[Federal Register Volume 60, Number 245 (Thursday, December 21, 1995)]
[Rules and Regulations]
[Pages 66134-66139]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-30831]



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DEPARTMENT OF THE TREASURY
26 CFR Parts 1 and 602

[TD 8643]
RIN 1545-AQ42


Distributions of Stock and Stock Rights

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations amending regulations 
under section 305(c) of the Internal Revenue Code relating to 
constructive distributions on preferred stock. The final regulations 
concern the treatment of stock redeemable at a premium by the issuer. 
The regulations generally treat a call premium as giving rise to a 
constructive distribution only if redemption pursuant to the call 
provision is more likely than not to occur. The final regulations also 
reflect 1990 amendments to section 305(c).

DATES: These regulations are effective December 20, 1995.
    For dates of applicability of these regulations, see Effective 
dates under SUPPLEMENTARY INFORMATION.

FOR FURTHER INFORMATION CONTACT: Kirsten L. Simpson, (202) 622-7790 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under 
control number 1545-1438. Responses to this collection of information 
are required to comply with the consistency requirements of the 
regulation.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number. The 

[[Page 66135]]
estimated annual burden per respondent varies from 5 minutes to 15 
minutes, depending on individual circumstances, with an estimated 
average of 10 minutes.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington, 
DC 20224, and 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.
    Books or records relating to this collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    On June 22, 1994, a notice of proposed rulemaking (CO-8-91), 
amending regulations under section 305(c) of the Internal Revenue Code 
relating to constructive distributions on preferred stock, was 
published in the Federal Register (59 FR 32160). No public hearing was 
requested and none was held.
    Written comments responding to the notice were received. After 
consideration of all the comments, the regulations proposed by CO-8-91 
are adopted as revised by this Treasury decision. The principal 
revisions are discussed below.

Explanation of Provisions

    The primary focus of the final regulations is on preferred stock 
callable at a premium at the option of the issuer. The final 
regulations retain the approach of the proposed regulations and require 
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.
    Safe harbor rule. The proposed regulations provided a safe harbor, 
under which constructive distribution treatment does not result from an 
issuer call if the issuer and 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. In response to comments, the final regulations make certain 
modifications to the safe harbor to clarify its scope.
    Commentators suggested that the exclusion from the safe harbor 
where there are ``arrangements that effectively require the issuer to 
redeem'' is too narrow and will permit taxpayers who issue stock with 
``understandings'' concerning redemption, whether or not legally 
enforceable, to qualify for the safe harbor. Commentators recommended 
safeguarding against abuse by changing the effectively requires 
redemption test to one that requires a lesser degree of probability. 
The IRS and Treasury intend that the safe harbor not be available where 
an issuer and a holder have an underlying understanding. Although the 
IRS and Treasury believe that the word ``arrangement'' is broad enough 
to include such understandings, in response to these comments, this 
prong of the safe harbor has been clarified.
    To retain greater certainty for non-abusive transactions, however, 
the effectively requires redemption test has not been substantially 
modified. Instead, the final regulations safeguard against abuse by 
lowering the threshold for determining whether an issuer and a holder 
are related. The proposed regulations adopted a 50-percent threshold 
for determining whether an issuer and a holder are related. The final 
regulations lower this threshold to 20 percent. This threshold relates 
only to eligibility for the safe harbor, and not to the application of 
the general ``more likely than not'' test. When a holder's ownership 
interest exceeds this threshold, the IRS and Treasury believe it is 
appropriate to determine whether redemption is more likely than not to 
occur based on all of the facts and circumstances.
    Commentators also suggested that the IRS and Treasury except 
preferred stock within the meaning of section 1504(a)(4) in determining 
whether the issuer and holder are related. The regulations do not adopt 
this suggestion. As noted above, the determination of whether the 
issuer and holder are related only governs eligibility for the safe 
harbor. The IRS and Treasury believe that when a holder's ownership 
interest in an issuer exceeds the threshold, even if all that the 
holder owns is preferred stock within the meaning of section 
1504(a)(4), it is appropriate to determine whether redemption is more 
likely than not to occur based on all of the facts and circumstances.
    In response to comments, the final regulations clarify that the 
``arrangements'' that effectively require or are intended to compel the 
issuer to redeem the stock relate to the issuer call right, and not to 
a later mandatory redemption feature.
    In testing whether a call right meets the yield prong of the safe 
harbor, the final regulations clarify that principles similar to the 
principles of section 1272(a) and the original issue discount 
regulations apply to determine whether exercise of the right to redeem 
would reduce the yield of the stock.
    Miscellaneous. The final regulations expand the definition of 
issuer in certain circumstances. In particular, the regulations provide 
that if preferred stock may be acquired by a person other than the 
issuer (a third person), the term issuer includes such third person if 
the regulations would apply to the stock if the third person were the 
issuer, and acquisition of the stock by the third person would be 
treated as a redemption for federal income tax purposes (under section 
304 or otherwise). In addition, if the issuer and the third person are 
members of the same affiliated group, the term issuer includes the 
third person if a principal purpose of the arrangement is to avoid the 
application of section 305 and the final regulations. Furthermore, an 
agreement or other arrangement for a person other than the issuer of 
the stock to acquire the stock may create a conversion transaction 
within the meaning of section 1258.
    The final regulations provide rules for the treatment of mandatory 
redemption obligations and put options that are subject to 
contingencies. Generally, premiums on such stock are not subject to 
constructive distribution treatment if the contingency renders remote 
the likelihood of redemption. For example, where an issuer issues stock 
that is mandatorily redeemable in the event of an initial public 
offering, the regulations require evaluation of the likelihood of the 
occurrence of the initial public offering. The regulations provide, 
however, that a contingency does not include the possibility of 
default, insolvency, or similar circumstances, or that a redemption may 
be precluded by applicable law due to insufficient capital.
    The preamble to the proposed regulations requested comments on the 
appropriate treatment of unpaid cumulative dividends. Because of the 
complexity of this issue, the final regulations do not provide rules 
for those dividends. The IRS and Treasury will continue to consider the 
issue, as well as other issues involving the implementation of the 
amendments to section 305(c) made by the Revenue Reconciliation Act of 
1990. The IRS and Treasury continue to invite public comments on these 
issues.


[[Page 66136]]

EFFECTIVE DATES. The regulations apply to stock issued on or after 
December 20, 1995. Although the regulations do not apply to stock 
issued before December 20, 1995, 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 Stat.). Moreover, except as 
provided in section 11322(b)(2) of the Revenue Reconciliation Act of 
1990 (Pub. L. 101-508 Stat.), with respect to stock issued on or after 
October 10, 1990, and issued before December 20, 1995, the economic 
accrual rule of section 305(c)(3) will apply to the entire call premium 
on stock that is not described in paragraph (b)(2) of this section if 
the premium is considered to be unreasonable under the principles of 
Sec. 1.305-5(b) (as contained in the 26 CFR part 1 edition revised 
April 1, 1995). A call premium described in the preceding sentence will 
be accrued over the period of time during which the preferred stock 
cannot be called for redemption.

Special Analyses

    It has been determined that this Treasury decision 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, 
the notice of proposed rulemaking preceding these regulations was 
submitted to the Small Business Administration for comment on its 
impact on small business.

Drafting Information

    The principal author of these 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

26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 1 and 602 are 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. In 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 at 
the holder's option 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 December 20, 1995. For previously issued stock, see 
Sec. 1.305-3(e) Example (15) (as contained in the 26 CFR part 1 
edition revised April 1, 1995).

    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), redesignate Examples 8 and 9 as 
Examples 9 and 10, respectively.
    3. In paragraph (d), Examples 4, 5, and 7 are revised, and Example 
8 is added.
    4. Paragraph (e) is added.
    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 (b) if the redemption premium does not exceed a de minimis 
amount, as determined under the principles of section 1273(a)(3). For 
purposes of this paragraph (b), preferred stock that may be acquired by 
a person other than the issuer (the third person) is deemed to be 
redeemable under the circumstances described in this paragraph (b), and 
references to the issuer include the third person, if--
    (i) This paragraph (b) would apply to the stock if the third person 
were the issuer; and
    (ii) Either--
    (A) The acquisition of the stock by the third person would be 
treated as a redemption for federal income tax purposes (under section 
304 or otherwise); or
    (B) The third person and the issuer are members of the same 
affiliated group (having the meaning for this purpose given the term by 
section 1504(a), except that section 1504(b) shall not apply) and a 
principal purpose of the arrangement for the third person to acquire 
the stock is to avoid the application of section 305 and paragraph 
(b)(1) of this section.
    (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 (whether or not 
currently exercisable) to require the issuer to redeem the stock. 
However, paragraph (b)(1) of this section will not 

[[Page 66137]]
apply if the issuer's obligation to redeem or the holder's ability to 
require the issuer to redeem is subject to a contingency that is beyond 
the legal or practical control of either the holder or the holders as a 
group (or through a related party within the meaning of section 267(b) 
or 707(b)), and that, based on all of the facts and circumstances as of 
the issue date, renders remote the likelihood of redemption. For 
purposes of this paragraph, a contingency does not include the 
possibility of default, insolvency, or similar circumstances, or that a 
redemption may be precluded by applicable law which requires that the 
issuer have a particular level of capital, surplus, or similar items. A 
contingency also does not include an issuer's option to require earlier 
redemption of the stock. For rules applicable if stock may be redeemed 
at more than one time, see paragraph (b)(4) of this section.
    (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 redemption premium is 
not a penalty for premature redemption unless it is a premium paid as a 
result of changes in economic or market conditions over which neither 
the issuer nor the holder has legal or practical control.
    (ii) Safe harbor. For purposes of this paragraph (b)(3), redemption 
pursuant to an issuer's right to redeem 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) (for purposes of applying sections 267(b) and 
707(b) (including section 267(f)(1)), the phrase ``20 percent'' shall 
be substituted for the phrase ``50 percent'');
    (B) There are no plans, arrangements, or agreements that 
effectively require or are intended to compel the issuer to redeem the 
stock (disregarding, for this purpose, a separate mandatory redemption 
obligation described in paragraph (b)(2) of this section); 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) and the regulations under sections 1271 through 1275.
    (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 a redemption 
pursuant to the right to redeem is more likely than not to occur.
    (4) Coordination of multiple redemption provisions. If stock may be 
redeemed 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 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).
* * * * *
    (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 
both before and after the transaction. 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 plans, arrangements, or agreements that 
effectively require or are intended to compel X to redeem the 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 plans, 
arrangements, or agreements that effectively require or are intended 
to compel 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, 1996, 
Y issues 100 shares of its 10% preferred stock to a holder. The 
holder is unrelated to Y both before and after the stock issuance. 
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, 2001, at 
a price of $105 per share plus any accrued but unpaid dividends; and
    (2) Mandatorily redeemable on January 1, 2006, 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, 2001, the 
holder will be entitled to appoint a majority of Y's directors. 
Based on all of the facts and circumstances as of the issue date, Y 
is likely to have the legal and financial capacity to exercise its 
right to redeem. There are no other facts and circumstances as of 
the issue date that would affect whether Y will call the preferred 
stock on or before January 1, 2001.
    (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, 2001. 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 a plan, arrangement, or agreement that 
effectively requires or is intended to compel Y to redeem the 
preferred stock. Under paragraph (b)(4) of this section, the 
constructive distribution occurs over the period ending on January 
1, 2001. 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 while preventing 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 

[[Page 66138]]
received by the holder on an economic accrual basis over the five-year 
period ending on January 1, 2001, 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, 1996, 
Z issues 100 shares of its 10% preferred stock to C, an individual 
unrelated to Z both before and after the stock issuance. 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, 2001, at a price 
of $110 per share plus any accrued but unpaid dividends;
    (3) Callable at the option of Z on July 1, 2002, at a price of 
$120 per share plus any accrued but unpaid dividends; and
    (4) Mandatorily redeemable on January 1, 2004, at a price of 
$150 per share plus any accrued but unpaid dividends.
    (B) There are no other plans, arrangements, or agreements 
between Z and C concerning redemption of the stock. Moreover, there 
are no other facts and circumstances as of the issue date that would 
affect whether Z will call the preferred stock on either January 1, 
2001, or July 1, 2002.
    (ii) Analysis. This stock is described in paragraph (b)(2) of 
this section because it is mandatorily redeemable. It is also 
potentially described in paragraph (b)(3)(i) of this section because 
it is callable at the option of the issuer. The safe harbor rule of 
paragraph (b)(3)(ii) of this section does not apply to the option to 
call on January 1, 2001, because the call would reduce the yield of 
the stock when compared to the yield produced by the January 1, 
2004, mandatory redemption feature. Moreover, absent any other facts 
indicating a contrary result, the fact that redemption on January 1, 
2001, would produce the lowest yield indicates that redemption is 
most likely to occur on that date. Under paragraph (b)(4) of this 
section, paragraph (b)(1) of this section applies with respect to 
the issuer's right to call on January 1, 2001, because redemption is 
most likely to occur on January 1, 2001, for $110 per share. 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 2001 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, 2001, 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, 2001, 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, 2002, would produce a lower yield than the 
yield produced by the mandatory redemption feature indicates that 
redemption on that date is most likely 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, 2002, because, as of January 1, 2001, a 
call by Z on July 1, 2002, 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 as provided by paragraph (b)(4) of this section) 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, 2002, is 
treated as a constructive distribution received by the holder on an 
economic accrual basis over the period between January 1, 2001, and 
July 1, 2002, 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, 2002, then the $30 additional redemption 
premium that is payable on January 1, 2004, 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, 2002, and January 1, 2004, 
under principles similar to the principles of section 1272(a).
    Example 8--(i) Facts. The facts are the same as in paragraph (i) 
of Example 7, except that, based on all of the facts and 
circumstances as of the issue date (including an expected lack of 
funds on the part of Z), it is unlikely that Z will exercise the 
right to redeem on either January 1, 2001, or July 1, 2002.
    (ii) Analysis. The safe harbor rule of paragraph (b)(3)(ii) of 
this section does not apply to the option to call on either January 
1, 2001, or July 1, 2002, because each call would reduce the yield 
of the stock. Under paragraph (b)(3)(i) of this section, neither 
option to call is more likely than not to occur, because, based on 
all of the facts and circumstances as of the issue date (including 
an expected lack of funds on the part of Z), it is not more likely 
than not that Z will exercise either option. However, the $50 per 
share redemption premium that is payable on January 1, 2004, is 
treated as a constructive distribution under paragraphs (b) (1) and 
(2) of this section, regardless of whether Z is anticipated to have 
sufficient funds to redeem on that date, because Z is required to 
redeem the stock on that date. The de minimis exception of paragraph 
(b)(1) of this section does not apply because the $50 per share 
difference between the redemption price and the issue price exceeds 
the amount determined under the principles of section 1273(a)(3) 
(8 x .0025 x $150=$3).
* * * * *
    (e) Effective date. The rules of paragraph (b) of this section and 
Examples 4, 5, 7, and 8 of paragraph (d) of this section apply to stock 
issued on or after December 20, 1995. For rules applicable to 
previously issued stock, see Sec. 1.305-5 (b) and (d) Examples (4), 
(5), and (7) (as contained in the 26 CFR part 1 edition revised April 
1, 1995). Although the rules of paragraph (b) of this section and the 
revised examples do not apply to stock issued before December 20, 1995, 
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 (Public 
Law 101-508 Stat.). Moreover, except as provided in section 11322(b)(2) 
of the Revenue Reconciliation Act of 1990 (Public Law 101-508 Stat.), 
with respect to stock issued on or after October 10, 1990, and issued 
before December 20, 1995, the economic accrual rule of section 
305(c)(3) will apply to the entire call premium on stock that is not 
described in paragraph (b)(2) of this section if the premium is 
considered to be unreasonable under the principles of Sec. 1.305-5(b) 
(as contained in the 26 CFR part 1 edition revised April 1, 1995). A 
call premium described in the preceding sentence will be accrued over 
the period of time during which the preferred stock cannot be called 
for redemption.
    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. * * *
* * * * *

[[Page 66139]]


PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 5. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.
Sec. 602.101  [Amended]

    Par. 6. In Sec. 602.101, paragraph (c) is amended in the table by 
adding the entry ``1.305-5.........1545-1438'' in numerical order.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
    Approved: December 11, 1995.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 95-30831 Filed 12-20-95; 8:45 am]
BILLING CODE 4830-01-U