Internal Revenue Service
Revenue Ruling
TaxLinks.com
smRev. Rul. 78-60
1978-1 C.B. 81
Sec. 301
Sec. 302
Sec. 305
IRS Headnote
Stock redemption; annual voluntary redemption plan. The redemption by a corporation of some of its stock pursuant to an annual redemption plan is a distribution of property to which sections 302(d) and 301 of the Code apply. Shareholders whose proportionate interests in the earnings and profits and assets of the corporation are increased by the redemption are deemed to have received stock distributions to which sections 305(b)(2) and 301 apply.
Full Text
Rev. Rul. 78-60
Advice has been requested whether under section 302(a) of the Internal Revenue Code of 1954 the stock redemptions described below qualified for exchange treatment, and whether under section 305(b)(2) and (c) the shareholders who experienced increases in their proportionate interests in the redeeming corporation as a result of the stock redemptions will be treated as having received distributions of property to which section 301 applies.
Corporation Z has only one class of stock outstanding. The Z common stock is held by 24 shareholders, all of whom are descendants, or spouses of descendants, of the founder of Z.
In 1975, when Z had 6,000 shares of common stock outstanding, the board of directors of Z adopted a plan of annual redemption to provide a means for its shareholders to sell their stock. The plan provides that Z will annually redeem up to 40 shares of its outstanding stock at a price established annually by the Z board of directors. Each shareholder of Z is entitled to cause Z to redeem two-thirds of one percent of the shareholder's stock each year. If some shareholders choose not to participate fully in the plan during any year, the other shareholders can cause Z to redeem more than two-thirds of one percent of their stock, up to the maximum of 40 shares.
Pursuant to the plan of annual redemption, Z redeemed 40 shares of its stock in 1976. Eight shareholders participated in the redemptions. The following table shows the ownership interests of the Z shareholders before and after the 1976 redemptions:
Ownership of Common Stock
-------------------------------------------------------------------
Actual ownership
---------------------------------------------------------
January 1, 1976 January 1, 1977
-----------------------------------------
Percent
Percent Percent change in
Number of total Number of total proportionate
of shares of shares ownership
Share- shares outstanding shares outstanding during 1976
holder (1) (2) (3) (4) (5)
-------------------------------------------------------------------
A 31 .5167 31 .5201 .6711
B 241 4.0167 240 4.0269 .2534
C 241 4.0167 237 3.9765 (.9997)
D 417 6.9500 409 6.8624 (1.2602)
E 221 3.6833 221 3.7081 .6711
F 47 .7833 47 .7886 .6711
G 188 3.1333 182 3.0537 (2.5418)
H 7 .1167 7 .1175 .6711
I 100 1.6667 100 1.6779 .6711
J 472 7.8667 464 7.7852 (1.0352)
K 50 .8333 50 .8389 .6711
L 50 .8333 50 .8389 .6711
M 391 6.5167 391 6.5604 .6711
N 443 7.3833 443 7.4329 .6711
O 443 7.3833 443 7.4329 .6711
P 738 12.3000 738 12.3826 .6711
Q 219 3.6500 219 3.6745 .6711
R 92 1.5333 92 1.5436 .6711
S 40 .6667 40 .6711 .6711
T 423 7.0500 423 7.0973 .6711
U 16 .2667 16 .2685 .6711
V 181 3.0167 177 2.9698 (1.5536)
W 300 5.0000 294 4.9329 (1.3423)
X 649 10.8167 646 10.8389 .2058
-------------------------------------------------------------------
TOTALS 6,000 100. /*/ 5,960 100. /*/
-------------------------------------------------------------------
Ownership of Common Stock
-------------------------------------------------------------------
Actual plus constructive ownership (sec. 318)
-------------------------------------------------------------------
January 1, 1976 January 1, 1977
------------------------------------------
Percent Percent Percent
Number of total Number of total change in
of shares of shares ownership
Share- shares outstanding shares outstanding during 1976
holder (6) (7) (8) (9) (10)
-------------------------------------------------------------------
A 31 .5167 31 .5201 .6711
B 482 8.0333 477 8.0034 (.3732)
C 482 8.0333 477 8.0034 (.3732)
D 685 11.4167 677 11.3591 (.5046)
E 685 11.4167 677 11.3591 (.5046)
F 685 11.4167 677 11.3591 (.5046)G
G 195 3.2500 189 3.1711 (2.4264)
H 195 3.2500 189 3.1711 (2.4264)
I 100 1.6667 100 1.6779 .6711
J 572 9.5333 564 9.4631 (.7368)
K 572 9.5333 564 9.4631 (.7368)
L 572 9.5333 564 9.4631 (.7368)
M 391 6.5167 391 6.5604 .6711
N 886 14.7667 886 14.8658 .6711
O 886 14.7667 886 14.8658 .6711
P 738 12.3000 738 12.3826 .6711
Q 311 5.1833 311 5.2181 .6711
R 311 5.1833 311 5.2181 .6711
S 463 7.7167 463 7.7685 .6711
T 463 7.7167 463 7.7685 .6711
U 197 3.2833 193 3.2383 (1.3729)
V 197 3.2833 193 3.2383 (1.3729)
W 300 5.0000 294 4.9329 (1.3423)
X 649 10.8167 646 10.8389 .2058
-------------------------------------------------------------------
-------------------------------------------------------------------
* Detail may not add to total due to rounding.
Issue 1
Section 302(a) of the Code provides that if a corporation redeems its stock, and if section 302(b)(1), (2) or (3) applies, the redemption will be treated as a distribution in part or full payment in exchange for the stock.
Section 302(b)(1) of the Code provides that section 302(a) will apply if the redemption is not essentially equivalent to a dividend. Section 302(b)(2) provides that section 302(a) will apply if the redemption is substantially disproportionate with respect to the shareholder unless the redemption is made pursuant to a plan the purpose or effect of which, in the aggregate, is not substantially disporportionate with respect to the shareholder. Section 302(b)(3) provides that section 302(a) will apply if all of the stock of the corporation owned by the shareholder is redeemed. Section 318(a) contains rules of constructive stock ownership to be applied to those provisions of subchapter C to which they are expressly made applicable. Section 302(c)(1) provides, with an exception not relevant here, that the constructive ownership rules of section 318(a) apply in determining the ownership of stock for purposes of section 302.
Section 302(d) of the Code provides that a stock redemption to which section 302(a) does not apply will be treated as a distribution of property to which section 301 applies.
None of the redemptions here qualified under section 302(b)(3) of the Code because all of the shareholders who participated in the redemptions continue to own stock of Z. Moreover, none of the redemptions qualified under section 302(b)(2) because none of the shareholders who participated in the redemptions experienced a reduction in interest of more than 20 percent, as section 302(b)(2)(C) requires. Therefore, the first question is whether the redemptions were "not essentially equivalent to a dividend" within the meaning of section 302(b)(1).
Section 1.302-2(b) of the regulations provides that the question whether a distribution in redemption of stock is not essentially equivalent to a dividend under section 302(b)(1) of the Code depends on the facts and circumstances.
In United States v. Davis, 397 U.S. 301 (1970), rehearing denied, 397 U.S. 1071 (1970), 1970-1 C.B. 62, the Supreme Court of the United States said that for a redemption to qualify as not essentially equivalent to a dividend under section 302(b)(1) of the Code, the redemption must result in a meaningful reduction of the shareholder's proportionate interest in the corporation. The Court held that the business purpose of the redemption is irrelevant to this determination and that the ownership attribution rules of section 318(a) apply.
Several of the shareholders of Z experienced reductions in their proportionate interests in Z (taking into account constructive stock ownership under section 318 of the Code) as a result of the 1976 redemptions. If their reductions were "meaningful," they are entitled to exchange treatment for their redemptions under section 302(a). Whether the reductions in proportionate interests were "meaningful" depends on the facts and circumstances.
In this case, an important fact is that the 1976 redemptions were not isolated occurrences but were undertaken pursuant to an ongoing plan for Z to redeem 40 shares of its stock each year. None of the reductions in proportionate interests experienced by Z shareholders as a result of the 1976 redemptions was "meaningful" because the reductions were small and each shareholder has the power to recover the lost interest by electing not to participate in the redemption plan in later years.
Accordingly, none of the 1976 redemptions qualified for exchange treatment under section 302(a) of the Code. All of the redemptions are to be treated as distributions of property to which section 301 applies.
Issue 2
Section 305(b)(2) of the Code provides that section 301 will apply to a distribution by a corporation of its stock if the distribution, or a series of distributions that includes the distribution, has the result of the receipt of property by some shareholders, and increases in the proportionate interests of other shareholders in the assets or earnings and profits of the corporation.
Section 305(c) of the Code authorizes regulations under which a redemption treated as a section 301 distribution will be treated as a section 301 distribution to any shareholder whose proportionate interest in the earnings and profits or assets of the corporation is increased by the redemption.
Section 1.305-7(a) of the Income Tax Regulations provides that a redemption treated as a section 301 distribution will generally be treated as a distribution to which sections 305(b)(2) and 301 of the Code apply if the proportionate interest of any shareholder in the earnings and profits or assets of the corporation deemed to have made the stock distribution is increased by the redemption, and the distribution has the result described in section 305(b)(2). The distribution is to be deemed made to any shareholder whose interest in the earnings and profits or assets of the distributing corporation is increased by the redemption.
Section 1.305-3(b)(3) of the regulations provides that for a distribution of property to meet the requirements of section 305(b)(2) of the Code, the distribution must be made to a shareholder in the capacity as a shareholder and must be a distribution to which section 301 [or one of several other specified sections] applies. A distribution of property incident to an isolated redemption will not cause section 305(b)(2) to apply even though the redemption distribution is treated as a section 301 distribution.
Section 305 of the Code does not make the constructive stock ownership rules of section 318(a) applicable to its provisions.
The 16 shareholders of Z who did not tender any stock for redemption in 1976 experienced increases in their proportionate interests of the earnings and profits and assets of Z (without taking into account constructive stock ownership under section 318 of the Code) as a result of the redemptions. Shareholders B and X, who surrendered small amounts of their stock for redemption in 1976, also experienced increases in their proportionate interests. The 1976 redemptions were not isolated but were undertaken pursuant to an ongoing plan of annual stock redemptions. Finally, the 1976 redemptions are to be treated as distributions of property to which section 301 of the Code applies.
Accordingly, B, X and the 16 shareholders of Z who did not participate in the 1976 redemptions are deemed to have received stock distributions to which sections 305(b)(2) and 301 of the Code apply. See examples (8) and (9) of section 1.305-3(e) of the regulations for a method of computing the amounts of the deemed distributions.