tax imposed by section 821 (a), and the taxable investment income (as defined in sec. 822 (a) (1)) in the case of the tax imposed by section 821 (c). (2) Adjustments to basis for depreciation sustained. Subsection (g) (2) amends section 1016(a)(3) of the code (relating to adjustments to basis for depreciation, etc., sustained) to provide, in effect, that any exhaustion, wear and tear, obsolescence, amortization, and depreciation, to the extent sustained (and to the extent sec. 1016(a)(2) does not apply), on property held in respect of any period since February 28, 1913, by a person subject to tax under part II of subchapter L (or the corresponding provisions of prior income tax laws), must be taken into account in determining the adjusted basis of such property. (3) Alternative tax on capital gains. Subsection (g)(3) amends section 1201 (a) of the code (relating to alternative tax on capital gains) to conform to the amendment to section 821. (4) Clerical amendments.-Subsection (g) (4) makes clerical conforming changes. (h) Effective date.-Subsection (h) of section 8 of the bill provides that the amendments made by section 8 of the bill (other than by subsec. (f)) shall apply only with respect to taxable years beginning after December 31, 1962. Section 831 (c) of the code, as added by subsection (f) of section 8, is applicable for taxable years beginning after December 31, 1961. SECTION 9. DOMESTIC CORPORATIONS RECEIVING DIVIDENDS FROM FOREIGN CORPORATIONS Section 9 of the bill, corresponding to section 11 of the bill as passed by the House, deals with the method to be used for determining the amount of foreign income tax deemed to have been paid by domestic corporations with respect to dividends received from foreign corporations for purposes of allowance of a foreign tax credit under section 902 of the code. Section 9 of the bill revises section 902 of the code, and requires (under a new sec. 78) the inclusion of certain taxes deemed paid in income as a dividend from corporations other than certain less developed country corporations (the bill as passed by the House applied such rule to dividends from all foreign corporations). The new section 902 omits the present subsection (d), which provides a special rule for allowance of a foreign tax credit with respect to royalty or compensation payments made by certain wholly owned foreign subsidiaries to domestic parents in lieu of dividends. Section 9 also changes the source of income rule of section 861(a)(2)(B) with respect to dividend income received from a foreign corporation which derived income from sources within the United States and for which a dividends received deduction was allowed under section 245. (a) Entire amount of foreign tax to be taken into account.-Subsection (a) of the new section 9 revises section 902. Paragraph (1) of subsections (a) and (b) of section 902 as revised, and subparagraph (A) of subsection (c) (1), provide a new formula for determining the amount of foreign income tax deemed to have been paid by a domestic corporation with respect to dividends received from a foreign corporation other than a less developed country corporation. Paragraph (2) of subsections (a) and (b), and subparagraph (B) of subsection (c)(1), section 902 as revised continue existing law for determining the aount of foreign income tax deemed to have been paid by a doestic corporation with respect to dividends from less developed untry corporations. Subsections (b) (1) and (c)(1)(A) apply only subsection (a)(1) applies, and subsections (b)(2) and (c)(1)(B) apply ly if subsection (a) (2) applies. The first clause of section 902 (c) (1) existing law defines accumulated profits as gains, profits, or income educed by the amount of taxes with respect thereto. Under subsecon (c)(1)(A) of section 902 as revised, however, accumulated profits re defined as gains, profits, or income computed without reduction y the amount of the income, war profits, and excess profits taxes nposed by a foreign country or possession of the United States on r with respect to such profits or income. Taxes imposed by the Jnited States will, however, continue to reduce such accumulated ›rofits. The redefinition of accumulated profits increases the amount of taxes to be taken into account in applying the proportions provided n section 902 (a)(1) and (b)(1) of the code. Under existing law, a credit is allowed to a domestic corporation for all or a part of the foreign taxes paid on or with respect to the accumulated profits of the foreign corporation making a distribution. However, by the existing definition, accumulated profits are total profits less taxes thereon. The Supreme Court, in American Chicle Co. v. United States, 316 U.S. 450 (1942), has held that the amount of tax paid on or with respect to a foreign corporation's accumulated profits is the same proportion of total taxes on profits as accumulated profits is of total profits. Thus, if a corporation had total profits of $100, foreign taxes of $40, and therefore accumulated profits of $60, the amount of taxes paid on or with respect to accumulated profits would be $24 ($40 $60/100). If the accumulated profits of $60 were paid as a dividend, no more than $24 could be allowed as a credit as deemed paid under section 902 of existing law. As amended, the section 902 (c) (1) (A) definition will permit the taking into account of a stated proportion of total taxes under section 902 (a) (1) and 902(b)(1). For such purpose it is no longer necessary to apply the American Chicle rule. Since accumulated profits would be total profits without reduction for taxes paid thereon, the amount of taxes paid on or with respect to accumulated profits would, in the above example, be $40 rather than $24. Subsections (a)(1) and (b)(1) of section 902 as revised provide for the use of the proportion which distributed dividends bear to the accumulated profits in excess of foreign taxes. The result is to continue under such subsections the use of the ratios under existing law, but because of section 902 (c) (1) (A) the amount against which the ratios operate is increased. The application of these changes in a section 902 (a) (1) computation may be illustrated by the following example involving corporation P, a domestic corporation which owns 100 percent of the voting stock of corporation FC, a foreign corporation not a less developed country corporation. It is assumed that all transactions have taken place within, and are related to, the same taxable year. Example 1 (i) Gains, profits, and income of corporation FC.. (ii) Foreign tax paid by corporation FC with respect to such gains, profits, and income.. (iii) Accumulated profits of corporation FC computed without reduction for foreign taxes (sec. 902(c)) (iv) Accumulated profits of corporation FC reduced by foreign taxes (sec. 902(a))____ (v) Dividends paid by corporation FC to corporation P.. 15 (vi) Corporation P is deemed to have paid the same proportion of the total tax paid by corporation FC as dividends, determined without regard to section 78, bear to accumulated profits in excess of taxes: $30× 35/70... Example 1 will apply to all dividends received by a domestic corporation after December 31, 1964, from a foreign corporation (not a less developed country corporation), regardless of the year in which the profits from which such dividends were paid were accumulated. Example 1 will also apply with respect to dividends received by a domestic corporation from such a foreign corporation in its taxable years beginning after December 31, 1962, so long as the dividends from the foreign corporation are attributable to accumulated profits of the foreign corporation for its taxable years beginning after December 31, 1962. However, for periods before January 1, 1965, the American Chicle rule and the present section 902 (a) treatment will continue to apply where the dividends from such a foreign corporation are attributable to accumulated profits for taxable years beginning before January 1, 1963. Following the established rule, a foreign corporation is considered to be making a distribution first from its accumulated profits for its current taxable year and then from its accumulated profits of its immediately preceding year, etc. The following example illustrates the above rules where a dividend is distributed out of both accumulated profits for taxable years beginning after December 31, 1962, and accumulated profits for taxable years beginning before January 1, 1963. The facts are the same as in example 1 except for the noted differences: Example 2 (i) Gains, profits, and income of corporation FC in 1963. $100 40 Accumulated profits (existing sec. 902(c)). ) Dividends paid by corporation FC to corporation P in 1963 and the year to which such dividends are attributable: 1963__ $60 1962 30 90 (v) Corporation P is deemed to have paid a foreign tax with respect to the 1963 accumulated profits of corporation FC computed in the same manner as in example 1 ($40×60/60) 40 123 52 (vi) Corporation P is deemed to have paid a foreign tax with respect to the 1962 accumulated profits of corporation FC in the same manner as existing rules ($40 X 60/100 × 30/60) _ _. (vii) Total foreign tax corporation P is deemed to have paid ((v) + (vi))_ _ The new subsections (a)(1), (b)(1), and (c)(1)(A), when applied to dividends received after December 31, 1964, will not be affected by the fact that there may have been in an earlier year a partial distribution of accumulated profits to which the Chicle rule applied. For example, if a wholly owned foreign subsidiary (not a less developed country corporation) of a domestic corporation had total profits of $100, upon which foreign taxes of $40 had been paid, accumulated profits under existing law would be $60. Under the Chicle rule the axes paid with respect to the accumulated profits would be $24 ($40X$60/100). Upon a distribution of one-half ($30) of such accumulated profits the domestic parent would be entitled under existing section 902 (a) to a maximum credit of $12. However, if at any time after 1964, the subsidiary distributes another dividend, $30, with respect to the accumulated profits of such earlier year, and taxes deemed paid, determined in accordance with new section 902 (a)(1), will be the same proportion of total taxes as the dividend bears to accumulated profits in excess of foreign taxes. Thus, the total tax of $40 would be multiplied by the fraction 30/60 and the parent would be entitled under section 902 (a), as amended, to a credit of $20. No account is to be taken of the foreign tax of $8 which, because of the Chicle rule, was not taken into account in the earlier dividend year. If a dividend from a foreign corporation (not a less developed country corporation) is distributed out of its accumulated profits for a taxable year beginning after 1962, and such accumulated profits are composed in whole or in part of dividends which were received from accumulated profits of a foreign subsidiary of the foreign corporation accumulated in taxable years beginning after 1962, both subsections (a)(1) and (b) (1) applies. After 1964 the new subsections (a)(1) and (b)(1) of section 902 will apply whether the distributions are from accumulated profits of the foreign corporation and its foreign subsidiary for their taxable years beginning after 1962 or before 1963. The computation involving these rules may be illustrated by the following example involving corporation P, a domestic corporation which owns 100 percent of the voting stock of foreign corporation FC (not a less developed country corporation) which in turn owns 100 percent of the voting stock of foreign subsidiary FS. It is assumed that all transactions have taken place and are related to the taxable year 1963. Example 3 (A) Application of section 902(b) (1) to determine tax deemed to be paid by corporation FS: (i) Gains, profits, and income of corporation FS... $100 20 (iii) Accumulated profits in excess of taxes of corporation FS: $100 less $20. (iv) Dividends paid by corporation FS to corporation FC.. (v) Corporation FS foreign tax which is deemed paid by corporation FC: $20X40/80... (B) Application of amended section 902 (a)(1) to determine tax deemed to be paid by corporation P: (i) Gains, profits, and income of corporation FC: Business profits... $100 Dividends from corporation FS. 40 140 (ii) Foreign tax paid by corporation FC with respect to its gains, profits, and income... 40 (iii) Accumulated profits in excess of taxes paid by corporation FC: $140 less $40.. (iv) Dividend paid by corporation FC to corporation P.. Where a dividend from a foreign corporation (not a less developed country corporation) before 1965 is attributable to its accumulated profits for a taxable year beginning after 1962, but which profits are composed in part of a dividend received by such foreign corporation from the accumulated profits of its foreign subsidiary for a taxable year or years of the subsidiary beginning before 1963, for purposes of computing the foreign tax credit a pro rata amount of the dividend received from the foreign corporation will be deemed to consist of accumulated profits of its foreign subsidiary attributable to the period before 1963. Existing law will apply to that portion of the foreign tax paid or accrued or deemed paid by the foreign corporation with respect to such pro rata amount of the dividend considered attributable to the accumulated profits of its subsidiary for taxable years before 1963 and the amendment made by section 9 of the bill will apply to the balance of such tax. The new subsections (a)(1), (b)(1), and (c)(1)(A) apply to the extent that a domestic corporation receives dividends from the accumulated profits of a foreign corporation for a taxable year for which it is not a less developed country corporation, and shall apply although such accumulated profits include dividends from accumulated profits of another foreign corporation for a taxable year for which such other foreign corporation is a less developed country corporation. Such provisions do not apply if the dividend is from accumulated profits of a corporation for a taxable year for which it is a less developed untry corporation even though such accumulated profits includes vidends from accumulated profits of another foreign corporation for axable year for which such other corporation is not a less developed untry corporation. The new subsection (d) of section 902 as revised defines a less deeloped country corporation for the purpose of section 902 as a foreign corporation (1) which, for its taxable year, is a less developed country corporation under section 955(c) (1) or (2), or (2) which owns at least 10 percent of all classes of stock entitled to vote of a less developed country corporation under section 955(c) (1), derives at least 80 percent of its gross income for its taxable year from sources within less developed countries under section 955(c)(1)(A), and at least 80 percent in value of its assets on each day of such year consists of property described in section 955(c) (1) (B). A foreign corporation which is a less developed country corporation for its first taxable year beginning after December 31, 1962, is to be treated as such for each of its prior taxable years. Thus, if, after December 31, 1964, a domestic corporation receives a dividend from a foreign corporation from its accumulated profits for a taxable year beginning before December 31, 1962, the rules of existing law apply if such foreign corporation is a less developed country corporation for its first taxable year beginning after December 31, 1962, without regard to its earlier status. (b) Inclusion in gross income of amount equal to taxes deemed paid.— Subsection (b) of section 9 of the bill amends part II of subchapter B of chapter 1 (relating to items specifically included in income) by adding at the end thereof a new section 78. Section 78 requires a domestic corporation to include in gross income as a dividend an amount equal |