Qualified Intermediary News Issue 2016-03

DEEMED DISTRIBUTIONS OF STOCK AND RIGHTS TO ACQUIRE STOCK

On April 12, 2016, Treasury and the IRS issued proposed regulations regarding deemed distributions of stock and rights to acquire stock (REG-133673-15). The proposed regulations will affect corporations issuing rights to acquire stock, their shareholders and holders of rights, and withholding agents with respect to deemed distributions. The regulations are intended to:

Resolve ambiguities concerning the amount and timing of deemed distributions that are or result from adjustments to rights to acquire stock. Provide additional guidance to withholding agents regarding their withholding and reporting obligations under chapters 3 and 4 with respect to deemed distributions. BACKGROUND

The regulations under Section 305 govern actual and deemed distributions by a corporation of its own stock and rights to acquire its own stock. Specifically:

Section 305(a) provides the general rule that the receipt of these distributions is not included in the gross income of the recipient; Section 305(b) requires certain actual and deemed distributions of stock and stock rights to be treated as distributions of property to which the regulations under section 301 apply. Section 305(c) authorizes Treasury to prescribe regulations to treat changes in the conversion ratio of instruments convertible into stock and other events having similar effects as distributions to shareholders whose proportionate interests in the assets or earnings and profits of the corporation are increased by such events. Under current regulations, when a distribution of stock (including a right to acquire stock) is a distribution of property, the amount of the distribution is the fair market value, on the date of the distribution, of the stock or right to acquire stock that is distributed.

APPLICATION OF SECTION 305(B) AND (C) TO ADJUSTMENTS TO RIGHTS TO ACQUIRE STOCK

A corporation may issue rights to acquire its stock in a number of forms, including warrants, subscription rights, options, convertible instruments that give the holder a right to convert the instruments into shares of stock in the issuing corporation, and similar instruments. In any of these forms, rights to acquire stock may provide for applicable adjustments that grant deemed shareholders economic benefits that correspond to distributions of stock, cash, or other property made to actual shareholders. Similarly, rights to acquire stock may provide for adjustments to prevent actual shareholders' interests from being diluted as a result of distributions of stock, cash, or other property to deemed shareholders (that is, holders of rights to acquire stock). An applicable adjustment to a convertible instrument may consist of an increase in the number of shares of stock a holder would receive upon conversion. Similarly, an applicable adjustment to a warrant, subscription right, stock right, option, or similar right to acquire stock may consist of an increase in the number of shares the holder would receive upon exercise. In either situation, the...