Were payments made by subsidiaries to their parent under preexisting consolidated-tax agreements ordinary dividends after liquidation began?

Plain-English summary

California Legal Ruling 288 treated payments made by subsidiaries to their parent after liquidation began as liquidating distributions rather than ordinary dividends.

The subsidiaries owed the payments under consolidated federal tax-return agreements signed before their liquidation plans. FTB held that the earlier agreements created the obligation to pay but did not determine the payment's tax character.

Once liquidation proceedings had commenced, the circumstances existing when the payments were made controlled. Under former section 24501, the payments were treated as made in exchange for the parent's stock.

Facts addressed by the ruling

X Corporation owned 80% interests in several subsidiaries.

The group agreed to file consolidated federal income-tax returns. Each subsidiary paid X the amount it would have owed on a separate federal return, X paid the group's consolidated liability, and X retained amounts received above that liability in the years at issue.

Several subsidiaries later sold their assets, and their shareholders adopted liquidation plans. The liquidations qualified for historical nonrecognition treatment under former section 24502.

After adopting their plans, the subsidiaries made payments to X under the preexisting consolidated-tax agreements.

Ordinary-course payments contrasted

The ruling acknowledged that an excess tax-agreement payment ordinarily was treated as a dividend when:

• the payment occurred in the ordinary course of business; and
• the parties intended to maintain the subsidiary as a going concern.

Former section 24495 supplied the historical dividend definition.

Those conditions did not describe payments made after the subsidiaries had begun liquidation.

Why the prior agreement did not control

The parent-side argument was that the agreements predated the liquidation plans, so the resulting payments should keep their ordinary-dividend character.

FTB rejected that reasoning. The agreements created obligations, but the ruling looked to the facts and circumstances at the time of distribution to classify the payments.

The cited authorities supported the broader propositions that:

• once liquidation begins or has clearly been decided upon, later shareholder payments are liquidating distributions;
• declaring or accruing a payment does not necessarily complete the distribution; and
• dividend inclusion and characterization can depend on when payment is received.

Result under former section 24501

Former section 24501 treated amounts distributed in a corporate liquidation as full payment in exchange for stock.

Because these subsidiaries had already adopted liquidation plans, their later payments to X fell under that provision rather than the ordinary-dividend rule.

What this means for you

Parent and subsidiary groups

Under the historical ruling, the timing of an intercompany payment relative to a subsidiary's liquidation could change its character even when the obligation arose under an earlier agreement.

Corporate tax attorneys

Review when the liquidation plan was adopted, whether liquidation was clearly underway, when each payment was made, the legal source of the obligation, and the applicable recognition provisions.

Accountants and tax professionals

Do not classify a payment solely by the contract that generated it. The entity's status and circumstances at payment may control whether it is an ordinary dividend or liquidation proceeds.

Common questions

Q: Were the tax-sharing payments ordinary dividends after liquidation began?

A: No. The ruling treated them as liquidating distributions.

Q: Did signing the agreements before liquidation preserve dividend treatment?

A: No. The agreements created the obligation but did not control the payment's later tax character.

Q: How would the excess have been treated while a subsidiary remained a going concern?

A: The ruling said an excess paid in the ordinary course with intent to maintain the subsidiary as a going concern was treated as an ordinary dividend.

Q: What did former section 24501 do?

A: It treated amounts distributed in liquidation as full payment in exchange for stock.

Q: Did the subsidiaries' liquidations qualify for nonrecognition?

A: The ruling states that they came within former section 24502, but the question decided was the character of the later payments to the parent.

Citations and references

• Former Cal. Rev. & Tax. Code §§ 24495, 24501, and 24502
• Beneficial Corp., 18 T.C. 396, aff'd, 202 F.2d 150
• Texas Empire Pipe Line Co. v. Commissioner, 127 F.2d 220
• Holmby Corp. v. Commissioner, 83 F.2d 548
• Mason v. Routzahn, 275 U.S. 175
• Avery v. Commissioner, 292 U.S. 210

Source

• Landing page: California FTB Legal Rulings
• Official HTML: Legal Ruling 288

Original ruling text

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Legal Ruling 1965-288

California Franchise Tax Board
Legal Ruling No. 288

April 23, 1965

Franchise-Subsidiaries Corporations: Intercorporate Payments After Commencement of Liquidation

Payments by subsidiary corporations to their parent after the commencement of liquidation are to be treated as a distribution in liquidation within the meaning of Section 24501, Revenue and Taxation Code.

X Corporation had an ownership interest of 80 percent in a number of corporations. Agreements were entered into by X and its subsidiaries for the filing of a Federal consolidated income tax return for the group. The agreements provided that each subsidiary would pay to the parent an amount equal to that which each would have been required to pay if a separate Federal income tax return were filed. X paid the consolidated income tax liability, and, in the particular years involved, retained an excess received under the agreements over the liability disclosed by the consolidated return.

A number of these subsidiary corporations sold their assets, and subsequently the shareholders of each adopted plans of liquidation. The liquidations came within the provisions of Section 24502 of the Bank and Corporation Tax Law, providing for nonrecognition of gain or loss on the liquidation of certain subsidiary corporations.

During the years prior to 1956, these corporations made payments to X pursuant to the consolidated tax agreements. The payments were made after the respective corporations had adopted a plan of liquidation.

How is the payment made by the subsidiary after it has commenced liquidation to be treated by the parent?

There is agreement that any excess received by a parent corporation over a subsidiary's allocable share of the consolidated tax liability is to be treated as an ordinary dividend, where paid in the ordinary course of business with intent to maintain the subsidiary as a going concern. See Section 24495, defining "dividend"; also, Beneficial Corp., 18 T.C. 396 aff'd per cur. 202 Fed. 2d 150 43 AFTR 282.

Section 24501 provides that amounts distributed in liquidation of a corporation shall be treated as in full payment in exchange for stock. Inasmuch as, in this case, the subsidiaries have commenced liquidation proceedings, it is concluded that the payments made thereafter are governed by this section.

The view has been expressed that the payments, even though made after liquidation has commenced, should not be treated as distributions in liquidations, because they arise under an agreement entered into prior to the adoption of the plan of liquidation. It is contended that, by reason of the obligation created by the prior agreement, the payments retain their nature as ordinary dividends. This view does not appear to be supportable. Although the agreement creates an obligation to make the payment, it does not, per se, determine the treatment of the payment. Although no case directly in point has been found, a number of cases tend to support the conclusion that, once liquidation proceedings have been commenced or a course of liquidation has been clearly decided upon, the fact of liquidation is controlling, and all subsequent payments are treated as distributions in liquidation and not as ordinary dividends. Texas Empire Pipe Line Co. v. Com., 127 Fed. 2d 220; Holmby Corp. v. Com., 83 Fed. 2d 548; Canal-Commercial T. & S. Bank v. Com., 63 Fed. 2d 619; Herbert A. Nieman & Co. 33 T.C. 451; Arthur Letts, Jr., 30 BTA 800; Cf.Tate v. Com., 97 Fed. 2d 658; Virginia Ice and Freezing Corp., 30 T.C. 1251.

Furthermore, support for the conclusion reached herein, that the prior agreement is not controlling, is found in cases holding that in the particular circumstances various events or conditions occurring prior to payment are not controlling with respect to the dividend. For example, the declaration of a dividend does not constitute a distribution of the dividend, there being no realization until subsequently paid, Mason v. Routzahn, 275 U.S. 175; the source of the dividend, whether from earnings and profits, is determined not as of the date of declaration when the debtor and creditor relationship is created between the corporation and the stockholder but as of the date of payment, Emily D. Proctor, 11 BTA 235; see Com. v. American Light & Traction Co., 156 Fed. 2d 398; and, the prior accrual of a reserve for patronage dividends payable, which is subject to contingent charges, was held not to be income to members of the cooperative, Farmers Grain Dealers Assn. of Iowa v. U.S., 116 Fed. Supp. 685. In Beneficial Corporation, 18 T.C. 396, a case involving a payment similar to that herein, the court rejected the taxpayer’s contention that the transaction "accrued" in the tax year for which the consolidated return was filed and should not be taken into account the following year when the payment was made by the subsidiary to the parent. The court stated that there was no question of any accrual of a liability; and, that the transaction was governed by the rule covering includibility of a dividend distribution. The foregoing cases, although not directly on the question herein, are relevant in that they tend to discount the significance of actions, conditions, or events preceding the time of distribution, and, rather, stress the importance of considering the facts and circumstances existing at the time the payment is made.

Also of some general support for the conclusion reached are those cases considering the date on which a dividend is properly includible by the recipient. The rule is established that dividends are includible when received, whether the recipient is on the cash or the accrual basis. Avery v. Com., 292 U.S. 210; Tar Products Corp. v. Com., 130 Fed. 2d 866; Com v. American Light & Traction Co., 156 Fed. 2d 398.

Last updated: 09/24/2025