Rev. Rul. 75-512: Meaningful reduction

Citations: Rev. Rul. 75-512; 1975-2 C.B. 112

Rev. Rul. 75-512

Advice has been requested whether, under the circumstances described below, a redemption of stock was a redemption which was not essentially equivalent to a dividend under section 302(b)(1) of the Internal Revenue Code of 1954.

Corporation X had outstanding one class of stock consisting of 1,000 shares of common stock which were held as follows:

     Shareholders               Shares

          A                        625

          B                         75

          C                         75

          D                         75

          E                         75

        Trust                     75

                                 -----

            Total              1,000

A controls and manages the affairs of X. A and B are the grandparents of C, D, and E. The primary beneficiary of the trust is the father of C, D, and E and the son-in-law of A and B. C, D, and E are equal remaindermen of the trust and the actuarial interest of each in the trust is more than 5 percent. Therefore, the common stock held by C, D, and E was attributable to the trust under section 318(a)(3)(B) of the Code. Under section 318(a) grandchildren are not considered as owning the stock owned by their grandparents.

X redeemed for cash all 75 of its shares of common stock held by the trust. Prior to the redemption, the trust owned, directly and indirectly, 300 shares or 30 percent of the stock of X. After the redemption, the trust's ownership of the common stock decreased to 225 shares or 24.3 percent of the stock of X. The percentage of stock owned by the trust after the redemption was 81 percent of the percentage of stock owned by the trust prior to the redemption.

The redemption was not a termination of interest under section 302(b)(3) of the Code because the trust continued to own, through the application of section 318(a)(3)(B), the common stock held by C, D, and E. Further, the redemption did not qualify as a substantially disproportionate redemption under section 302(b)(2) because the percentage of shares held, directly and indirectly, by the trust after the redemption was more than 80 percent of the percentage of shares held by the trust prior to the redemption.

In the case of United States v. Davis, 397 U.S. 301 (1970), rehearing denied, 397 U.S. 1071 (1970), 1970-1 C.B. 62, the Supreme Court of the United States held that in order to qualify under section 302(b)(1) of the Code a redemption must result in a meaningful reduction of the shareholder's proportionate interest in the corporation, and for purposes of this determination, the attribution rules of section 318(a) apply.

Rev. Rul. 75-502, page 111, this Bulletin, indicates factors to be considered in determining whether a reduction in a shareholder's proportionate interest in a corporation results in a meaningful reduction within the meaning of Davis. The factors considered relate to a shareholder's right to vote and exercise control, a shareholder's right to participate in current earnings and accumulated surplus, and a shareholder's right to share in net assets on liquidation.

In the instant case, the trust was a minority shareholder and took no part in the management of X. As a result of the redemption, the trust experienced a reduction of its voting rights, its right to participate in current earnings and accumulated surplus, and its right to share in net assets on liquidation. Thus, under the facts and circumstances of the instant case, the redemption constituted a meaningful reduction of the trust's interest in X within the meaning of Davis.

Accordingly, the redemption was not essentially equivalent to a dividend within the meaning of section 302(b)(1) of the Code, and, therefore, qualified as an exchange under section 302(a).

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