Sec. 452--Effect on Earnings and Profits In The House bill provides, as recommended by Treasury, that accelerated depreciation in excess of straight-line depreciation shall not be taken into account for purposes of computing the earnings and profits of a corporation. this respect, the bill would treat the excess depreciation in the same way as the excess of percentage over cost depletion is treated in determining earnings and profits under existing law. The stated purpose of this provision is to prevent the payment of dividends which are not treated as ordinary income because accelerated depreciation in the case of some companies exhausts earnings and profits. Questions have been raised as to the application of this provision in the determination of the foreign tax credit under section 902 of the Code. - 96 Section 902 allows a "deemed paid" foreign tax credit to a domestic corporation, owning 10 percent or more of the voting stock of a foreign corporation, with respect to foreign income taxes paid by such foreign corporation to the extent the taxes are allocable to a dividend paid by the foreign corporation to the domestic corporation. In general, the allocation of foreign taxes to the dividend is made on the basis of the ratio of the dividend to "accumulated profits," and any increase in "accumulated profits" will result in an allocation of less of the foreign taxes to the dividend. Since "accumulated profits" are determined in accordance with criteria applied under United States income tax law for determining earnings and profits (see Rev. Rul. 63-6, 1963-1 C.B. 126), the increase in earnings and profits accomplished by the House bill (representing the excess of accelerated depreciation over straight-line depreciation) will increase "accumulated profits" and thereby decrease the foreign income taxes allocated to the dividend. *While the taxpayer can elect to determine accumulated profits under one of two methods, both methods depend upon the U.S. concept of earnings and profits. The net effect of this provision is to deny the benefits of accelerated depreciation to operations conducted through foreign subsidiaries by allowing a credit for the foreign taxes on the income as if only straight-line depreciation had been taken. The same result occurs under existing law with respect to percentage depletion. While not previously stated as an intended purpose of the provision, Treasury considers that this result is proper and that the provision should be retained in the form contained in the House bill. Section 452 of the bill will effect a similar reduction in the foreign tax credit for foreign income taxes paid by a 50 percent or more owned foreign subsidiary of a 10 percent owned foreign subsidiary. In addition, this provision would affect the U.S. taxation of subpart F income (section 951-964 of the Code) including minimum distributions under section 963 and the special foreign tax credit provisions, the increase in earnings of controlled foreign corporations invested in United States property (section 956 of the Code), gain on sale or exchange of stock in a foreign investment company (section 1246 of the Code) and gain on sale or exchange of stock of a controlled foreign corporation (section 1248 of the Code). - 98 1. Sec. 461, 511-516--Capital Gains and Losses Alternative Capital Gains Rate for Corporations Under existing law, corporations which have an excess of net long-term capital gains over net short-term capital losses may exclude such excess from taxable income and pay an alternative tax of 25 percent of such excess. The bill increases the alternative capital gains tax rate to 30 percent for sales or other dispositions made after July 31, 1969. Treasury recommends that the increase in the capital gain rate be made applicable only to the extent that in any year net long-term capital gains exceed net short-term cap ital losses plus $50,000. 2. Alternative Capital Gains Tax for Individuals Under existing law, 50 percent of an individual's net long-term capital gain in excess of his net short-term capital loss is included in adjusted gross income. Existing law establishes a limit on the tax of a person other than a corporation by providing that the tax rate on the excess of long-term capital gains over short-term capital losses may not exceed 25 percent. - 99 The effect of this limitation on the rate of tax is to increase above 50 percent the amount of long-term capital gains that are not subject to tax. In other words, the same tax burden would result if, instead of taxing the included 50 percent of these gains at a maximum rate of 50 percent, the portion of the total gains subject to tax were reduced below 50 percent and that portion were subject to the regular graduated rates of tax. The following example will illustrate the interchangeability of these approaches: Assume that a single individual has $500,000 of longterm capital gains and no other income for the taxable year. Disregarding personal exemptions and itemized deductions, his tax is $125,000, i.e., 50 percent of the $250,000 of long-term capital gains which are included in his adjusted The same tax would result, however, if instead of taxing $250,000 at a 50 percent rate, $199,300 (39.86 percent) of his gains were subject to tax at the regular graduated rates of tax now in effect. gross income. |