When a utility buys its publicly traded parent's stock from a third party and keeps it, is that a constructive dividend to the parent subject to the section 186 excess dividends tax?

Plain-English summary

Consolidated Edison Company of New York, Inc., a regulated utility taxed under Article 9 (section 186), is a wholly owned subsidiary of the publicly traded holding company CEI (taxed under Article 9-A). CEI and Con Ed authorized the repurchase of up to $1 billion of CEI's stock. Con Ed proposed to directly purchase CEI's publicly traded common stock on the open market -- a "related party redemption" -- and to continue holding it. Con Ed asked whether that purchase is a constructive dividend to CEI subject to the section 186 excess dividends tax.

The Department first noted that, unlike Article 9-A (which starts from federal taxable income), section 186 is not federally conformed; "gross earnings" and "dividends" are determined from the section's own terms, the case law, and GAAP. Under section 186, a dividend "implies a division or distribution of corporate profits" (Adams Electric). The IRS had similarly ruled (Rev. Rul. 80-189) that a subsidiary's purchase of its parent's stock from a shareholder is not a constructive distribution to the parent for federal purposes.

Because Con Ed buys and continues to hold the CEI stock, there is no distribution of property to shareholders. So the related-party redemption is treated as a distribution in redemption of CEI's stock and is not a constructive dividend subject to the section 186 excess dividends tax. (This opinion is the authority a later RG&E opinion, TSB-A-98(21)C, followed.)

What this means for you

Buying and holding parent stock distributes nothing

A utility's open-market purchase of its parent's stock, retained by the utility, is a redemption, not a constructive dividend to the parent.

Section 186 stands on its own terms

Because section 186 is not federally conformed, "dividend" and "gross earnings" are read from the statute and case law -- though here the federal result (Rev. Rul. 80-189) agreed.

Retention is the key fact

The conclusion depends on the utility continuing to hold the repurchased stock rather than distributing it.

Common questions

Q: Why isn't this a dividend to the parent?
A: Because Con Ed retains the stock and distributes nothing; there is no division or distribution of profits.

Q: Does the federal treatment matter?
A: Section 186 is not federally conformed, but the IRS reached the same no-constructive-distribution result in Rev. Rul. 80-189.

Q: Is this the same as the RG&E opinion?
A: Yes -- TSB-A-98(21)C follows this Con Edison opinion on identical facts.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 186 (franchise tax on gas and electric utilities; excess dividends tax)
- People ex rel Adams Electric Light Co v Graves, 272 NY 77
- Revenue Ruling 80-189, 1980-2 CB 106
- IRC section 1012 (cost basis)
- Consolidated Edison Company of New York, Inc., TSB-A-98(6)C (May 29, 1998)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1998.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a98_6c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-98(6)C
Corporation Tax

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C980324A

On March 24, 1998, a Petition for Advisory Opinion was received from
Consolidated Edison Company of New York, Inc., 4 Irving Place, Room 1875-S, New
York, New York 10003.
The issue raised by Petitioner, Consolidated Edison Company of New York,
Inc., is whether Petitioner's purchase of the stock of its parent from a third
party results in a constructive dividend distribution from Petitioner to its
parent, and if so, whether such constructive dividend distribution by Petitioner
is subject to the excess dividends tax pursuant to section 186 of the Tax Law.
Petitioner submits the following facts as the basis for this Advisory
Opinion.
Petitioner, a wholly-owned subsidiary of Consolidated Edison, Inc. ("CEI"),
is a regulated public utility incorporated in New York State on November 10,
1884. Petitioner supplies electricity and electric services in all of New York
City (except a part of the Borough of Queens) and most of Westchester County.
It also supplies gas and gas services in Manhattan, the Bronx and parts of Queens
and Westchester County, as well as steam and steam services in Manhattan.
Petitioner is subject to tax under Article 9 of the Tax Law. CEI is a publicly
traded holding company and is subject to tax under Article 9-A of the Tax Law.
The principal offices of both Petitioner and CEI are located at 4 Irving Place,
New York, New York.
CEI and Petitioner have authorized the repurchase of up to $1 billion of
CEI common stock, subject to receiving New York State Public Service Commission
("PSC") approval and market conditions. To effectuate this stock repurchase, it
is proposed that Petitioner directly purchase the publicly traded common stock
of CEI, its parent corporation, on the open market in a transaction known as a
related party redemption. After purchasing such stock, Petitioner will continue
to hold the CEI common stock. There will be no pro rata distribution of property
to shareholders or a class of shareholders. Petitioner will simply purchase the
stock of CEI from those shareholders of CEI who wish to sell their stock.
Petitioner states that for federal income tax purposes, Petitioner's
purchase of the CEI common stock held by CEI's public shareholders would be
treated as a direct redemption by CEI for purposes of determining the tax
consequences to such public shareholders.
Section 304(a)(2) of the Internal
Revenue Code provides that if (1) a corporation (referred to as the "subsidiary"
or "acquiring" corporation) acquires the stock of another corporation (referred
to as the "parent" or "issuing" corporation) from a stockholder of the parent
corporation in return for "property", and (2) the parent corporation "controls"
the acquiring corporation, then the property paid for the parent stock shall be
treated as a distribution in redemption of the stock of the parent corporation.

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Corporation Tax

Petitioner also states that the Internal Revenue Service, in Revenue Ruling
80-189, 1980-2 CB 106, specifically ruled that the purchase of the stock of a
parent corporation (Parent) from a shareholder of the Parent by a subsidiary of
the Parent will not result in a constructive distribution to the Parent from the
subsidiary for federal income tax purposes. The Parent's adjusted basis in the
subsidiary's stock will remain the same as it was prior to the transaction, and
the subsidiary, under section 1012 of the Internal Revenue Code, will have a
basis in the Parent's stock acquired in the transaction equal to the amount paid
therefor.
Discussion
Unlike Article 9-A of the Tax Law which uses federal taxable income as the
starting point for computing entire net income, section 186 of the Tax Law is not
federally conformed. The determination of what constitutes "gross earnings" and
"dividends" for purposes of section 186 is made using the definitions contained
in the section, including the case history in these areas, and applying generally
accepted accounting principles.
Section 186 of the Tax Law imposes a franchise tax upon every corporation,
joint-stock company or association formed for or principally engaged in the
business of supplying gas, when delivered through mains or pipes, or electricity,
"for the privilege of exercising its corporate franchise or carrying on its
business in such corporate or organized capacity in this state". The tax is
three-quarters of one percent on the taxpayer's gross earnings from all sources
within New York State, and four and one-half percent on the amount of dividends
paid during each year ending on the thirty-first day of December in excess of
four percent on the actual amount of paid-in capital employed in New York State
by the taxpayer.
In People ex rel Adams Electric Light Co v Graves, 272 NY 77,79, the Court
of Appeals stated that under the franchise tax imposed by section 186 of the Tax
Law "[a] dividend on corporate stock implies a division or distribution of
corporate profits." In that case, the Court held that the transfer of a portion
of earned surplus to its non-par capital stock account, pursuant to a resolution
of its board of directors, was not a distribution of dividends for tax purposes.
Neither money nor property nor stock dividend went into the hands of
stockholders. No stockholder acquired a right to receive any equivalent of the
amount transferred unless further corporate action was taken.
In this case, Petitioner will directly purchase publicly traded common
stock of CEI, its parent corporation, on the open market in a transaction known
as a related party redemption. After purchasing such stock, Petitioner will
continue to hold the CEI common stock. There will be no distribution of property

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Corporation Tax

to shareholders or a class of shareholders. Accordingly, Petitioner's related
party redemption and the holding of the common stock will be treated as a
distribution in redemption of the stock of CEI, and does not constitute a
constructive dividend distribution from Petitioner to its parent for purposes of
computing the excess dividends tax under section 186 of the Tax Law.

DATED: May 29, 1998

NOTE:

/s/
John W. Bartlett
Deputy Director
Technical Services Bureau

The opinions expressed in Advisory Opinions
are limited to the facts set forth therein.