PLR 1039013: IRS approved section 382 treatment for preferred stock exchanges

Plain-English summary

A publicly traded corporation asked how section 382 would apply to several preferred stock issuances, exchanges, conversions, and a warrant cancellation. The IRS ruled that the replacement instruments and common stock would be allocated to the corporation's direct public groups in the specified proportions. It also allowed the corporation to apply the Hold Constant Principle from Notice 2010-50 to identify 5-percent shareholders for section 382 purposes. The IRS further ruled that two preferred stock classes qualified as registered stock under the applicable section 382 regulations, while reserving other questions about ownership changes and the tax treatment of the transactions.

Ruling snapshot

• Question: How would several preferred stock transactions be treated for section 382 shareholder identification?
• Outcome: Approved
• Key authorities: IRC § 382; Treas. Reg. §§ 1.382-2T, 1.382-3, and 1.382-4; Notice 2010-50

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201039013 Third Party Communication: None
Release Date: 10/1/2010 Date of Communication: Not Applicable
Index Number: 382.00-00, 382.07-00,
382.07-05, 382.12-00, Person To Contact:
382.12-06 ----------------------------
ID No. -----------------
-------------------- Telephone Number:
----------------------- ---------------------
------------------- Refer Reply To:
----------------------- CC:CORP:02
------------------------------------ PLR-113764-10
Date:
June 29, 2010

                                                LEGEND

Taxpayer = --------------------

State A = ---------------

Series 1 Preferred Stock = --------------------------------------------------------

Series 2 Preferred Stock = ------------------------------------------------

Security A = -----------------------------------------------

Group A = ------------------------------------------------------------------------
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--------------------------------------------

Person A = ------------------------------------------------------------------------
-----

Person B = -------------------------------------

Date 1 = ----------------------

Date 2 = -----------------------
PLR-113764-10 2

Date 3 = -----------------------

Date 4 = -----------------------

Date 5 = ------------------------

Date 6 = ------------------

Date 7 = ------------------

Date 8 = -------------------------

Date 9 = ---------------------------

a = --------------

b = --------------

c = -------

d = -----------

e = ----

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

This letter responds to your letter dated March 26, 2010 requesting rulings regarding
application of section 382 of the Internal Revenue Code to Taxpayer. The information
provided in that letter and in later correspondence is summarized below.

The rulings contained in this letter are based upon facts and representations submitted
by the taxpayer and accompanied by a penalties of perjury statement executed by an
appropriate party. This office has not verified any of the material submitted in support of
the request for rulings. Verification of the information, representations, and other data
may be required as part of the audit process.

                             SUMMARY OF FACTS

Taxpayer is a publicly traded, State A corporation and is the common parent of an
affiliated group whose includible corporations join in the filing of a consolidated federal
income tax return. As of Date 1, Taxpayer had outstanding a single class of common
stock (the “Common Stock”) and multiple classes of preferred stock described in section
1504(a)(4).
PLR-113764-10 3

On Date 2, Taxpayer completed a $a private offering of Series 1 Preferred Stock to
Group A, which included Person A and Person B, by issuing b corresponding depository
shares (the “Offering”). Each share of the Series 1 Preferred Stock was convertible at
any time, at the option of the holder, into shares of Common Stock at a conversion price
of $c, subject to certain adjustments. Pursuant to Treas. Reg. § 1.382-3(j)(3), Taxpayer
applied the cash issuance exception to the issuance of the Series 1 Preferred Stock in
the Offering. Applying the Hold Constant Principle, as defined in Notice 2010-50,
2010-27 I.R.B. __, to identify 5-percent shareholders for purposes of section 382, all
shares issued in the Offering would be treated as issued to direct public groups of
Taxpayer.

On Date 2 and Date 3, Taxpayer issued Series 2 Preferred Stock by issuing depository
shares to direct public groups of Taxpayer. Shares of the Series 2 Preferred Stock
were convertible at any time, at the option of the holder, into shares of Common Stock
at a set conversion price, subject to certain adjustments. Pursuant to Treas. Reg.
§ 1.382-3(j)(3), Taxpayer applied the cash issuance exception to the issuance of the
Series 2 Preferred Stock.

On Date 4, under the terms of an anti-dilution adjustment mechanism in the investor
agreements, the conversion price for the Series 1 Preferred Stock was reset from $c per
share to $d per share (the “Reset”). In connection with the Reset, on Date 5, Taxpayer
exchanged shares of the originally issued Series 1 Preferred Stock for an equal number
of shares of New Series 1 Preferred Stock with identical terms and conditions, except
for the reset conversion price. Taxpayer treated the Reset as a reorganization within
the meaning of section 368(a)(1)(E) or otherwise tax-free under Treas. Reg.
§ 1.305-7(b)(1).

On Date 6, Taxpayer issued newly created Security A and a warrant to acquire shares
of Common Stock at $e per share in exchange for all of the shares of New Series 1
Preferred Stock held by Group A (the “Series 1 Exchange”). Security A generally had
the same voting rights as the Common Stock. Taxpayer treated the Series 1 Exchange
as a reorganization within the meaning of section 368(a)(1)(E).

On Date 7, Taxpayer issued shares of Common Stock in exchange for shares of
Series 2 Preferred Stock and shares of certain other preferred stock that are not stock
within the meaning of section 382(k)(6) (the “Series 2 Exchange”). Taxpayer treated the
Series 2 Exchange as a reorganization within the meaning of section 368(a)(1)(E).

On Date 8, the holders of a majority of the shares of Common Stock outstanding
consented to increase the number of authorized shares of Common Stock. As a result
of this consent each warrant issued in connection with Security A held by Group A was
cancelled.
PLR-113764-10 4

On Date 9, Security A held by Group A was converted into shares of Common Stock
pursuant to the terms of Security A (the “Conversion”). Taxpayer treated the
Conversion as a reorganization within the meaning of section 368(a)(1)(E).

                            REPRESENTATIONS

The following representations have been made with respect to the equity ownership of
Taxpayer:

(a) Applying the Hold Constant Principle, as defined in Notice 2010-50, 2010-27
I.R.B. __, Taxpayer has not had a section 382 ownership change during the
period from Date 1 to the date of this letter.

(b) The amount of Security A received in the Series 1 Exchange and the amount
of the Common Stock received in the Series 2 Exchange were determined, in
the case of the Series 1 Exchange, based on arm’s length negotiations, and
in the case of the Series 2 Exchange, based on exchange ratios derived from
the Series 1 Exchange, and hence the Series 1 Exchange and the Series 2
Exchange each constituted a value-for-value exchange. The amount of New
Series 1 Preferred Stock received in the Reset and the amount of Common
Stock received in the Conversion, were determined based on the terms of the
Series 1 Preferred Stock and Security A, respectively, and hence the Reset
and the Conversion, each constituted a value-for-value exchange.

                                   RULINGS

Based solely on the information submitted and the representations set forth above, we
rule as follows:

(1) Shares of New Series 1 Preferred Stock issued in exchange for shares of the
old Series 1 Preferred Stock in the Reset, Security A issued in exchange for
shares of New Series 1 Preferred Stock in the Series 1 Exchange, shares of
Common Stock issued pursuant to the conversion of Security A in the
Conversion, and shares of Common Stock issued in exchange for shares of
Series 2 Preferred Stock in the Series 2 Exchange, each will be allocated to
Taxpayer’s direct public groups in the same proportion as such groups were
treated as having tendered the instruments respectively surrendered in the
Reset, the Series 1 Exchange, the Conversion, and the Series 2 Exchange.

(2) The Hold Constant Principle, as defined in, and subject to the terms and
conditions of, Notice 2010-50, 2010-27 I.R.B. __, may be applied to identify
5-percent shareholders for all purposes of section 382.
PLR-113764-10 5

(3) The Series 1 Preferred Stock and the Series 2 Preferred Stock are stock
described in “any rule or regulation to generally the same effect” as Rule
13d-1(d) of Regulation 13D-G within the meaning of Treas. Reg.
§ 1.382-2T(k)(1) and, therefore, constitute “registered stock” within the
meaning of such regulation. Any reliance on the existence or absence of
filings of Schedules 13D or 13G to identify 5-percent shareholders pursuant to
Treas. Reg. § 1.382-2T(k)(1) is subject to actual knowledge regarding stock
ownership as provided in Treas. Reg. § 1.382-2T(k)(2).

                                    CAVEATS

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. In particular, no opinion is expressed as to whether or not (i) any stock
issued before, on, or after Date 1 should be treated as stock for purposes of section
382; (ii) Taxpayer had a testing date on any given date; (iii) Taxpayer had an ownership
change on any testing date (under either the methodology set forth at Treas. Reg.
§ 1.382-2T(c)(1) or the Hold Constant Principle, as defined in Notice 2010-50, 2010-27
I.R.B. __); (iv) any warrants or options should be treated as exercised under Treas.
Reg. § 1.382-4(d); or (v) any exchange of stock pursuant to a recapitalization or
conversion represented a value-for-value exchange. One or more rulings given in this
letter deal with issues that may be addressed in subsequent published guidance. See
section 11.04 of Rev. Proc. 2010-1, 2010-1 I.R.B. 1, 49 (regarding the circumstances,
including published guidance, which may result in the revocation or modification of a
letter ruling).

                         PROCEDURAL STATEMENTS

This ruling letter is directed only to the taxpayer who requested it. Section 6110(k)(3) of
the Internal Revenue Code provides that it may not be used or cited as precedent.

A copy of this ruling 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.
PLR-113764-10 6

In accordance with the Power of Attorney on file with this office, a copy of this ruling
letter is being sent to your authorized representative.

                                   Sincerely,



                                   Douglas C. Bates
                                   Reviewing Attorney, Branch 5
                                   Office of Associate Chief Counsel (Corporate)