Question

DC is preparing to distribute cash dividends to its shareholders. Must it w/h tax under sec 1441 from the dividends?

(a) Shareholder A is a US citizen who resides in France. Only her French address appears in the corporation's books.

see reg 1.1441-1(b)(1), (b)(2)(i), (b)(2)(vii), (b)(3)(i), (b)(3)(iii).

(b) Shares of Shareholder B, a citizen and resident of France, are held by a New York broker and are registered in the name of a nominee corporation of the broker.

For the w/h obligation generally, see reg 1.1441-1(b)(1), (b)(2)(i), (b)(2)(ii). For w/h at treaty rates, see reg. 1.1441-1(e)(1)(ii)(A)(1), (e)(2), -6(a), (b)(1), (b)(3), (c)(1), (c)(2).

Answer 1

adjustment of 0.1258 × $40 per share), for a total increase in value to the bondholder of $5,032.

CRAs come in various forms. The convertible debt of a company may provide for a CRA for any distributions paid, whereas a company with a fairly steady distribution history may issue debt providing for a CRA only to the extent that the distributions exceed a specified threshold.

Under Sec. 305(c), a change in the conversion ratio or conversion price or a similar transaction is treated "as a distribution [by the corporation] with respect to any shareholder whose proportionate interest in the earnings and profits or assets of the corporation is increased by such change." Under Sec. 305(d), the term "shareholder" includes a holder of rights or convertible securities for Sec. 305(c) purposes.

Regs. Sec. 1.305-7(b)(1) states that an adjustment in the conversion ratio or price made under a bona fide, reasonable adjustment formula will not be considered to be a deemed distribution of stock. Examples of these types of formulas are anti-dilution provisions including a conversion price adjustment related to new stock issuances below the conversion price and return-of-capital distributions.

However, if the adjustment is to compensate the debt holder for cash or property distributions to other shareholders that are taxable under Sec. 301 (or other sections), it will not be considered as made pursuant to a bona fide adjustment formula under Regs. Sec. 1.305-7(b). Accordingly, CRAs that are based on nontaxable distributions (i.e., return of capital) are not taxable. However, CRAs that are based on dividend payments under Sec. 301 made to common shareholders will be considered to be deemed-dividend payments to bondholders even before the bondholders convert the debt to equity.

In the example above, assuming the corporation had sufficient earnings and profits, the convertible debt holder would be deemed to have received dividend income of $5,032.

Sec 305(c) is not a new rule, but it has gained attention because of proposed regulations (REG-120282-10) issued under Sec. 871(m) related to U.S. tax withholding on dividend-equivalent payments made to non-U.S. recipients. Sec. 871(m) was added as part of the Hiring Incentives to Restore Employment (HIRE) Act, P.L. 111-147, enacted on March 18, 2010. One of the primary concerns addressed in Sec. 871(m) was the use of derivative instruments to avoid U.S. withholding tax for foreign recipients.