Internal Revenue Service
Revenue Ruling
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smRev. Rul. 79-42
1979-1 C.B. 130
Section 301
Section 305
IRS Headnote
Dividend reinvestment plan; distributions to shareholders. Participants in a dividend reinvestment plan under which a corporation transfers participating shareholders' cash dividends to an agent who purchases stock for the shareholders directly from the corporation for 95 percent of the average of the closing market prices on the dividend payment date are treated as having received distributions to which section 301 of the Code applies by reason of section 305(b)(1). The amount of the distribution to the participants is the fair market value of the stock on the dividend payment date. The amount of the distribution to nonparticipants is the cash received. Rev. Rul. 77-149 distinguished.
Full Text
Rev. Rul. 79-42
ISSUE
Does participation in the dividend reinvestment plan described below constitute an election to take stock or property under section 305(b)(1) of the Internal Revenue Code of 1954.
FACTS
X corporation adopted a shareholder dividend reinvestment plan that confers on all holders of X common stock, a right to acquire from X additional common shares of X stock at 95 percent of the average of the closing market prices of the common shares of X on the dividend payment date. The shareholders' option to purchase common stock under the plan is not transferable apart from a transfer of the common shares themselves.
Any holder of record of common shares of X is eligible to enroll in the plan at any time by signing an authorization form and returning it to X. A completed authorization form must be received by X on or before a dividend record date in order for that dividend to be invested under the plan in accordance with such authorization. Each participant's account will be credited with that number of common shares purchased for the participant, including fractions, which is equal to the amounts invested for each participant. The investment in X stock will be effected on the dividend payment date at which time X will transfer cash to the agent and then the agent will transfer to X the cash originally received from X as a dividend to pay for common shares to be purchased directly from X. There are no commissions payable because the agent purchases the common shares directly from X.
Shareholders may stop the investment of a dividend up to the close of business on any dividend payment date by submitting written notification to X that is received by X no later than the dividend payment date.
Participation in the plan may be terminated by a participant at any time by giving written notice to the treasurer of X. When a participant terminates participation in the plan, the participant will receive a certificate for the whole common shares held for such participant's account and a cash payment for any fraction of a share and for any uninvested optional cash payments. As an alternative, upon termination of participation, a participant may request that all common shares, both whole shares and any fraction of a share, held for the participant's account under the plan be sold. If sale of all shares is specified in the notice of termination, such sale will be made by the agent, through a stock broker designated by the agent, as soon as practicable following receipt by the agent of instructions from X to do so. The proceeds of such sale, less brokerage commissions and transfer taxes, if any, will be paid to the terminating participant by X.
LAW AND ANALYSIS
The applicable sections of the Code and Income Tax Regulations thereunder are 301, relating to the distributions of property; 305, relating to the distributions of stock and stock rights; and section 1.301-1(b) and (d); and section 1.305-2(a) and (b).
Section 305(a) provides that, with certain exceptions, gross income does not include the amount of any distribution of the stock (or rights) of a corporation made by such corporation with respect to its stock (see section 305(d)(1)). Section 305(b)(1) provides that section 305(a) will not apply, and the distribution will be treated as a distribution to which section 301 applies, if the distribution is, at the election of any shareholder (whether exercised before or after the declaration), payable either in the stock of the distributing corporation or property. Section 1.305-2(a)(4) of the regulations provides that an election can arise from the circumstances of the distribution and section 1.305-2(a)(3) states that an election can arise even if the declaration of the distribution provides that the distribution will be made in one medium unless the shareholder specifically requests payment in the other.
In Rev. Rul. 76-53, 1976-1 C.B. 87, a corporation adopted a plan permitting the shareholders to choose to have all of the cash dividends, otherwise payable on common shares owned by the shareholder, automatically invested to purchase additional shares of the corporation's stock, the shareholders who elect to participate under this plan acquire the company's stock at a price equal to 95 percent of the fair market value of such stock on the dividend payment date. That Revenue Ruling, which is based upon a factual situation in which neither the participating shareholder nor the agent is in actual receipt of a cash receipt of a cash dividend, concludes that the distributions made by the corporation while the plan is in effect are treated as payable either in stock or in cash at the election of the shareholder within the meaning of section 305(b)(1) of the Code, and therefore, such participating shareholders will be treated as having received a distribution to which section 301 applies by reason of section 305(b)(1). Rev. Rul. 78-375, 1978-2 C.B. 130, also concludes that a shareholder who participates in a dividend reinvestment plan will be treated as having received an elective stock dividend under section 305(b)(1) with respect to the dividends reinvested, however, with respect to shareholders who make bargain purchases of their corporation's stock by making optional payments in connection with such a plan will be treated as having received a disproportionate distribution within the meaning of section 305(b)(2).
In Rev. Rul. 77-149, 1977-1 C.B. 82, a corporation established a dividend reinvestment plan administered by a local bank, acting as agent for the shareholders. At a shareholder's direction the shareholder's cash dividends would be received by the bank, who would then purchase the corporation's stock on the open market at 100 percent of fair market value. That Revenue Ruling held that section 301 of the Code applies directly to the cash dividends without reference to section 305(b)(1) because the distribution is payable by the corporation only in cash, and the shareholders of the corporation do not have the election of receiving their dividend distribution from the corporation in either stock or cash.
The only difference between the plan in the present case and the plan described in Rev. Rul. 76-53 is that in the present case, the corporation actually transfers cash representing the dividend out of corporate solution to the agent who also acts on behalf of the shareholders electing to receive stock, whereas under the plan in Rev. Rul. 76-53 the cash representing the dividend is not transferred out of corporate solution. However, the fact that cash is transferred to the agent in the present case is not meaningful with respect to the participating shareholders because it is transitory since the cash is immediately returned to X's corporate solution which is unlike the circumstances that existed in Rev. Rul. 77-149. Thus, the integrated steps of the instant transaction, viewed as a whole, merely serve to distribute stock to X's shareholders in lieu of the otherwise payable cash distribution.
HOLDING
Under the circumstances described above, a shareholder of X who participates in the plan will be treated as having received a distribution to which section 301 of the Code applies by reason of the application of section 305(b)(1). Pursuant to section 1.305-1(b) of the regulations, the amount of the distribution to the participating shareholders (including participating corporate shareholders) will be the fair market value of the X stock on the dividend payment date. Section 1.301-1(b) and (d). The amount of the distribution to the nonparticipating shareholders under section 301 will be the amount of the cash received by such shareholders. Section 1.305-2(b), Example (1).
EFFECT ON OTHER REVENUE RULINGS
Rev. Rul. 77-149 is distinguished.