Rev. Rul. 83-42

1983-1 C.B. 76, 1983-11 I.R.B. 5.

                       Internal Revenue Service
                                 Revenue Ruling

        STOCK DISTRIBUTION;  COMMON STOCK ON CONVERTIBLE PREFERRED STOCK

                           Published: March 14, 1983

26 CFR 1.305-5: Distributions on preferred stock

(Also Section 301; 1.301-1.)

  Stock distribution;  common stock on convertible preferred stock.  A distribution of common stock to holders of convertible preferred stock will be a distribution to which section 301 of the Code applies by reason of section 305(b)(4) even though the distribution is made to take into account a dilution of the holders' conversion rights.

ISSUE

  Is the distribution of common stock on convertible preferred stock, as described below, treated as the distribution of property to which section 301 of the Internal Revenue Code applies by reason of section 305(b)(4)?

FACTS

  X is a corporation that has both common and convertible preferred stock outstanding.  The convertible preferred stock has been issued earlier in connection with the acquisition of an unrelated corporation.  The convertible preferred stock is convertible into common stock according to a certain conversion ratio.  The terms of the convertible preferred stock do not provide for anti-dilution protection by means of an increase in the conversion ratio made solely to take account of a stock dividend or stock split with respect to the stock into which such convertible stock is convertible.

  On June 1, 1981, X distributed a 10 percent common stock dividend to the holders of its common stock.  In addition, X distributed shares of its common stock to holders of its convertible preferred stock in order to offset the dilution of the holder's conversion rights.  Dilution of the conversion rights of the holders of convertible preferred would have occurred but for the distribution of common stock to them because of the lack of a full adjustment in the conversion ratio of the preferred stock to reflect the stock dividend on the common stock.

LAW AND ANALYSIS

  Section 305(a) of the Code provides generally that gross income does not include the amount of any distribution of the stock of a corporation made by such corporation to its shareholders with respect to its stock, except as otherwise provided in section 305(b) or (c).

  Section 305(b)(4) of the Code provides that section 305(a) will not apply to a distribution by a corporation of its stock, and the distribution will be treated as a distribution of property to which section 301 applies, if the distribution is with respect to preferred stock, other than an increase in the conversion ratio of convertible preferred stock made solely to take account of a stock dividend or stock split with respect to the stock into which such convertible stock is convertible.

  Section 1.305(a) of the regulations states, in part, that under section 305(b)(4), a distribution by a corporation of its stock made with respect to its preferred stock is treated as a distribution of property to which section 301 applies unless the distribution is made with respect to convertible preferred stock to take into account a stock dividend, stock split, or any similar event which would otherwise result in the dilution of the conversion right.

  The exception contained in section 305(b)(4) of the Code would permit X to adjust the conversion ratio of its preferred stock to eliminate the dilution which resulted from the 10 percent common stock dividend on June 1, but it will not permit an actual distribution of stock to the holders of preferred stock, even if undertaken for the same anti-dilution purposes.  The "distribution" referred to in section 1.305-5(a) of the regulations is only the deemed distribution which is considered to result when the conversion ratio is adjusted for the purpose described in section 305(b)(4).  All other distributions on preferred stock are taxable, as expressly provided by section 305(b)(4).

HOLDING

  The distribution of X common stock to holders of its convertible preferred stock is a distribution to which section 301 of the Code applies by reason of section 305(b)(4).

Rev. Rul. 83-42, 1983-1 C.B. 76, 1983-11 I.R.B. 5.