Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 79-21

1979-1 C.B. 290

Section 1504

IRS Headnote

Consolidated return; membership in affiliated group; participating preferred nonvoting stock. Participating preferred nonvoting stock, which is entitled not only to receive a preferred dividend in priority to that given common stock, but also to participate with common stock in any further distributions of earnings, is not "limited and preferred as to dividends" for purposes of qualification for affiliation under section 1504(a) of the Code.

Full Text

Rev. Rul. 79-21

ISSUE

Is preferred nonvoting stock that is participating stock "limited and preferred as to dividends" for purposes of qualification for affiliation under section 1504(a) of the Internal Revenue Code of 1954? FACTS

During its post-1976 taxable years, P, a domestic corporation, owned both common and preferred shares of S, its only domestic subsidiary corporation. Each share of the common stock was entitled to be voted. However, each share of preferred stock was noncumulative participating stock but was not entitled to be voted. P held 100 percent of the outstanding common shares of S's stock and 70 percent of the preferred shares. For its taxable year 1977, P filed a consolidated federal income tax return with S.

LAW AND ANALYSIS

Section 1504(a)(2) of the Code provides that the common parent of an affiliated group must own directly stock possessing at least 80 percent of the voting power of all classes of stock and 80 percent of each class of the nonvoting stock of at least one of the other includible corporations. As used in this subsection, the term stock does not include nonvoting stock which is limited and preferred as to dividends.

In order for a share of stock to be considered limited and preferred as to dividends, both criteria must be met, that is, the stock must be both limited as to dividends and preferred as to dividends.

In United States v. Liberty Baking Corporation, 25 F. Supp. 203 (S.D.N.Y. 1938), the court stated that preferred stock of the conventional type is "limited and preferred as to dividends" by being entitled to a specific dividend in priority to any dividend on common stock but to nothing more in the way of dividends. The preferred stock in question was of the kind known as participating preferred stock, entitled not merely to receive the fixed preferred dividend in priority to common stock but also to share on a parity with common in any further distribution of earnings. The court concluded that this preferred stock was, therefore, not limited and preferred as to dividends.

In the instant situation, P's preferred stock in S is not limited and preferred as to dividends, because the preferred stock is entitled not only to receive a preferred dividend in priority to common stock but also to participate with common stock in any further distributions of earnings. See also Pioneer Parachute Co. v. Commissioner, 162 F.2d 249 (2d Cir. 1947). Therefore, the 70 percent of the preferred stock of S owned by P must be taken into account in determining whether S and P constitute an affiliated group within the meaning of section 1504(a) of the Code. Since it is less than the 80 percent required therein with respect to the ownership of each class of nonvoting stock, S and P do not constitute an affiliated group and P may not file a consolidated federal income tax return for taxable year 1977.

HOLDING

Preferred nonvoting stock that is participating stock is not limited and preferred as to dividends and must be taken into account in making a determination as to whether the requisite percentage of ownership of each class of nonvoting stock is present for purposes of qualification for affiliation under section 1504(a) of the Code.