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Code Sec. 304 Related Party Stock Sales

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Discussion on Code Sec.304 Related Party Stock Sales and tax consequences.

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Code Sec. 304 Related Party Stock Sales

  1. 1. Code Sec.304 Related Party Stock Sales Silicon Valley, San Francisco, Los Angeles rroyse@rroyselaw.com www.rroyselaw.com
  2. 2. Constructive Redemption  Sale of Corporate stock either to a Subsidiary Corporation or to a Sister Corporation is subject to §304  Requires “control” o brother-sister stock sale - the person selling the stock is in control of both issuing and acquiring corporation; o parent-subsidiary stock sale - the issuing corporation is in control of the acquiring corporation.  Recharacterization of the stock sale as a §302 stock redemption. o Reflect the acknowledgment that a related party sale is an easy device for withdrawing corporate earnings; o Capital gain treatment is not warranted where the selling shareholder has not really severed its ownership interests in the “sold” target shares.
  3. 3. Brother-Sister stock sale §304(a)(1)  T owns 50% of X Corp.  T owns 50% of Y Corp.  T sells 10% of X Corp. to Y Corp. for cash.  Treated as T exchanged X stock for fictitious Y stock in a §351 transaction, followed immediately by a redemption of the fictitious Y stock.  T will be deemed as received distribution from Y Corp. unless the provisions of §302(b) or §303 are applicable. X Corp Y Corp T
  4. 4. Parent-Subsidiary stock sale §304(a)(2)  T owns 15% of X Corp.  X Corp. owns 100% of Y Corp.  T sells 10% of X Corp. to Y Corp. for cash.  X is deemed to have redeemed 10% of its stock from T, even though the cash is in fact paid directly to T by Y.  The tax consequences to T will depend on whether the redemption is treated as a “distribution of property” to which §302(d) and, thus, the provisions of §301 apply, or whether the redemption will be treated as an “exchange” under §302(b) or §303. See Regs. §1.304-3 X Corp Y Corp T 10% X Stock
  5. 5. Tax Consequences of T  If the transaction is treated as §301 distribution, all of the distribution will be a dividend to T to the extent it does not exceeds the combined e and p of X Corp. and Y Corp. o In a parent-subsidiary sale, T’s basis in the transferred stock is added to his basis in his remaining shares of X Corp. o In a brother-sister sale, T’s basis in the transferred stock is added to his basis in his remaining shares of Y Corp.  For purpose of determining whether the “redemption” qualifies as a purchase under §302(b), the stock position of the issuing corporation (X Corp.) is determinative. §304(b)(1)
  6. 6. Rev. Rul. 2004-83 Apply the Step-Transaction Doctrine  Corp. P sells the stock of Corp. T to Corp. S in exchange for cash  As part of the same plan, Corp. T is liquidated into Corp. S immediately after the sale of Corp. T stock  Rev. Rul. 2004-83, the sale of Corp. T stock and the subsequent liquidation are collapsed under the step-transaction doctrine
  7. 7. Rev. Rul. 2004-83 Apply the Step-Transaction Doctrine  First, Corp. P’ transfer of Corp. T stock to Corp. S is ignored - §351 does not apply.  Thus, Corp. T is viewed as transferring its assets to Corp. S in exchange for the cash sale proceeds.  Second, the asset sale is combined with the liquidation, treated as a qualifying §368(a)(1)(D) reorganization with boot.
  8. 8. Different Tax Consequences Under §304  Treated as two step transaction: o Deemed redemption of Corp. S shares o Tax-free liquidation of Corp. T under section 332  Purchase Price is treated as dividend to the extent of the e and p of both Corp. S and Corp. T Under §368(a)(1)(D)  Deemed as §368(a)(1)(D) reorganization with boot  Unlike §304, realized gain is tested under §356, which subject to the less of o The gain inherent in the stock deemed o The amount of non-qualifying consideration received o The amount of e and p inherent in the transacting entities IRS: Stock sale nominally described in §304 is not immune from a recast under the step-transaction doctrine

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