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February 1, 2023
2023-5123

US | Interim guidance on stock buyback excise tax offers mixed bag for corporate taxpayers

  • Notice 2023-2 announces upcoming proposed regulations and provides interim guidance under Internal Revenue Code Section 4501, which generally imposes a non-deductible, 1% excise tax on the fair market value (FMV) of repurchases of corporate stock made after 31 December 2022.

  • The Notice confirms that transactions such as preferred stock redemptions and certain leveraged buyout transactions are subject to the 1% excise tax.

  • Some "outlier" transactions, such as Internal Revenue Code Section 304(a)(1) transactions and complete liquidations, will not be treated as repurchases subject to the excise tax.

  • There will be significant compliance burdens to calculating the stock repurchase excise tax base.

Notice 2023-2 (Notice) announces that the Treasury Department and the Internal Revenue Service (IRS) intend to issue proposed regulations on the application of the new 1% excise tax on repurchases of certain corporate stock under Internal Revenue CodeSection 4501, which was enacted by the Inflation Reduction Act. The excise tax applies to repurchases made after 31 December 2022.

To provide taxpayers with interim guidance in the meantime, the Notice describes certain rules that the Treasury Department and IRS intend to include in the forthcoming proposed regulations. Taxpayers may rely on these rules until the forthcoming proposed regulations are issued.

Background

Section 4501 imposes an excise tax on a "covered corporation" to the extent its stock is repurchased by the covered corporation or its majority-owned or controlled subsidiary during the tax year. A "covered corporation" is generally defined as any publicly traded domestic corporation. A repurchase by the covered corporation includes a repurchase by a specified affiliate of the covered corporation from a person who is not the covered corporation or its specified affiliate. A specified affiliate is generally a greater-than-50% subsidiary of the covered corporation that is treated either as a partnership or corporation.

For foreign corporations whose stock is publicly traded, Section 4501 treats a domestic specified affiliate of the foreign parent corporation as a covered corporation with respect to certain purchases of the foreign parent corporation's stock.

For inversions under Section 7874, additional special rules apply to a "surrogate foreign corporation." In that case, repurchases of stock by a covered surrogate foreign corporation or a specified affiliate of that corporation result in the "expatriated entity" (i.e., the domestic entity described in Section 7874(a)(2)(A)) being treated as the covered corporation that repurchased stock. A "covered surrogate foreign corporation" means a surrogate foreign corporation whose inversion was completed after 20 September 2021.

Subject to certain exceptions and adjustments, the excise tax equals 1% of the FMV of the stock repurchased by the covered corporation during the tax year. The excise tax payment is non-deductible for income tax purposes. The repurchase amount subject to the excise tax decreases by the value of any stock issued by the covered corporation during the tax year, including stock issued to the covered corporation's or a subsidiary's employees (the netting rule).

Section 4501 defines a "repurchase" as (1) a stock redemption under Section 317(b) (i.e., any acquisition of stock by a corporation from a shareholder in exchange for property, which, under Section 317(a), is almost anything other than stock of the corporation), or (2) any other economically similar transaction as determined by Treasury. The statute provides for the following exceptions:

  • A repurchase that is part of a Section 368(a) reorganization, and for which the shareholder did not recognize gain or loss (i.e., the exclusion appears to apply only to exempt reorganization exchanges for shareholders that only receive qualifying stock)

  • A contribution of repurchased stock or its equivalent value to an employee pension plan, employee stock ownership plan or similar plan

  • Total stock repurchases of US$1 million or less during the tax year

  • A repurchase by a securities dealer in the ordinary course of business

  • A repurchase by a regulated investment company (RIC) or real estate investment trust (REIT)

  • A repurchase that is treated as a dividend

The FMV of the repurchased stock resulting from one of the statutory exceptions listed previously is treated as a reduction from the covered corporation's stock repurchase excise tax base (explained later) (i.e., these repurchases are not subject to the excise tax).

The Notice

The Notice introduces a new term, the "stock repurchase excise tax base," which is the bottom-line value of stock repurchases that is multiplied by 1% to arrive at the stock repurchase excise tax. For purposes of the excise tax, the Notice essentially organizes transactions into three categories:

(1) Section 317(b) redemptions, which are generally treated as repurchases (with some exceptions)

(2) Economically similar transactions, which are generally treated as repurchases (except for Section 332 distributions in combined Section 331 and 332 liquidations)

(3) Transactions that are not economically similar, which are not treated as repurchases

Determining the stock repurchase excise tax base

The stock repurchase excise tax base is the conceptual underpinning of the excise tax, as outlined in the Notice. It begins with determining the aggregate FMV of all repurchases of the covered corporation stock by the covered corporation during the tax year, and then reducing that amount, first by statutory exceptions and then by other transactions that the Notice identifies as subject to the netting rule. Following adjustments, the remaining amount of the stock repurchase excise tax base is then multiplied by 1% to compute the stock repurchase excise tax.

A key term under the Notice is a "repurchase." The Notice defines a "repurchase" for purposes of the stock repurchase excise tax as (1) a redemption under Section 317(b), except as provided in the Notice; and (2) an "economically similar" transaction, except for a distribution to which Section 332 applies in a combined Sections 331 and 332 liquidation, as described in the Notice. An example illustrates that even preferred stock redemptions by a covered corporation are a repurchase, notwithstanding that such stock may not be publicly traded or may be mandatorily redeemed under terms established before the excise tax was enacted.

While Section 4501 addresses repurchases after 31 December 2022, the Notice acknowledges the role of a tax year. In particular, it notes that covered corporations whose tax year is not a calendar year may apply the netting rule to reduce the FMV of repurchases after 31 December 2022, by the FMV of stock issued during the entire the tax year, including the portion of the tax year that includes 2022.

Section 317(b) redemptions that are not repurchases

Section 317(b) treats the typical stock repurchase program as a redemption and thus a "repurchase." The Notice has an "exclusive list" of two types of transactions that are not repurchases, even though they may meet the technical definition of a redemption under Section 317(b): (1) brother-sister sales of controlled corporation stock (i.e., Section 304(a)(1) transactions) and (2) cash issued in lieu of a fractional share in certain corporate nonrecognition transactions.

Transactions that are economically similar to a Section 317(b) redemption

The Notice sets forth an exclusive list of transactions that are economically similar to a Section 317(b) redemption, and are generally repurchases:

  • Acquisitive Section 368 reorganizations (excluding a stock-for-stock reorganization under Section 368(a)(1)(B))

  • Single-company reorganizations under Section 368(a)(1)(E) and (F)

  • Split-offs under Section 355 (or so much of Section 356 as relates to Section 355)

  • Complete liquidations to which both Sections 331 and 332 apply

The Notice does not explicitly address other nonrecognition provisions that might apply — including in "overlap" scenarios — such as Section 351(a).

"Complete liquidations" are generally not economically similar to a repurchase. If a complete liquidation occurs in which both Sections 331 and 332 apply, however, then the Notice considers distributions to which Section 331 applies to be a repurchase under the Notice. Conversely, it does not consider distributions to which Section 332 applies to be a repurchase. This may occur when one or more minority shareholders own stock in the liquidating corporation in addition to a parent corporation that owns at least 80% of the liquidating corporation stock, in which case stock acquired by the covered corporation from the minority shareholders is treated as repurchased.

Transactions that are not economically similar to a Section 317(b) redemption

The Notice also contains a "nonexclusive" list of transactions that are not "economically similar" to a Section 317(b) redemption, and therefore not treated as a repurchase. First, the excise tax does not apply to complete liquidations of a corporation that are fully taxable under Section 331 or fully nontaxable under Section 332. Second, divisive transactions under Section 355 (other than "split-offs") are not economically similar to a repurchase. Thus, the Notice distinguishes between the form of a divisive transaction under Section 355: (1) a pro-rata spin-off under Section 355 is not economically similar to a Section 317(b) redemption, and is not treated as a repurchase, but (2) a split-off under Section 355 is economically similar to a Section 317(b) redemption and is treated as a repurchase (but might not be subject to the excise tax under the statutory exception, discussed later).

Nonrecognition transactions that are "repurchases" but whose value is reduced for "qualifying property"

While treating acquisitive reorganizations as certain single-entity reorganizations and split-offs as repurchases, the Notice allows the covered corporation's excise tax base to be "reduced" by the repurchased stock to the extent the repurchase is for property that may be received under Sections 354 or 355 (e.g., stock of the issuing/acquiring corporation under Section 354 or controlled corporation under Section 355). Thus, where no taxable "boot" is issued in either a reorganization or split-off, no excise tax would arise simply from the transaction, as the value of such transaction would be "zeroed out" by the reduction. Put another way, the presence of taxable boot in an acquisitive reorganization or Section 355 split-off will generally "count" toward the stock repurchase excise tax base, but the "qualifying property" stock portion is essentially backed out of the stock repurchase excise tax base.

Reductions for stock contributions to an employer-sponsored retirement plan and other reductions

The Notice also allows reductions in the FMV of repurchased stock for purposes of computing the covered corporation's stock repurchase excise tax base if the repurchased stock, "or an amount of stock equal to the [FMV] of the stock repurchased," is contributed to an employer-sponsored retirement plan. Special rules apply, for purposes of the reduction, when determining the value of these contributions, including stock contributions that differ in class from the repurchased stock. The rules also permit covered corporations to treat current-year contributions as having been made in the prior tax year if they are completed by the filing deadline for Form 720.

The Notice allows reductions for repurchases by a securities dealer in the ordinary course of business, repurchases by a RIC or REIT and repurchases treated as a dividend (which is subject to a rebuttable presumption of no dividend-equivalence).

The Notice also incorporates the netting rule, which reduces the stock repurchase excise tax base by the aggregate FMV of covered corporation stock issued or provided to employees of the covered corporation, or a specified affiliate or other persons during the covered corporation's tax year. The Notice provides methodologies for determining the timing and FMV of stock issued to an employee, generally as determined under Section 83, i.e., as of the date the stock is issued or provided to the employee. In addition, the Notice disregards certain issuances of stock (including the deemed issuance by the acquiring corporation in a Section 304(a)(1) transaction, issuances to a specified affiliate and issuances that are backed out of a covered corporation's stock repurchase excise tax base under the "qualified property" exception).

Foreign-parented groups

Along with rules regarding specified affiliate acquisitions of covered corporation stock, the Notice contains additional rules addressing certain acquisitions of foreign corporation stock. Consistent with the statute, if an "applicable specified affiliate" of an "applicable foreign corporation" — i.e., a domestic subsidiary of a publicly traded foreign corporation — acquires the applicable foreign corporation's stock from a person that is not the applicable foreign corporation or its specified affiliate, the Notice treats the acquisition as a repurchase by a covered corporation; in other words, the specified affiliate is treated as a covered corporation with regard to the acquisition.

The Notice introduces a "funding rule" that operates like an anti-avoidance rule. If a domestic subsidiary that is treated as an applicable specified affiliate "funds by any means (including through distributions, debt or capital contributions) the acquisition or repurchase" of an applicable foreign corporation's stock, the rule deems the affiliate to have acquired that stock where the funding "is undertaken for a principal purpose of avoiding the stock repurchase excise tax."

A "per se" rule treats the applicable specified affiliate as fulfilling this principal purpose if (1) it funds, "by any means, other than through distributions," the applicable foreign corporation or a specified affiliate; and (2) the "funded entity" acquires or repurchase stock within two years of the funding. Thus, distributions by an applicable specified affiliate to an applicable foreign corporation or affiliate within two years of a repurchase are not automatically subject to the funding rule but instead require a finding of "principal purpose." The Notice provides a special applicability date for this funding rule; i.e., the funding rule applies to a funding that occurs on or after 27 December 2022, the date the Notice was publicly released.

Special rules also apply to a "covered surrogate foreign corporation," i.e., certain surrogate foreign corporations within the meaning of Section 7874(a)(2)(B).

Compliance considerations                             

The Notice contemplates annual reporting on the quarterly excise tax return, i.e., Form 720. The Notice also contemplates a separate schedule to be attached to Form 720, which is due for the first full quarter following the end of the tax year (e.g., due by April 30 of the following year for a calendar-year taxpayer).

As far as calculating the excise tax, the Notice includes several guidelines. For example, the Notice provides valuation methodologies for determining an offsetting repurchase "reduction" for contributions to employer-sponsored retirement plans. It also provides timing rules, generally when ownership of stock transfers for income tax purposes (and for economically similar transactions, when a covered corporation's shareholders exchange their stock in the covered corporation or the covered surrogate foreign corporation).

Request for comments

The Notice requests comments on numerous topics, including, among other things, valuation methodologies, whether special rules should apply to the treatment of preferred stock or other special classes of stock or debt and whether the definition of employer-sponsored retirement plans should include plans other than qualified plans under Section 401(a).

Implications

The Notice offers something of a mixed bag for corporate taxpayers. Taxpayers will likely be pleased that outlier transactions such as brother-sister stock sales under Section 304 will not be treated as repurchases for excise tax purposes. Similarly, special purchase acquisition companies (SPACs) dissolving in 2023 or beyond — in addition to other dissolving covered corporations — will likely welcome the fact that they do not have to contend with an excise tax as they wind up, as the Notice generally deems complete liquidations not to be an economically similar transaction, and not a repurchase. Covered corporations with tax years that do not coincide with the calendar year will appreciate the Notice confirming that the netting rule may include certain stock issuances from the portion of 2022 that is included in their tax year.

On the other hand, some taxpayers may be surprised that the Notice treats certain transactions as repurchases. Of course, the typical ongoing stock repurchase program results in excise tax, to the extent not offset by issuances and reductions. But the Notice treats certain other redemptions as repurchases too — including, as noted, redemptions of preferred stock — if the issuer is otherwise a covered corporation. In addition, the Notice does not exempt a covered corporation that is acquired in a leveraged acquisition if some portion of the acquisition is treated as a redemption for income tax purposes, even if the acquired corporation will cease to be a covered corporation because its stock will no longer be publicly traded. Relatedly, it does not matter if the target in a leveraged buyout will cease to be a covered corporation; it will be subject to the excise tax to the extent it is treated as engaging in a redemption of its shareholders for income tax purposes.

Finally, the Notice portends significant recordkeeping and reporting obligations for many, if not most, covered corporations, including those that do not have an ongoing stock repurchase program. For example, a covered corporation that is acquired by another corporation in an acquisitive reorganization, e.g., 20% boot paid to exchanging target corporation shareholders, will be required to report and pay excise tax on the value of "repurchased" target corporation stock equal to the boot. Even acquisitive reorganizations with no boot will result in an annual reporting obligation, because such nonrecognition transactions are technically treated as repurchases, albeit repurchases that ultimately may result in no excise tax being owed because the "value" of the repurchase has been reduced under the "qualifying property" rules. As another example of compliance obligations, a company that does not expect to owe excise tax because of issuances or transfers to employer-sponsored retirement plans will still need to track and calculate the value of repurchase "reductions" using the valuation methodologies prescribed by the Notice.

In sum, the repurchase excise tax is going to affect significantly more companies — even if as a compliance matter — than those covered corporations with ongoing stock repurchase programs.

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For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP (United States), National Tax M&A Group – International Tax and Transaction Services

Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor

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Endnotes

  1. All “Section” references are to the Internal Revenue Code of 1986, and the regulations promulgated thereunder.
 
 

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