ch03 - H Chapter Three H CORPORATE DISTRIBUTIONS: CASH,...

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Unformatted text preview: H Chapter Three H CORPORATE DISTRIBUTIONS: CASH, PROPERTY, AND STOCK DIVIDENDS SOLUTIONS TO RESEARCH PROBLEM RESEARCH PROBLEM 3-36 The first step in this problem is to ascertain the objective of the plan. It is Ps hope that the pre-sale distribution of cash by the subsidiary, T, will be accorded favorable dividend treatment. If the distribution is treated as a dividend, it is wholly nontaxable due to the 100 percent dividends-received deduction allowed for distributions from an affiliated company (see 243). Because the distribution reduces the value of T, the sales price is correspondingly reduced, thereby reducing the amount of capital gain to be reported by P. In effect, P receives part of the sales price tax-free. On the other hand, if the distribution is considered part of the proceeds received from the sale of Ts stock, unfavorable capital gain results. 5- This plan was unsuccessfully attempted in Waterman Steamship Corp. , 70-2 USTC { 9514, 26 AFTR2d 5185, 430 F.2d 1185 (CA-5, 1970). In this case, the prospective buyer originally offered $3.5 million for Watermans two subsidiaries. The Waterman board rejected that offer and made a counter-proposal to sell the two subsidiaries for $700,180, after a dividend of $2,799,820, to Waterman. Not only was this reallocation of the purchase price clearly linked to the dividend, but the dividend was actually paid using funds supplied by the buyerthe dividend was in the form of a note that the buyer subsequently discharged. Accordingly, the court had no trouble in finding that in substance there had been no dividend, and thus treated the purported dividend as part of the purchase price. 5- In the strictest sense, Waterman could support a holding of ignoring all dividends made in anticipation of a sale of a subsidiary, even in those cases where the subsidiary distributed its own cash or other assets (perhaps those undesirable to the buyer). This reading is supported by the decision in Casner v. Comm. , 71-2 USTC { 9651, 450 F.2d 379 (CA-5, 1971) where the taxpayer used the Waterman argument to his benefit. In Casner , the shareholders were individuals and argued that Waterman should apply to cause dividends to be treated as part of the sales price and thus convert ordinary income into capital gain. The Fifth Circuit stood by their decision in Waterman and granted favorable treatment to the taxpayer. However, in Revenue Ruling 75-493, 75-2 C.B. 103, the IRS attempted to clarify its position, hoping to prevent individual taxpayers receiving favorable capital gain treatment while at the same time hoping to prevent corporations receiving favorable dividend treatment. In this ruling, an individual, A, owned 100 percent of the outstanding stock of Y Corporation, which had substantial cash. X Corporation wanted to purchase the Y stock but not the cash. Accordingly, the individual caused Y to pay a large dividend and subsequently sold the stock of X. Because A and X were under no legal obligation at thedividend and subsequently sold the stock of X....
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ch03 - H Chapter Three H CORPORATE DISTRIBUTIONS: CASH,...

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