Section 305 Proposed Regulations, Part 2:  The Timing of the Deemed Dividend

The proposed rules relating to the timing of the deemed dividend are relatively straightforward.  Pursuant to Prop. Reg. 1.305-7(c)(5), when an applicable adjustment is a deemed distribution under 1.305-7(c)(1) or (2), the deemed distribution occurs at earlier of (x) the time of the adjustment in accordance with the terms of the instrument setting forth the rights to acquire the stock, or (y) the date of the distribution of the cash or property that resulted in the deemed distribution.

There are special rules for when the instrument does not set forth the time of the applicable adjustment.  In the case of publicly traded stock, the deemed distribution occurs immediately prior to the opening of business on the ex-dividend date for the distribution of the cash or property that resulted in the deemed distribution.  In the case of non-publicly traded stock, the deemed distribution occurs on the date that a holder is legally entitled to the distribution of cash or property that results in the deemed distribution.

While these rules make substantive sense, they do have implications for reporting and withholding.  Most reporting and withholding systems are based on capturing cash movements and are generally not based on deemed events.  Therefore, the reporting and withholding rules will have to take those concepts into account (at least in order to be helpful to the withholding agents and the taxpayers).

Also see:  Section 305 Proposed Regulations, Part 1:  The Amount of Deemed Distributions and New Proposed Regulations under Section 305

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