When a section 186 utility buys back its parent holding company's stock on the open market and then transfers it to the parent, is the transfer an excess-dividend distribution under section 186?

Plain-English summary

Rochester Gas and Electric (RG&E), a section 186 electric/gas utility, was reorganizing into a holding-company structure under the PSC's Competitive Opportunities restructuring. Separately, it ran a stock-repurchase program, buying its parent Holding Company's publicly traded shares on the open market. It asked whether two ways of handing that repurchased stock back to the parent are subject to the section 186 excess dividends tax.

The Department's answers turned on the rule that a section 186 dividend is a distribution of corporate profits (Adams Electric), and that distributions made as part of the PSC-mandated restructuring are not profit distributions (Central Hudson):

• Transaction 1 -- distribute the repurchased stock to the parent for nothing. Because the stock-repurchase program is outside the PSC-mandated restructuring series, this distribution is a distribution of profits and therefore a dividend subject to the excess dividends tax, measured at the fair market value (GAAP) of the Holding Company stock.
• Transaction 2 -- exchange the repurchased stock for RG&E's own stock the parent holds. If the fair market values are equal, this is not a dividend. But if the Holding Company stock RG&E distributes is worth more than the RG&E stock it receives back, the excess is a dividend subject to the excess dividends tax.

What this means for you

"Within the mandate" versus ordinary corporate action

Restructuring steps the PSC requires are not profit distributions; a utility's own stock-repurchase program is ordinary corporate action, so handing the stock to the parent for nothing is a taxable dividend.

An equal-value exchange is not a dividend

Swapping stock for stock of equal value is not a distribution of profits. Only value transferred in excess of what comes back is a dividend.

Fair market value is the measure

Where a dividend results, it is measured at the fair market value (under GAAP) of the stock distributed.

Common questions

Q: Is distributing repurchased parent stock to the parent for no consideration a dividend?
A: Yes. Done outside the PSC-mandated restructuring, it is a distribution of profits subject to the section 186 excess dividends tax at fair market value.

Q: What about exchanging it for the utility's own stock?
A: No dividend if the values are equal; only the excess of the distributed stock's value over the value received is a dividend.

Q: Why does the PSC restructuring matter?
A: Distributions made as part of the PSC-mandated restructuring are not distributions of profits, so they are not excess-dividend dividends.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 186 (franchise tax on gas and electric companies; excess dividends tax)
- People ex rel Adams Electric Light Co v Graves, 272 NY 77
- Central Hudson Gas & Electric Corporation, TSB-A-98(12)C (July 29, 1998)
- Rochester Gas and Electric Corporation, TSB-A-99(7)C (Jan. 27, 1999)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_1999.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a99_7c.pdf

Original ruling text

New York State Department of Taxation and Finance

Taxpayer Services Division
Technical Services Bureau

TSB-A-99(7)C
Corporation Tax
January 27, 1999

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C980922D

On September 22, 1998, a Petition for Advisory Opinion was received from Rochester Gas
and Electric Corporation, 89 East Avenue, Rochester, New York 14649.
The issue raised by Petitioner, Rochester Gas and Electric Corporation, is whether either of
the transactions enumerated below, transacted subsequent to purchase of Holding Company stock
in the open market, will be treated as a dividend subject to tax on excess dividends ("Excess
Dividends Tax") under section 186 of the Tax Law. The transactions are:
Transaction 1. Petitioner distributes the Holding Company stock to Holding
Company.
Transaction 2. Petitioner transfers the Holding Company stock to Holding
Company in exchange for Petitioner's stock held by Holding Company.
Petitioner submits the following facts as the basis for this Advisory Opinion.
Petitioner is a regulated public utility incorporated in New York State that supplies utility
services in western New York. Its principal offices are located in Rochester, New York and its
common stock is publicly traded. In 1998, Petitioner commenced a stock repurchase program
pursuant to which it has repurchased and will continue to repurchase its common stock on the open
market, subject to PSC approval and market conditions.
Under a proposed reorganization that is expected to take effect in the spring of 1999,
Petitioner will become a subsidiary of Holding Company ("Holding Company"). Pursuant to the
proposed reorganization, the following steps will occur:
1. Petitioner will create Holding Company as a first tier, wholly owned subsidiary.1
2. In accordance with a plan of share exchange adopted pursuant to section 913 of the
Business Corporation Law, each share of Petitioner's common stock immediately

1

Simultaneously with or shortly before the binding share exchange, it is expected that
Petitioner will contribute the stock of certain unregulated subsidiaries to Holding Company so
that after the binding share exchange such companies will be first tier subsidiaries of Holding
Company.

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prior to the effective time of the reorganization will be exchanged for one share of
Holding Company common stock.
3. As a result of the binding share exchange, Holding Company will own 100
percent of Petitioner's common stock. The current preferred shareholders of
Petitioner will remain preferred shareholders of Petitioner after the exchange.
After the binding share exchange, Holding Company will become a publicly traded company and
will be subject to taxation under Article 9-A of the Tax Law. Petitioner states that before and after
the reorganization, it will be taxed under section 186 of the Tax Law.
Petitioner is engaging in the proposed reorganization in response to the Public Service
Commission's ("PSC") direction to restructure the electric utility industry in New York State. In
1994, the PSC commenced hearings to explore restructuring the electric utility industry to encourage
competition and permit customers to choose their electricity providers. In PSC Opinion and Order
Regarding Competitive Opportunities for Electric Service, Opinion No. 96-12, issued May 20, 1996,
the PSC enunciated its desire to bring New York consumers the innovations and efficiencies of
competitive markets, together with economic development, lower electric prices and greater
consumer choice, while, at the same time, maintaining the safety and reliability of electric service.
In furtherance of this stated goal, the PSC required Petitioner, along with other utilities, to file plans
to create a competitive electricity market in New York State.
In response to Opinion No. 96-12, Petitioner submitted its plan on October 1, 1996, and the
PSC instituted Case 96-E-0898 for the purpose of examining Petitioner's submission. The initial
Settlement Agreement was filed on April 8, 1997, and after revisions, an Amended and Restated
Settlement Agreement ("Revised Settlement") was reached on October 23, 1997 by Petitioner PSC
staff, Multiple Intervenors, Joint supporters, and the National Association of Energy Service
Companies. The Revised Settlement was revised by the PSC's Opinion and Order Adopting Terms
of Settlement Subject to Conditions and Changes, Opinion No. 98-1 ("Order"), issued and effective
January 14, 1998. On July 30, 1998, Petitioner submitted to the PSC its Petition to Form a Holding
Company and for Certain Related Transactions.
In response to the Order, and subject to PSC approval of its July 30, 1998 submission,
Petitioner will establish a holding company structure under which one regulated and one or more
unregulated companies may operate. The holding company structure is responsive to the PSC's
directive to promote competition in the utility industry, while at the same time protecting Petitioner's
customers and the regulated businesses from the risks inherent in operating competitive businesses.
This is accomplished by establishing Petitioner, which will operate the regulated businesses, as a
direct subsidiary of Holding Company. Current and future unregulated businesses will operate in

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companies that are subsidiaries of Holding Company. This corporate structure will protect the
regulated businesses from the risks inherent in the Holding Company's competitive businesses.
Subsequent to the formation of Holding Company, Petitioner plans to continue its
commitment to carry out the stock repurchase program that it announced prior to the formation of
the Holding Company. The repurchase program will be carried out by Petitioner directly purchasing
the publicly traded common stock of Holding Company, its parent corporation, on the open market,
subject to PSC approval and market conditions. Under the program, Petitioner expects to repurchase
up to 4.5 million shares of publicly traded common stock during the period 1998 through 2000.
Immediately after repurchasing the Holding Company stock, one of three possible scenarios
may occur:
1. Petitioner will distribute the Holding Company stock to Holding Company;
2. Petitioner will transfer the Holding Company stock to Holding Company in
exchange for Petitioner's stock held by Holding Company; or
3. Petitioner will hold on to the repurchased Holding Company stock.
Discussion
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 Central Hudson Gas & Electric Corporation, Adv Op Comm T&F, July 29, 1998, TSB-A­
98(12)C, several questions pertaining to the tax ramifications resulting from petitioner's corporate

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restructuring under the PSC's Competitive Opportunities Proceeding were addressed. One of the
holdings in that opinion stated that "Petitioner's distribution to Holdco, directly after the Share
Exchange, of all of the common stock of the corporations included in the Existing Subsidiaries
Spin-Off and any Genco Spin-Off, is part of the series of transactions being entered into by
Petitioner as mandated by the PSC pursuant to the Competitive Opportunities Proceeding and the
PSC's policy objectives set forth in the Order (Opinion No. 96-12), and implemented under the
restructuring plan described in the Restated Settlement Agreement dated January 2, 1998 and
modified February 26, 1998, whereby Petitioner is reorganized into the holding company structure.
It does not represent a distribution of the profits of Petitioner. Accordingly, these restructuring
distributions are not treated as dividends subject to the Excess Dividends Tax under section 186 of
the Tax Law." The opinion held further that the answer would not change if petitioner invests up
to $100 million of equity in the Existing Subsidiaries prior to the Share Exchange and the Existing
Subsidiaries Spin-0ff.
In this case, with respect to Transaction 1, the distribution of the Holding Company stock
to Holding Company, for no consideration, subsequent to Petitioner's purchase of the Holding
Company stock in the open market through its stock repurchase program, would be made outside
the context of the series of transactions being entered into by Petitioner as mandated by the PSC
pursuant to the Competitive Opportunities Proceeding and the PSC's policy objectives set forth in
PSC Opinion No. 96-12, and implemented under the restructuring plan described in the Revised
Settlement dated October 23, 1997, revised by the PSC's Opinion and Order Adopting Terms of
Settlement Subject to Conditions and Changes, Opinion No. 98-1 ("Order"), issued and effective
January 14, 1998. Accordingly, pursuant to Adams Electric, supra, such distribution to Holding
Company would constitute a dividend subject to the Excess Dividends Tax under section 186 of the
Tax Law. The dividend would equal the fair market value of the Holding Company stock
determined using generally accepted accounting principles.
With respect to Transaction 2, the distribution of the Holding Company stock to Holding
Company in exchange for Petitioner's stock that is held by Holding Company, would also be a
transaction made outside the context of the series of transactions being entered into by Petitioner as
mandated by the PSC pursuant to the Competitive Opportunities Proceeding and the PSC's policy
objectives set forth in PSC Opinion No. 96-12, and implemented under the restructuring plan
described in the Revised Settlement dated October 23, 1997, revised by the PSC's Opinion and Order
Adopting Terms of Settlement Subject to Conditions and Changes, Opinion No. 98-1 ("Order"),
issued and effective January 14, 1998. If the fair market value of the Holding Company stock
distributed equals the fair market value of Petitioner's stock received in exchange, such distribution
of stock to Holding Company would not constitute a dividend subject to the Excess Dividends Tax
under section 186 of the Tax Law. For purposes of the previous sentence, fair market value is
determined using generally accepted accounting principles. However, if the fair market value of the
Holding Company stock distributed to the Holding Company exceeds the fair market value of

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Petitioner's stock received by Petitioner in exchange, the difference in value would constitute a
dividend, pursuant to Adams Electric, supra, that is subject to the Excess Dividends Tax under
section 186 of the Tax Law.

DATED: January 27, 1999

NOTE:

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

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