17 June 2016 Corporate redemptions of voting common stock aren't acts of self-dealing, IRS rules In two separate private letter rulings (201624001; 201624013) involving the same parties, the IRS has ruled that two proposed corporate stock redemptions will not constitute acts of self-dealing under Section 4941. DISC, a domestic international sales corporation, and Company are both closely held corporations owned by members of the same family and various related entities. A private foundation (Foundation) described in Sections 501(c)(3) and 509(a) is a shareholder of both DISC and Company. The shareholders of the two entities are identical, except that Company is also a shareholder of DISC. Company has two classes of stock — voting common stock and nonvoting common stock. DISC has one class of voting common stock. The shareholders of DISC entered into a shareholder agreement requiring that any transfer of Company's stock must be accompanied by a transfer of an equal amount of DISC's stock. A shareholder that participates in a redemption with Company must then also participate in a redemption with DISC. Company and DISC are both disqualified persons with respect to Foundation, which holds nonvoting common stock in Company and voting common stock in DISC. The boards of directors of DISC and Company authorized redemptions involving Company's nonvoting common stock and DISC's voting common stock. Pursuant to the shareholder agreement, Foundation will participate in both the redemption of Company stock and DISC stock. Foundation plans to participate in the redemption for various reasons, including obtaining cash to facilitate its charitable efforts. The redemption price in both redemptions will be equal to the fair market value of the stock at the redemption date, which will be determined by a competent, independent appraiser who is not a disqualified person with respect to the Foundation. The redemption price will be paid in cash. The proposed redemptions of the Company will be subject to a maximum aggregate redemption price, and if the total fair market value of the stock offered on the redemption date exceeds this pre-established price, the total number of shares redeemed from each participating shareholder will be adjusted so that the total redemption price will not exceed the pre-established maximum. In this situation, equivalent reductions would be made in the number of shares redeemed by DISC. It was represented that no shareholder would receive preferential treatment in any aspect of the redemptions. Section 4941 imposes an excise tax on each act of self-dealing between a private foundation and a disqualified person. A redemption transaction between a private foundation and a corporation that is a disqualified person is not considered an act of self-dealing if all of the securities of the same class as the class held by the private foundation are subject to the same terms, and those terms provide that the private foundation will receive at least fair market value. (Section 4941(d)(2)(F)). Reg. Section 53.4941(d)-3(d)(1) explains that under Section 4941(d)(2)(F) any transactions between a private foundation and a corporation that is a disqualified person will not be considered an act of self-dealing if: (1) the transaction is pursuant to a redemption; (2) all of the securities that are of the same class as the private foundation held prior to the transaction are subject to the same terms; and (3) those terms require that the private foundation receive no less than fair market value. The securities are deemed subject to the same terms if, before the transaction, the corporation makes a bona fide offer on a uniform basis to the private foundation and every other person who holds such securities. An example of evidence that an offer was not made on a uniform basis is if the private foundation receives property while all other persons holding securities of the same class receive cash. The IRS ruled that the proposed redemptions at issue will not be acts of self-dealing, based on the representations made by DISC and Company (both disqualified persons with respect to Foundation) that each class of stock is subject to the same terms which require that Foundation will receive no less than fair market value for its shares. The Company is redeeming nonvoting stock and DISC is redeeming voting stock. Further, the IRS notes that with respect to each class of common stock (the Foundation owned voting stock in DISC and nonvoting stock in the Company), DISC and Company will make bona fide offers on a uniform basis to all shareholders, including Foundation, and all participating shareholders will receive cash in exchange for their interests. Finally the IRS states that the fact that the redemption offer by the Company is limited to a fixed dollar amount, and the fact that the redemption offer by DISC is in tandem with the equivalent offer by the Company, "does not detract from the uniform nature of [their offers] under the facts presented." These two private letter rulings involve identical fact patterns under which the IRS was asked to rule separately on the potential self-dealing aspects of two transactions between a private foundation and two related organizations, in this case DISC and Company. These rulings provide instructive application of the longstanding "pursuant to" exception to self-dealing provided in Reg. Section 53.4941(d)-3(d)(1). In addition, the rulings demonstrate that the domestic international sales corporation entity form does not change the analysis. Furthermore, the fact that the redemption offer is in tandem with an equivalent offer by another related company does not detract from the uniform nature of the offer under the facts presented. Finally, the limitation of an offer under a fixed dollar amount is also not prohibitive as long as the private foundation receives no less than fair market value, which in this case is determined by an independent appraiser. A private letter ruling is a written statement issued to a particular taxpayer that interprets and applies tax laws to the taxpayer's specific, represented set of facts, and may not be used or cited as precedent by other taxpayers or by IRS personnel. Thus, although the rulings are instructive on how the IRS might view a corporation's redemption of a private foundation shareholder's stock, organizations are cautioned not to rely on the rulings as authority, but should consult with their tax advisors to determine the tax consequences of their own facts and circumstances. — For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg.
Document ID: 2016-1062 | |||||||||||||
