PLR 200952031 (12/24/2009) addressed the application of the dividends received deduction (DRD) in the foreign context where a foreign corporation is the parent of a U.S. subsidiary. As a comment before discussing the ruling, sometimes in structuring an acquisition of a target that engages in both U.S. and non-U.S. business enterprises, it may be better to restructure the target's business operations before the acquisition instead of afterwards which may be the normal course.

Under the general facts of the ruling, acquisition group ("A") owned a U.S. subsidiary which had purchased all of the stock of a domestic target corporation ("T"). T conducted business operations both within and outside of the U.S. After the acquisition, T reincorporated as a foreign corporation, FT, which contributed its domestic business to New U.S.T. Then A’s U.S. subsidiary liquidated which resulted in A’s owned new FT with FT owning New U.S. T. This U.S. parent, foreign subsidiary, wholly owned U.S. subsidiary structure has been referred to as the "foreign sandwich". How will this structure affect the flow of profits from the lowest tier US subsidiary up the change of command?

The taxpayer seeking the ruling did not ask about the domestic to foreign transaction. The IRS simply stated in the ruling that the outbound transfer was an F reorganization. But, consider the drop out or drop down into the New U.S.T. Can it really be said that it was a true F reorganization? Perhaps it was instead an F involving the U.S.T. and then a dividend up of the foreign based business to the foreign company? See Treas. Regs. §§1.368-1(k)(1). 1.368-2(m). The ruling did not dwell on the F reorganization issues or problems but instead focused on the treatment of dividends from New U.S.T. to the FT and then from FT to A.

The ruling held: of course, based on the FT’s status as a foreign corporation, it is ineligible to qualify under §§902 and 960 on foreign tax credits (and corresponding gross up). FT’s foreign base company income for dividends paid by New U.S.T. will be reduced by the 80% DRD (dividends received deduction). Dividends paid up to A can be sheltered by 80% DRD for the U.S. source portion of the dividends from FT citing Weyerhaeuser, 38 BTA 594 (1935). Thus, FT would increase its earnings and profits account by the gross amount of its dividends received from New U.S.T. despite using the DRD in determining subpart F income.

Example. Assume that New U.S.T. had has earnings and profits of $500 and pays a $500 dividend to FT. New Foreign Target receives $100 in foreign base company income, assuming the 80% dividends received deduction applies. Acquirer includes this $100 in income currently and gets step-up in basis of stock per §961(a). This $20 amount is not a “dividend” and does not qualify for the dividends received deduction. Section 964(a)(6) does not mitigate because New U.S. Target is not a CFC.) When A receives a dividend of $100 (previously taxed income) it will reduce its basis in FT stock. §961(b). For amounts above the $100 of PTI, if from the U.S. source earnings, Acquirer will be allowed an 80% DRD. Thus, on a subsequent distribution of the $100 from New Foreign Target (assuming no change in accumulated earnings and profit and no current earnings and profits), $100 will reduce basis, and $400 will be treated as a dividend, 80% of which will qualify for the DRD.