Question: Suppose a corporation (the investor company) owns 164 million shares in another corporation (the investee company). The investor company wishes to liquidate the majority of its holdings. The average basis per share of the investor company's holdings is $17.62, and the investee company is currently trading at $61 per share.
a. Assume that the investor company's tax rate is 35%. What are the tax consequences of an openmarket sale of 95% of its holdings in the investee company (that is, a sale of 156 million shares)?
b. Note that the after-tax gain to the investor is the same if, instead of an open market sale, the investor sold the stock back to the investee company directly. Now instead of selling the stock back to the investee company, suppose the transaction could be structured such that the "sale proceeds" would be taxed as a dividend to the investor company. Further suppose the investor company could exclude from taxable income 80% of the dividend received (because the investor company owned approximately 25% of the investee company prior to this transaction). What are the tax consequences of dividend treatment of the "sales proceeds"?
c. Which tax treatment is better for the investor company? What are the tax effects, if any, for the investee company? Are there any nontax costs to the dividend treatment?