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   Dividend.......................................................   $28.98Gross-up under section 78 ($28.98/ $70x$30)....................    12.42Taxable income.................................................    41.40U.S. tax before foreign tax credit ($41.40x0.48)...............    19.87Foreign tax credit ($12.42+[0.06 x$28.98]).....................    14.16U.S. tax payable...............................................     5.71 

Example 4.  (a) For 1966 domestic corporation M makes a chain election with respect to controlled foreign corporation A, all of whose one class of stock it directly owns, and controlled foreign corporation B, all of whose one class of stock is directly owned by A Corporation. Both foreign corporations are subject to a foreign income tax at a flat rate of 30 percent, and all corporations use the calendar year as a taxable year. For 1966, B Corporation has pretax earnings and profits of $100 and distributes $51.50. For 1966, A Corporation has pretax earnings and profits of $151.50, consisting of $100 from selling activities and $51.50 received as a distribution from B Corporation, upon which it pays a foreign income tax of $45.45 (i.e., 30 percent of $151.50).

(b) Corporation M chooses under paragraph (d)(1)(iii) of this section to take the foreign tax paid by A Corporation on the dividend received from B Corporation into account in determining the effective foreign tax rate of the chain rather than count it toward the amount of the minimum distribution. Thus, to determine consolidated earnings and profits of the chain for 1966, A Corporation's pretax earnings and profits of $151.50 are first reduced by the intercorporate dividend of $51.50 received from B Corporation so that A Corporation has pretax and predistribution earnings and profits of $100 ($151.50 less $51.50). Corporation A's pretax and predistribution earnings and profits of $100 are then reduced by the foreign income tax of $30 (30 percent of $100) paid on such earnings and profits, resulting in predistribution earnings and profits of $70 ($100 less $30). Since M Corporation chooses to count toward the effective foreign tax rate, rather than toward the minimum distribution, A Corporation's foreign income tax of $15.45 (0.30×51.50) imposed on the dividend received from B Corporation, such predistribution earnings and profits of $70 of A Corporation are further reduced by such $15.45 of tax to $54.55 ($70−$15.45). Corporation B, having received no dividends from any other corporation in the chain, has predistribution earnings and profits of $70 ($100 less foreign income tax of $30).

(c) The consolidated earnings and profits of the chain for 1966 are $124.55 ($54.55+$70). The consolidated foreign income taxes for such year are $75.45 ($30+$15.45+$30). The effective foreign tax rate of the chain for 1966 is 37.73 percent ($75.45/[$124.55+$75.45]). The statutory percentage for 1966 under section 963(b)(3) is 51 percent. Thus, the amount of the minimum distribution which M Corporation must receive from the 1966 consolidated earnings and profits of the chain is $63.52 (0.51×$124.55).

Example 5.  The facts are the same as in example 4 except that M Corporation does not choose under paragraph (d)(1)(iii) of this section to take into account, in determining the effective foreign tax rate, the foreign income tax of $15.45 paid by A Corporation on the distribution of $51.50 received from B Corporation. In such case, the consolidated earnings and profits of the chain are $140 ($70+$70) and the consolidated foreign income taxes are $60 ($30+$30), the latter amount being determined without taking into account A Corporation's foreign income tax of $15.45 on the distribution of $51.50 received from B Corporation. The effective foreign tax rate for 1966 is 30 percent ($60/[$140+$60]), and the statutory percentage under section 963(b) is 69 percent. Thus, the amount of the minimum distribution which must be made from the 1966 consolidated earnings and profits of the chain is $96.60 (0.69×$140). For the counting of such $15.45 of A Corporation's tax toward the $96.60 amount of the minimum distribution, see paragraph (b)(2) of §1.963–3.

Example 6.  For 1966 domestic corporation M directly owns the following percentages of the one class of stock of the following controlled foreign corporations in respect of which it makes a group election: 80 percent of A Corporation, 60 percent of B Corporation, and 70 percent of C Corporation. All corporations use the calendar year as the taxable year; none of the foreign corporations is a less developed country corporation under section 902(d). Each foreign corporation makes distributions during 1966. The consolidated earnings and profits, and the consolidated foreign income taxes, of the group for 1966 with respect to M Corporation, and the amount of the minimum distribution which M Corporation must receive, are determined as follows, based on the earnings and profits and foreign income tax shown in the following table:

 ------------------------------------------------------------------------                                                    Controlled foreign                                                       corporations                                                 -----------------------                                                    A      B        C------------------------------------------------------------------------Predistribution and pretax earnings and profits.   $100   $100   $100.00Foreign income tax..............................     15     25     35.00Predistribution earnings and profits............     85     75     65.00M Corporation's proportionate share of earnings and profits:  (0.80x$85)....................................     68  .....  ........  (0.60x$75)....................................  .....     45  ........  (0.70x$65)....................................  .....  .....     45.50Consolidated earnings and profits with respect    .....  .....    158.50 to M Corporation ($68+$45+$45.50)..............M Corporation's proportionate share of foreign income tax:  ($15x[$68/$85])...............................     12  .....  ........  ($25x[$45/$75])...............................  .....     15  ........  ($35x[$45.50/$65])............................  .....  .....     24.50Consolidated foreign income taxes with respect    .....  .....     51.50 to M Corporation ($12+$15+$24.50)..............------------------------------------------------------------------------

The effective foreign tax rate for 1966 is 24.5 percent ($51.50/[$158.50+$51.50]) and the statutory percentage under section 963(b)(3) for such year is 76 percent. Thus, the amount of the minimum distribution which M Corporation must receive from the 1966 consolidated earnings and profits of the group is $120.46 (0.76×$158.50).

Example 7.  (a) For 1966 domestic corporation M makes a chain election with respect to the following controlled foreign corporations: A Corporation, 80 percent of whose one class of stock M Corporation owns directly; B Corporation, 60 percent of whose one class of stock is directly owned by A Corporation; and C Corporation, 70 percent of whose one class of stock is directly owned by B Corporation. All corporations use the calendar year as the taxable year; none of the foreign corporations is a less developed country corporation under section 902(d). The predistribution and pretax earnings and profits of each foreign corporation are $100. Each foreign corporation pays a flat rate of foreign income tax on all income computed without reduction for dividends paid and determined by including dividends received. Such rate is 15 percent for A Corporation, 25 percent for B Corporation, and 35 percent for C Corporation. Corporation C distributes $65, and B Corporation distributes $100, for 1966. Corporation M chooses under paragraph (d)(1)(iii) of this section to count toward the effective foreign tax rate, rather than toward the amount of the minimum distribution, the foreign income tax paid by corporations A and B, respectively, on distributions received from corporations B and C, respectively.

(b) The consolidated earnings and profits, and the consolidated foreign income taxes, of the chain, and the amount of the minimum distribution for 1966, with respect to M Corporation are determined as follows:

 ------------------------------------------------------------------------                                      Controlled foreign corporations                                 ---------------------------------------                                      A         B         C       Total------------------------------------------------------------------------Pretax earnings and profits.....   $160.00   $145.50   $100.00  ........Reduction for intercorporate dividends:  (0.60x$100)...................     60.00  ........  ........  ........  (0.70x$65)....................  ........     45.50  ........  ........                                 ------------------------------Pretax and predistribution          100.00    100.00    100.00  ........ earnings and profits...........Reduction for foreign income tax on such pretax and predistribution earnings and profits:  (0.15x$100)...................     15.00  ........  ........  ........  (0.25x$100)...................  ........     25.00  ........  ........  (0.35x$100)...................  ........  ........     35.00  ........                                 ------------------------------Predistribution earnings and         85.00     75.00     65.00  ........ profits........................Reduction for foreign income tax on intercorporate distributions of 1966 earnings and profits:  (0.15x$60)....................      9.00  ........  ........  ........  (0.25x$45.50).................  ........     11.38  ........  ........                                 ------------------------------                                     76.00     63.62     65.00                                 ==============================Consolidated earnings and profits with respect to M Corporation:  (0.80x$76)....................     60.80  ........  ........  ........  (0.80x0.60x$63.62)............  ........     30.54  ........  ........  (0.80x0.60x0.70x$65)..........  ........  ........     21.84   $113.18Consolidated foreign income taxes with respect to M Corporation:  ($60.80/$76x[$15+$9]).........     19.20  ........  ........  ........  ($30.54/$63.62x[$25+$11.38])..  ........     17.46  ........  ........  ($21.84/$65x$35)..............  ........  ........     11.76    $48.42Effective foreign tax rate        ........  ........  ........    29.96% ($48.42/[$113.18+$48.42])......Statutory percentage under        ........  ........  ........       69% section 963(b).................Amount of minimum distribution    ........  ........  ........     $78.0 which M Corporation must receive from 1966 consolidated earnings and profits (0.69x$113.18), no amount of the tax on intercorporate distributions being counted toward the minimum distribution------------------------------------------------------------------------

Example 8.  The facts are the same as in example 7 except that M Corporation does not choose under paragraph (d)(1)(iii) of this section to take into account, in determining the effective foreign tax rate, the foreign income tax paid by the recipient corporations on the intercorporate distributions. The consolidated earnings and profits, the consolidated foreign income taxes, of the chain, and the amount of the minimum distribution which M Corporation must receive, for 1966 are determined as follows:

 ------------------------------------------------------------------------                                      Controlled foreign corporations                                 ---------------------------------------                                      A         B         C       Total------------------------------------------------------------------------Pretax earnings and profits.....   $160.00   $145.50   $100.00  ........Reduction for intercorporate dividends:  (0.60x$100)...................     60.00  ........  ........  ........  (0.70x$65)....................  ........     45.50  ........  ........                                 ------------------------------Pretax and predistribution          100.00    100.00    100.00  ........ earnings and profits...........Reduction for foreign income tax on such pretax and predistribution earnings and profits:  (0.15x$100)...................     15.00  ........  ........  ........  (0.25x$100)...................  ........     25.00  ........  ........  (0.35x$100)...................  ........  ........     35.00  ........------------------------------------------------------------------------Predistribution earnings and         85.00     75.00     65.00  ........ profits........................Consolidated earnings and profits with respect to M Corporation:  (0.80x$85)....................     68.00  ........  ........  ........  (0.80x0.60x$75)...............  ........     36.00  ........  ........  (0.80x0.60x0.70x$65)..........  ........  ........     21.84   $125.84Consolidated foreign income taxes with respect to M Corporation:  ($68/$85x$15).................     12.00  ........  ........  ........  ($36/$75x$25).................  ........     12.00  ........  ........  ($21.84/$65x$35)..............  ........  ........     11.76    $35.76Effective foreign tax rate        ........  ........  ........    22.13% ($35.76/[$125.84+$35.76])......Statutory percentage under        ........  ........  ........       76% section 963(b).................Amount of minimum distribution    ........  ........  ........    $95.64 to be made from 1966 consolidated earnings and profits with respect to M Corporation: (0.76x$125.84)....Foreign income tax on intercorporate distributions of 1966 earnings and profits which is counted toward the minimum distribution (see § 1.963- 3(b)(2)):  ($68/$85x[0.15x$60])..........      7.20  ........  ........  ........  ($36/$75x[0.25x$45.50]).......  ........      5.46  ........    $12.66Amount of minimum distribution    ........  ........  ........    $82.98 which M Corporation must actually receive from the chain ($95.64-$12.66)................------------------------------------------------------------------------

[T.D. 6759, 29 FR 13329, Sept. 25, 1964, as amended by T.D. 6767, 29 FR 14877, Nov. 3, 1964; T.D. 7100, 36 FR 5335, Mar. 20, 1971]

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