Question

Research Problem 2. Your client, White Corporation, has done well since its formation 20 years ago. This year, it recognized a $50 million capital gain from the sale of a subsidiary. White’s CEO has contacted you to discuss a proposed transaction to reduce the tax on the capital gain. Under the proposal, White will purchase all of the common stock in Purple Corporation for $200 million. Purple is a profitable corporation that has $63 million in cash and marketable securities, $137 million in operating assets, and approximately $280 million in E & P. After its acquisition, Purple will distribute $50 million in cash and marketable securities to White. Due to the 100% dividends received deduction, no taxable income results to White from the dividend. White will then resell Purple for $150 million. The subsequent sale of Purple generates a $50 million capital loss [$200 million (stock basis) – $150 million (sales price)]. The loss from the stock sale can then be used to offset the preexisting $50 million capital gain. Will the proposed plan work? Why or why not?

Partial list of research aids:

§ 1059.

Answer 1

1) No the proposed plan will not work.

By reading the code 1059 carefully we will know that if any corporation received non - ordinary dividends from another corporation and it sold the stock with in a period of 2 years then the basis will be reduced by non taxed portion of that company.Then value of purple will be decreased by $150 million at the time of purchase.And white corporation cant show the dividends received from the purple corporation are deductible under other code.Since it is not good as per law because the stock was held for less than 2 years.So it must be recognized as investment for white corporation which in makes the tax liability again equal to $50 million.

And dividend will be treated as extra ordinary dividends . So that white will not get any tax benefits from this transaction.

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