the IRS’s reading of Reg. section 1.902-1(a)(8)(i) were correct, then this legislative change would not be needed.


*The memorandum is legal advice, signed by executives in the National Office of the Office of Chief Counsel and issued to IRS personnel who are national program executives and managers. The memo is issued to assist IRS personnel in administering their programs by providing authoritative legal opinions on certain matters, such as industry-wide issues. It is not to be used or cited as precedent.




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