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April 16, 1990
TO: CLOSED-END FUND MEMBERS NO. 15-90
TAX MEMBERS NO. 16-90
ACCOUNTING/TREASURERS MEMBERS NO. 12-90
RE: IRS REVENUE RULING TREATING "DUTCH-AUCTION RATE"
PREFERRED STOCK AS EQUITY
__________________________________________________________
The attached IRS revenue ruling holds that certain dutch-
auction rate preferred stock is treated as equity for tax
purposes and that a corporation holding this preferred stock can
treat dividends received with respect to such stock as qualifying
for the Code section 243 dividends received deduction.
The purchase of the dutch-auction rate preferred stock
involved in the ruling is conditioned upon the purchaser agreeing
to sell the shares only through a "dutch auction" proceeding.
The dividend rate on the shares is reset by "dutch auction" every
49 days. Prior to each auction, holders of preferred stock elect
to either (i) continue to hold shares at whatever rate is set for
the next dividend, (ii) place a bid order to hold shares,
provided the applicable rate for the next dividend period is not
below the rate specified in the bid, or (iii) place an order to
sell shares regardless of the applicable rate. No guarantees
(either express or implied) are made that any holder of the
preferred shares will be able to sell its shares in the auction.
The revenue ruling states that the question of whether
dutch-auction rate preferred stock is debt or equity depends on
the facts and circumstances of each case. In this case, the
dutch-auction rate preferred stock is treated as equity because
(i) shareholders have no right to receive a sum certain either on
demand or on a specified date, (ii) at liquidation or in
bankruptcy, the shareholders' rights are subordinate to the
claims of the corporation's creditors, (iii) the corporation may
redeem the stock, but the shareholder cannot compel redemption,
(iv) the corporation has not guaranteed or otherwise arranged to
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ensure that the shareholders can sell their preferred stock in an
auction, and (v) the shareholders' receipt of dividends is
dependent upon dividends being declared by the corporation and
paid out of legally available funds.
The ruling further concludes that, because the preferred
shareholders do not have either an option to sell shares, or
rights equivalent to an option to sell shares, a corporation
receiving a dividend distribution with respect to the preferred
stock will not be precluded by the dutch-auction mechanism from
claiming a dividends received deduction under Code section 243.
Finally, the ruling provides relief with respect to any
dutch-auction rate preferred stock issued before March 15, 1990,
whereby the IRS will not seek to (i) recharacterize the stock as
debt, or (ii) apply the holding period limitations to treat
shareholders as ineligible for the dividends received deduction.
However, the holding period limitations will apply if an
agreement or other arrangement exists that effectively guarantees
that a shareholder can sell its preferred stock.
We will keep you informed of developments.
Keith D. Lawson
Assistant General Counsel
Attachment
KDL:bmb