The Seagram's stock redemption plan may not last long.

• Author: Weld, Leonard G.

Recent articles in The Wall Street Journal and The New York Times have drawn attention to a stock redemption by DuPont of shares owned by Seagram Co. On May 3, 1995, in response to this redemption, Reps. Archer and Gibbons introduced HR 1551, intended to end the perceived abuse by copycat redemptions that may follow the Seagram plan. Although the bill probably is not needed, it will certainly clarify the issue. The controversy centers on the tax effects of the redemption of stock, the simultaneous issue of an equal number of stock warrants, use of the dividends-received deduction (DRD) and the application of Sec. 302(b)(1).

A major shareholder of Seagram Co. Ltd. wanted cash for Seagram to invest in the entertainment conglomerate MCA. Seagram obtained the cash by having DuPont redeem 156 million DuPont shares owned by Seagram. Seagram still retains 8.2 million shares. Seagram's ownership interest in DuPont declined from 24.2% to 1.2%. The shares were exchanged for $8.3 billion in cash and notes, plus approximately $440 million in warrants to purchase DuPont shares, approximately $56 per share in total. Seagram received one warrant for each share redeemed. The warrants issued allow Seagram to purchase 48 million DuPont shares for a 60-day period ending on Oct. 6, 1997, at a price of $89 per share; 54 million shares for a 60-day period ending on Oct. 6, 1998, at a price of $101 per share; and 54 million shares for a 60-day period ending on Oct. 6, 1999, at a price of $114 per share. The warrants are subject to various conditions, including limitations on the sale to parties other than DuPont.

Redemptions under Sec. 302

Sec. 302(a) provides that if a redemption meets one of the requirements in Sec. 302(b)(1), (2), (3) or (4), the redemption will be treated as a sale or exchange. Otherwise, Sec. 302(d) states that the redemption is treated as a distribution of property to which the Sec. 301 dividend rules apply. Usually, the taxpayer wants the distribution to meet one of the Sec. 302(b) requirements, thereby receiving exchange treatment and allowing for recovery of basis before any tax on the gain associated with the redemption. However, Seagram wanted the opposite result, to take advantage of the corporate 80% DRD.

The tax incentive

Since the 80% DRD applies to the redemption, Seagram plans to pay a net tax rate of 7% (20% X 35% maximum tax rate for corporations) on the dividend amount. Seven percent of $8.8 billion is approximately $615...