Treas. Reg. §1.305-3(b)(3) provides, in relevant part, that: a distribution of property incident to an isolated redemption of stock, e.g., a tender offer, will not trigger application of §305(b)(2) even though the redemption distribution is treated as a distribution of property to which §301 applies. Thus, an isolated non-pro rata redemption of stock does not result in a deemed distribution of stock under §305(c) to the nonredeeming shareholders, thereby negating the application of §305(b)(2) when the redemption is either (1) not treated by the redeeming shareholder as a Section 301(c)(1) distribution, or (2) an "isolated redemption."
The regulations illustrate Congressional intent where a majority shareholder causes a corporation to redeem some of its stock in a single, one-time redemption.
Treas. Reg. §1.305-3(e) Example (10) P has 1,000 shares of stock outstanding. T owns 700 shares of the P stock and G owns 300 shares of the P stock. In a single and isolated redemption to which §301 applies, the corporation redeems 150 shares of T's stock. Since this is an isolated redemption and is not part of a periodic redemption plan, G is not treated as having received a deemed distribution under §305(c) to which §§305(b)(2) and 301 apply even though he has an increased proportionate interest in the corporation.
Finally, the regulations contain an example in which a series of non-pro rata redemptions does not result in a deemed distribution under §305(c) when the redemptions have some valid business purpose (e.g., to fund an employee benefit plan), provided that the redemptions were not in pursuance of a plan to increase the proportionate interests of some shareholders and to distribute property to other shareholders. Because the redemptions in the cited examples are not motivated by an intent to increase the proportionate interest of some shareholders, §305(b)(2) does not tax the increased interests as a dividend. See also Rev. Rul. 77-19, 1977-1 C.B. 83 (corporation’s redemption of stock from some minority shareholders for cash in a merger was not equivalent to a taxable dividend with respect to the continuing shareholders in the surviving corporation).
With that as a backdrop, in PLR 201002022 the Service hints a significant nontax business purpose for the redemption will support a conclusion that §305 is inapplicable even though the distributions increase the proportionate interests of nonredeeming shareholders, and even if the distribution of stock and other properties is part of a series of distributions. In addition, if the distributing corporation is publicly held, a strong argument can be made that any stock and property distribution policy or plan adopted by the corporation that results in changes in proportionate interest of the remaining shareholders is not intended as a device to bail out the corporation's E&P. This argument is particularly applicable where the change in proportionate interests among the shareholders is minor. But neither the statute nor the regulations specifically adopt these implicit and practical limitations on the finding of a Section 305(b)(2) dividend distribution in a non-pro rata redemption.
Unlike the examples in the regulations which set out the isolated redemption exception, neither the legislative history nor the preamble to the regulations make any reference to a business purpose exception. While the more typical isolated redemption avoids dividend equivalence for valid reason, the expanse of a business purpose exception could be limitless and perhaps is too optimistic. Redemptions by co. of Class B common stock held by described retirement plan will qualify as redemptions that aren't essentially equivalent to dividend within meaning of Code Sec. 302(b)(1); , and distributions in redemption of stock owned by retirement fund will be treated as distributions in full payment in exchange for stock owned by retirement plan as provided in Code Sec. 302(a); .
Under the facts of the PLR, the Company is a privately owned company engaged in a business and has 2 class of outstanding common stock, voting and non-voting. The Company has an ESOP which owns shares of the nonvoting stock. Prior to Date 1, in order to provide liquidity to the Retirement Plan and to help the Retirement Plan diversify its assets, Company's board of directors plan to annually redeem an amount of shares of Class B common stock held by the Retirement Plan. At the meeting, the board of directors approved a financial forecast that included a dedicated line item for the planned redemptions. Absent further redemptions, the Retirement Plan will have sufficient liquidity to meet its obligations for only the next 3 to 5 years.
On Date 1, Company redeemed e shares of Class B common stock from the Retirement Plan in exchange for cash, which reduced the Retirement Plan's ownership of Company's total shares of common stock outstanding . On or about Date 2, Company will redeem shares of Class B common stock from the Retirement Plan in exchange for cash which will reduce the Retirement Plan's ownership of Company's total shares of common stock outstanding. Barring unforeseen or unanticipated business circumstances regarding cash flow, Company plans additional annual redemptions from the Retirement Plan.
On or about Date 3, Company will redeem shares of Class B common stock from the Family Group in exchange for cash. Currently, there is no plan to offer any further redemptions to the Family Group.
The Service rule that the planned series of redemptions of Class B stock from the Retirement Plan will be treated as redemptions that are not essentially equivalent to a dividend per §302(b)(1). See United States v. Davis , 397 U.S. 301 (1970); Rev. Rul. 75-512, 1975-2 C.B. 112; Rev. Rul. 77-426, 1977-2 C.B. 87. It further ruled that the redemption of the family’s stock will constitute a single and isolated transaction and will not result in a deemed distribution under section 305 with respect to any of Company's shareholders, regardless of whether such shareholder has a portion of its stock redeemed in the transaction. See Treas. Reg. § 1.305-3(e), Examples (10) and (11). See also Rev. Rul. 77-19, 1979-1 C.B. 84.