Stock buyback excise could impact many companies

The Inflation Reduction Act added a new excise tax under Section 4501 on certain repurchases of corporate stock that could have a significant impact on M&A and other redemption activity.

The excise tax will apply to repurchases that occur after Dec. 31, 2022. It is imposed on a “covered corporation” and is equal to 1% of the fair market value of the corporation’s stock repurchased by that corporation during a taxable year. The amount subject to tax is reduced by stock issued by the covered corporation during the taxable year. The tax is not deductible by the covered corporation for U.S. federal income tax purposes.

The new excise tax may significantly impact corporations that have publicly traded stock and redeem stock from their shareholders or engage in economically similar transactions. Transactions subject to the tax may include certain kinds of M&A transactions. However, without clarifying guidance from the IRS, there is uncertainty regarding the range of transactions that will be subject to the tax. The government has broad authority to issue regulations and other guidance, and initial guidance may be imminent.

Below is a description of the key provisions and observations about certain issues related to the new excise tax.


 

Covered corporation

A “covered corporation” is any domestic corporation the stock of which is traded on an established market within the meaning of Section 7704(b)(1). 

Regulations under Section 7704(b) provide that an established securities market includes the following:

• A national securities exchange registered under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f)
• A national securities exchange exempt from registration under Section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f) because of the limited volume of transactions
• A foreign securities exchange that, under the law of the jurisdiction where it is organized, satisfies regulatory requirements that are analogous to the above regulatory requirements under the Securities Exchange Act of 1934 (e.g, the London International Financial Futures Exchange, the Marche a Terme International de France, the International Stock Exchange of the United Kingdom and the Republic of Ireland, Limited, the Frankfurt Stock Exchange, and the Tokyo Stock Exchange)
• A regional or local exchange
• An interdealer quotation system that regularly disseminates firm buy or sell quotations by identified brokers or dealers by electronic means or otherwise

Repurchase

A “repurchase” for purposes of the tax means: (i) a redemption within the meaning of Section 317(b) with regard to stock of a covered corporation; and (ii) any transaction determined by Treasury to be economically similar to such a redemption under Section 317(b).

Redemptions under Section 317(b)

A redemption under Section 317(b) requires that a corporation acquires its own stock from a shareholder in exchange for property. For this purpose, property means any property (e.g., money, securities, and debt of the corporation) other than stock in the corporation, or rights to acquire such stock. Thus, a repurchase would generally include when a corporation redeems its own stock from a shareholder in exchange for money subject to certain exceptions.

Economically similar transactions

Treasury and the IRS have authority to designate a type of transaction as a repurchase because it is economically similar to a redemption under Section 317(b). Because there is little legislative history on the purpose of the excise tax, it is not clear what types of transactions that are not technically redemptions under Section 317(b) could be considered economically similar or how broadly the IRS will use its authority to issue guidance.

• Leveraged corporate acquisitions
• Partial or complete liquidations of a corporation
• Tax-free reorganizations involving boot
• Redemptions of preferred stock
• Split-offs (tax-free or taxable)

Offsetting adjustments

For purposes of determining the amount of tax, the fair market value of any stock repurchased by a covered corporation is reduced by the fair market value of any stock issued by the covered corporation during the taxable year (the “offsetting adjustment”).

This offsetting adjustment may include stock issued by the covered corporation in exchange for property. The statute provides specifically that the offsetting adjustment includes the fair market value of any stock issued or provided during the taxable year to: (i) employees of the covered corporation; or (ii) employees of a specified affiliate of such covered corporation.

Exceptions

The law provides the following exceptions in which the excise tax does not apply:

• Repurchases to the extent that they are part of a reorganization (within the meaning of section 368(a)) and no gain or loss is recognized on such repurchase by the shareholder by reason of such reorganization
  
• Repurchases where the repurchased stock (or stock of equal value) is contributed to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan
• Repurchases in which the total value of repurchased stock during the taxable year does not exceed $1 million
• Repurchases by a dealer in securities in the ordinary course of business as prescribed in regulations by Treasury
• Repurchases by a regulated investment company (RIC) under Section 851 (a RIC) or a real estate investment trust (REIT)
• Repurchases to the extent treated as a dividend. 

Specified affiliate

The acquisition of stock of a covered corporation by a “specified affiliate” of that covered corporation is treated as a repurchase by the covered corporation. 

A “specified affiliate” means:

• Any corporation of which more than 50% of its stock (by vote or by value) is owned, directly or indirectly, by the covered corporation
  
• Any partnership of which more than 50% of the capital interests or profits interests is held, directly or indirectly, by the covered corporation

Foreign corporations

The statute provides special rules for the acquisition of stock of certain foreign corporations that are defined as either: (i) an applicable foreign corporation; or (ii) a covered surrogate corporation.

 

Applicable foreign corporation

An acquisition of stock of an “applicable foreign corporation” by a specified affiliate of such applicable foreign corporation is potentially subject to the excise tax under Section 4501(d).

Specifically, if an acquisition of applicable foreign corporation stock by a specified affiliate occurs: (i) the specified affiliate is treated as a covered corporation for such acquisition; (ii) the acquisition is treated as a repurchase of stock of a covered corporation; and (iii) the offsetting adjustment is determined only with respect to stock issued or provided by the specified affiliate to its employees.

Such acquisition by the specified affiliate must be from a person who is not: (i) the applicable foreign corporation; or (ii) a specified affiliate of such corporation.

The term “applicable foreign corporation” means any foreign corporation that has stock traded on an established market (within the meaning of Section 7704(b)(1)). A specified affiliate of an applicable foreign corporation for this purpose does not include a foreign corporation or a foreign partnership, unless such partnership has a domestic entity as a direct or indirect partner.

The rules may be implicated when a foreign parent has stock that is publicly traded, and a U.S. subsidiary acquires the foreign parent stock. 

Covered surrogate foreign corporation

The excise tax may also apply to either: (i) a repurchase of stock of a “covered surrogate foreign corporation” by such covered surrogate foreign corporation; or (ii) an acquisition of stock of a covered surrogate foreign corporation by a specified affiliate of such corporation.

A “covered surrogate foreign corporation” means any surrogate foreign corporation under Section 7874(a)(2)(B) (the anti-inversion rules) that has stock traded on an established securities market, but only with respect to taxable years within the applicable period under Section 7874(d)(1). The determination whether a corporation is a surrogate foreign corporation is made by substituting ‘Sep. 20, 2021’ for ‘March 4, 2003’ each place that it appears in Section 7874(a)(2)(B).

If such a repurchase or acquisition of covered surrogate foreign corporation stock occurs: (i) the expatriated entity with respect to such covered surrogate foreign corporation is treated as a covered corporation with respect to such repurchase or acquisition; (ii) such repurchase or acquisition is treated as a repurchase of stock of a covered corporation by the covered corporation; and (iii) the offsetting adjustment is determined only with respect to stock issued or provided by the expatriated entity to employees of the expatriated entity.


 

Payment and reporting

The IRS has not yet provided any reporting and payment procedures to administer the tax. While the statute provides that the tax will be imposed on an annual basis, it is unclear whether the tax will be required to be assessed more frequently than annually. Other excise taxes are reported on quarterly returns, such as Form 720, and require frequent deposits.


 

Outlook for IRS guidance

Treasury has authority to prescribe regulations and other guidance as “necessary or appropriate to carry out, and to prevent the avoidance of” the purposes of Section 4501. The statute explicitly provides that such regulations and other guidance may include: (i) preventing the abuse of the exceptions under Section 4501(e); (ii) addressing special classes of stock and preferred stock; and (iii) the application of the special rules for foreign corporations.

Next steps

The new excise tax will apply to repurchases beginning on Jan. 1, 2023. For affected corporations, the tax will require at least an annual assessment, which will include taking into account stock that is repurchased and issued by a covered corporation in a given taxable year.

It also may have a significant impact for future transactions and M&A activity involving covered corporations and their specified affiliates. While guidance from the IRS is potentially imminent, the lack of clarity on the scope of transactions subject to the excise tax has the potential to significantly affect the planning and structuring of transactions.

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