Preferred shares treated as common stock for consolidated adjustments

Plain-English summary

A publicly traded parent requested rulings about investment adjustments for stock of a subsidiary held within its consolidated group. The subsidiary had four stock types with different voting rights, and two types had liquidation preferences, but all shares participated equally in dividends and the preferred shares could convert into the other types. The IRS ruled that the two preferred types constituted common stock under the consolidated return regulations. It also allowed the parent to allocate negative remaining adjustments equally among all subsidiary shares while the subsidiary's value remained above the combined liquidation preferences. The rulings applied only to the subsidiary's represented capital structure as of the specified date.

Ruling snapshot

• Question: Did two classes with liquidation preferences qualify as common stock, and could negative remaining adjustments be allocated equally among all shares?
• Outcome: Approved, subject to the represented value and capital-structure conditions.
• Key authorities: Treas. Reg. § 1.1502-32(c)(1)(iii) and (d)(3).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201641019 Third Party Communication: None
Release Date: 10/7/2016 Date of Communication: Not Applicable
Index Number: 1502.32-00
Person To Contact:
----------------------------- -----------------, ID No. ------------------
----------------------------------------- Telephone Number:
------------------------ --------------------
----------------------------------------- Refer Reply To:
----------------------- CC:CORP:2
---------------------------------- PLR-127305-15
Date:
July 05, 2016

Legend

Corp = ---------------------------

Sub 1 = ---------------------

Sub 2 = --------------------------------

Third Party = ------------------------------------

Employees = --------------------------------------------------------------------------------

------------------------------------------------------------------------------------------------------------------

State A = ---------------------

State B = -------------

a = ------

b = ------

PLR-127305-15 2

c = ----

d = ----

e = ----

f = ---------------

g = ----

h = --

i = ----

j = ------

k = --------

l = ------

Type 1 = --------------------------------

Type 2 = ----------------------------------

Type 3 = ----------------------------------

Type 4 = --------------------------------

Date 1 = -----------------------

Date 2 = -------------------

Dear --------------:

This letter responds to your August 14, 2015 letter requesting a ruling on certain federal
income tax consequences under the consolidated return regulations. The material
information provided in that letter and in later correspondence is summarized below.

The rulings contained in this letter are based upon information submitted by the
taxpayer and accompanied by a penalties of perjury statement executed by an
appropriate party. While this office has not verified any of the material submitted in
support of the request for rulings, it is subject to verification on examination.

Summary of Facts

PLR-127305-15 3

Corp is a State A corporation, the stock of which is publicly traded. Corp is the common
parent of an affiliated group of corporations that join in filing a consolidated income tax
return (the “Corp Consolidated Group”). The Corp Consolidated Group includes Sub 1
and Sub 2, as explained below.

Sub 1 is a direct subsidiary of Corp. As of Date 1, Corp owned stock representing
approximately a percent of the value and b percent of the voting power of the
outstanding stock of Sub 1. The remaining stock of Sub 1 is publicly traded.

As of Date 1, Corp and Sub 1 owned approximately c and d percent of the outstanding
shares of Sub 2, respectively. Corp owned Type 1 and Type 2 stock in Sub 2. Sub 1
only owned Type 2 stock in Sub 2. Third Party owned approximately e percent of the
outstanding shares of Sub 2 consisting of Type 3 stock, and Employees owned
approximately f percent of the outstanding shares of Sub 2, consisting of Type 4 stock
(together Type 1, Type 2, Type 3, and Type 4, the “Sub 2 stock”).

The Sub 2 stock is identical in all respects except that Type 1 and Type 2 are entitled to
g votes per share and Type 3 and Type 4 are entitled to h votes per share. The Sub 2
stock votes together as a single class in connection with the election of directors and all
other matters submitted to shareholder vote. Additionally, the Sub 2 stock participates
equally in dividends and other corporate distributions, i.e. each share of Sub 2 stock
receives dividends and other distributions equally on a per-share basis.

Type 2 and Type 3 stock have liquidation preferences that entitle their respective
shareholders to receive their original investment upon liquidation. The liquidation
preference of Type 3 stock is subordinate to Type 2 stock. Thus, payment is made on
Type 3 stock only after Type 2 stock is fully paid upon liquidation. However, liquidation
of Sub 2 requires an affirmative vote of i percent of the Type 2 and Type 3 shareholders
voting together as a separate class. After payment is made on the Type 2 and Type 3
stock, Type 1 and Type 4 stock will receive the remaining assets of Sub 2 on a pro-rata
basis. Type 2 and Type 3 shareholders could always receive a proportionate share of
the Sub 2 assets along with the Type 1 and Type 4 shareholders because 1) Type 2
and Type 3 shareholders have the right to convert their stock into Type 4 and Type 1
stock, respectively, and 2) Type 2 and Type 3 shareholders must approve a plan of
liquidation.

For purposes of complying with regulations related to deferred compensation under
section 409A, Sub 2 hires an independent accounting firm to value its stock on a
quarterly basis. The Sub 2 stock has never fallen below its original issue price and, as
of Date 2, the value of a single share of Sub 2 is $j, which is approximately k% over its
original issue price of $l.

PLR-127305-15 4

Rulings

1. Sub 2’sType 2 and Type 3 stock constitute common stock under Treas. Reg.
   § 1.1502-32(d)(3).

2. Assuming that the value of Sub 2 (as reflected in the aggregate value of all its
   stock) remains above the combined amount of the Type 2 and Type 3 liquidation
   preferences, Corp may allocate any negative remaining adjustment (as defined in
   Treas. Reg. § 1.1502-32(c)(1)(iii)) equally among all shares of Sub 2 stock.

Caveats

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. Specifically, the rulings in this letter are limited to Sub 2’s capital structure as
of Date 1. No opinion is expressed concerning the tax consequences of any
subsequent change to Sub 2’s capital structure.

Procedural Statements

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

Sincerely,

Gerald B. Fleming
Senior Technician Reviewer, Branch 2
Office of Associate Chief Counsel (Corporate)