Executive Summary -

On April 12, 2016, the Internal Revenue Service (“IRS”) and Treasury Department issued long-awaited proposed regulations (REG-133673-15, RIN 1545-BN07) (the “Proposed Regulations”) regarding the constructive stock distribution rules of Section 305(c) of the Internal Revenue Code of 1986, as amended (the “Code”). The proposed rules clarify certain computational and timing issues associated with deemed distributions occurring under Section 305(c). The Proposed Regulations also provide guidance relating to the appropriate manner and timing of withholding on deemed distributions. Generally, the new rules should bring more certainty and uniformity to the treatment of common adjustments made to convertible debt instruments and similar securities.

Background -

Section 305 of the Code governs the tax consequences of stock dividends to shareholders of corporations (or any other entities treated as corporations for U.S. federal income tax purposes). The general rule under Section 305(a) is that a stock distribution made by a corporation is not includible in gross income of the recipient shareholder. This general rule, however, is subject to various exceptions set forth in Section 305(b). For example, Section 305(b)(1) provides that where a shareholder has a right to receive either money (or other nonstock property) or stock, then the distribution will be taxable even where the shareholder elects to receive stock. Perhaps the most commonly applicable (and potentially most complex) exception is found in Section 305(b)(2), which provides for the taxability of a stock distribution that is part of a series of distributions pursuant to which some shareholders receive property and other shareholders benefit from an increase in their proportionate interests in the assets or earnings of the corporation.