Rev. Rul. 86-27

1986-1 C.B. 248, 1986-8 I.R.B. 20.

DIVIDENDS PAID DEDUCTION; PERSONAL HOLDING COMPANY INCOME

Published: February 24, 1986

Section 561.-Definition of Deduction for Dividends Paid, 26 CFR 1.561-1: Deduction for dividends paid

(Also Sections 541, 545, 562; 1.541-1, 1.545-1, 1.562-1.)

  Dividends paid deduction; personal holding company income. A personal holding company subsidiary liquidated into its parent corporation may claim a deduction for dividends paid under section 561 of the Code to the extent of the amount distributed to the parent that represents the subsidiary's undistributed personal holding company income.

ISSUE

  May a personal holding company subsidiary that is liquidated into its parent corporation claim a deduction for dividends paid under section 561 of the Internal Revenue Code to the extent of the amount distributed to the parent that represents the subsidiary's undistributed personal holding company income under the circumstances described below?

FACTS

  P and S are corporations. S was a wholly owned subsidiary of P. P is, and S was, engaged in the business of investing and reinvesting in stocks and securities and collecting, investing, and distributing the income therefrom. P is, and S was, a personal holding company within the meaning of section 542 of the Code.

  In February 1984 the management of each corporation determined that it would be administratively convenient to liquidate S and place all of its assets in P. Accordingly, the Board of Directors of S adopted a resolution containing a plan of complete liquidation under which S was to be merged into P pursuant to state law. P approved and adopted S's plan of liquidation. Pursuant to the plan, the liquidation and merger occurred in November 1985. Neither P nor S transferred any of S's assets to another corporation before or after S's liquidation except to unrelated third parties in the ordinary course of their businesses of investing and reinvesting in stocks and other securities. S sought to take its liquidation distribution into account when computing its undistributed personal holding company income under section 545(a) for the taxable year of the distribution.

LAW AND ANALYSIS

  Section 541 of the Code provides for the imposition of a personal holding company tax for each tax year on the undistributed personal holding company income of personal holding companies equal to 50 percent of the undistributed personal holding company income.

  Section 545(a) of the Code provides that the term 'undistributed personal holding company income' means taxable income of a personal holding company adjusted in the manner provided in subsection (b), (c), and (d), minus the dividends paid deduction.

  Section 561(a) of the Code provides that the deduction for dividends paid shall be the sum of (1) the dividends paid during the taxable year, (2) the consent dividends for the taxable year (determined under section 565), and (3) in the case of a personal holding company, the dividend carryover described in section 564.

  Section 562(a) of the Code provides the the term 'dividend' shall, except as otherwise provided in this section, include only dividends described in section

316 (relating to definition of dividends for purposes of corporate distributions).

  Section 562(b)(2) provides that in the case of a complete liquidation of a personal holding company occurring within 24 months after the adoption of a plan of liquidation, the amount of any distribution within that period pursuant to the plan shall be treated as a dividend for purposes of computing the dividends paid deduction, to the extent the amount is distributed to corporate distributees and represent the distributees' allocable share of the undistributed personal holding company income for the taxable year of the distribution computed without regard to this paragraph and section 316(b)(2)(B).

  Section 1.562-1(b)(2)(i) of the Income Tax Regulations notes that section

562(b)(2) of the Code makes an exception to the general rule that a deduction for dividends paid is permitted only with respect to dividends described in section 316. This regulation also provides that amounts distributed in liquidation in a transaction which is preceded or followed by a transfer to another corporation of all or part of the assets of the liquidating corporation may not be eligible for the dividends paid deduction. This language indicates that a dividends paid deduction in the context of a complete liquidation will be closely scrutinized to assure that the benefit of the deduction is only obtained if there is in fact a complete liquidation. Thus, the dividends paid deduction will not be available where the distributed assets are reincorporated by the distributee.

  Section 1.562-1(b)(2)(ii) of the regulations provides that the corporate distributees' allocable share of undistributed personal holding company income for the taxable year of the distribution (computed without regard to section

316(b)(2)(B) and 562(b)(2) of the Code) shall be determined by multiplying the undistributed personal holding company income by the ratio which the aggregate value of the stock held by all corporate shareholders immediately before the record date of the last liquidating distribution in the year bears to the total value of all stock outstanding on that date.

  In the present situation S was a personal holding company and P was a corporate distributee. S's complete liquidation occurred within 24 months of adoption of the plan of liquidation. Because S was a wholly owned subsidiary of P, the amount distributed to P, to the extent it represents S's undistributed personal holding company income, represented P's allocable share of that income within the meaning of section 562(b)(2) of the Code. In addition, none of S's assets was transferred to another corporation before or after S's liquidation except to unrelated third parties in the ordinary course of P's or S's business of investing and reinvesting in stocks and securities. Any such transfer did not affect the complete nature of S's liquidation and, therefore, the abuse that section 1.562- 1(b)(2)(i) of the regulations was intended to prevent is absent. Under these circumstances S's liquidation falls within the scope of section 562(b)(2) and the regulations thereunder.

HOLDING

  A personal holding company subsidiary that is liquidated into its parent corporation may claim a deduction for dividends paid under section 561 of the Code to the extent of the amount distributed to the parent that represents the subsidiary's undistributed personal holding company income under the circumstances described above.

Rev. Rul. 86-27, 1986-1 C.B. 248, 1986-8 I.R.B. 20.