US Inbound: Obama Budget proposals: Tax corporate distributions as dividends
We discussed some of the new Obama Budget proposals last month. The Budget also has a category of proposed changes entitled 'tax corporate distributions as dividends'. These proposals are not targeted solely at international transactions, but can be important internationally. We will discuss two. Unless or until these proposals become law, they may present planning opportunities. One of these proposals focuses on a planning opportunity to permit corporate distributions to be tax-free to the company's shareholders. The plan involves having the corporation distribute stock in a subsidiary or subsidiaries having a high basis but minimal value. The goal is to reduce earnings and profits before making a large distribution to shareholders in the subsequent tax year.
Assume, for example, a foreign-owned US corporation (P) owns all of the common and preferred stock of a US subsidiary (S). P has $1 billion in accumulated earnings and profits. The preferred stock has a value of $10 million, but a basis of $1 billion because of previous dividend-equivalent redemptions in which P received $990 million in cash. Under current law, if an actual or deemed redemption of stock is treated as equivalent to a dividend, the shareholder's basis in any remaining shares of the corporation is increased by the shareholder's basis in the redeemed stock. Thus, the remaining preferred stock has a high basis, even though it has a low value.
If P distributes its $10 million of S preferred stock to its foreign shareholder, P would permanently eliminate any earnings and profits equal to the adjusted basis of the distributed stock ($1 billion). In the following year, P could distribute its accumulated cash of $990 million to its foreign shareholder and avoid dividend characterisation, and any resulting US withholding tax.
Under the Obama Budget proposal, a corporation's distribution of stock of another corporation would reduce the distributing corporation's earnings and profits by the greater of the stock's fair market value or the corporation's basis in the stock. For this purpose, the distributing corporation's basis in the distributed stock would be determined without regard to any adjustments as a result of actual or deemed dividend-equivalent redemptions by S and without regard to any other distributions or transactions undertaken with the view to create and distribute high-basis S stock.
The second of the Obama dividend proposals addresses another avenue through which the earnings and profits of a US corporation may be distributed to its foreign shareholders without being characterised as a dividend. In this case, the cash-rich corporation with earnings and profits funds a second, related corporation that does not have earnings and profits. Funding transactions could include capital contributions, loans, or distributions to the distributing corporation.
Under the proposal, to the extent the funding corporation has funded the other corporation with a principal purpose of avoiding dividend treatment, the amount would be treated as a dividend from the funding corporation.
Jim Fuller (firstname.lastname@example.org) and David Forst (email@example.com)
Fenwick & West
Tel: +1 650 335 7205; +1 650 335 7274