## Facts

- TSN Liquidating Corporation owned more than 90% of Community Life Insurance Company (CLIC).
- TSN negotiated to sell all CLIC stock to Union Mutual Life Insurance Company under a stock purchase agreement executed May 5, 1969.
- The agreement set the purchase price primarily by reference to CLIC’s assets on the closing date and expressly contemplated that certain specified assets would be removed from CLIC before closing, with the price reduced accordingly.
- To implement that condition, CLIC’s board declared a dividend in kind payable May 19, 1969, distributing primarily thinly traded securities and related assets to its shareholders, including TSN.
- Union Mutual did not want the distributed assets and did not intend to pay for them; the transaction was structured so Union Mutual acquired CLIC without those assets.
- TSN reported the distribution as a dividend and claimed the dividends-received deduction.
- The IRS recharacterized the distribution as additional consideration for TSN’s sale of CLIC stock, increasing TSN’s capital gain and tax.
- TSN paid the additional tax, sought a refund, and filed a refund suit; the district court ruled for the United States, treating the distribution as part of the sale proceeds.
- TSN appealed to the Fifth Circuit.

## Issues

1. Whether a subsidiary’s dividend in kind to its parent, declared immediately before the parent sells all subsidiary stock to a third party, is taxable as a dividend or as part of the consideration received for the stock sale.
2. Whether step-transaction or substance-over-form principles require collapsing the distribution into the stock sale when the purchaser neither desires nor pays for the distributed assets and the purchase agreement excludes them.

## Decision

- The Fifth Circuit reversed the district court.
- The court held that, on these facts, the distributed assets were a dividend from CLIC to TSN, not additional consideration paid for the CLIC stock.
- The court concluded the distribution was economically and contractually separate from the stock sale because the purchaser did not want or pay for the assets and the purchase price was computed on the remaining assets.
- The case was remanded for proceedings consistent with treating the distribution as a dividend.

## Legal Principles

- A pre-closing distribution may be respected as a dividend, rather than recharacterized as stock-sale consideration, when the distribution is made by the target to its shareholders, the buyer does not want the distributed assets, and the buyer’s price reflects their exclusion.
- Step-transaction treatment is less likely when the distribution has a non-tax business purpose reflected in the parties’ bargain (e.g., a buyer-required disposition of unwanted assets) and does not function as indirect payment by the buyer for those assets.
- In determining characterization, courts examine economic reality: who transferred the assets, who paid for them, and whether the sales agreement priced the transaction as if the assets were never part of the acquisition.

## Conclusion

The Fifth Circuit held that a buyer-driven, contractually excluded pre-closing dividend of unwanted assets from a subsidiary to its parent remained a dividend for federal income tax purposes and could not be treated as additional consideration for the parent’s sale of the subsidiary’s stock.


TSN Liquidating Corp. v. United States, 624 F.2d 1328 (5th Cir. 1980)