CAREFUL when selling a subsidiary to a related company.

A Dutch company with operations in the United States sold one of its US subsidiaries – Sub A – to another US subsidiary – Sub B. The IRS invoked section 304 of the US tax code to treat the purchase price paid by Sub B as a dividend to the Dutch parent. It demanded withholding taxes on the dividend. The US collects a 30% withholding tax on dividends paid by US companies to foreign shareholders, although the rate may be reduced by treaty.

The IRS action is described in a legal memorandum the agency released in September.

Section 304 of the US tax code is aimed at preventing end runs around the US tax system by paying out earnings in form as purchase price for a related company. Under this section, money paid to buy a sister subsidiary is treated as a dividend to the common parent to the extent of the combined “earnings and profits” of the two subsidiaries.

Keith Martin