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In a shareholder's derivative litigation I have the following statement of the financial situation which this case arises from:

"Plaintiffs contend that if the company were to sell the purchased stock on the market, it would sustain a capital loss of $25 million which could be offset against taxable capital gains on other investments. Such a sale, Plaintiffs allege, would result in tax-savings to the company of approximately $8 million, which would not be available if the purchased stock were distributed to the shareholders."

  • Note that the company's board of directors had previously made a statement announcing a special divided which would distribute the purchased stock amongst the shareholders. It is presumably this dividend to which Plaintiffs are objecting to.

First, what does it mean to be "offset against taxable capital gains"?

Second, the Plaintiffs want the board of directors to RESCIND the previous statement announcing a special divided. They want the stock to be sold (which would result in a $25 million loss). Why do they want the stock to be sold even if it would sustain a loss?

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"Offset against taxable gains" means that the amount - $25 million in this case - can be used to reduce another sum that the company would otherwise have to pay tax on.

Suppose the company had made a profit of $100 million on some other investments. At some point, they are likely to have to pay corporation tax on that amount before being able to distribute it as a cash dividend to shareholders. However if they can offset the $25 million, then they will only have to pay tax on $75 million. This is quite normal as you usually only pay tax on the aggregate of your gains and losses.

If corporation tax is about 32% that would explain the claimed saving of approximately $8 million.

It sounds like the Plaintiffs want the stock to be sold on the market to get that tax saving. Presumably they believe that distributing it directly would not have the same effect because of the way the tax rules work.

I don't know if the Plaintiffs are right or not, but if they are the difference would probably come about due to the stock being treated as a "realized loss" in the case where they sell it but not in the case where they distribute it.

It's also possible - though this is all very speculative - that if the loss isn't realised when they distribute it directly, then the "cost basis" of the shareholders would be the price the company originally paid for the stock, rather than the value at the time they receive it. That in turn could mean a tax advantage for the shareholders.

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  • To clarify: you're saying that if the company keeps the money internal to its organization by using the capital gain to pay down its other outstanding debts, it will pay the tax on the profit OFFSET by its payment of other debts. If that's true, then wouldn't that incentivize companies to hold off on paying dividends because they don't want to eat the losses from tax? – user20687 Oct 4 '14 at 15:49
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    I think the (claimed) difference is here is solely to do with paying the stock out as a dividend rather than selling it. If they sold it and then distributed the proceeds as a cash dividend I think they would still get the tax break. – GS - Apologise to Monica Oct 4 '14 at 15:50

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