Rev. Rul. 85-14

1985-1 C.B. 92, 1985-8 I.R.B. 5.

REDEMPTIONS OF STOCK; SUBSTANTIALLY DISPROPORTIONATE; SERIES OF

REDEMPTIONS; NO PLAN OR AGREEMENT BETWEEN REDEEMED SHAREHOLDERS

Published: February 25, 1985

Section 302.-Distributions in Redemption of Stock, 26 CFR 1.302- 3: Substantially disproportionate redemption.

  Redemptions of stock; substantially disproportionate; series of redemptions; no plan or agreement between redeemed shareholders. For purposes of determining whether a redemption qualifies as substantially disproportionate, two redemptions must be considered in aggregate, pursuant to section 302(b)(2)(D) of the Code, when the first shareholder's redemption is undertaken with knowledge of the impending redemption of the redemption of the second shareholder, despite the absence of any agreement between the two.

ISSUE

  Should qualification under section 302(b)(2) of the Internal Revenue Code of a redemption of one shareholder be measured immediately after that redemption, or after a second redemption of another shareholder that followed soon after the first redemption, under the following acts?

FACTS

  X, a corporation founded by A, is engaged in an ongoing business. As of January 1, 1983, X's sole class of stock, voting common stock, was held by A, B, C, and D, who are unrelated to each other. A owned 1,466 shares, B owned 210 shares, C owned 200 shares, and D owned 155 shares of X stock. A was president and B was vice-president of X.

  X has a repurchase agreement with all X shareholders, except A. This agreement provides that if any such shareholder ceases to be actively connected with the business operations of X, such shareholder must promptly tender to X the then-held X shares for an amount equal to the book value of such stock. X has a reciprocal obligation to purchase such shares at book value within 6 months of such shareholder's ceasing to be actively connected with X's business operations.

  On January 1, 1983, B informed A of B's intention to resign as of March 22, 1983. Based on this information, A caused X to adopt a plan of redemption and to redeem 902 shares of A's X stock, on March 15, 1983, for which A received 700x dollars. Thus, A then held 564 shares of the 1129 shares (49.96 percent) of the X stock still outstanding, temporarily yielding majority control over the affairs of X until B ceased to be a shareholder. On March 22, 1983, B resigned from X and, in accordance with the X stock purchase agreement, X redeemed for cash all of B's shares within the next 6 months, thus leaving 919 shares of X stock outstanding, restoring majority control to A.

LAW AND ANALYSIS

  Section 302(a) of the Code provides that if a corporation redeems its stock and if one of the paragraphs of subsection (b) applies, then such redemption will be treated as a distribution in part or full payment in exchange for the stock.

  Section 302(b)(2) of the Code provides that a redemption will be treated as an exchange pursuant to section 302(a) if the redemption is substantially disproportionate with respect to the shareholder, but that this paragraph will not apply unless immediately after the redemption the shareholder owns less than 50 percent of the total combined voting power of all classes of stock entitled to vote.

  Under section 302(b)(2)(C) of the Code, one of the requirements for the distribution to be substantially disproportionate is that the ratio that the voting stock of the corporation owned by the shareholder immediately after the redemption bears to all the voting stock of the corporation at such time, is less than 80 percent of the ratio that the voting stock of the corporation owned by the shareholder immediately before the redemption bears to all the voting stock of the corporation at such time.

  Section 302(b)(2)(D) of the Code, in dealing with a series of redemptions, provides that section 302(b)(2) is not applicable to any redemption made pursuant to a plan the purpose or effect of which is a series of redemptions resulting in a distribution which (in the aggregate) is not substantially disproportionate with respect to the shareholder.

  The percentage provisions contained in sections 302(b)(2)(B) and 302(b)(2)(C) of the Code provide 'safe harbor' exchange treatment. Examined separately, the transaction that occurred on March 15, 1983, would qualify as a substantially disproportionate redemption because (i) A's ownership of X's voting stock immediately after the redemption was less than 50 percent of the total combined voting power of all the X stock and (ii) A's ownership of X's voting stock was reduced from 72.18 percent to 49.96 percent, which meets the 80 percent requirement of section 302(b)(2)(C). However, if A's redemption is considered to be part of a section 302(b)(2)(D) series of redemptions which included X's redemption of B's shares, then A's redemption would not constitute a substantially disproportionate redemption because (i) A's ownership of X's voting stock after the redemptions exceeded 50 percent of the total combined voting power of X and (ii) A's ownership of X's voting stock after the redemptions was reduced from 72.18 percent to 61.37 percent, which does not meet the 80 percent requirement of section 302(b)(2)(C).

  Section 1.302-3(a) of the Income Tax Regulations states that whether or not a plan described in section 302(b)(2)(D) of the Code exists will be determined from all the facts and circumstances.

  In the present situation, although A and B had no joint plan, arrangement, or agreement for a series of redemptions, the redemption of A's shares was causally related to the redemption of B's shares in that A saw an apparent opportunity to secure exchange treatment under section 302(b)(2) of the Code by temporarily yielding majority control over the affairs of X.

  Nothing in section 302(b)(2)(D) of the Code or in the legislative history of this section (S. Rep. 1622, 83d Cong., 2d Sess. 234-235 (1954)) indicates that the existence of a plan depends upon an agreement between two or more shareholders. Thus, a 'plan' for purposes of section 302(b)(2)(D) need be nothing more than a design by a single redeemed shareholder to arrange a redemption as part of a sequence of events that ultimately restores to such shareholder the control that was apparently reduced in the redemption.

  Under the facts and circumstances here, section 302(b)(2)(D) of the Code requires that the redemptions of A and B be considered in the aggregate. Accordingly, A's redemption meets neither the 50 percent limitation of section 302(b)(2)(B) nor the 80 percent test of section 302(b)(2)(C). Thus, the redemption of A's shares was not substantially disproportionate within the meaning of section 302(b)(2).

HOLDING

  Under the facts of this ruling, qualification under section 302(b)(2) of the Code of A's redemption should not be measured immediately after that redemption, but, instead, should be measured after B's redemption that followed soon after A's redemption.

Rev. Rul. 85-14, 1985-1 C.B. 92, 1985-8 I.R.B. 5.