Monday, July 14, 2014
David P. Hariton (Sullivan & Cromwell, New York), Should Share Repurchases Be Dividends to Remaining Holders?, 144 Tax Notes 175 (July 14, 2014):
Under current law, holders of common stock pay less tax than holders of debt, and arguably less tax than might be deemed desirable from a utilitarian perspective. The most frequently proposed solution is to require investors to mark publicly traded stocks to market and pay current tax on their associated gains. But there is a more modest alternative that might present fewer problems and better target the simple objective of ensuring that most shareholders pay at least some amount of tax.
Much of the tax that would otherwise be imposed on shareholders is effectively avoided under current law because corporations do not make taxable dividend distributions. Instead, they use their accumulated earnings to redeem outstanding shares. Those earnings effectively leave corporate solution to fund an increase in the remaining shareholders’ proportionate interests in the corporation. Yet the transaction does not subject those remaining shareholders to any dividend tax. Hariton suggests that those earnings might be deemed distributed pro rata to shareholders as taxable dividends. (Shareholders would then be deemed to use them to acquire more stock in the corporation and would therefore have a corresponding increase in stock basis.) This treatment would not be a great departure from current rules under section 305 or proscribed by constitutional concerns.