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              d=$38-0.20d-0.40($38-d)           d=$38-0.20d-$15.20+0.40d           d=$22.80+0.20d     0.80  d=$22.80           d=$22.80/0.80           d=$28.50 

Example 2.  Domestic corporation M directly owns 80 percent of the one class of stock of each of controlled foreign corporations A and B, which constitute a group and each of which for 1964 has pretax earnings and profits of $100. All corporations use the calendar year as the taxable year. Corporation A is subject to foreign income tax at a flat rate of 40 percent; and B Corporation is subject to a foreign income tax of 40 percent of $100 minus dividends for the taxable year and of 20 percent of the amount of such dividends. The effective foreign tax rate with respect to the group, as determined under paragraph (c) of §1.963–2, is 40 percent, and the statutory percentage under paragraph (b) of §1.963–2 for 1964 is 38 percent. Corporation B distributes $25 for 1964 toward a minimum distribution from the group which is not a pro rata minimum distribution. The minimum distribution by the group for 1964 with respect to M Corporation is determined as follows:

   M Corporation's proportionate share of B Corporation's            $20.00 distribution (0.80x$25).......................................                                                                --------Pretax and predistribution consolidated earnings and profits of   160.00 the group (0.80x$200).........................................                                                                --------Statutory percentage of pretax and predistribution consolidated    60.80 earnings and profits (0.33x$160)..............................                                                                --------Less: portion of such statutory percentage to which the $20        25.00 dividend received from B Corporation is attributable: Total dividend paid by B CorporationPlus: Foreign income tax on B Corporation's pretax and predistribution earnings and profits to which such dividend is attributable, letting ``t'' represent such tax:    t=0.20 ($25)+0.40t.........................................    t=$5+0.40t.................................................  0.60t=$5.....................................................    t=$5/0.60..................................................     8.33                                                                --------B Corporation's pretax and predistribution earnings and profits    33.33 to which such dividend is attributable........................                                                                ========M Corporation's proportionate share of B Corporation's pretax      26.67 and predistribution earnings and profits to which the dividend is attributable (0.80x$33.33).................................                                                                --------The statutory percentage of the pretax and predistribution         34.13 consolidated earnings and profits of the group to which A Corporation's distribution must be attributable...............                                                                ========Dividend required to be received from A Corporation ($34.13-       20.48 [0.40x$34.13])................................................                                                                --------Minimum distribution to M Corporation of the taxable year's        40.48 consolidated earnings and profits of the group ($20+$20.48)...                                                                -------- 

Example 3.  The facts are the same as in example 2 except that the $25 distribution of earnings and profits is made by A Corporation. The amount of the minimum distribution for 1964 is determined as follows:

   M Corporation's proportionate share of A Corporation's            $20.00 distribution (0.80x$25).......................................                                                                --------Pretax and predistribution consolidated earnings and profits of   160.00 the group (0.80x$200).........................................                                                                --------Statutory percentage of pretax and predistribution consolidated    60.80 earnings and profits (0.38x$160)..............................                                                                --------Less: Portion of such statutory percentage to which the $20        25.00 dividend received from A Corporation is attributable: Total dividend paid by A Corporation................................Plus: Foreign income tax on A Corporation's pretax and             16.67 predistribution earnings and profits to which such dividend is attributable (0.40x[$25/0.60])................................                                                                --------A Corporation's pretax and predistribution earnings and profits    41.67 to which such dividend is attributable........................                                                                ========M Corporation's proportionate share of A Corporation's pretax      33.34 and predistribution earnings and profits to which dividend is attributable ($41.67x0.80)....................................                                                                --------Portion of the statutory percentage of the pretax and              27.46 predistribution consolidated earnings and profits of the group to which B Corporation's distribution must be attributable....                                                                ========Dividend received from B Corporation, letting ``d'' represent the dividend:    d=$27.46-0.20d-0.40 ($27.46-d).............................    d=$27.46-0.20d-$10.98+0.40d................................    d=$16.48+0.20d.............................................  0.80d=$16.48.................................................    d=$16.48/0.80..............................................    20.60                                                                --------Minimum distribution to M Corporation of the taxable year's        40.60 consolidated earnings and profits of the group ($20+$20.60)... 

(d) Distributions through a chain or group. In the application of paragraph (b)(3)(i) of §1.963–4, relating to the allocation of dividend payments first to income received as a distribution from other foreign corporations in the chain or group, if one or more of such other foreign corporations is a corporation whose foreign income tax rate decreases as the distributions are made, the allocation under such paragraph shall be made first to such corporations' distributions.

(e) Foreign tax credit—(1) Year of minimum distribution. If a United States shareholder receives for a taxable year a distribution of the earnings and profits for the taxable year of a foreign corporation described in paragraph (a) of this section and if for such year such corporation is a first-tier corporation, or a second-tier corporation described in section 902 (a) or (b), as the case may be, then, in applying paragraph (c)(2)(i) of §1.963–4, only the foreign income tax which is effectively applicable to pretax earnings and profits to which are attributable the earnings and profits which are distributed shall be deemed paid for such year under section 902 (a) or (b), as the case may be, and the foreign income tax so paid or accrued by such corporation shall not be averaged, for purposes of such section, with its foreign income tax paid or accrued for such year on its pretax earnings and profits to which are attributable the earnings and profits which are not distributed.

(2) Year of distribution of remaining earnings and profits. If for a taxable year a United States shareholder receives a minimum distribution from a corporation described in paragraph (a) of this section, the pretax and predistribution earnings and profits of such corporation for the taxable year to which such minimum distribution is attributable and the foreign income tax which is taken into account, in accordance with paragraph (c)(2)(i) of §1.963–4, in determining tax deemed paid under section 902 on such pretax and predistribution earnings and profits shall not be taken into account in the application of section 902 when other earnings and profits of such foreign corporation for such year are distributed in a subsequent taxable year of such foreign corporation to such shareholder.

(3) Illustration. The application of this paragraph may be illustrated by the following examples:

Example 1.  (a) All the income of controlled foreign corporation B, wholly owned directly by domestic corporation M, is taxed by foreign country Y, the tax laws of which impose at the local level a corporate income tax of 10 percent of earnings and profits (before reduction for income taxes) and, at the national level, an income tax of 30 percent of such earnings and profits reduced by the local tax and by any profits which are distributed. Also, at the national level, a tax of 20 percent is imposed on B Corporation on the dividends which are paid for the taxable year. Both corporations use the calendar year as the taxable year. For 1963, B Corporation has earnings and profits (before reduction by income taxes) of $100. B Corporation is not a less developed country corporation under section 902(d). For 1963, M Corporation makes a first-tier election with respect to B Corporation and receives a minimum distribution. Corporation B has no 1964 earnings and profits, and its remaining 1963 earnings and profits are distributed late in 1964. The amount of the minimum distribution required to be received by M Corporation for 1963 and the United States tax with respect to the 1963 earnings and profits of B Corporation are determined as follows, assuming a United States corporate income tax rate of 52 percent (instead of 50 percent) for 1964 and no surtax exemption under section 11(c) for either year:

                                  1963   Effective foreign tax rate which obtains if no                       37% earnings and profits of B Corporation are distributed [($100x0.10)+ ([$100- ($100x0.10)]x0.30)]/$100...........................Minimum percentage of earnings and profits required                  68% under section 963(b) to be distributed, given a 37 percent effective foreign tax rate.................Amount of earnings and profits (before reduction by               $68.00 foreign income tax) to which minimum distribution would be attributable if the effective foreign tax rate of 37 percent obtained (0.68x$100)............Minimum distribution required to be received by M Corporation, i.e., such an amount that is $68 less the foreign income tax on such $68, determined by letting ``d'' equal the dividend in the algebraic equation:    d=$68 - (0.10 x $68) - 0.30 ($68 - [0.10 x $68] -      d) - 0.20d....................................    d=$68 - $6.80 - ($20.40 - $2.04 - 0.30d) - 0.20d    d=$61.20 - $20.40 + $2.04 + 0.30d - 0.20d.......    d=$42.84 + 0.10d................................  0.90d=$42.84......................................    d=$42.84/0.90, or...............................              $47.60Gross-up under section 78, using the actual foreign               $20.40 income tax imposed on pretax profits to which are attributable the earnings and profits distributed ($6.80+0.30 [$61.20-$47.60]+0.20 [$47.60]).........Taxable income of M Corporation for 1963                          $68.00 ($47.60+$20.40)....................................U.S. tax before foreign tax credit ($68x0.52).......              $35.36Foreign tax credit ($47.60/$47.60x $20.40)..........              $20.40U.S. tax payable for 1963 ($35.36- $20.40)..........              $14.96Overall U.S. and foreign income tax rate                          47.20% [$14.96+$20.40+($32x0.37)]/$100....................                                  1964Dividend received by M Corporation ($32-[0.37x$32]).              $20.16Gross-up under section 78, using the foreign income               $11.84 tax paid or accrued on pretax earnings and profits to which are attributable 1963 earnings and profits distributed during 1964 ($20.16/$20.16x[$32x 0.37])Taxable income of M Corporation for 1964                          $32.00 ($20.16+$11.84)....................................U.S. tax before foreign tax credit ($32x0.52).......              $16.64Foreign tax credit ($20.16/$20.16x $11.84)..........              $11.84U.S. tax payable ($16.64-$11.84)....................               $4.80 
  (b) If B Corporation were a less developed country corporation under section 902(d), there would be no gross-up under section 78 and the foreign tax credit of M Corporation would be $14.28 for 1963 ($47.60/[47.60+ $20.40]×$20.40), and $7.46 for 1964 ($20.16/ [$20.16+$11.84]×$11.84).

Example 2.  For 1963, domestic corporation M receives a dividend of $21 from B Corporation which counts toward a minimum distribution from a group, determined by applying the special rules of paragraphs (b) and (c) of §1.963–4. Both corporations use the calendar year as the taxable year. Foreign law imposes on B Corporation an income tax of 40 percent of the year's pretax earnings and profits, less dividends paid for such year, and of 20 percent of such dividends. Corporation M directly owns 70 percent of the one class of stock of B Corporation, which for 1963 has pretax and predistribution earnings and profits of $100. Corporation B is not a less developed country corporation under section 902(d). In late 1964, M Corporation receives a distribution of all of B Corporation's 1964 earnings and profits and of $25.20 from its 1963 earnings and profits. The foreign income tax of B Corporation deemed paid for 1963 by M Corporation under section 902(a) is based on the foreign income tax actually paid by B Corporation on an amount of pretax earnings and profits which, when reduced by the tax so paid, equals the total dividend which is paid. The determination of tax deemed paid by M Corporation with respect to distributions from 1963 earnings and profits of B Corporation is as follows:

                                     1963Pretax and predistribution earnings and profits of B                $100 Corporation for 1963..........................................Total dividend paid by B Corporation in 1963 ($21/0.70)........       30Total foreign income tax paid by B Corporation for 1963               34 (0.40[$100- $30]+[0.20x$30]) or ($28+$6)......................Foreign income tax, represented by ``t'' in the following equation, to be taken into account with respect to total dividend in determining tax deemed paid under section 902(a) by M Corporation:    t=(0.20x$30)+0.40t.........................................    t=$6+0.40t.................................................  0.60t=$6.....................................................    t=$6/0.60, or..............................................      $10Foreign income tax deemed paid by M Corporation for 1963 ($21/         7 $30x$10)......................................................                                  1964Remaining 1963 earnings and profits of B Corporation ([$100-          36 $34]-$30) or ($66-$30)........................................Dividend received by M Corporation for 1964 (0.70x$36).........    25.20Foreign income tax deemed paid by M Corporation for 1964           16.80 ($25.20/$36x [$34-$10]) or ($25.20/$36x$24)................... 

[T.D. 6759, 29 Sept. 25, 1964; 29 FR 13896, Oct. 8, 1964, as amended by T.D. 6767, 29 FR 14879, Nov. 3, 1964]

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