Closed-end fund tender offers escape adverse tax consequences.

Many closed-end regulated investment fund companies reserve the fight to tender for their stock (that is, to buy back shares at a set price) when management believes it is undervalued by the market. These tender offers typically are made at net asset value as of the close of business on the day they end.

The question from a tax viewpoint is whether such a buyback is part of a "periodic redemption plan." If it is, the tendering shareholders will realize dividend income equal to the full buyback proceeds. The buyback will not qualify for sale treatment because the tendering shareholders do not incur a meaningful reduction in proportionate interest (the shareholder has the power to recover lost interest by electing not to participate in later buybacks).

More significant, the nontendering shareholders are deemed to receive a "constructive" dividend reflecting the value of their increased proportionate interest in the corporation.

A recent ruling indicates these arrangements will generally not be construed as periodic redemption plans, so no shareholder will be deemed to receive constructive dividends. To avoid periodic redemption plan status a corporation must not be required to redeem its stock and, at the time of a buyback, may have no plan or commitment to make further offers.

Moreover, periodic redemption plan classification will not be found even though the corporation reserves the right to make additional offers in the future.

Observation: Closed-end funds will have the ability to make tender offers without adverse tax consequences-so long as each offer is not required and there is no plan or commitment to make subsequent tender offers.