IRS Proposal Addresses Treatment of Deemed Distributions

The Internal Revenue Service ("IRS") issued a proposed rulemaking to "resolve ambiguities concerning the amount and timing of deemed distributions that are or result from adjustments to rights to acquire stock." The proposal also includes guidance and information for withholding agents on their current withholding and reporting obligations with respect to deemed distributions.

The proposal specifies that the current regulations are unclear about the amount of a deemed distribution to a deemed shareholder, and reasonably may be interpreted as providing that such a deemed distribution is treated as either (i) a distribution of a right to acquire stock, or (ii) a distribution of the actual stock to which the right relates.

The IRS stated that it will not challenge positions taken with respect to deemed distributions prior to the publication of final regulations, but noted the IRS and the U.S. Treasury Department's conclusion that a deemed distribution of the right to acquire stock may be viewed more accurately as a distribution of additional rights to acquire stock, the amount of which is the fair market value of the right. The proposal also provides that such a distribution would be deemed to occur at the time at which the applicable adjustment occurs, but in no event later than the date of the distribution of cash or property that results in the deemed distribution.

The proposed rulemaking also clarifies that a withholding agent has an obligation to withhold on a deemed distribution that is made on a security. Additionally, it establishes that the issuer of a security upon which a deemed distribution is made, and any person who holds a security directly or indirectly on behalf of the beneficial owner of the security (or a flow-through entity that owns a security), is a withholding agent with respect to the deemed distribution made on the security. Notwithstanding the general obligation to withhold, the proposed regulations also would provide that withholding agents (other than the issuer of a security) would not be required to withhold with respect to deemed distributions unless either (i) the issuer satisfied certain reporting requirements with respect to the distribution, or (ii) the withholding agent possessed actual knowledge that a deemed distribution had occurred. Withholding agents may rely on the proposed regulations with respect to payments that occur from the beginning of 2016 through the publication date of the final regulations.

The proposed rulemaking affects (i) corporations issuing rights to acquire stock, (ii) their shareholders and the holders of these rights, and (iii) withholding agents with respect to these deemed distributions. Comments are due within 90 days after publication of the proposal in the Federal Register.