The following article is adapted from reprinted from the M&A Tax Report, Vol. 7, No. 8, March 1999, Panel Publishers, New York, NY.


By Robert W. Wood, San Francisco

Most tax professionals, investment bankers and company executives know what voting power means. At its core, it means the power to elect the Board of Directors. Apart from this common-sensical understanding, there is considerable tax authority that says just that. In companies with complex stock structures, an acquisition or reorganization may prompt a scramble to determine who holds what. But the main index for what is considered voting stock has generally been one thing; who gets to vote for directors? There is reason to question this maxim now, at least in consolidations.

Oh, Those Appealing Losses

For many years, Alumax was operated as a joint venture between Amax and a changing group of Japanese interests. In 1984, with a view toward including Alumax in the Amax consolidated tax return, so that the former's profits could be offset against the latter's losses, the shareholder votes were redistributed. Amax was issued a class of stock that possessed 80% of the total votes of Alumax's outstanding stock.

However, this voting power had limits. Certain actions, had to be approved by a majority of each class of stock, and these actions were numerous and significant: mergers, partial or complete liquidations, the purchase or sale of any asset worth more than 5% of net worth, capital appropriation or asset disposition worth more than $30 million, election and dismissal of the CEO, and loans to affiliated corporations. Moreover, the voting advantage obtained by Amax also extended to the election of the board of directors.

Furthermore, any action on any of the above matters had to be approved by a majority of the Amax directors as well as the directors appointed by the Japanese interests. Plus, the Alumax charter was amended to require that it pay dividends amounting to 35% of its net income.

Under the law existing in 1984, the right to consolidation turned on whether Amax held 80% of the voting power in Alumax. Under current law, ownership of 80% of both the voting power and value of the outstanding stock is necessary for consolidation. Contrast this to spinoffs. For a spinoff to be tax-free, the distributing corporation must, immediately before the distribution, control the corporation whose shares it is distributing. For this purpose under Section 355, control means ownership of stock possessing 80% of the total combined voting power of all classes of stock entitled to vote. The control definition used for spinoffs, actually found in Sec. 368(c), does not require the ownership of any particular percentage of the value of the outstanding stock.

In Alumax, the taxpayer argued that it possessed the requisite voting power because it had the power to elect directors who held 80% of the board votes. The IRS contended (and the Tax Court agreed) that voting power also entails the actual power to "run the corporation" that would normally accompany control of a "supermajority" of the board.

Court of Appeals' Quandary

The Court of Appeals has now upheld the Tax Court. It concluded that voting power means the power to control the corporation's business through the election of the board. Here, the voting authority of the Amax directors was too diluted, and the voting power of the Alumax board too restricted, for Amax to reach 80% of the voting power.

Plus, said the court, the mandatory dividend provision robbed the directors of some of the discretion they customarily would have had. Even more significantly, the measures eliminating the Amax directors' supermajority voting power (with respect to the above matters) further reduced Amax's control.

With respect to the above matters, the Amax directors' voting power effectively declined to 50%. According to the court, these matters were significant, in that they lay at the core of the board's authority to run a corporation's business. All in all, the court concluded, these restrictions prevented Amax from operating Alumax as part of the former's single enterprise (the theoretical basis for consolidation). As a result, Amax did not posses 80% of the voting power in Alumax, so the attempted consolidation failed the requisite tests.

Voting Power and Consolidations: The Alumax Story, Vol. 7, No. 8, The M&A Tax Report (March 1999), p. 5.