In our last issue of Tax Talk, we highlighted a Chief Counsel Advice Memorandum in which the IRS argued that cumulative preferred stock was Section 1504(a)(4) preferred stock because a payment of unpaid accumulated dividends upon redemption at maturity was not an “unreasonable redemption premium.”5 On March 23, 2012, the IRS released a second ruling in a short period of time that attacks a dividends-received deduction transaction; Field Attorney Advice 20121201F denies the dividends-received deduction on the grounds that the taxpayer had diminished its risk of loss.
The taxpayer (“Taxpayer”) at issue purchased preferred shares from the issuer (“Issuer”) which paid dividends for which Taxpayer claimed a dividendsreceived deduction. The dividend rates associates with these shares were fixed for a period of months and then reset. The dividend rates were reset to an agreed upon rate; however, if the parties could not agree, then the shares were remarketed. Upon a successful remarketing, Taxpayer would receive its purchase price for the shares. If the shares were not successfully remarketed, the dividend rate was reset at a higher rate, which would economically compel the shares to be redeemed at least according to the IRS. Upon a redemption, Taxpayer would receive its purchase price plus a redemption premium. If Issuer liquidated, Taxpayer also received its purchase price.
A corporation is entitled to a dividendsreceived deduction on preferred shares if it holds the shares for a specified period of time (in the case of preferred stock for 90 days or less during the 181-day period beginning on the date that is 90 days before the date on which such share becomes ex-dividend with respect to such dividend). A taxpayer’s holding period is reduced where the taxpayer (i) is obligated to sell, or has made (and not closed) a short sale of, substantially identical stock or securities, (ii) is the grantor of an option to buy substantially identical stock or securities, or (iii) has diminished his risk of loss by holding one or more other positions with respect to substantially similar or related property.
In the Field Attorney Advice, the IRS concluded that Taxpayer’s ability to receive its purchase price for the shares upon a redemption, liquidation and after a period of months, upon a remarketing, was essentially a put option to sell the shares for their purchase price, which reduced Taxpayer’s holding period. Additionally, Taxpayer was the beneficiary of certain guarantee agreements which, in the IRS’s view, diminished the taxpayer’s risk of loss. Taken together, the IRS held that these transaction features were all implemented simultaneously with each other and with Taxpayer’s acquisition of the preferred shares. Because these features diminished Taxpayer’s risk of loss, Taxpayer’s holding period for the preferred shares was reduced to zero. As a result, the Field Attorney Advice found Taxpayer was ineligible for a dividends-received deduction for dividends attributable to the preferred shares of Issuer.