PORTFOLIO

Stock Sales Subject to Section 304 (Portfolio 768)

Tax Management Portfolio, Stock Sales Subject to Section 304, No. 768-3rd, discusses the tax rules governing a stock sale where: (1) a person sells stock of a parent corporation to its subsidiary (a “parent-subsidiary” stock purchase), and (2) a person controls each of two corporations and sells stock of one corporation to the other corporation (a “brother-sister” stock purchase). Section 304 governs these transactions and treats them as stock redemptions, not as stock sales to third persons, thus bringing into play the redemption provisions, the most important of which is §302.

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DESCRIPTION

Tax Management Portfolio, Stock Sales Subject to Section 304, No. 768-3rd, discusses the tax rules governing a stock sale where: (1) a person sells stock of a parent corporation to its subsidiary (a “parent-subsidiary” stock purchase), and (2) a person controls each of two corporations and sells stock of one corporation to the other corporation (a “brother-sister” stock purchase). Section 304 governs these transactions and treats them as stock redemptions, not as stock sales to third persons, thus bringing into play the redemption provisions, the most important of which is §302.
Congress originally enacted §304 (and its statutory predecessor) to prevent the bailout of corporate earnings and profits as capital gain or return of capital via a sale of stock of one corporation to a related corporation, thereby avoiding the ordinary income tax on dividends. When capital gains are taxed at preferential rates, many individual taxpayers structure transactions to avoid the grasp of §304 in order to obtain the preferential rate for capital gains; even when the rates on capital gains and dividends are the same, the basis offset allowed for sales and exchanges motivates taxpayers to avoid dividend treatment. However, for many corporate taxpayers (especially in the international arena) §304 may be used to generate tax benefits in the context of stock sales (e.g., the §243 dividends received deduction and the §902 deemed-paid tax credit).
This Portfolio examines the judicial and legislative background of §304 and provides a detailed discussion of the rules of §304. As a part of this discussion, the separate rules applicable to parent-subsidiary and brother-sister stock purchases are compared, and the interrelation of §304 with other sections of the Code is explored.


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AUTHORS

CLIFFORD R. GROSS
Clifford R. Gross, J.D., The University of Chicago Law School (member of Law Review); B.S., Yale College; member, District of Columbia Bar and New York State Bar; formerly law clerk to Chief Judge Arthur L. Nims III, U.S. Tax Court.

JOSEPH M. DOLOBOFF
Joseph M. Doloboff, J.D. (cum laude), Harvard Law School; B.A., University of North Carolina (Phi Beta Kappa); Senior Managing Director, FTI Consulting; member, California State Bar, District of Columbia Bar and Virginia State Bar; formerly Acting Deputy Tax Legislative Counsel, Department of the Treasury.

GEORGE C. KOUTOURAS
George C. Koutouras, LL.M. (Taxation), Georgetown University Law Center; J.D., University of Detroit School of Law; B.S.A., University of Michigan; bar membership, Michigan and Illinois; formerly Attorney/Advisor to Special Trial Judge Stanley J. Goldberg, United States Tax Court; Managing Director, Alvarez & Marsal Taxand, LLC; Co-Author, 767-2nd T.M., Redemptions, 564 T.M., Related Party Transactions and 782-3rd T.M., Boot Distributions and Assumption of Liabilities; Adjunct Professor, University of Illinois Urbana-Champaign Master of Tax Program.

MARK Q. TIZABGAR
Mark Q. Tizabgar, LL.M. (Taxation), New York University School of Law; J.D. (cum laude), Southwestern University School of Law; B.S., California State University Northridge; State Bar of California; Co-Author, 564 T.M., Related Party Transactions and 782-2nd T.M., Boot Distributions and Assumption of Liabilities; Adjunct Professor, Golden Gate University, Master of Tax Program.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

A. In General

B. Background

II. Parent-Subsidiary Stock Sales

Introductory Material

A. Prerequisites for Application of § 304(a)(2)

1. Control

a. What Constitutes Control?

b. Who Has Control?

(1) Constructive Stock Ownership

(2) Indirect Control

(3) Control by More Than One Person

(4) Disguised Stock Ownership

c. When Is Control Tested?

2. Property

B. Effect of § 304(a)(2)

1. Parent-Subsidiary Stock Purchase Treated as an Exchange

a. Section 302

(1) Section 302(b)(2) - Substantially Disproportionate Redemption

(2) Section 302(b)(3) - Complete Termination of Stockholder's Interest

(3) Section 302(b)(1) - Not Essentially Equivalent to a Dividend

(4) Section 302(b)(4) - Partial Liquidation Distribution in Redemption of the Stock of a Noncorporate Stockholder

b. Section 303

2. Parent-Subsidiary Stock Purchase Treated as a Distribution

3. Basis

a. Distribution

(1) Seller

(2) Purchaser

b. Sale or Exchange

(1) Seller

(2) Purchaser

4. Effect of Parent-Subsidiary Stock Purchase on Earnings and Profits

5. Gain to the Issuing or Acquiring Corporation

C. Relation to Other Provisions of the Code

1. Section 351 Transfers to Controlled Corporations

a. Transactions Under Current Law

b. Transactions Under Old Law

(1) Haserot v. Comr.

(2) Coates Trust Case

(3) Falkoff Case

(4) View of the Service

2. Reorganizations - § 368

3. Tax Consequences of International § 304 Transactions

a. Foreign Tax Credits and Withholding Taxes

b. Sections 367 and 1491

c. CFC Issues

d. PFIC Issues

4. Installment Sales - § § 453 and 453A

5. Consolidated Return Regulations

6. Small Business Stock

7. Extension of Time to Pay Estate Tax - § 6166

8. S Corporations

9. Inversions

D. Reporting Requirements

E. Ruling Requests

1. When a Ruling Should Be Sought

2. Procedure for Requesting a Ruling

3. No Ruling Areas

III. Brother-Sister Stock Sales

Introductory Material

A. Prerequisites for Application of § 304(a)(1)

1. Control

a. What Constitutes Control?

b. Who Has Control?

(1) Constructive Stock Ownership

(2) Indirect Control

(3) Control by More Than One Person

(4) Disguised Stock Ownership

c. When Is Control Tested?

2. Property

a. In General

b. Acquisition Indebtedness Exception

c. Bank Holding Company Exception

B. Effect of Section 304(a)(1)

1. Brother-Sister Stock Purchase Treated as an “Exchange”

a. Section 302

(1) Section 302(b)(2) - Substantially Disproportionate Redemption

(2) Section 302(b)(3) - Complete Termination of Stockholder's Interest

(3) Section 302(b)(1) - Not Essentially Equivalent to a Dividend

(4) Section 302(b)(4) - Partial Liquidation Distribution in Redemption of the Stock of a Noncorporate Stockholder

b. Section 303

2. Brother-Sister Stock Purchase Treated as a Distribution

a. Transactions Under Current Law

b. Transactions Subject to TEFRA

c. Transactions Occurring Before TEFRA

3. Basis

a. Distribution

(1) Seller

(a) Transactions Under Current Law

(b) Transactions Under Prior Law

(2) Purchaser

b. Sale or Exchange

(1) Seller

(2) Purchaser

4. Effect of Brother-Sister Stock Purchase on Earnings and Profits

a. Distribution

b. Redemption

5. Gain to the Acquiring Corporation

C. Relation to Other Provisions of the Code

1. Section 351 Transfers to Controlled Corporations

2. Reorganizations - § 368

3. International Tax Consequences of § 304 Transactions

4. Distribution of Stock of a Controlled Corporation - § 355

5. Section 306 Stock

6. Substantial Similarity to Fast-Pay Preferred

7. Stock Purchases Treated as Asset Acquisitions - § 338

8. Installment Sales - § § 453 and 453A

9. Small Business Stock

10. Extension of Time to Pay Estate Tax - § 6166

11. S Corporations

D. Reporting Requirements

E. Ruling Requests


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Typical Parent-Subsidiary Stock Purchase

Worksheet 2 Typical Brother-Sister Stock Purchase

Worksheet 3 Statement of Assumed Facts on the Basis of Which a Brother-Sister Stock Redemption is Contemplated

Worksheet 4 Directors' Resolution Authorizing Stock Acquisition

Worksheet 5 Stock Purchase Agreement

Worksheet 6 Request for Ruling

Worksheet 7 Acquisition by a Subsidiary

Worksheet 8 Acquisition by a Sister Corporation

Worksheet 9 Acquisition by a Sister Corporation Treated as a Dividend

Worksheet 10 Acquisition by a Sister Corporation Treated as a Sale

Worksheet 11 Acquisition by a Subsidiary Corporation Treated as Dividend, Illustration I

Worksheet 12 Acquisition by a Subsidiary Corporation Treated as Dividend, Illustration II

Worksheet 13 Acquisition by a Subsidiary Corporation Treated as a Sale

Worksheet 14 H.R. Rep. No. 432, Pt. 2, 98th Cong., 2d Sess. (1984); H.R. Rep. No. 861, 98th Cong., 2d Sess. (1984)

Worksheet 15 General Explanation of the Amendments Made to Section 304 by the Tax Reform Act of 1984, by the Staff of the Joint Committee on Taxation, pp. 1000–1004

Worksheet 16 S. Rep. No. 530 (Conf. Rep.), 97th Cong., 2d Sess. (1982)

Worksheet 17 General Explanation of the Amendments Made to Section 304 by the Tax Equity and Fiscal Responsibility Act of 1982, by the Joint Committee on Taxation, pp. 141–144

Worksheet 18 H.R. Rep. No. 2319, 81st Cong., 2d Sess. 53 (1950)

Worksheet 19 H.R. Rep. No. 1337, 83d Cong., 2d Sess. 35–38 (1954)

Worksheet 20 S. Rep. No. 1622, 83d Cong., 2d Sess. 45–48 (1954)

Worksheet 21 H.R. Conf. Rep. No. 760, 97th Cong., 2d Sess. 409, 543 (1982)

Worksheet 22 H.R. Conf. Rep. No. 495, 100th Cong., 1st Sess. 499, 969–70 (1987)

Bibliography

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