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Redemption distribution treated asDistribution in part or full payment of stock" (i.e., gain treatment), orDistribution of property to which 301 applies" Distribution receives gain treatment if -- Not essentially equivalent to a dividendSubstantially Disproportionate"Can be problematic because of 80% and voting stock requirementsIn complete redemption of all shareholder's stock.
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1. John M. Staples
Bank Depository User Group 2008 Annual Meeting
2. Redemption distribution treated as
Distribution in part or full payment of stock (i.e., gain treatment), or
Distribution of property to which 301 applies
Distribution receives gain treatment if --
Not essentially equivalent to a dividend
Substantially Disproportionate
Can be problematic because of 80% and voting stock requirements
In complete redemption of all shareholders stock 2
3. Distributions in Redemption of Stock Background (Contd) United States v. Davis, 397 U.S. 301 (1970). Supreme Court: not essentially equivalent to a dividend requires meaningful reduction in proportionate interest in the corporation
Application of Davis to publicly traded stock:
Rev. Rul. 76-385
Reduction from 0.0001118% (actual and constructive) to 0.0001081% (all constructive) of stock in publicly traded corporation is meaningful reduction
Rev. Rul. 81-289
Shareholder who owned 0.2% of stock widely held publicly traded company before and after redemption did not satisfy meaningful reduction 3
4. Current Regulations Treas. Reg. 1.1441-3(d)(1): If do not know amount subject to withholding because calculation of amount depends upon unknown facts, must withhold on entire amount
or
Make a reasonable estimate of the amount and hold such portion in escrow until amount determined
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5. Current Regulations (Contd) Treas. Reg. 1.1441-3(c)(1): intermediary required to withhold on entire amount of corporate distribution unless it elects to reduce the withholding under exceptions of -3(c)(2)
Treas. Reg. 1.1441-3(c)(2)(B): intermediary may elect not to withhold on a distribution to the extent it represents a distribution in part or full payment in exchange for stock 5
6. Issue Addressed by Proposed Regulations Do reasonable estimate/escrow procedures apply to situations where distribution may be dividend or gain?
If so, how?
PLR 200552007 addressed issue
Prop. Reg. generally follows PLR 6
7. Prop. Reg. In General Would apply to distributions after 12/31/2008, but preamble states may apply before that date
Applies only to distributions in redemption of stock for which there is an established financial market (a Public 302 Distribution)
Must withhold on entire distribution unless apply Escrow Procedure 7
8. Escrow Procedure Establishing Escrow Can be used only by an intermediary that is a U.S. financial institution
Can be used only for documented foreign beneficial owners
Note: current reg. does not require documentation (Treas. Reg. 1.1441-3(c)(1))
Set aside 30% (or applicable treaty dividend rate) of distribution attributable to stock of foreign account holders 8
9. Escrow Procedure Information Provided to Foreign Beneficial Owner U.S. financial institution provides to foreign beneficial owner --
Total number of shares outstanding before and after Public 302 Distribution
Explanation of when a Public 302 Distribution will be treated as a dividend or a payment in exchange for stock (including an explanation of constructive ownership rules)
Request for beneficial owner to provide a certification (302 Payment Certification) within 60 days stating whether Public 302 Distribution is a dividend or payment in exchange for stock (gain)
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10. Escrow Procedure - 302 Payment Certification 302 Payment Certification must contain
Beneficial owners name and account number
Distributing corporations name
Total shares outstanding before and after Public 302 Distribution
Certification that the Public 302 Distribution is a --
Payment in exchange for stock because beneficial owners proportionate interest has been reduced (gain treatment)
Payment in exchange for stock because beneficial owners interest completely terminated (gain treatment)
Dividend
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11. Escrow Procedure - 302 Payment Certification (Contd) 302 Payment Certification must contain
Number of shares owned by beneficial owner and percentage ownership before and after distribution
Penalties of perjury statement
Signature and date of signature
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12. Escrow Procedure Certification of Gain If 302 Payment Certification received within 60 days specifies gain treatment, amount set aside in escrow credited to beneficial owner
Entire amount reported on Form 1042-S as capital gains
Subject to know or have reason to know standard
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13. Escrow Procedure - Certification of Dividend If payment certification received within 60 days specifies dividend treatment, amount set aside treated as tax withheld and deposited with IRS
Entire amount reported on Form 1042-S as dividend 13
14. Escrow Procedure No or Unreliable Certification If no payment certification received or if U.S. financial institution believes 302 Payment Certification claiming gain treatment is unreliable or incorrect, must treat amount set aside as tax withheld as of 61st day and deposit
Entire payment reported on Form 1042-S as dividend 14
15. Escrow Procedure Late Certifications If certification stating gain treatment received after 60 day period, U.S. financial institution may apply reimbursement or set-off procedures of 1.1461-2(a) 15
16. Escrow Procedure Miscellaneous U.S. non-exempt recipients holding stock through foreign intermediaries or flow-throughs are treated in accordance with the 302 Payment Certifications they provide
U.S. financial institution must notify distributing corporation by filing date of Form 1042-S of aggregate amounts treated as capital gains and dividends 16
17. Qualified Intermediaries QIs cannot use escrow procedure
Escrow amount of U.S. financial institution includes 30% (or applicable treaty dividend rate) of amount attributable to QIs
U.S. financial institution provides same information to QI as it does to its direct foreign beneficial owners
QI provides information to its account holders
QI receives 302 Payment Certifications from its account holders
QI incorporates results in its withholding statement
Same procedures apply to withholding foreign partnerships and withholding foreign trust
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18. Implementation Issues Implement now or wait
How can financial institution identify affected transactions
Prop. Regs. apply to more than just self-tenders
How much detail should be provided regarding dividend vs. exchange and constructive ownership rules
Capital gains reporting on Form 1042-S required
Currently, capital gain reporting not required
Systems issues
Indirect U.S. non-exempt shareholders must apparently get 1099-DIV or 1099-B whereas direct U.S. non-exempt shareholders can get 1099-B + explanation.
Systems issues
Effect on 1099-B + explanation rule 18
19. Implementation Issues (Contd) Procedures for notifying distributing corporation of treatment
Usefulness of requirement?
Different reporting treatment of direct and indirect U.S. non-exempt recipients
No reporting for U.S. exempt recipients.
How to handle inconsistencies between Prop. Reg and PLR (deliberate changes vs. oversights)
Interest on escrow accounts
60 day period very short retail business issues
Prop. Regs. ask for comments
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20. Is This An Effective Solution? Small shareholders in publicly traded companies do not have control and cannot manipulate redemption
If redemption not pro rata, dividend treatment unlikely
Increased compliance costs
Requires non-U.S. passive investors to apply substantive tax rules
Probably little tax gain to government
Could complicate future basis reporting
Is it proper to extend Davis to small shareholders in publicly traded corporations? 20
21. John M. Staples
Burt, Staples & Maner LLP
1250 Eye St. NW, Suite 850
Washington, DC 20005-3922
jstaples@bsmlegal.com
Phone: 202-783-1500 ? Fax: 202-783-1523
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