While year-end often is a time for investors to reflect on their winning and losing holdings, the tax analysts and editors at CCH® Capital Changes have identified what they believe will be the top ten tax-complex and significant corporate actions likely to impact investors this year.
"Corporate actions, like stock splits, mergers, and spin-offs, happen every day and all impact the cost basis used to determine investors' actual capital gain or loss come tax time," Stevie D. Conlon, an attorney, CPA, and senior tax analyst for CCH Capital Changes, said. "Calculating basis for portfolio holdings of stock and securities can be a challenge, particularly for core holdings that have been held for many years where a number of corporate actions affecting basis such as splits, stock dividends, or reorganizations may have occurred. But, there are some transactions each year that raise significant concerns and require extra attention. Knowing what these are before you report to your investors or sit down to figure out your taxes can help you be better prepared."
Those securities that made the "CCH Capital Changes Top Ten Corporate Actions" for 2004, as reported in the December 7, 2004, issue of the CCH Capital Changes In-Depth™ newsletter, in order of significance, are:
- TECO® and PPL
- Rolls-Royce® Group
- Abbott Laboratories
- Telebras HOLDRs
- Tengasco Inc.
- Carlton Communications/Granada Merger
- Aventis merger into Sanofi-Aventis
WORLDCOM, INC.—ACCOUNTING FOR WORTHLESS SECURITIES
WorldCom [delisted by NASDAQ®: WCOM] emerged from bankruptcy as MCI in April 2004; however, there was no recovery for its shareholders. The key tax issue is determining the tax year in which WorldCom stockholders were entitled to deduct a loss on their stock. If stock held as a capital asset is sold in a bona fide sale—even if for only a nominal amount—a capital loss is generally recognized in the tax year the sale occurred. However, if a stockholder continued to hold the stock, a capital loss is recognized in the tax year the stock becomes worthless.
VIACOM, INC.—ALLOCATING BASIS IN SPLIT-OFF OF BLOCKBUSTER
In October 2004, international media conglomerate Viacom, Inc. [NYSE: VIA] split-off Blockbuster, Inc. and issued Blockbuster shares to shareholders in an exchange offer. Holders could elect to exchange all or a portion of their Viacom shares with various possible combinations of holdings that could result given the election options. The key tax issue is allocating a shareholder's basis in Viacom shares held prior to the split-off between the Viacom shares retained and the Blockbuster shares received, depending in part on the class of shares held and the holder's elections.
MICROSOFT CORP.—SPECIAL AND QUALIFIED DIVIDEND INCOME TAX TREATMENT
On December 2, 2004, Microsoft Corp. [NASDAQ: MSFT] paid a $3 per share special dividend totaling $32 billion to holders of record at the close of business November 17, 2004. Some observers have suggested the special dividend payment was motivated by the favorable tax treatment of dividends under the recently enacted "qualified dividend income" (QDI) rule, allowing eligible dividends to be taxed at a maximum federal individual income tax rate of 15 percent; however, all agree that given the magnitude of the dividend, significant tax planning is in order for major investors.
TECO ENERGY, INC. AND PPL CORP.—EARLY SETTLEMENT/EXCHANGE OF EQUITY/DEBT UNITS
In 2004, TECO Energy, Inc. [NYSE: TE] offered holders of its financial derivative-flavored equity/debt units (known at PEPS) a cash payment per unit for the early settlement of the units. These securities, which also have been used by PPL Corp. [NYSE: PPL] and many others, provide tax and financial accounting benefits to the issuer. Even though they are traded as units, for federal income tax purposes each unit has two separate components—a forward contract to acquire issuer stock and a debt instrument that is typically subject to special tax rules—requiring holders to allocate the purchase price of units between both components to determine their basis.
ROLLS-ROYCE GROUP, PLC—DETERMINING TAXES UPON RECEIPT OF B SHARES
Like a number of U.K. companies, Rolls-Royce Group plc [LSE: RR] issued "B shares" in lieu of a dividend to its shareholders because of the tax advantages they provide resident shareholders. However, for U.S. tax purposes, the redemption rights of holders in the B shares generally result in ordinary dividend income to recipient holders subject to U.S. tax. And, the continued holding of B shares after issuance raises character of income and timing issues because it is uncertain, given the redemption rights, whether such shares are treated as debt or equity for U.S. tax purposes.
ABBOTT LABORATORIES—DETERMINING BASIS FOR SPIN-OFF OF HOSPIRA
In April 2004, Abbott Laboratories [NYSE: ABT] spun off to its shareholders shares in Hospira, Inc. [NYSE: HSP] and holders of Abbott common received common stock of Hospira. Abbott received a ruling from the Internal Revenue Service (IRS) that the distribution of Hospira common stock was tax free to Abbott and to Abbott's U.S. shareholders for U.S. federal income tax purposes. However, the key tax issue for shareholders was allocating the basis in their Abbott shares between their Abbott shares and the new Hospira shares given multiple methods for determining the basis allocation.
TELEBRAS HOLDRS—DISTRIBUTION OF COMPONENT OF BUNDLED SHARES
When Telebras, the giant Brazilian telecommunications company, split up in 1998 into 12 separate telecoms, Merrill Lynch created a new type of security called a HOLDR [NYSE: TBH], which allowed these companies to be held and traded as one security. Since then (in December 2003, August 2004, and September 2004), three of the original 12 companies that made up Telebras HOLDR have spun off causing complexity for investors in allocating their basis between the HOLDR and the shares of the distributed companies, given that treatment of spin-offs in a HOLDR differ significantly than for spin-offs within a traditional company.
TENGASCO, INC.—REPORTING MANDATORY ALLOCATION OF BASIS IN RIGHTS OFFERING
In February 2004, Tengasco [AMEX: TGC], an independent oil company, issued rights to existing shareholders to purchase its common stock at 25 cents per share when the stock was trading at about 62 cents per share as a convenient means to raise additional capital. From a tax perspective, granting such rights is a nontaxable distribution to the shareholder; however, tax law requires shareholders exercising stock rights to allocate basis between the rights received and the common stock held whenever the fair market value of the stock rights received equals at least 15 percent of the fair market value of the stock at the time of distribution—as is the case with Tengasco shares
CARLTON COMMUNICATIONS/GRANADA PLC—FACTORING BASIS ALLOCATION FOR MERGER
On February 2, 2004, TV media company Carlton Communications [LSE: CCM] merged with Granada plc [LSE: GAA] to form ITV plc [LSE: ITV], which owns all ITV television franchises in England and Wales. In the merger, holders received shares of ITV ordinary and ITV convertible shares. However, U.S. tax treatment of the receipt of the ITV convertible shares received was not entirely clear and the potential adjustment of the conversion ratio complicates the allocation of basis to the convertible shares.
AVENTIS, S.A./SANOFI-AVENTIS—REALIZING FAIR MARKET VALUATIONS IN TAXABLE MERGER
In early 2004, Aventis, S.A. [ADS—NYSE: AVE] merged with Sanofi-Synthelabo, S.A. [ADS—NYSE: SNY] to create Sanofi-Aventis, S.A. [ADS—NYSE: SNY], the world's third largest drug company. In the merger, Aventis shareholders had the ability to elect different combinations of new shares and cash, but were required to recognize gain or loss based on the combination of consideration received and the fair market value of the shares received on the date of distribution. However, because of the manner in which the merger occurred, there were different dates of distribution applicable to different shareholders.