[Federal Register Volume 59, Number 119 (Wednesday, June 22, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-14971]
[[Page Unknown]]
[Federal Register: June 22, 1994]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[CO-8-91]
RIN 1545-AQ42
Distributions of Stock and Stock Rights
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document proposes amendments to regulations relating to
constructive distributions on preferred stock. The proposed regulations
concern the treatment of stock redeemable at a premium by the issuer.
Under the proposed regulations, a call premium is generally treated as
giving rise to a constructive distribution only if redemption pursuant
to the call provision is more likely than not to occur. The proposed
amendments to the regulations also reflect 1990 amendments to section
305(c) of the Internal Revenue Code.
DATES: Written comments must be received by October 24, 1994. Outlines
of oral comments to be presented at the public hearing scheduled for
November 14, 1994, must be received by October 24, 1994.
ADDRESSES: Send submissions to: CC:DOM:CORP:T:R (CO-8-91), room 5228,
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington,
DC 20044. In the alternative, submissions may be hand delivered between
the hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:T:R (CO-8-91), Courier's
Desk, Internal Revenue Service, 1111 Constitution Avenue NW.,
Washington, DC. The hearing will be held in the IRS auditorium, 1111
Constitution Avenue NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Kirsten L. Simpson, (202) 622-7790 (not a toll- free number);
concerning submissions and the hearing, Carol Savage, (202) 622-8452
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collection of information contained in this notice of proposed
rulemaking has been submitted to the Office of Management and Budget
for review in accordance with the Paperwork Reduction Act (44 U.S.C.
3504(h)). Comments on the collection of information should be sent to
the Office of Management and Budget, Attn: Desk Officer for the
Department of the Treasury, Office of Information and Regulatory
Affairs, Washington, DC 20503, with copies to the Internal Revenue
Service, Attn: IRS Reports Clearance Officer, PC:FP, Washington, DC
20224.
The collection of information is in Sec. 1.305-5(b)(5). This
information is required to notify the IRS that the issuer and holder of
stock subject to section 305 have made inconsistent determinations as
to whether there is a constructive distribution under Sec. 1.305-5(b).
The likely respondents are individuals or households and business or
other for-profit institutions.
The estimated total annual reporting burden: 333 hours. The
estimated annual burden per respondent varies from 5 minutes to 15
minutes, depending on individual circumstances, with an estimated
average of 10 minutes. The estimated number of respondents: 2000.
Estimated annual frequency of responses: one.
Background
This document proposes amendments to the Income Tax Regulations (26
CFR part 1) under section 305 of the Internal Revenue Code of 1986.
Section 305(a) provides that gross income generally does not include
stock dividends. Section 305(b)(4) provides an exception for certain
distributions with respect to preferred stock.
Section 305(c) provides that, under regulations, a difference
between redemption price and issue price, or any transaction having a
similar effect, shall be treated as a distribution. This provision
addresses methods ``devised to give preferred stockholders the
equivalent of dividends on preferred stock which are not taxable as
such under present law.'' S. Rep. No. 552, 91st Cong., 1st Sess. 151
(1969). For example, ``a corporation may issue preferred stock for $100
per share which pays no dividends, but which may be redeemed in 20
years for $200. The effect is the same as if the corporation
distributed preferred stock equal to 5 percent of the original stock
each year during the 20-year period in lieu of cash dividends.'' Id.
Current Sec. 1.305-5(b)(1) provides that if a corporation issues
preferred stock which may be redeemed after a specified period of time
at a price higher than the issue price, the difference is considered a
distribution of additional stock on preferred stock which is
constructively received by the shareholder over the period of time
during which the preferred stock cannot be called for redemption.
Current Sec. 1.305-5(b)(2) provides that this rule does not apply
to the extent that the higher redemption price represents a reasonable
redemption premium. A safe harbor is provided under which a redemption
premium is considered reasonable if it is not in excess of 10 percent
of the issue price on stock not redeemable for five years from the date
of issuance. A redemption premium that does not meet this safe harbor
is considered reasonable if it is in the nature of a penalty for
premature redemption and is not larger than the premiums being paid for
this purpose by other issuers of similar stock at the time of issuance.
Current Sec. 1.305-5(b)(1) can apply to preferred stock that is
redeemable solely at the option of the issuer. The holder generally
must treat a call premium as a constructive distribution under
Sec. 1.305-5(b) to the extent that the premium is unreasonable.
Section 305(c) was amended by the Revenue Reconciliation Act of
1990 (the 1990 Act), Pub. L. 101-508, which changed the treatment of
stock redeemable at a premium. The amendments provide that: (a) If the
issuer is required to redeem stock at a specified time, or the holder
has the option to require the issuer to redeem stock, at a premium, the
redemption premium will result in a constructive distribution if it
exceeds a de minimis amount computed under the principles of section
1273(a)(3); (b) a redemption premium will not fail to be treated as a
distribution (or series of distributions) merely because the stock is
callable; and (c) in any case where a redemption premium is treated as
a distribution (or series of distributions), the premium will be taken
into account under principles similar to those of section 1272(a).
The amendments to section 305(c) did not alter the requirement that
constructive distributions resulting from a redemption premium be
treated as distributions to which section 301 applies only if they have
the effect described in section 305(b), including section 305(b)(4).
Rather, the amendments were adopted because Congress believed that
``the economic accrual rules applicable to debt instruments issued with
[original issue discount (OID)] also should generally apply to certain
preferred stock issued with a redemption premium if the stock will be
redeemed, or if it can reasonably be assumed that the stock will be
redeemed, on a fixed date.'' H.R. Rep. No. 881, 101st Cong., 2d Sess.
347 (1990). The legislative history to the 1990 amendments indicates
that Congress did not intend to limit the authority of the Treasury and
the IRS to determine the proper treatment of redemption premiums on
callable preferred stock. Id. at 348-49.
Explanation of Proposed Regulations
1990 Act Amendments. Proposed Sec. 1.305-5 (b)(1) and (b)(2)
restate the basic rules concerning the treatment of mandatorily
redeemable and puttable stock in conformity with the 1990 Act. The IRS
and Treasury anticipate that other issues raised by the 1990 Act will
be addressed in subsequent guidance.
Treatment of issuer call rights. The primary focus of the proposed
regulations is on the treatment under section 305(c) of stock callable
at a premium at the option of the issuer.
If stock is subject to an issuer call, the holder cannot control
whether the stock will be redeemed at the premium amount. Moreover, if
the payment of a call premium merely reflects increases in the value of
the holder's stock resulting from market fluctuations after the date of
issuance, the call premium is not the equivalent of a distribution and
its payment is more appropriately taxable only upon realization.
If, on the date of issuance, however, it is more likely than not
that an issuer will exercise its call option based on the economic
terms of the stock, the holder's anticipated increase in the earnings
and assets of the issuer through the call premium is equivalent to a
periodic return on the stock that should be taxed over time as a
distribution. Such a call has the effect of a mandatory redemption
provision, and should produce comparable tax consequences.
Accordingly, proposed Sec. 1.305-5(b)(3) requires constructive
distribution treatment with respect to an issuer call only if, based on
all of the facts and circumstances as of the issue date, redemption
pursuant to the call right is more likely than not to occur. Even if
redemption may be likely, however, constructive distribution treatment
does not result if the redemption premium is solely in the nature of a
penalty for premature redemption. A penalty for premature redemption is
a premium paid as a result of changes in economic or market conditions
over which neither the issuer nor the holder has control. Examples
include changes in prevailing dividend rates or in the value of the
common stock into which the stock is convertible. Calls in such cases
reflect increases in the value of the holder's stock resulting from
events that occur after the date of issuance, and the premiums paid
thereon therefore represent a penalty for premature redemption rather
than the equivalent of a periodic return on the stock.
Under a safe harbor, constructive distribution treatment does not
result from an issuer call if the issuer and the holder are unrelated,
there are no arrangements that effectively require the issuer to redeem
the stock, and exercise of the option to redeem would not reduce the
yield of the stock.
The standard in the proposed safe harbor is similar to the standard
for taking into account call options in determining the yield of debt
instruments potentially subject to the accrual of OID. See Sec. 1.1272-
1(c)(5). However, the determination of whether a redemption premium
should be treated as a constructive distribution is not based solely on
the effect of an issuer call on yield.
Proposed Sec. 1.305-5(b)(1) does not provide any exception from
constructive distribution treatment for stock that is immediately
callable by the issuer. Under proposed Sec. 1.305-5(b)(3), a
constructive distribution by reason of the issuer call would only occur
in cases where a call is more likely than not to occur, based on the
facts and circumstances as of the issue date. The holder is treated as
constructively receiving the premium as a distribution over the period
from the issue date to the date on or by which redemption is most
likely to occur.
Under the proposed regulations, the tax consequences of callable
preferred stock are intended to reflect the economic expectations of
the parties and to afford issuers flexibility to issue stock on terms
that reflect their business needs. The proposed regulations are also
intended to foreclose corporations from attempting to use issuer calls
to create constructive distributions solely for tax planning reasons.
However, no inference is to be drawn from the proposed regulations as
to the appropriate treatment of such call rights under current law.
Such provisions are subject to scrutiny under general tax principles
(e.g., substance over form).
De minimis exception. Proposed Sec. 1.305-5(b)(1) would replace the
``reasonable redemption premium'' exception under current Sec. 1.305-
5(b)(2) with the statutory de minimis rule under section 305(c)(1) for
mandatorily redeemable and puttable stock, and extend the statutory
rule to issuer calls. Extending this rule to issuer calls differs from
the treatment discussed in the legislative history of the 1990 Act, but
is appropriate because the proposed regulations limit constructive
distribution treatment with respect to issuer calls to circumstances in
which the stock is economically similar to mandatorily redeemable
stock. In those cases, the call premium cannot fairly be said to be
``in the nature of a penalty for premature redemption.'' Since those
cases are outside of the intended scope of the exception in the current
regulations, there is no reason to retain current Sec. 1.305-5(b)(2)
for callable stock.
Conforming changes. The proposed regulations would conform the
examples in Secs. 1.305-3 and 1.305-5 to the proposed changes described
above. In addition, the proposed regulations would conform language in
Sec. 1.305-7(a) to the proposed changes described above.
Effective dates. Proposed Sec. 1.305-5(b)(6) contains the effective
date rules. In general, the regulations are proposed to apply to stock
issued on or after the date final regulations are filed with the
Federal Register.
The committee reports to the 1990 Act indicate that Congress did
not intend to limit the authority of the Secretary to promulgate
regulations relating to the accrual of redemption premiums on callable
preferred stock. However, the reports indicate that Congress
anticipated any such regulations would be prospective. H.R. Conf. Rep.
No. 964, 101st Cong., 2d Sess. 1095 (1990).
Although the proposed regulations do not apply to stock issued
before the date final regulations are filed with the Federal Register,
the rules of sections 305(c) (1), (2), and (3) apply to stock described
therein issued on or after October 10, 1990, except as provided in
section 11322(b)(2) of the 1990 Act. The committee reports to the 1990
Act express Congress' intention that the economic accrual and OID de
minimis rules generally apply as of the effective date of the 1990 Act
without regard to when regulations are amended to reflect such rules.
H.R. Conf. Rep. No. 964, 101st Cong., 2d Sess. 1095 (1990).
The committee reports note that, in general, the OID de minimis
rule will not apply to preferred stock that is callable solely at the
option of the issuer (unless such stock is subject to a mandatory
redemption or is puttable). However, the economic accrual rule will
apply as of the effective date of the 1990 Act to the entire call
premium on stock that is callable solely at the option of the issuer
(but not mandatorily redeemable or puttable) if such premium is
considered to be unreasonable under the current regulations. In such
cases, except as provided in regulations, the entire call premium will
be accrued over the period of time during which the preferred stock
cannot be called for redemption. It should be noted that the committee
reports also authorize the Secretary to treat stock that, in form, is
merely callable as being subject to a mandatory redemption or a put if
the existence of other arrangements effectively requires the issuer to
redeem the stock. H.R. Conf. Rep. No. 964, 101st Cong., 2d Sess. 1095
(1990).
Comments invited. The IRS and Treasury invite public comment on the
proposed regulations and on any issues involving the implementation of
the 1990 Act amendments to section 305(c), including the extent to
which OID principles should be adopted in the section 305(c) context
and the appropriate treatment of unpaid cumulative dividends.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It has also been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do
not apply to these regulations, and, therefore, a Regulatory
Flexibility Analysis is not required. Pursuant to section 7805(f) of
the Internal Revenue Code, this notice of proposed rulemaking will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed original
and eight (8) copies) that are submitted timely to the IRS. All
comments will be available for public inspection and copying.
A public hearing has been scheduled for November 14, 1994, at 10
a.m., in the auditorium. Because of access restrictions, visitors will
not be admitted beyond the Internal Revenue Building lobby more than 15
minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons that wish to present oral comments at the hearing must
submit written comments by October 24, 1994, and submit an outline of
the topics (signed original and eight (8) copies) to be discussed and
the time to be devoted to each topic by October 24, 1994.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information
The principal author of these proposed regulations is Kirsten L.
Simpson of the Office of Assistant Chief Counsel (Corporate), IRS.
However, other personnel of the IRS and Treasury Department
participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
the following entries in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.305-3 also issued under 26 U.S.C. 305.
Section 1.305-5 also issued under 26 U.S.C. 305.
Section 1.305-7 also issued under 26 U.S.C. 305. * * *
Par. 2. Section 1.305-3 is amended as follows:
1. In paragraph (e), remove the parentheses from the numbers in the
headings for Examples (1) through (15).
2. Paragraph (e), Example 15 is revised to read as follows:
Sec. 1.305-3 Disproportionate distributions.
* * * * *
(e) * * *
Example 15. (i) Facts. Corporation V is organized with two
classes of stock, class A common and class B convertible preferred.
The class B stock is issued for $100 per share and is convertible
into class A at a fixed ratio that is not subject to full adjustment
in the event stock dividends or rights are distributed to the class
A shareholders. The class B stock pays no dividends but it is
mandatorily redeemable in 10 years for $200. Under sections 305(c)
and 305(b)(4), the entire redemption premium (i.e., the excess of
the redemption price over the issue price) is deemed to be a
distribution of preferred stock on preferred stock which is taxable
as a distribution of property under section 301. This amount is
considered to be distributed over the 10-year period under
principles similar to the principles of section 1272(a). During the
year, the corporation declares a dividend on the class A stock
payable in additional shares of class A stock.
(ii) Analysis. The distribution on the class A stock is a
distribution to which sections 305(b)(2) and 301 apply since it
increases the proportionate interests of the class A shareholders in
the assets and earnings and profits of the corporation and the class
B shareholders have received property (i.e., the constructive
distribution described above). If, however, the conversion ratio of
the class B stock were subject to full adjustment to reflect the
distribution of stock to class A shareholders, the distribution of
stock dividends on the class A stock would not increase the
proportionate interest of the class A shareholders in the assets and
earnings and profits of the corporation and such distribution would
not be a distribution to which section 301 applies.
(iii) Effective date. This Example 15 applies to stock issued on
or after the date final regulations are filed with the Federal
Register. For previously issued stock, see 26 CFR part 1 edition
revised April 1, 1994, Sec. 1.305-3(e) Example (15).
Par. 3. Section 1.305-5 is amended as follows:
1. Paragraph (b) is revised.
2. In paragraph (d), remove the parentheses from the numbers in the
headings for Examples (1) through (9).
3. Paragraph (d), Examples 4, 5, and 7 are revised.
4. The revisions read as follows:
Sec. 1.305-5 Distributions on preferred stock.
* * * * *
(b) Redemption premium--(1) In general. If a corporation issues
preferred stock that may be redeemed under the circumstances described
in this paragraph (b) at a price higher than the issue price, the
difference (the redemption premium) is treated under section 305(c) as
a constructive distribution (or series of constructive distributions)
of additional stock on preferred stock that is taken into account under
principles similar to the principles of section 1272(a). However,
constructive distribution treatment does not result under this
paragraph if the redemption premium does not exceed a de minimis
amount, as determined under the principles of section 1273(a)(3).
(2) Mandatory redemption or holder put. Paragraph (b)(1) of this
section applies to stock if the issuer is required to redeem the stock
at a specified time or the holder has the option to require the issuer
to redeem the stock.
(3) Issuer call--(i) In general. Paragraph (b)(1) of this section
applies to stock by reason of the issuer's right to redeem the stock
(even if the right is immediately exercisable), but only if, based on
all of the facts and circumstances as of the issue date, redemption
pursuant to that right is more likely than not to occur. However, even
if redemption is more likely than not to occur, paragraph (b)(1) of
this section does not apply if the redemption premium is solely in the
nature of a penalty for premature redemption. A penalty for premature
redemption is a premium paid as a result of changes in economic or
market conditions over which neither the issuer nor the holder has
control.
(ii) Safe harbor. For purposes of this paragraph (b)(3), redemption
pursuant to an issuer's right is not treated as more likely than not to
occur if--
(A) The issuer and the holder are not related within the meaning of
section 267(b) or 707(b);
(B) There are no arrangements that effectively require the issuer
to redeem the stock; and
(C) Exercise of the right to redeem would not reduce the yield of
the stock, as determined under principles similar to the principles of
section 1272(a).
(iii) Effect of not satisfying safe harbor. The fact that a
redemption right is not described in paragraph (b)(3)(ii) of this
section does not affect the determination of whether the right to
redeem is more likely than not to occur.
(4) Coordination of multiple redemption provisions. If the
provisions of stock permit redemption at more than one time, the time
and price at which redemption is most likely to occur must be
determined based on all of the facts and circumstances as of the issue
date. Any constructive distribution under paragraph (b)(1) of this
section will be construed to result only with respect to the time and
price identified in the preceding sentence. However, if redemption does
not occur at that identified time, the amount of any additional premium
payable on any later redemption date, to the extent not previously
treated as distributed, is treated as a constructive distribution over
the period from the missed call or put date to that later date, to the
extent required under the principles of this paragraph (b).
(5) Consistency. The issuer's determination as to whether there is
a constructive distribution under this paragraph (b) is binding on all
holders of the stock, other than a holder that explicitly discloses
that its determination as to whether there is a constructive
distribution under this paragraph (b) differs from that of the issuer.
Unless otherwise prescribed by the Commissioner, the disclosure must be
made on a statement attached to the holder's timely filed Federal
income tax return for the taxable year that includes the date the
holder acquired the stock. The issuer must provide the relevant
information to the holder in a reasonable manner. For example, the
issuer may provide the name or title and either the address or
telephone number of a representative of the issuer who will make
available to holders upon request the information required for holders
to comply with this provision of this paragraph (b).
(6) Effective date. This paragraph (b) (and Examples 4, 5, and 7 of
paragraph (d) of this section) apply to stock issued on or after the
date final regulations are filed with the Federal Register. For rules
applicable to previously issued stock, see 26 CFR part 1 edition
revised April 1, 1994, Sec. 1.305-5(b) and (d) Examples (4), (5), and
(7). Although this paragraph (b) and the revised examples do not apply
to stock issued before the date final regulations are filed with the
Federal Register, the rules of sections 305(c)(1), (2), and (3) apply
to stock described therein issued on or after October 10, 1990, except
as provided in section 11322(b)(2) of the Revenue Reconciliation Act of
1990 (Pub. L. 101-508).
* * * * *
(d) * * *
Example 4--(i) Facts. Corporation X is a domestic corporation
with only common stock outstanding. In connection with its
acquisition of Corporation T, X issues 100 shares of its 4%
preferred stock to the shareholders of T, who are unrelated to X.
The issue price of the preferred stock is $40 per share. Each share
of preferred stock is convertible at the shareholder's election into
three shares of X common stock. At the time the preferred stock is
issued, the X common stock has a value of $10 per share. The
preferred stock does not provide for its mandatory redemption or for
redemption at the option of the holder. It is callable at the option
of X at any time beginning three years from the date of issuance for
$100 per share. There are no other arrangements that would affect
X's decision to call the preferred stock.
(ii) Analysis. The preferred stock is described in the safe
harbor rule of paragraph (b)(3)(ii) of this section because X and
the former shareholders of T are unrelated, there are no
arrangements that effectively require X to redeem the stock, and
calling the stock for $100 per share would not reduce the yield of
the preferred stock. Therefore, the $60 per share call premium is
not treated as a constructive distribution to the shareholders of
the preferred stock under paragraph (b) of this section.
Example 5--(i) Facts--(A) Corporation Y is a domestic
corporation with only common stock outstanding. On January 1, 1995,
Y issues 100 shares of its 10% preferred stock to an unrelated
holder. The issue price of the preferred stock is $100 per share.
The preferred stock is--
(1) Callable at the option of Y on or before January 1, 2000, at
a price of $105 per share plus any accrued but unpaid dividends; and
(2) Mandatorily redeemable on January 1, 2005, at a price of
$100 per share plus any accrued but unpaid dividends.
(B) The preferred stock provides that if Y fails to exercise its
option to call the preferred stock on or before January 1, 2000, the
holder will be entitled to appoint a majority of Y's directors. It
is reasonably anticipated that Y will have available funds
sufficient to exercise the right to redeem.
(ii) Analysis. Under paragraph (b)(3)(i) of this section,
paragraph (b)(1) of this section applies because, by virtue of the
change of control provision and the absence of any contrary facts,
it is more likely than not that Y will exercise its option to call
the preferred stock on or before January 1, 2000. The safe harbor
rule of paragraph (b)(3)(ii) of this section does not apply because
the provision that failure to call will cause the holder to gain
control of the corporation is an arrangement that effectively
requires Y to redeem the preferred stock. Under paragraph (b)(4) of
this section, the constructive distribution occurs over the period
ending on January 1, 2000. Redemption is most likely to occur on
that date, because that is the date on which the corporation
minimizes the rate of return to the holder but yet prevents the
holder from gaining control. The de minimis exception of paragraph
(b)(1) of this section does not apply because the $5 per share
difference between the redemption price and the issue price exceeds
the amount determined under the principles of section 1273(a)(3) (5
x .0025 x $105 = $1.31). Accordingly, $5 per share, the
difference between the redemption price and the issue price, is
treated as a constructive distribution received by the holder on an
economic accrual basis over the five year period ending on January
1, 2000, under principles similar to the principles of section
1272(a).
* * * * *
Example 7--(i) Facts--(A) Corporation Z is a domestic
corporation with only common stock outstanding. On January 1, 1995,
Z issues 100 shares of its 10% preferred stock to C, an unrelated
individual. The issue price of the preferred stock is $100 per
share. The preferred stock is--
(1) Not callable for a period of 5 years from the issue date;
(2) Callable at the option of Z on January 1, 2000, at a price
of $110 per share plus any accrued but unpaid dividends;
(3) Callable at the option of Z on July 1, 2001, at a price of
$120 per share plus any accrued but unpaid dividends; and
(4) Mandatorily redeemable on January 1, 2003, at a price of
$150 per share plus any accrued but unpaid dividends.
(B) There are no other arrangements between Z and C concerning
redemption of the stock.
(ii) Analysis. Under paragraphs (b)(3)(i) and (b)(4) of this
section, paragraph (b)(1) of this section applies because, absent
any other facts indicating a contrary result, the fact that
redemption on January 1, 2000, would reduce the yield of the stock
and produce the lowest yield indicates that exercise of the option
to call on that date is more likely than not to occur. The safe
harbor rule of paragraph (b)(3)(ii) of this section does not apply
to the option to call on January 1, 2000, because the call would
reduce the yield of the stock. The de minimis exception of paragraph
(b)(1) of this section does not apply because the $10 per share
difference between the redemption price payable in 2000 and the
issue price exceeds the amount determined under the principles of
section 1273(a)(3) (5 x .0025 x $110 = $1.38). Accordingly, $10
per share, the difference between the redemption price and the issue
price, is treated as a constructive distribution received by the
holder on an economic accrual basis over the five year period ending
January 1, 2000, under principles similar to the principles of
section 1272(a).
(iii) Coordination rules--(A) If Z does not exercise its option
to call the preferred stock on January 1, 2000, paragraph (b)(4) of
this section provides that the principles of paragraph (b) of this
section must be applied to determine if any remaining constructive
distribution occurs. Under paragraphs (b)(3)(i) and (b)(4) of this
section, paragraph (b)(1) of this section applies because, absent
any other facts indicating a contrary result, the fact that
redemption on July 1, 2001, would produce the lowest yield indicates
that exercise of the option to call on that date is more likely than
not to occur. The safe harbor rule of paragraph (b)(3)(ii) of this
section does not apply to the option to call on July 1, 2001,
because, as of the first call date, a call by Z on July 1, 2001, for
$120 would reduce the yield of the stock. The de minimis exception
of paragraph (b)(1) of this section does not apply because the $10
per share difference between the redemption price and the issue
price (revised as of the missed call date) exceeds the amount
determined under the principles of section 1273(a)(3) (1 x .0025
x $120 = $.30). Accordingly, the $10 per share of additional
redemption premium that is payable on July 1, 2001, is treated as a
constructive distribution received by the holder on an economic
accrual basis over the period between January 1, 2000, and July 1,
2001, under principles similar to the principles of section 1272(a).
(B) If Z does not exercise its second option to call the
preferred stock on July 1, 2001, then the $30 additional redemption
premium that is payable on January 1, 2003, is treated as a
constructive distribution under paragraphs (b)(2) and (b)(1) of this
section. The de minimis exception of paragraph (b)(1) of this
section does not apply because the $30 per share difference between
the redemption price and the issue price (revised as of the second
missed call date) exceeds the amount determined under the principles
of section 1273(a)(3) (1 x .0025 x $150 = $.38). The holder is
treated as receiving the constructive distribution on an economic
accrual basis over the period between July 1, 2001, and January 1,
2003, under principles similar to the principles of section 1272(a).
Par. 4. Section 1.305-7 is amended by revising the fourth sentence
in the concluding text of paragraph (a) to read as follows:
Sec. 1.305-7 Certain transactions treated as distributions.
(a) * * *
* * * For example, where a redemption premium exists with respect to a
class of preferred stock under the circumstances described in
Sec. 1.305-5(b) and the other requirements of this section are also
met, the distribution will be deemed made with respect to such
preferred stock, in stock of the same class. * * *
* * * * *
Margaret Milner Richardson,
Commissioner of Internal Revenue.
[FR Doc. 94-14971 Filed 6-21-94; 8:45 am]
BILLING CODE 4830-01-U