[Code of Federal Regulations]
[Title 26, Volume 4]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.305-6]

[Page 38-39]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.305-6  Distributions of convertible preferred.

    (a) In general. (1) Under section 305(b)(5), a distribution by a 
corporation of its convertible preferred stock or rights to acquire such 
stock made or considered as made with respect to its stock is treated as 
a distribution of property to which section 301 applies unless the 
corporation establishes that such distribution will not result in a 
disproportionate distribution as described in Sec. 1.305-3.
    (2) The distribution of convertible preferred stock is likely to 
result in a disproportionate distribution when both of the following 
conditions exist: (i) The conversion right must be exercised within a 
relatively short period of time after the date of distribution of the 
stock; and (ii) taking into account such factors as the dividend rate, 
the

[[Page 39]]

redemption provisions, the marketability of the convertible stock, and 
the conversion price, it may be anticipated that some shareholders will 
exercise their conversion rights and some will not. On the other hand, 
where the conversion right may be exercised over a period of many years 
and the dividend rate is consistent with market conditions at the time 
of distribution of the stock, there is no basis for predicting at what 
time and the extent to which the stock will be converted and it is 
unlikely that a disproportionate distribution will result.
    (b) Examples. The application of section 305(b)(5) may be 
illustrated by the following examples:

    Example (1). Corporation Z is organized with one class of stock, 
class A common. During the year the corporation declares a dividend on 
the class A stock payable in newly authorized class B preferred stock 
which is convertible into class A stock for a period of 20 years from 
the date of issuance. Assuming dividend rates are normal in light of 
existing conditions so that there is no basis for predicting the extent 
to which the stock will be converted, the circumstances will ordinarily 
be sufficient to establish that a disproportionate distribution will not 
result since it is impossible to predict the extent to which the class B 
stock will be converted into class A stock. Accordingly, the 
distribution of class B stock is not one to which section 301 applies.
    Example (2). Corporation X is organized with one class of stock, 
class A common. During the year the corporation declares a dividend on 
the class A stock payable in newly authorized redeemable class C 
preferred stock which is convertible into class A common stock no later 
than 4 months from the date of distribution at a price slightly higher 
than the market price of class A stock on the date of distribution. By 
prearrangement with corporation X, corporation Y, an insurance company, 
agrees to purchase class C stock from any shareholder who does not wish 
to convert. By reason of this prearrangement, it is anticipated that the 
shareholders will either sell the class C stock to the insurance company 
(which expects to retain the shares for investment purposes) or will 
convert. As a result, some of the shareholders exercise their conversion 
privilege and receive additional shares of class A stock, while other 
shareholders sell their class C stock to corporation Y and receive cash. 
The distribution is a distribution to which section 301 applies since it 
results in the receipt of property by some shareholders and an increase 
in the proportionate interests of other shareholders.

[T.D. 7281, 38 FR 18538, July 12, 1973]