PLR 200820019: Shareholders' partial dividend waiver does not create income

Plain-English summary

A public corporation wanted to increase cash dividends for its nonwaiving shareholders while keeping enough cash for growth and working capital. Several shareholders offered to waive the portion of each quarterly dividend above a redacted per-share amount. The IRS accepted the stated business reason and the representation that relatives of the waiving shareholders could not receive more than 20 percent of the increased dividends paid to nonwaiving shareholders. It ruled that the waiver would not create gross income for the waiving shareholders for up to three years. The ruling would cease to apply if a stock ownership change, other than death, put nonwaiving relatives above that 20 percent limit.

Ruling snapshot

• Question: Would waiving part of a dividend cause the waiving shareholders to recognize income?
• Outcome: Approved; no gross income from the waiver during the specified period and subject to the ownership limit.
• Key authorities: IRC § 61(a)(7); Rev. Proc. 67-14; Rev. Rul. 45 and Rev. Rul. 56-431.

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury
Washington, DC 20224

Number: 200820019
Third Party Communication: None
Release Date: 5/16/2008
Date of Communication: Not Applicable
Index Number: 61.00-00, 61.05-04
Person To Contact:
---------------------------------
--------------------, ID No. -------------
---------------------------------------------- Telephone Number:
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Refer Reply To:
CC:ITA:B04
PLR-140294-07
Date:
February 11, 2008

LEGEND

X = -----------------------------------------------
Year 1 = -------
Date 1 = ------------------
$r = ------
$s = --------
A = ---------------------------- B = ------------------------- C = -------------------------- D = ----------------------------------------- E = ------------------------ F = ------------------------------ G = -------------------------------------------------

Dear ------------------:

This is in reply to a letter dated September 5, 2007, submitted by your authorized representatives, requesting a ruling on behalf of A, B, C, D, E, F and G concerning the federal income tax consequences of a proposed waiver of dividends.

FACTS

X is a publicly traded corporation that was incorporated in Year 1. The authorized capital stock of X consists of shares of outstanding Class A common stock, shares of outstanding Class B common stock and Preferred Stock, of which no shares were outstanding as of Date 1. The Class A and Class B common stock are identical in all respects, except that each share of Class A common stock has one vote per share and each share of Class B common stock has ten votes per share. Shares of Class B common stock are freely convertible into Class A common stock on a share-for-share basis. X’s Class A common stock is traded on the New York Stock Exchange. The

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Class B common stock is not traded or quoted on any national securities exchange or interdealer quotation system.

The X Board of Directors expects that a contemplated diversification and growth strategy for X will be pursued using both cash and equity. Because a valuable public equity is likely to be more desirable to potential acquisition targets and to provide greater access to capital markets for future equity offerings, the Board believes that creating additional value in X’s public equity will provide considerable flexibility to pursue the desired strategy. The Board believes that for X to continue to expand and grow its business, it must act to maintain and enhance the value of its publicly traded stock.

Essentially, the Board desires to increase X’s regular quarterly cash dividend from the current $r per share to an amount of up to $s per share, but is concerned that the total amount required for payment of such an increase on all issued and outstanding shares of common stock could impair X’s ability to pursue other aspects of its diversification and growth strategy while also financing its working capital needs. As a result, and given the amounts of cash reasonably projected to be available for the payment of additional dividends, management believes that it will be possible to increase X’s per share regular quarterly cash dividend only if the incremental amount above $r per share is distributed solely to the minority shareholders who own X’s publicly traded common stock.

To enable X to make significant additional dividend distributions to minority shareholders who own the publicly traded common stock, A, and all shareholders related to him, B, C, D, E, F and G (Waiving Shareholders) have offered to enter into a formal agreement with X to waive their rights in and to any portion of the regular quarterly cash dividend in excess of the first $r per share declared by X with respect to all of their shares of Class A and Class B common stock.

The following representations have also been made with respect to the dividend waiver:

(1) X has in the past and is expected to continue to declare and pay cash dividends on a quarterly basis;

(2) No dividend waivers will be made by any of the Waiving Shareholders with respect to stock dividends, if any, declared and paid by X;

(3) The Waiving Shareholders will execute a formal agreement with X to waive their rights in and to any portion of the regular quarterly cash dividend in excess of the first $r per share declared by X with respect to all of their shares of Class A and Class B common stock; and

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(4) Persons related to the Waiving Shareholders (as defined in Rev. Proc. 67-14, 1967- 1 C.B. 591) will not receive in the aggregate, either directly or beneficially, more than 20 percent of the amount of any regular quarterly cash dividend in excess of $r per share declared and paid to nonwaiving shareholders of X. As of Date 1, no Waiving Shareholder is related, within the meaning of section 3.02 of Rev. Proc. 67-14, to any nonwaiving shareholder.

LAW AND ANALYSIS:

Section 61(a)(7) of the Internal Revenue Code provides that except as otherwise provided in subtitle A, gross income means all income from whatever source derived, including dividends.

Generally, a majority shareholder who agrees to waive dividends while other shareholders receive theirs does not realize income if there is no family or direct business relationship between the majority and minority shareholders and the waiver is executed for valid business reasons. Rev. Rul. 45, 1953-1 C.B. 178. However, the waiver by a majority shareholder of the right to receive a pro rata share of any dividends paid by a corporation will not be recognized for income tax purposes where such dividends are paid to the relatives as minority shareholders in the form of increased dividends, and the waiver results primarily in a benefit to the relatives. In general, if minority shareholder relatives benefit from a majority shareholder’s dividend waiver, income is realized by the majority shareholder to the extent of the increased distribution to the related shareholders resulting from the waiver. See Rev. Rul. 56-431, 1956-2 C.B. 171.

Rev. Proc. 67-14 lists the conditions under which the Service will consider a request for a ruling on a proposed waiver of dividends transaction when the waiving and nonwaiving shareholders are individuals. The following four conditions must be satisfied: (1) a bona fide business reason must exist for the proposed waiver of dividends; (2) the relatives (e.g., brothers, sisters, spouse, ancestors, and lineal descendants) of the waiving shareholder must not be in a position to receive more than 20 percent of the total dividends distributed to the nonwaiving shareholders; (3) the ruling is not effective if any change in stock ownership (other than death) enables nonwaiving relatives to receive more than 20 percent of the dividend; and (4) a ruling issued on a proposed waiver of dividends transaction will not be effective for a period longer than three years from the date of the ruling.

In this ruling request, it is represented that there is a bona fide business reason for the proposed waiver of dividends because the waiver would allow X to make dividend distributions to the nonwaiving minority shareholders who own the publicly traded common stock of X, thereby enhancing its market value and providing X with greater access to capital markets for future equity offerings. Further, the waiver will permit X to maintain adequate capital to support its operations and expand its business.

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In addition, it is represented that the Waiving Shareholders have no relatives who are in a position to receive in the aggregate more than 20 percent of the total dividends distributed by X to the nonwaiving shareholders. The Waiving Shareholders recognize that this ruling will no longer be applicable if any change in the stock ownership during the waiver period enables nonwaiving relatives to receive more than 20 percent of a dividend, unless the change occurs because of death. The Waiving Shareholders understand that pursuant to Rev. Proc. 67-14, a ruling issued on a proposed waiver of dividends transaction will not be effective for a period longer than three years from the date of the ruling.

CONCLUSION

Based on the information submitted, the applicable law, and the representations made, we conclude that a bona fide business reason does exist for the proposed dividends waiver and that no relatives are in a position to receive in the aggregate more that 20 percent of the total dividends distributed by X to the nonwaiving shareholders. Accordingly, the waiver by the Waiving Shareholders of any portion of the regular quarterly cash dividend in excess of the first $r per share declared by X during the period beginning on the date of this ruling through a period of three years after the issuance of this letter ruling will not result in gross income to any of the Waiving Shareholders.

This ruling will no longer be applicable if any change in the stock ownership during the waiver period enables nonwaiving relatives to receive more than 20 percent of the total dividends distributed to the nonwaiving shareholders, unless the change occurs because of death. In addition, this ruling will not be effective for a period longer than three years from the date of the ruling.

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent. In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representatives.

A copy of this letter must be attached to any income tax return to which it is relevant. Alternatively, taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter ruling.

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The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

Sincerely,

Michael J. Montemurro
Branch Chief, Branch 4
(Income Tax & Accounting)