Section 304: Stock Redemptions Through Related Brother-Sister Corporations
How Section 304 Works:
- The redemption of a small number of shares out of a relatively large number of shares will be treated as a dividend
- The sale of these same shares to an unrelated party will likely generate capital gain treatment
- What about when the sale of shares by the shareholder are sold to a related party? This is what Section 304 deals with.
Section 304 Creates the Potential for Dividend Treatment
- Two types of Section 304 transactions exist:
- Brother-Sister Sales
- Parent-Subsidiary Sales
Requirements of Brother-Sister Sales
- Shareholder (or shareholders) of Issuer “I” sell shares to Acquirer “A” in exchange for cash or property
- Shareholder(s) must be in control of both “I” and “A”
- Control is defined as owning 50% or more by vote or value (Section 304(c))
- For purpose of control, the attribution rules apply
- In terms of attribution rules, the 50% corporation-shareholder test is reduced to 5%
Section 304 Example of a Redemption through Related Corporations
- John owns two corporations: ABC and DEF
- John decides to sell 20% of ABC to DEF in exchange for $300,000
- On the surface, this looks like a sale or exchange
- But in reality, Chris still indirectly owns everything… he owns both corporations, whether or not DEF now owns 20% of ABC
- It’s pretty clear that the $300,000 will be treated as a dividend in this situation
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