Treasury Department's First Repurchase Excise Tax Guidance Contains Rotten "Easter Eggs"
- IRS Notice 2023-2 provides interim guidance regarding transactions falling purview to the stock repurchase excise tax.
- Foreign corporations should analyze operations and planned transactions to begin tracking potential funding of foreign stock repurchases.
- Interested parties are encouraged to submit comments to the U.S. Department of the Treasury and IRS in response to Notice 2023-2 by March 20, 2023.
The U.S. Department of the Treasury and IRS intend to issue proposed regulations addressing application of a new excise tax on repurchases of corporate stock under Section 4501 of the Internal Revenue Code (Code). Section 4501 was added to a new Chapter 37 of the Code through enactment of the Inflation Reduction Act of 2022 (IRA). This alert highlights certain rules and procedures – many of which are reminiscent of "Easter eggs" hidden in movies and video games – the Treasury Department and IRS plan to include in the new regulations.
To Whom Does the Share Repurchase Excise Tax Apply?
Section 4501 imposes an excise tax equal to 1 percent of the fair market value of any stock of a corporation that is repurchased by a covered corporation during the taxable year. A covered corporation is any domestic corporation where the stock of which is traded on an established securities market.
Further, the excise tax also applies to repurchases by specified affiliates. A "specified affiliate" is generally a domestic corporation that is owned by more than 50 percent by vote or value, directly or indirectly, by the covered corporation or any partnership owned by more than 50 percent of the capital interests or profits interests of which is held, directly or indirectly, by the covered corporation. If the specified affiliate acquires the stock of the covered corporation from a person other than the covered corporation or other specified affiliate of the covered corporation, the specified affiliate is treated as making a stock repurchase under Section 4501.
When Does the Tax Apply to Non-U.S. Companies?
As discussed above, if a specified affiliate of a covered corporation acquires stock of the covered corporation from a person who is not the covered corporation or another specified affiliate of the covered corporation, the specified affiliate is treated as a covered corporation with regard to such acquisition, and such acquisition is treated as a repurchase of stock of a covered corporation by the covered corporation.
The excise tax under Section 4501(d)(1) applies in the case of an acquisition of stock of an applicable foreign corporation by a specified affiliate of the corporation (other than a foreign corporation or a foreign partnership – unless the partnership has a domestic entity as a direct or indirect partner) from a person who is not the applicable foreign corporation or a specified affiliate of the applicable foreign corporation. An "applicable foreign corporation" is the foreign equivalent of a covered corporation.
The notice greatly expands the reach of the excise tax to cover foreign stock repurchases without any connection to the U.S.. An applicable specified affiliate is treated as acquiring stock of an applicable foreign corporation if the applicable specified affiliate 1) funds by any means (including through distributions, debt, capital contributions, the acquisition of inventory or payment for services provided by the parents) the acquisition or repurchase of stock of the applicable foreign corporation by the applicable foreign corporation or a specified affiliate that is not also an applicable specified affiliate, and 2) such funding is undertaken for a principal purpose of avoiding the stock repurchase excise tax. The fair market value (FMV) of stock treated as acquired by the applicable specified affiliate is limited to the amount funded by the applicable specified affiliate. Under the per se funding rule, a principal purpose is deemed to exist if the applicable specified affiliate funds by any means, other than through distributions, the applicable foreign corporation or a specified affiliate that is not also an applicable specified affiliate, and such funded entity acquires or repurchases stock of the applicable foreign corporation within two years of the funding. The Treasury Department anticipates that forthcoming proposed regulations will provide rules consistent with the rules described above and apply to repurchases and acquisitions of stock made after Dec. 31, 2022, that are funded on or after Jan. 17, 2023.
Further, a "covered surrogate foreign corporation" is a surrogate foreign corporation where the stock of which is traded on an established securities market, but only with respect to taxable years that include any portion of the applicable period with respect to such corporation under Section 7874(d)(1).1 If a covered surrogate foreign corporation repurchases its stock, or if a specified affiliate of the covered surrogate foreign corporation acquires stock of the covered surrogate foreign corporation, the expatriated entity, with respect to the covered surrogate foreign corporation, is treated as a covered corporation with respect to the repurchase or acquisition, and the repurchase or acquisition is treated as a repurchase of stock of a covered corporation by the covered corporation.
Holland & Knight Insight: A prior version of the share repurchase excise tax would have applied to any covered corporation that is a subsidiary of a foreign publicly held corporation, to the extent that the value of any securities repurchased by such corporation during the taxable year as bears the same ratio to the total value of all such securities repurchased during such taxable year as the U.S. gross receipts of such corporation bears to the global gross receipts of the parent corporation and all its subsidiaries. Viewed by many as an indirect tax on a foreign corporation's non-U.S. income and stricken from the final bill, the funding rule of Section 4501 appears to be another attempt to capture foreign-parented group income. The funding rule is similar in design to the per se rules in the Section 385 regulations. The rule requires foreign-headquartered groups to track all transactions with the foreign parent (and possibly any other related foreign entity) to be able to track the percentage of a foreign stock buyback subject to the excise tax.
When Is the Stock Repurchase Excise Tax Triggered?
Section 4501(c)(1) expressly mandates that the stock repurchase excise tax applies to the following two situations: 1) Section 317(b) redemptions, and 2) any transaction determined by the Secretary of the Treasury to be economically similar to a Section 317(b) redemption. The IRS provided guidance regarding the two statutory triggers of the excise tax in Notice 2023-2.
Section 317(b) Redemptions
Under a Section 317(b) redemption, stock is treated as redeemed by a corporation if the corporation acquires its stock from a shareholder in exchange for property, whether or not the stock so acquired is canceled, retired or held as treasury stock.
For purposes of the share repurchase excise tax, Section 317(b) redemption treatment does not trigger the excise tax if Section 304(a)(1) applies to the acquisition of stock by an acquiring corporation (i.e., an acquisition by a non-subsidiary-related corporation). Additionally, certain payments by a covered corporation of cash in lieu of fractional shares are not repurchases in the following circumstances:
- the payment is carried out as part of a transaction that qualifies as a reorganization under Section 368(a) or as a distribution to which Section 355 applies, or pursuant to the settlement of an option or similar financial instrument (e.g., convertible bond or convertible preferred share)
- the cash received by the shareholder entitled to the fractional share is not separately bargained-for consideration (i.e., the cash paid by the covered corporation in lieu of the fractional share represents a mere rounding off of the shares issued in the exchange or settlement)
- the payment is carried out solely for administrative convenience and solely for non-tax reasons
- the amount of cash paid to the shareholder in lieu of a fractional share does not exceed the value of one full share of the stock of the covered corporation
Any Transaction Determined by the Secretary of the Treasury to Be Economically Similar to a Section 317(b) Redemption
Notice 2023-2 provides the following five initial transactions determined by the Secretary of the Treasury as economically similar to a Section 317(b) redemption:
- Acquisitive Reorganizations: Where a target corporation that is a covered corporation or a covered surrogate foreign corporation is acquired in an acquisitive reorganization, the exchange by the target corporation shareholders of target corporation stock as part of the acquisitive reorganization is a repurchase by the target corporation.
- E Reorganizations: Where recapitalization under Section 368(a)(1)(E) occurs, an exchange by the recapitalizing corporation shareholders of their recapitalizing corporation stock as part of the E reorganization is a repurchase by the recapitalizing corporation.
- F Reorganizations: In the case of a transaction qualifying as a reorganization under Section 368(a)(1)(F) where the transferor corporation is a covered corporation or a covered surrogate foreign corporation, the exchange by the transferor corporation shareholders of their transferor corporation stock as part of the F reorganization is a repurchase by the transferor corporation.
- Split-Offs: In the case of a split-off by a covered corporation or a covered surrogate foreign corporation, the exchange by the distributing corporation shareholders of their distributing corporation stock for controlled corporation stock and, if applicable, other property (including securities of the controlled corporation) or money is a repurchase by the distributing corporation.
- Complete Liquidations Under Sections 331 and 332: Where a complete liquidation of a covered corporation or a covered surrogate foreign corporation to which Sections 331 and 332(a) apply, each distribution to which Section 331 applies is a repurchase by the covered corporation or the covered surrogate foreign corporation, and the distribution to which Section 332(a) applies is not a repurchase by the covered corporation or the covered surrogate foreign corporation.
Complete liquidations of a covered corporation or a covered surrogate foreign corporation under which Section 331 or Section 332(a) applies, as well as non-split-off divisive reorganizations under Section 355, are not economically similar to a Section 317(b) redemption.
Holland & Knight Insight: A reorganizations, C reorganizations, triangular mergers, E reorganizations and F reorganizations are subject to the share repurchase excise tax, unless the qualifying property exception applies. If the qualifying property exception applies, the FMV of stock repurchased by a covered corporation in a qualifying repurchase is a reduction for purposes of computing the covered corporation's stock repurchase excise tax base to the extent that such repurchase is for property permitted by Section 354 or Section 355 to be received without the recognition of gain or loss. Qualifying repurchases include:
- a repurchase by a target corporation as part of an acquisitive reorganization
- a repurchase by a covered corporation or a covered surrogate foreign corporation (as appropriate) as part of an E reorganization
- a repurchase by a transferor corporation as part of an F reorganization
- a repurchase by a distributing corporation as part of a split-off (whether or not part of a D reorganization)
In addition to determining whether transactions trigger share repurchase excise tax liability, covered corporations must contend with timing and reporting rules. As taxpayers await proposed regulations, interested parties should consider submitting comments in response to Notice 2023-2 no later than March 20, 2023.
1 A company is a surrogate foreign corporation if, pursuant to a plan (or a series of related transactions), the following are true:
- The entity completes after Sept. 20, 2021, the direct or indirect acquisition of substantially all of the properties held directly or indirectly by a domestic corporation or substantially all of the properties constituting a trade or business of a domestic partnership.
- After the acquisition, at least 60 percent of the stock (by vote or value) of the entity is held by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation.
- After the acquisition, the expanded affiliated group that includes the entity does not have substantial business activities in the foreign country in which, or under the law of which, the entity is created or organized, when compared to the total business activities of such expanded affiliated group.
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.