[Code of Federal Regulations]
[Title 26, Volume 7]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.551-5]

[Page 285-286]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.551-5  Effect on capital account of foreign personal holding 
company and basis of stock in hands of shareholders.

    (a) Sections 551(e) and 551(f) are designed to prevent double 
taxation with respect to the undistributed foreign personal holding 
company income.
    (b) The application of sections 551(e) and 551(f) may be illustrated 
by the following examples:

    Example 1. The M Corporation is a foreign personal holding company. 
Seventy-five percent in value of its capital stock is owned by A, a 
citizen of the United States, and the remainder, or 25 percent, of its 
stock is owned by B, a nonresident alien individual. For the calendar 
year 1954 the M Corporation has an undistributed foreign personal 
holding company income of $100,000. A is required to include $75,000 of 
such income in gross income as a dividend in his return for the calendar 
year 1954. The $100,000 is treated as paid-in surplus or as a 
contribution to the capital of the M Corporation and its accumulated 
earnings and profits as of the close of the calendar year 1954 are 
correspondingly reduced. If after treating such $100,000 as paid-in 
surplus or as a contribution to capital, the M Corporation has no 
accumulatedearnings and

[[Page 286]]

profits at the close of 1954, and if for the calendar year 1955, the M 
Corporation had no earnings and profits, but distributed $40,000, the 
amount so distributed would be a nontaxable distribution and would not 
be included in the gross income of either A or B for the calendar year 
1955. If, however, after treating the $100,000 as paid-in surplus or as 
a contribution to capital, the M Corporation had accumulated earnings 
and profits of $100,000 at the close of 1954, the facts otherwise being 
the same, the distributions in 1955 would be taxable to A as a dividend, 
and the taxability of such distributions to B would depend upon the 
application of section 861(a)(2), relating to the treatment of dividends 
from a foreign corporation as income from sources within or without the 
United States.
    Example 2. In example 1 assume the basis of A's stock to be 
$300,000. If A includes in gross income in his return for the calendar 
year 1954, $75,000 as a dividend from the M Corporation, the basis of 
his stock would be $375,000. After the nontaxable distribution of 
$30,000 to A by the M Corporation in 1955 (75 percent of the $40,000 
distribution) the basis of A's stock, assuming no other changes, would 
be $345,000. If A failed to include the $75,000 as a dividend in gross 
income in his return for 1954 and his failure was not discovered until 
after the 6-year period of limitations had expired, the application of 
the rule would not increase the basis of A's stock. The subsequent 
nontaxable distribution of $30,000 to A in 1955 would reduce his basis 
of $300,000 to $270,000, thus tending to compensate for his failure to 
include the amount of $75,000 as a dividend in his gross income for 
1954. If the undistributed foreign personal holding company income of 
the M Corporation is readjusted within the statutory period of 
limitations, thus increasing or decreasing the amount A would have to 
include in his gross income, proper adjustment is required to be made to 
the basis of A's stock on account of such readjustment.