Federal Court Permits Dividend Deduction for Stock Redeemed from ESOP

On January 14, 2008, the U.S. District Court for the District of Minnesota, on a motion for summary judgment, ruled in General Mills v. United States, No. 06-3457 DSD/SRN (D. Minn. Jan. 14, 2008), that a corporation could deduct as dividends amounts it paid to redeem shares of its stock held by an ESOP when participants terminated employment. The court ruled that the dividends paid were deductible under Internal Revenue Code (IRC) section 404(k) and that IRC section 162(k) does not prohibit the cash distribution of redemptive dividends. The court reasoned that payment of dividends was not necessary and incident to the redemption expenses since the redemptions were not mandatory and, at times, the dividends were used by the ESOP for activities other than paying out cash distributions. This ruling is contrary to the Internal Revenue Service (IRS) position set out in Revenue Ruling 2001-6. In explaining its refusal to follow Revenue Ruling 2001-6, the court stated that IRC section 404(k) empowers only the Secretary of the Treasury Department to determine whether an avoidance or evasion of taxation exists. In the court’s analysis, since the IRS’s Chief Counsel issued Revenue Ruling 2001-6, this interpretation as to what constitutes an avoidance or evasion of taxation was not an authorized determination. Consequently, the court did not feel bound to follow Revenue Ruling 2001-6 and so permitted the dividend deduction. The allowability of this deduction has been challenged over the last several years, with the IRS insisting that the deduction should not be permitted, as it would allow a corporation to claim two deductions for the same economic cost.

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