The Eighth Circuit Court of Appeals denied food giant General Mills’ deductions for “cash distribution redemptive dividends” it paid participants in the company’s employee stock ownership plans (ESOPs). In so doing, the Eighth Circuit reversed a district court decision and ignored the Ninth Circuit’s ruling six years ago in Boise Cascade Corp. v. U.S. (329 F.3d 751 (9th Cir. 2003)). The Eighth Circuit’s holding also vindicated the IRS’ opposition to this and similar positions. The Service has maintained its opposition in litigation, regulations (TD 9282) and a revenue ruling (2001-6).
General Mills Inc. (GMI) established three ESOPs, funding them primarily with its own stock. Upon termination from employment, ESOP participants could receive their benefits in cash or stock. If the participant requested cash, GMI would fund the payment from proceeds of redeemed stock. For tax years 1992 through 1995 and 1997, GMI treated the stock redemptions used to fund cash distributions ($14.7 million, cumulatively) as dividends under IRC § 302 (“redemptive dividends”). It deducted the portion of them paid to participants ($13.8 million) as “cash distribution redemptive dividends.” The IRS disallowed the deductions, and GMI filed suit in the U.S. District Court for Minnesota to recover $4.7 million in claimed refunds.
GMI pointed to section 404(k), which allows a deduction for dividends a corporation pays on its stock held by an ESOP. The dividends must be paid to the plan’s participants or beneficiaries or distributed to them by the plan within 90 days after the end of the plan year. The parties stipulated that these provisions were met, but the IRS argued that the general prohibition of section 162(k)(1) of a deduction for payments by a company to redeem its stock controlled the treatment of the transaction. The provision denies any “deduction otherwise allowable” for “any amount paid or incurred by a corporation in connection with the reacquisition [pre-1996: ‘redemption’] of its stock” (emphasis added). In granting summary judgment to GMI, the district court reasoned that section 162(k)(1) didn’t bar the deduction because GMI claimed the deduction not for its redemptive dividends but for the portion of them distributed. The district court also followed the Ninth Circuit’s reading in Boise Cascade Corp. of the phrase “in connection with” as applying to expenditures “necessary and incident” to a stock redemption.
The Eighth Circuit rejected the district court’s distinction between a stock redemption and distribution of its proceeds. It also countered the narrow interpretation by the district court and the Ninth Circuit of “in connection with.” Rather, the Eighth Circuit viewed the redemption and distribution as connected parts of one transaction and thus not deductible under section 162(k)(1). In the Eighth Circuit, the phrase “in connection with” in a tax code setting is broadly construed, the court said.
General Mills Inc. v. U.S., No. 08-1638 (8th Cir. 1/26/09)
By Edward J. Schnee, CPA, Ph.D., Hugh Culverhouse Professor of Accounting and director, MTA Program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.