Stock "spin-offs"

[Jean-David Beyer]

Derek Atkins wrote:
> Roland Roberts <roland at astrofoto.org> writes:
> 
> 
>>>>>>>"Derek" == Derek Atkins <warlord at MIT.EDU> writes:
>>
>>    Derek> Jean-David Beyer <jdbeyer at exit109.com> writes:
>>
>>    >> It is neither; it is a return of capital originally invested in
>>    >> the company doing the spin-off; the returned capital being used
>>    >> to buy the shares of the spun-off company.
>>
>>    Derek> A return on capital is called "equity" ;)
>>
>>I noticed Jean-David twice said "return _of_" not "return _on_".  Was
>>this deliberate?
> 
> 
> A return _of_ capital is ALSO called "equity"  :)
> 
I guess I am confused about that (far too much time wasted running 
various versions of Quicken). If I buy shares of a company, and it pays 
me a dividend, or if I buy a bond and it pays me interest, I would call 
those _return on capital_. But if I bought a bond, and the issuer called 
it, the amount I received (not counting the interest) I would call a 
_return of capital_. Similarly, if I bought shares of a company that 
later started another company and gave the new company half its assets 
and gave my my proportional share of stock in the new company, I would 
call that a return of capital of the original company, and the purchase 
of shares of the new company with that returned capital.

If I buy shares of a company, I get the money to do so from some 
account, and it is not an equity account. It could be a savings account, 
a checking account, or a cash-on-hand account for that matter (although 
a broker might fear I wanted to do money laundering were I to walk in 
with a significant amount of cash for share purchase). That gets me 
shares of that company. Now if that company pays a dividend, that is 
sure not a return of capital, and the tax guys know that because they 
tax it. If it does a split, that just doubles (in the case of a 2:1 
split) the number of shares and cuts the cost basis per share in half.

Now a spin-off works as though some of the investment was returned to 
the owner, which reduces the cost basis of the shares; it is not the 
result of selling a portion of the shares, nor can it be the result of 
reducing the share price at the moment of the transaction (though if 
stock markets were rational, the share prices would go down exactly as 
the value of the spin-off was distributed). Now if we do this in more 
than one step, that returned capital can be stored in an equity account, 
or a checking account, or what not, because it will be there less than 
an instant, being used to purchase the shares of the new company.

Quicken does not care where it was, but that is just another example of 
Quicken's many failings.

If GnuCash does (and I assume it does) care, it probably makes more 
sense to stuff it into some temporary equity account (temporary in terms 
of its contents: the account could be created anytime before it was 
needed and just left there the rest of the time) than any other "real" 
account, such as checking, because if you put it in one of those, there 
would be transactions that would be difficult to justify even though the 
balances would all work out except for the "instant" they were in the 
(inappropriate) account.

Now a complication (or simplification, depending on how you choose to 
look at it) is that most people do not take delivery of their share 
certificates. They are not record owners of the shares, just beneficial 
owners. The shares are held in street name at a brokerage house. In that 
case, there seems to be no need for an equity account to hold the 
returned principle: it can just sit for less than an instant in the 
brokerage account. (It never even appears at the brokerage either, but 
only on the books of the company itself, but I cannot imagine anyone 
choosing to keep a subset the accounts of the companies in which they 
own stocks just for purposes of accounting niceties.)

Where "money" goes can be very important for these "instants."
If I transfer assets from one IRA to another, for example, if it passes 
through my hands (bank account, etc.) for even an instant, withholding 
tax must be paid, and will be deducted by the originating broker. If it 
goes broker-to-broker, then it is not a taxible event (except IRA to 
Roth-IRA).

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