The Code of Federal Regulations of the United States of America

or otherwise. Where a corporation having two types of common stock outstanding, with respect to which dividends may be paid in stock on one type and in money (or other property) on the other type, makes a distribution (or series of related distributions) in money (or other property) as to one type and in stock (or rights to acquire stock) as to the other, the distribution of the stock is not under section 305 (a) since, in substance, there is a choice as to the medium of payment of any distribution by virtue of the existence of the two types of common stock, shares of either of which may be exchanged for shares of the other under section 1036 without recognition of gain or loss.

(2) The application of the above rules may be illustrated by the following examples:

Example (1). Pursuant to a recapitalization (to which section 368(a) (1) (E) upplies) all of the outstanding shares of common stock of corporation X are surrendered in exchange for Type A common stock and Type B common stock. Some shareholders choose to receive only Type A stock, some shareholders choose to receive only Type B stock, and some shareholders choose to receive some of each. Dividends may be paid in stock or in cash on either type of stock without regard to the medium of payment of dividends on the other type. A dividend is declared upon the Type A stock payable in additional shares of Type A stock and a dividend is declared on the Type B stock payable in cash. Section 305(a) does not apply to the stock distributed to the Type A shareholders.

Example (2). Pursuant to a recapitalization (to which section 368(a) (1) (E) applies) all of the outstanding shares of common stock of corporation Y are surrendered in exchange for Type A common stock and Type B common stock, every shareholder receiving one share of Type A stock and one share of Type B stock in exchange for each share of the common stock surrendered by him. Dividends may be paid in stock or in cash on either type of stock without regard to the medium of payment of dividends on the other type. After the recapitalization, and before any of the Type A or Type B stock has been transferred, a dividend is declared on the Type A stock payable in additional shares of Type A stock and a dividend is declared on the Type B stock payable in cash. Section 305 (a) does not apply to any of the stock distributed to the Type A shareholders. The same result would follow if, before the dividend declaration, some of the Type A or Type B stock had been transferred.

Example (3). (i) On January 1, 1969, pursuant to a reorganization to which section 368(a) (1) (B) applies, corporation N, which has only Type A common stock outstanding, acquires all of the outstanding stock of cor

poration M solely in exchange for its newly issued Type B voting common stock. Each Type B share may be converted, at the option of the holder, into Type A shares. During the first year following the reorganization, the conversion ratio is one share of Type A stock for each share of Type B stock. At the beginning of each subsequent year, the conversion ratio is increased by 0.04 shares of Type A stock for each share of Type B stock. Thus, during the second year the conversion ratio would be 1.04 shares of Type A stock for each share of Type B stock, during the third year the ratio would be 1.08 shares, etc. However, if the cash dividend paid on the Type A stock in any one year is less than $1 per share, then the increase in the conversion ratio that would otherwise occur at the beginning of the following year will be reduced by an amount which is proportionate to the amount by which such dividend falls short of the $1 per share.

(ii) During 1969, a $0.50 cash dividend per share is declared and paid on the Type A stock of corporation N. On January 1, 1970, when the conversion ratio is increased to 1.02 shares of Type A stock for each share of Type B stock, a distribution is considered as made with respect to each share of Type B stock of a right to acquire 0.02 share of Type A stock. Section 305(a) does not apply to the distribution of this right.

Example (4). (i) On January 1, 1969, pursuant to a reorganization to which section 368 (a) (1) (B) applies, corporation P, which has only Type A common stock outstanding, acquires all of the outstanding stock of corporation O solely in exchange for its newly issued Type B voting stock. Each Type B share is convertible, at the option of the holder, into one share of Type A stock. However, in accordance with a specified formula, this ratio is decreased each time a cash dividend is paid on the Type B stock to reflect the amount of the cash dividend. The conversion ratio is also adjusted in the event that cash dividends are paid on the Type A stock.

(ii) On December 31, 1969, a $1.00 cash dividend per share is declared and paid on the Type B stock of corporation P. On such date, when the conversion ratio is decreased date, when the conversion ratio is decreased, a distribution of stock is considered as made with respect to each share of Type A stock reflecting each such share's increased equity in P. Section 305(a) does not apply to this distribution.

(3) If any corporation having two or more types of common stock outstanding makes a distribution (or series of related distributions) in money (or other property) as to one type and in stock (or rights to acquire stock) as to the other, the provisions of this section shall not apply to a distribution made on or before

(1) December 31, 1968, or

(ii) December 31, 1990, if made with respect to stock outstanding on September 7, 1968, or with respect to stock issued pursuant to a contract binding on September 7, 1968, upon the distributing corporation (including stock distributed, directly or indirectly, with respect to stock outstanding on September 7, 1968, or with respect to stock so issued, if this section would have applied to the distribution but for the application of this subdivision).

(1)

(c) Amount of distribution. Where a distribution of stock or rights to acquire stock of a corporation is treated as a distribution of property to which section 301 applies by reason of section 305(b) (2), the amount of the distribution, in accordance with section 301(b) and § 1.301-1, is the fair market value of such stock or rights on the date of distribution. Accordingly, where a corporation makes a distribution, to which section 305(b) (2) is applicable, which is payable either in property or in its own stock or rights to acquire its stock the amount distributed with respect to all shareholders receiving stock or rights is the fair market value, on the date of distribution, of the stock or rights received. The amount distributed with respect to shareholders receiving property is the fair market value, on the date of distribution, of such property received or, in the case of corporate distributees, the adjusted basis of such property in the hands of the distributing corporation if less than its fair market value. Where a corporation which regularly distributes its earnings and profits, such as a regulated investment company, declares a dividend pursuant to which the shareholders may elect to receive either money or stock of the distributing corporation of equivalent value and, on a date shortly before the distribution, there is a determination of the amount of stock to be distributed to those shareholders who elect to receive stock equal in value to the amount of money that could be received instead, the amount of the distribution of the stock received by any shareholder will be considered to equal the amount of the money which could have been received instead.

(2) The application of section 305(b) may be illustrated by the following examples:

Example (1). (1) Corporation X declared a dividend payable in additional shares of its common stock to the holders of its outstanding common stock on the basis of two addi

tional shares for each share held on the record date but with the provision that, at the election of any shareholder made within a specified period prior to the distribution date, he may receive one additional share for each share held on the record date plus $12 principal amount of securities of Corporation Y owned by Corporation X. The fair market value of the stock of Corporation X on the distribution date was $10 per share. The fair market value of $12 principal amount of securities of Corporation Y on the distribution date was $11 but such securities had a cost basis to Corporation X of $9.

(ii) The distribution to all shareholders of one additional share of stock of Corporation X (with respect to which no election applies) for each share outstanding is not a distribution to which section 301 applies.

(iii) The distribution of the second share of stock of Corporation X to those shareholders who do not elect to receive securities of Corporation Y is a distribution of property to which section 301 applies,

whether such shareholders are individuals or corporations. The amount of the distribution to which section 301 applies is $10 per share of stock of Corporation X held on the record date (the fair market value of the stock of Corporation X on the distribution date).

(iv) The distribution of securities of Corporation Y in lieu of the second share of stock of Corporation X to the shareholders of Corporation X, whether individuals or corporations, who elect to receive such securities, is also a distribution of property to which section 301 applies.

(v) In the case of the individual shareholders of Corporation X who elect to receive such securities, the amount of the distribution to which section 301 applies is $11 per share of stock of Corporation X held on the record date (the fair market value of the $12 principal amount of securities of Corporation Y on the distribution date).

(vi) In the case of the corporate shareholders of Corporation X electing to receive such securities, the amount of the distribution to which section 301 applies is $9 per share of stock of Corporation X held on the record date (the basis of the securities of Corporation Y in the hands of Corporation X).

Example (2). On January 10, 1960, Corporation X, a regulated investment company, declared a dividend of $1 per share on its common stock payable on February 11, 1960, in cash or in stock of Corporation X of equivalent value determined as of January 22, 1960, at the election of the shareholder made on or before January 22, 1960. The amount of the distribution to which section 301 applies is $1 per share whether the shareholder elects to take cash or stock and whether the shareholder is an individual or a corporation. Such amount will also be used in determining the dividend paid deduction of Corporation X and the reduction

in earnings and profits of Corporation X. [T.D. 6500, 25 F.R. 11607, Nov. 26, 1960, as amended by T.D. 6990, 34 F.R. 502, Jan. 14, 1969; T.D. 7004, 34 F.R. 1896, Feb. 8, 1969] § 1.305-3 Distributions in discharge of preference dividends.

(a) A distribution made by a corporation to its shareholders in its stock or in rights to acquire its stock shall be treated as a distribution of property to which section 301 applies to the extent that the distribution is made in discharge of preference dividends for the taxable year of the corporation in which the distribution is made or for the preceding taxable year.

(b) (1) If, in the case of a corporation having two or more classes of outstanding stock, the terms of one class require, in all events, periodic distributions with respect to it of stock or rights to acquire stock, then the stock of such class is preferred stock. Such a distribution of stock or rights with respect to the preferred stock is a distribution made in discharge of preference dividends.

(2) The principles of subparagraph (1) of this paragraph may be illustrated by the following examples:

Example (1). On January 1, 1969, corporation X, a calendar year taxpayer, is organized. On such date, X has outstanding Class A and Class B stock. The terms of the Class B stock require that a distribution of one share of Class A stock be made annually with respect to each 20 shares of Class B stock. The Class A stock is not preferred as to dividends. During 1969, the required dividend in Class A shares is declared and paid on the Class B stock. The Class B stock is preferred stock, and the distribution of Class A shares is a distribution made in discharge of preference dividends for 1969.

Example (2). (i) On January 1, 1969, corporation Y, a calendar year taxpayer, is organized. On such date, Y has outstanding Class A and Class B stock. The Class A stock is not preferred as to dividends. The Class B stock may be converted, at the option of the holder, into Class A stock. During 1969, the conversion ratio is one share of Class A stock for each share of Class B stock. At the beginning of each subsequent year, the conversion ratio is increased by 0.05 shares of Class A stock for each share of Class B stock. Thus, during 1970 the conversion ratio would be 1.05 shares of Class A stock for each share of Class B stock, during 1971 the ratio would be 1.10 shares, etc.

(ii) On January 1, 1970, when the conversion ratio is increased to 1.05 shares of Class A stock for each share of Class B stock, a distribution is considered as made with respect to each share of Class B stock of a right to acquire 0.05 shares of Class A stock. The

Class B stock is preferred stock, and the distribution of rights on January 1, 1970, is a distribution made in discharge of preference dividends for 1970.

(3) An increase in the conversion ratio with respect to convertible stock shall not be considered as a distribution for purposes of subparagraph (1) of this paragraph if—

(i) Such increase is made solely to take account of a stock dividend or stock split with respect to the class of stock into which the convertible stock may be converted, or

(ii) (a) The increase occurs within 3 years after the issuance of such convertible stock,

(b) All such increases with respect to such stock must, under the terms of its issuance, occur within 3 years after its issuance, and

(c) Such stock was not acquired, directly or indirectly, in exchange for stock which qualified for the benefits of this subdivision.

(4) Subparagraph (1) of this paragraph shall not apply to a distribution with respect to stock transferred by the distributing corporation in exchange for the assets or stock of another corporation, provided that (i) such distribution represents an adjustment of the consideration transferred in the exchange, and (ii) all distributions reflecting such an adjustment must, under the terms of the exchange, be made within 5 years after the date of such exchange.

(5) Subparagraph (1) of this paragraph shall not apply to a distribution made on or before

(i) December 31, 1968, or

[T.D. 6990, 34 F.R. 503, Jan. 14, 1969, as amended by T.D. 7004, 34 F.R. 1896, Feb. 8, 1969]

§ 1.306 Statutory provisions; dispositions of certain stock.

SEC. 306. Dispositions of certain stock(a) General rule. If a shareholder sells or otherwise disposes of section 306 stock (as defined in subsection (c))—

(1) Dispositions other than redemptions. If such disposition is not a redemption (within the meaning of section 317 (b)) — (A) The amount realized shall be treated as gain from the sale of property which is not a capital asset. This subparagraph shall not apply to the extent that

(1) The amount realized, exceeds

(ii) Such stock's ratable share of the amount which would have been a dividend at the time of distribution if (in lieu of section 306 stock) the corporation had distributed money in an amount equal to the fair market value of the stock at the time of distribution.

(B) Any excess of the amount realized over the sum of

(1) The amount treated under subparagraph (A) as gain from the sale of property which is not a capital asset, plus

(11) The adjusted basis of the stock, shall be treated as gain from the sale of such stock.

(2) Redemption. If the disposition is a redemption, the amount realized shall be treated as a distribution of property to which section 301 applies.

(b) Exceptions. Subsection (a) shall not apply

(1) Termination of shareholder's interest (A) Not in redemption. If the disposition

(1) Is not a redemption;

(ii) Is not, directly or indirectly, to a person the ownership of whose stock would (under section 318 (a)) be attributable to the shareholder; and

(iii) Terminates the entire stock interest of the shareholder in the corporation (and for purposes of this clause, section 318 (a) shall apply).

(B) In redemption. If the disposition is a redemption and section 302 (b) (3) applies. (2) Liquidations. If the section 306 stock is redeemed in a distribution in partial or complete liquidation to which part II (sec. 331 and following) applies.

(3) Where gain or loss is not recognized. To the extent that, under any provision of this subtitle, gain or loss to the shareholder is not recognized with respect to the disposition of the section 306 stock.

(4) Transactions not in avoidance. If it is established to the satisfaction of the Secretary or his delegate

(A) That the distribution, and the disposition or redemption, or

(B) In the case of a prior or simultaneous disposition (or redemption) of the stock with respect to which the section 306 stock disposed of (or redeemed) was issued, that the disposition (or redemption) of the section 306 stock,

was not in pursuance of a plan having as one of its principal purposes the avoidance of Federal income tax.

(c) Section 306 stock defined—(1) In general. For purposes of this subchapter, the term "section 306 stock" means stock which

meets the requirements of subparagraph (A), (B), or (C) of this paragraph.

(A) Distributed to seller. Stock (other than common stock issued with respect to common stock) which was distributed to the shareholder selling or otherwise disposing of such stock if, by reason of section 305 (a), any part of such distribution was not includible in the gross income of the shareholder.

(B) Received in a corporate reorganization or separation. Stock which is not common stock and

(1) Which was received, by the shareholder selling or otherwise disposing of such stock, in pursuance of a plan of reorganization (within the meaning of section 368 (a)), or in a distribution or exchange to which section 355 (or so much of section 356 as relates to section 355) applied, and

(ii) With respect to the receipt of which gain or loss to the shareholder was to any extent not recognized by reason of part III, but only to the extent that either the effect of the transaction was substantially the same as the receipt of a stock dividend, or the stock was received in exchange for section 306 stock.

For purposes of this section, a receipt of stock to which the foregoing provisions of this subparagraph apply shall be treated as a distribution of stock.

(C) Stock having transferred or substituted basis. Except as otherwise provided in subparagraph (B), stock the basis of which (in the hands of the shareholder selling or otherwise disposing of such stock) is determined by reference to the basis (in the hands of such shareholder or any other person) of section 306 stock.

(2) Exception where no earnings and profits. For purposes of this section, the term "section 306 stock" does not include any stock no part of the distribution of which would have been a dividend at the time of the distribution if money had been distributed in lieu of the stock.

(d) Stock rights. For purposes of this section

(1) Stock rights shall be treated as stock, and

(2) Stock acquired through the exercise of stock rights shall be treated as stock distributed at the time of the distribution of the stock rights, to the extent of the fair market value of such rights at the time of the distribution.

(e) Convertible stock. For purposes of subsection (c)

(1) If section 306 stock was issued with respect to common stock and later such section 306 stock is exchanged for common stock in the same corporation (whether or not such exchange is pursuant to a conversion privilege contained in the section 306 stock), then (except as provided in paragraph (2)) the common stock so received shall not be treated as section 306 stock; and

(2) Common stock with respect to which there is a privilege of converting into stock

other than common stock (or into property), whether or not the conversion privilege is contained in such stock, shall not be treated as common stock.

(f) Source of gain. The amount treated under subsection (a) (1) (A) as gain from the sale of property which is not a capital asset shall, for purposes of part I of subchapter N (sec. 861 and following, relating to determination of sources of income), be treated as derived from the same source as would have been the source if money had been received from the corporation as a dividend at the time of the distribution of such stock. If under the preceding sentence such amount is determined to be derived from sources within the United States, such amount shall be considered to be fixed or determinable annual or periodical gains, profits, and income within the meaning of section 871 (a) or section 881 (a), as the case may be.

(g) Change in terms and conditions of stock. If a substantial change is made in the terms and conditions of any stock, then, for purposes of this section

(1) The fair market value of such stock shall be the fair market value at the time of the distribution or at the time of such change, whichever such value is higher;

(2) Such stock's ratable share of the amount which would have been a dividend if money had been distributed in lieu of stock shall be determined as of the time of distribution or as of the time of such change, whichever such ratable share is higher; and (3) Subsection (c) (2) shall not apply unless the stock meets the requirements of such subsection both at the time of such distribution and at the time of such change. (h) Stock received in distributions and reorganizations to which 1939 Code applied. If stock

(1) Was received in a distribution or reorganization to which the Internal Revenue Code of 1939 (or the corresponding provisions of prior law) applied,

(2) Such stock would have been section 306 stock if this Code applied to such distribution or reorganization, and

(3) Such stock is disposed of or redeemed on or after June 22, 1954,

then the foregoing subsections of this section shall not apply in respect of such disposition or redemption. The extent to which such disposition or redemption shall be treated as a dividend shall be determined as if the Internal Revenue Code of 1939 (as modified by the provisions of this Code other than the foregoing subsections of this section) continued to apply in respect of such disposition or redemption.

§ 1.306-1 General.

(a) Section 306 provides, in general, that the proceeds from the sale or redemption of certain stock (referred to as "section 306 stock") shall be treated either as gain from the sale of property

which is not a capital asset, or as a distribution of property to which section 301 applies. Section 306 stock is defined in section 306 (c) and is usually preferred stock received either as a nontaxable dividend or in a transaction in which no gain or loss is recognized. Section 306 (b) lists certain circumstances in which the special rules of section 306(a) shall not apply.

(b) (1) If a shareholder sells or otherwise disposes of section 306 stock (other than by redemption or within the exceptions listed in section 306 (b)), the entire proceeds received from such disposition shall be treated as gain from the sale of property not a capital asset to the extent that the fair market value of the stock sold, on the date distributed to the shareholder, would have been a dividend to such shareholder had the distributing corporation distributed cash in lieu of stock. Any excess of the amount received over the sum of the amount treated as ordinary income plus the adjusted basis of the stock disposed of, shall be treated as gain from the sale of a capital asset or noncapital asset as the case may be. No loss shall be recognized. While the amount of earnings and profits at the time of the distribution is one of the measures of the amount to be treated as ordinary income, no reduction of earnings and profits results from any disposition of stock other than a redemption. The term "disposition" under section 306 (a) (1) includes, among other things, pledges of stock under certain circumstances, particularly where the pledgee can look only to the stock itself as its security.

(2) Section 306 (a) (1) may be illustrated by the following examples:

Example (1). On December 15, 1954, A and B owned equally all of the stock of Corporation X which files its income tax return on a calendar year basis. On that date Corporation X distributed pro rata 100 shares of preferred stock as a dividend on its outstanding common stock. On December 15, 1954, the preferred stock had a fair market value of $10,000. On December 31. 1954, the earnings and profits of Corporation X were $20,000. The 50 shares of preferred stock so distributed to A had an allocated basis to him of $10 per share or a total of $500 for the 50 shares. Such shares had a fair market value of $5,000 when issued. A sold the 50 shares of preferred stock on July 1, 1955, for $6,000. Of this amount $5,000 will be treated as gain from the sale of property which is not a capital asset; $500 ($6,000 minus $5,500) will be treated as gain from

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