Internal Revenue Service
Revenue Ruling
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smRev. Rul. 57-45
1957-1 C.B. 509
Caution: Revoked by Rev. Rul. 58-621
IRS Headnote
A public utility is not entitled to the dividends paid credit in respect of dividends paid on preferred stock issued by it on or after October 1, 1942, to replace preferred stock issued prior to such date by another corporation which, at the time of such replacement was not a "public utility" as defined in section 26(h)(2)(A) of the Internal Revenue Code of 1939 and was not entitled to the section 26(h) credit in respect of any dividends paid by it on its own preferred stock so replaced. Philadelphia Electric Co. v. United States, 117 Fed. Supp. 424, discussed.
Full Text
Rev. Rul. 57-45
In Philadelphia Electric Co. v. United States, 117 Fed. Supp. 424, the question presented was whether the plaintiff, a "public utility" as defined in section 26(h)(2)(A) of the Internal Revenue Code of 1939, was entitled to the credit allowed by section 26(h) of the 1939 Code in respect of dividends paid by it on its "$1.00 dividend preference common stock." The dividends in respect of such stock were cumulative and payable in preference to dividends on the common stock of the plaintiff, which was its only other class of stock outstanding. The dividend rate on such preference common stock was fixed and limited to the same amount. However, in the event of liquidation, the holders of such preference common stock were entitled to participate on an equal basis with the holders of the common stock in the assets of the corporation.
Section 26(h)(1) of the Code allows a public utility, as defined in section 26(h)(2)(A), a credit for dividends paid on its preferred stock. Section 26(h)(2)(A) of the Code defines a "public utility" as follows:
(A) PUBLIC UTILITY.--The term "public utility" means a corporation engaged in the furnishing of telephone service or in the sale of electric energy, gas, or water, if the rates for such furnishing or sale, as the case may be, have been established or approved by a State or political subdivision thereof or by an agency or instrumentality of the United States or by a public utility or public service commission or other similar body of the District of Columbia or of any State or political subdivision thereof.
Section 26(h)(2)(B) of the Code defines the term "preferred stock" as follows:
(B) PREFERRED STOCK.--The term "preferred stock" means stock issued prior to October 1, 1942, which during the whole of the taxable year (or the part of the taxable year after its issue) was stock the dividends in respect of which were cumulative, limited to the same amount, and issued on or after October 1, 1942, shall be deemed for the purposes payable in preference to the payment of dividends on other stock. Stock of this paragraph to have been issued prior to October 1, 1942, if it was issued (including issuance either by the same or another corporation in a transaction which is a reorganization, as defined in section 112(g)(1), or a transaction to which section 112(b)(10), or so much of section 112(d) or (e) as relates to section 112(b)(10), is applicable, or which is a transaction subject to Supplement R) to refund or replace bonds or debentures issued prior to October 1, 1942, or to refund or replace other preferred stock (including stock which is preferred stock by reason of this sentence), but only to the extent that the par or stated value of the new stock does not exceed the par, stated, or face value of the bonds or debentures issued prior to October 1, 1942, or the other preferred stock, which such new stock is issued to refund or replace. The determination of whether stock was issued to refund or replace bonds or debentures issued prior to October 1, 1942, or to refund or replace other preferred stock, shall be made under regulations prescribed by the Commissioner with the approval of the Secretary.
Prior to the amendment made by Treasury Decision 6195, approved August 8, 1956, C. B. 1956-2, 979, section 39.26(h)-1(c)(1) of Regulations 118 and section 29.26-5(a) of Regulations 111 contained the following provision:
For the purposes of section 26(h) * * * preferred stock means stock which * * * was stock nonparticipating as to earnings or profits either currently or in liquidation, * * *.
Under these regulations prior to the amendment made by Treasury Decision 6195, supra, stock which is participating as to earnings or profits in liquidation could not qualify as "preferred stock" for the purposes of section 26(h) credit. However, in the Philadelphia Electric Company case, the court held that this provision of the regulations was invalid, being in addition to the requirements of the statute and unnecessary to effectuate the statutory conditions of the credit. Under the court's decision, the plaintiff was allowed the dividends paid credit in respect of the dividends paid by it during the calendar year 1947 on its outstanding preference common stock.
Treasury Decision 6195, supra, amended the provisions of Regulations 111 and 118 quoted above to omit the words "earnings or profits either currently or in liquidation" and inserted in lieu thereof the words "current distributions." This amendment was made to conform the regulations to the decision in the Philadelphia Electric Company case. However, in other cases involving facts similar to those in the Philadelphia Electric Company case, it will be the position of the Internal Revenue Service that the credit in respect of dividends paid on public utility preferred stock is not allowable for another reason discussed below.
The Philadelphia Electric Company issued its preference stock in 1943 in the reclassification of its common stock into new common stock and the preference stock. At the time of such reclassification, all the outstanding common stock of the company was held by its parent corporation, which was a "registered holding company" within the meaning of section 2 of the Public Utility Holding Company Act of 1935, 49 Stat. 803, 15 U. S. C. 79b(a). After the company issued its new common stock and preference stock to its parent corporation in exchange for the company's old common stock, the parent corporation distributed the company's new preference stock plus cash to the holders of the parent's preferred stock in partial liquidation and redemption of such stock. The exchanges in respect of the company's new preference stock, both between the company and its parent corporation and between the parent corporation and the latter's preferred stockholders, were made in obedience to orders of the Securities and Exchange Commission to facilitate the parent corporation's compliance with section 11(b) of the Public Utility Holding Company Act of 1935. Such exchanges were subject to the provisions of Supplement R of the 1939 Code. See section 371(a) and (g) of the Code.
However, the parent corporation of the plaintiff company was not "engaged in the furnishing of telephone service or in the sale of electric energy, gas, or water * * *," and, thus, was not a "public utility" within the meaning of section 26(h)(2)(A) of the Code. See In the Matter of United Gas Improvement Co., 12 S. E. C. 1080 (1943). Prior to the redemption of its preferred stock, the parent corporation was not entitled to the section 26(h) credit in respect of dividends paid by it on its own preferred stock. As provided in section 26(h)(2)(B), stock issued on or after October 1, 1942, under certain circumstances will be considered as having been issued before October 1, 1942, for purposes of the section 26(h) credit. However, in the case of new preferred stock issued on or after October 1, 1942, by a public utility to replace preferred stock of another company, as in the instant case, it is the position of the Service that the dividends paid credit is not allowable in respect of dividends paid on the new preferred stock if the other company whose preferred stock was replaced by the new preferred stock was not itself a "public utility" and entitled to the section 26(h) credit in respect of dividends paid by it on the preferred stock so replaced.
Under such circumstances, it is not believed that the allowance of the dividends paid credit in respect of dividends paid on the new preferred stock would be consistent with the intended meaning of the statute. It is the position of the Service that the purpose of the statutory provision relating to the replacement of preferred stock issued prior to October 1, 1942, by one corporation by preferred stock of another corporation issued on or after that date was to prevent the loss of credit allowable to the first corporation prior to the replacement of its preferred stock by the stock of the latter corporation, and not to grant the latter a credit not previously allowable to the former corporation.
Accordingly, it is held that a "public utility" as defined in section 26(h)(2)(A) of the Code is not entitled to the dividends paid credit in respect of dividends paid on preferred stock issued by such "public utility" on or after October 1, 1942, pursuant to an order of the Securities and Exchange Commission under section 11(b) of the Public Utility Holding Company Act of 1935, supra, to replace preferred stock issued prior to October 1, 1942, by another corporation, where at the time of such replacement such other corporation was not a "public utility" as defined in section 26(h)(2)(A) of the Code and had not been entitled to the section 26(h) credit in respect of any dividends paid by it on its own preferred stock so replaced.