Employee Benefits-Eighth Circuit Denies Deduction For Company Cash Payments Used To Redeem ESOP Stock and Pay Out Participants.

In Nestlé Purina Petcare Co. v. Commissioner of Internal Revenue, No. 09-1381 (8th Cir. 2010), the Nestlé Purina Petcare Company, known as “Ralston” during the relevant years, had established an employee stock ownership plan (an “ESOP”). A trust held the ESOP’s assets, which consisted primarily of Ralston preferred stock. When a participant left Ralston, the participant was required to direct the ESOP to convert the value of the preferred stock allocated to his or her ESOP account into cash, shares of Ralston common stock, or a combination of both. If a participant elected to receive cash, the trust could require that Ralston purchase Ralston preferred stock from it, paying the trust a cash dividend (a “redemptive dividend”) in exchange for the stock. From the redemptive dividend, the Trust could distribute to the participant a “cash distribution redemptive dividend” , as all or part of the total cash to be paid to the participant. The question for the Court was whether Ralston could deduct the cash distributed redemption dividend. The Tax Court had ruled that it could not.

In answering this question, the Court revisited its earlier decision in General Mills, Inc. v. United States, 554 F.3d 727 (8th Cir. 2009), in which it had concluded that section 162(k)(1) of the Internal Revenue Code (the “Code”)-which says that no deduction is allowed for any amount paid by a corporation in connection with the redemption of its stock – bars the deduction otherwise allowed by section 404(k)(1) of the Code for amounts paid by an employer to an ESOP’s trust in order to redeem shares of the employer’s stock. Ralston had argued that the exception in section 162(k)(2)(A)(iii) applies. Under that exception, section 162(k)(1) does not apply to-and will not bar a deduction for-dividends paid within the meaning of section 561 of the Code. However, the Court said that the exception in section 162(k)(2)(A)(iii) applies only when the Code has authorized the taxpayer to take a “deduction for dividends paid” within the meaning of section 561. Section 404(k) does not authorize such a deduction. Therefore, the exception in section 162(k)(2)(A)(iii) is not available here. The Court therefore concluded that Ralston may not deduct the cash distribution redemptive dividends, and affirmed the Tax Court’s decision.