Calculating gain on corporate distributions.

In 1986, Congress repealed the last element of the General Utilities doctrine. As a result, corporations must recognize gain when they distribute appreciated assets to stockholders, regardless of whether they structure the transaction as a property dividend or as a stock redemption. Recently, the Ninth Circuit Court of Appeals addressed how to calculate the gain on distribution.

Pope & Talbot, a publicly held corporation, owned properties in the state of Washington. The company believed the market price of its shares did not properly reflect the value of these properties so it transferred them to a limited partnership and distributed the partnership interests to company shareholders. Between the time the properties were transferred to the limited partnership and the interests distributed to shareholders, the partnership interests began to trade on the Pacific Stock Exchange on a "when-issued" basis.

To calculate the gain on the distribution, Pope & Talbot subtracted the basis of the partnership interests (the carry-over basis from the properties transferred to the partnership) from their aggregate value, based on the average price on the exchange. The IRS recalculated the gain based on the higher fair market value of the properties the company transferred to the partnership.

Result. For the IRS, with one dissenting opinion. Pope & Talbot argued that the purpose of the code's gain recognition requirement is to equate a predistribution sale by the company with a postdistribution sale by the shareholders. However, the Ninth Circuit rejected this argument on the grounds that the wording of IRC section 311 is clear and unambiguous. The corporation must recognize gain as if it had sold the property. The value or gain at the shareholder level is immaterial.

Pope & Talbot also argued that gain should be calculated based on the property distributed--in this case, a limited partnership. The Ninth Circuit rejected this argument as well and accepted the IRS position that the gain must be measured based on a hypothetical sale of the entire property. In this instance, it would be the properties the company contributed to the partnership--not the partnership interests themselves. The lone dissenting opinion accepted the taxpayer's argument and would have measured the gain based on the value of the partnership interests.

As a result of this decision, there is no symmetry when a company distributes property. The value the company uses to calculate gain at the corporate level is not necessarily the value for purposes of determining how much income shareholders will recognize. The case leaves open the issue of how to determine the exact asset the company distributed. It remains to be seen if other courts will look through the asset distributed to determine an underlying value, as the Ninth Circuit did, or if they follow the dissent and value the exact property distributed.

* Pope & Talbot v. Commissioner, 162 E3d 1236, 99-1 USTC P50, 158, 83 AFTR.2d 364 (CA-9).

Prepared by Edward J. Schnee, CPA, PhD, Joe Lane Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.