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FASB issues new guidance on why some dividends must be treated like a stock issuance when shareholders have a choice between stock and cash distributions.
Robert Willens, CFO.com | US
January 19, 2010
Many real estate investment trusts (REITs), and certain regulated investment companies (RICs), as a way of conserving cash while satisfying their dividend-payment obligations, have resorted to declaring dividends that provide shareholders with an election to receive either cash or stock of equivalent value. However, in these cases, a limitation is placed on the aggregate amount of cash that will be remitted.
In many cases, not more than 10% of the aggregate distributions will be in the form of cash, with the balance comprised of the REIT or RIC's own stock. For tax purposes, in light of the election afforded the shareholders, the distribution of stock is considered a "distribution of property to which Section 301 of the Internal Revenue Code applies."1 The result is that the corporation's dividend-payment obligation is considered defrayed by the disbursement of both the cash and the stock.
Recently, the Internal Revenue Service announced that its acceptance of the 10%/90% split between cash and shares will continue through the end of 2010. Accordingly, when forestry-products company Weyerhaeuser Co. converts into a REIT later this year,2 and complies with the requirement that a REIT must disgorge all the earnings and profits it had accumulated in non-REIT years,3 we can expect that as much as $5.4 billion of the $6 billion dividend it is required to disburse will be in the form of stock.
The Financial Accounting Standards Board has been analyzing how these elective distributions should be accounted for, and its views were recently finalized. Most affected companies, we believe, will be quite satisfied with the conclusions FASB has reached.
Stock Issuance vs. Stock Dividend
The document in which FASB's views are contained is Accounting Standards Update (ASU) No. 2010-1, issued this month and dubbed "Accounting for Distributions to Shareholders with Components of Stock and Cash." The ASU provides that the stock portion of a distribution to shareholders is considered a stock issuance that is reflected in earnings per share prospectively, rather than a stock dividend requiring retroactive restatement of shares outstanding and EPS for all periods presented. (Of course, as described, the stock portion distributed must be one that allows shareholders to elect to receive cash or shares [of the distributing corporation] with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregated.)
This accounting guidance is effective for interim and annual periods ending on or after December 15, 2009, and should be applied on a retrospective basis, according to FASB.
The board's conclusions were dictated by the fact that these arrangements simply do not exhibit the essential characteristics of a stock dividend as that term is defined in the accounting literature. As a result, for accounting purposes, a stock dividend "takes nothing" from the property of the corporation and "adds nothing" to the interests of the shareholders. In other words, the corporation's property is not diminished and the interests of the shareholders are not increased and, most notably, the proportional interest of each shareholder remains the same.
That is not the case here. In an elective distribution scenario, some shareholders will increase their proportional interest in each of the corporation's assets and earnings and profits compared with other shareholders. Those shareholders whose proportional interests are diminished will have received cash in compensation for this diminution. As a result, these elective distributions do not have the essential "result" of a stock dividend; that is, there is no change in the distributee shareholders' proportionate interest in the corporation. Accordingly, it follows that the stock portion of an elective distribution must be accounted for, prospectively, as a stock issuance, and not retroactively, as a stock dividend.
Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.
1 See Section 305(b)(1) of the Internal Revenue Code.
2 See CFO.com article "Presto! Weyerhaeuser's a REIT."
3 See Section 857(a)(2)(B).