Paul L. Caron

Monday, July 14, 2014

Hariton: Should Share Repurchases Be Dividends to Remaining Holders?

Tax Analysys Logo (2013)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.

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What percentage of share repurchases are done to boost stock price (in lieu of dividend) and what percentage were done to facilitate executive comp. (no immediate return for shareholders)? Does it matter?

Posted by: HTA | Jul 14, 2014 11:19:09 AM

This would pretty much stop corporate buy back programs. How is a person suppose to pay the tax if they receive nothing (i.e the practical implications that arise from PHANTOM INCOME).

Posted by: George | Jul 15, 2014 8:55:11 AM

Do my eyes deceive me? Is Mr. Hariton really thinking that "Under current law, holders of common stock pay less tax than holders of debt…"? What rock does he live under? Everyone knows, or should know, that dividends are paid out of after-tax corporate income. Thus shareholders are paying tax for the second time. It would be far more equitable to either allow dividends to be deductions for the corporation or make them non-taxable to the recipients. Something is askew in Hariton's perspective.

Posted by: Paul Miller | Jul 15, 2014 12:17:32 PM