Question

LN Corporation, a U.S corporation, owns all the stock of Foreign Sub 1, a foreign corporation. Foreign Sub 1 in turn owns 20% of the voting stock of Foreign Sub 2, also a foreign corporation. LN Corporation also owns 10% of the nonvoting common stock of Foreign Sub 2 but owns no voting stock in Foreign Sub 2. During the current year, Foreign Sub 2 pays dividends on its nonvoting common stock, but pays no dividends on its voting stock. Is LN Corporation eligible for an Internal Revenue Code Section 902 indirect foreign tax credit for the current year with respect to the foreign income taxes paid by Foreign Sub 2? See Revenue Ruling 74-549, 1974-2 C.B. 207, 208 (holding that the Section 902 credit is not available to a U.S. parent corporation receiving a dividend owned only nonvoting stock of the second-tier corporation; IRS reasoned that the Section 902 credit is “contingent upon distribution [of a dividend] through the chain of corporations possessing voting stock ownership in the distributing corporation”).

Answer 1

In order for a domestic corporation to claim the indirect foreign tax credit,it must own at least 10 percent of the voting stock of a foreign subsidiary at the time it receives a dividend from the subsidiary. If a first tier subsidiary owns at least 10 percent of the voting stock of a second tier foreign subsidiary, a distribution from the second tier subsidiary to the first tier subsidiary has the effect of increasing the amount of foreign taxes that the first tier subsidiary is considered to have paid. This can significantly benefit the U.S. parent, since it increases the amount of foreign taxes available to be claimed as a credit. This mechanism is also applicable to distributions from third tier foreign subsidiaries to second tier foreign subsidiaries provided the second tier subsidiary owns at least 10 percent of the voting stock of the third tier subsidiary.

Since, LN corporation doesnt own the voting stock of the Second-tier corporation, and also as the Foreign Sub 2 doesn't pay dividend on its voting stock to Foreign Sub 1, Ln corporation becomes ineligible for indirect tax credit.