Inflation Reduction Act imposes a nondeductible 1% excise tax on certain corporate stock buybacks

Kyle Colonna, Xenia Garofalo
Eversheds Sutherland (US) LLP
Contact
LinkedIn
Facebook
X
Send
Embed

Eversheds Sutherland (US) LLPOn August 16, 2022, President Biden signed the Inflation Reduction Act of 2022 (the IRA) into law. Among the provisions of the IRA is a nondeductible 1% excise tax on the repurchase of corporate stock (the Buyback Tax). The Buyback Tax is directly levied on repurchasing corporations, which means that corporations that currently have, or are considering, the adoption of stock buyback programs will need to include the Buyback Tax in the evaluation of the costs of any such program. Not all stock buybacks are covered by the tax, and there are a number of exceptions that may apply to limit the impact of the Buyback Tax, as discussed in more detail below. The Buyback Tax is effective for transactions occurring in taxable years after December 31, 2022.

The Buyback Tax

The Buyback Tax imposes on each “covered corporation” a nondeductible tax equal to 1% of the fair market value of any stock of the covered corporation which is repurchased by such corporation during taxable years after December 31, 2022, unless an exception applies.

Eversheds Sutherland Observation: Aside from an updated effective date, the provisions of the Buyback Tax generally are the same as the provisions of the excise tax on stock repurchases that was part of the Build Back Better Act (the BBBA). A notable difference between the excise tax on stock repurchases that was part of the BBBA and the Buyback Tax is the language in the provision regarding the adjustment for stock issued during the taxable year. In the BBBA version, the adjustment for stock issued during the taxable year solely included stock “issued” to employees of the covered corporation or a specified affiliate of such covered corporation. In the IRA version, the adjustment for stock issued during the taxable year not only included stock “issued” to employees of the covered corporation or a specified affiliate of such covered corporation, but also included stock “provided” to such employees. Accordingly, the IRA broadened the scope of the adjustment provision introduced by the BBBA.

Covered Corporation

A “covered corporation” is any domestic corporation the stock of which is traded on an “established securities market” as defined under applicable law, which generally includes a national securities exchange, which is officially recognized, sanctioned, or supervised by a governmental authority (and certain analogous foreign securities exchanges); regional or local exchanges; as well as an over-the-counter market.

Eversheds Sutherland Observation: The scope of the term “covered corporation” is particularly broad. For example, certain entities or arrangements that are treated as corporations for US federal tax purposes—such as publicly traded partnerships—could be covered corporations to the extent the interests of such entities are traded on an established securities market. In addition, unlike the IRA’s 15% alternative minimum tax, which is limited to corporations with over $1 billion of book income, the Buyback Tax applies to any corporation with stock repurchases that exceed $1 million in a taxable year.

Notably, because the Buyback Tax is an excise tax, it will apply at a flat 1% rate to an applicable stock repurchase, regardless of whether the covered corporation has generated income for the taxable year.

Repurchase

A “repurchase” is (1) a redemption within the meaning of applicable law with regard to the stock of a covered corporation and (2) any transaction determined by the Secretary of the Treasury to be economically similar to a redemption under applicable law. In particular, stock is treated as redeemed by a corporation if the corporation acquires its stock from a shareholder in exchange for property—including money, securities, and any other property, but excluding stock in the corporation making the distribution (or rights to acquire such stock)—regardless of whether the stock so acquired is cancelled, retired, or held as treasury stock.

Eversheds Sutherland Observation: The scope of the term “repurchase” also is broad by virtue of defining repurchase as a redemption within the meaning of applicable law. For example, a repurchase can occur:

  • regardless of whether the transaction was effectuated pursuant to a formal share buyback program;
  • in connection with a bootstrap acquisition whereby the target corporation distributes some of its assets to its shareholders in exchange for their target corporation stock; and 
  • in connection with a leveraged buyout whereby the target corporation is treated as distributing cash (i.e., loan proceeds) to its shareholders in exchange for their stock.

In addition, a repurchase can be deemed to occur for US federal income tax purposes as a result of the application of the step transaction doctrine to a series of transactions that are integrated and treated as a redemption. These step transactions also may be covered by Treasury Regulations issued under the grant of authority to Treasury to include transactions economically similar to a redemption in transactions covered by the Buyback Tax.

Acquisitions by Specified Affiliates. In addition to direct repurchases made by a covered corporation of its own stock, if a “specified affiliate” of a covered corporation acquires the stock of the covered corporation from a person who is neither the covered corporation nor a specified affiliate of such covered corporation, then the Buyback Tax treats the acquisition by the specified affiliate as a stock repurchase of the covered corporation by such covered corporation. For this purpose, a “specified affiliate” of a corporation is (1) another corporation more than 50% of the stock of which is owned (by vote or value), directly or indirectly, by such corporation, and (2) any partnership more than 50% of the capital interests or profits interests of which is held, directly or indirectly, by such corporation. 

Eversheds Sutherland Observation: The scope of the Buyback Tax with respect to specified affiliates is limited to acquisitions of stock of a covered corporation by a specified affiliate of such covered corporation from an unrelated person. In addition, in determining whether an entity is a specified affiliate, although the Buyback Tax expressly refers to indirect ownership, there is no explicit reference to the constructive ownership rules of section 318.1 Accordingly, solely based on the language of the Buyback Tax, transactions between specified affiliates of the same covered corporation—including members of the same consolidated group—do not appear to be subject to these rules. It is possible that guidance from Treasury and the IRS will incorporate the application of the constructive ownership rules as it relates to interpreting the references to “indirect” ownership of stock in the statute.

Adjustments. The amount of repurchases by a covered corporation subject to the Buyback Tax is reduced by the fair market value of any stock issued by the covered corporation during the taxable year, including the fair market value of any stock issued or provided to employees of a specified affiliate of such covered corporation during the taxable year, regardless of whether such stock is issued or provided in response to the exercise of an option to purchase such stock (the Adjustment).

Eversheds Sutherland Observation: For companies that routinely perform stock buybacks in order to minimize the dilution effect of equity compensation, this rule should help mitigate the overall impact of the Buyback Tax. However, fluctuations in value between the time the stock is purchased and the time the stock is issued or provided to employees could still result in liability under the Buyback Tax. 

Notably, issuing additional stock generally has the effect of devaluing the stock on a share-by-share basis. Stock buybacks, however, generally have the effect of increasing the value of stock on a share-by-share basis. A business objective of companies generally is to maximize stock value. Therefore, the Buyback Tax appears to create an inverse relationship between mitigating the impact of the Buyback Tax by virtue of issuing additional stock versus maximizing stock value on a share-by-share basis.

Exceptions

Although the scope of the Buyback Tax is broad, the Buyback Tax has six important exceptions that, if applicable, prevent the Buyback Tax from applying to a stock repurchase. In particular, the Buyback Tax does not apply to a stock repurchase:

  • that occurs in connection with a tax-free reorganization;
Eversheds Sutherland Observation: If stock of a corporation that is directly wholly owned by a distributing corporation is distributed to its shareholders in exchange for such shareholders’ stock in a split-off transaction, the Buyback Tax appears to apply because there is no exception for distributions in split-off transactions that are not effectuated in connection with a tax-free reorganization.
  • in which the stock repurchased is contributed to employee-sponsored retirement plans, employee stock ownership plans, or similar plans;
  • by a US regulated investment company or a US real estate investment trust;
  • to the extent the total value of the stock repurchased by a covered corporation during the taxable year does not exceed $1 million;
  • to the extent such stock repurchase is treated as a dividend for US federal income tax purposes; and
Eversheds Sutherland Observation: The determination of whether a stock repurchase is treated as a dividend for US federal income tax purposes is made at the shareholder level. In many instances, the covered corporation will not possess the requisite information to ascertain whether a stock repurchase should be treated as a dividend with respect to a particular shareholder, which assures there will be administrative complexity in applying this exception.
  • in certain cases in which the stock repurchase is by a dealer in securities in the ordinary course of business.
Eversheds Sutherland Observation: There does not appear to be an exception that applies specifically to corporations that are financially distressed or in bankruptcy. Although it is possible to qualify for an exception to the extent there is a tax-free reorganization as a result of a transfer by a corporation of all or part of its assets to another corporation in a title 11 or similar case, such reorganizations are merely one of the many structuring options that corporations which are financially distressed or in bankruptcy can use.

Buybacks Involving Foreign Corporations

Acquisitions by Specified Affiliates. The Buyback Tax includes rules that apply to the acquisition of stock of a publicly traded foreign corporation by its US subsidiary from an unrelated party. Specifically, if a specified affiliate of an “applicable foreign corporation” acquires the stock of such foreign corporation from a person who is neither the foreign corporation nor another specified affiliate of such foreign corporation, then (1) the specified affiliate is treated as a covered corporation, (2) the acquisition is treated as a repurchase of the stock of the covered corporation by such covered corporation, and (3) the Adjustment is determined only with respect to stock issued or provided by such specified affiliate to employees of such specified affiliate. For this purpose, an “applicable foreign corporation” is any foreign corporation the stock of which is traded on an established securities market, as described above.

Eversheds Sutherland Observation: Similar to the specified affiliate rules discussed above with respect to covered corporations, the acquisition of applicable foreign corporation stock must be from an unrelated person. Notably, because a specified affiliate 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), if a wholly owned foreign corporation of an applicable foreign corporation acquires the stock of such applicable foreign corporation from another specified affiliate of such applicable foreign corporation, the Buyback Tax does not apply. Interestingly, these rules seem to contemplate transactions that create “hook stock”—i.e., stock in a parent that is owned by a subsidiary. Hook stock creates additional layers of complexity from a tax, corporate, and foreign law perspective, and many taxpayers try to avoid the imposition of hook stock in their organizational structures. Outside of the context of transactions between unrelated parties, these rules seem to have limited significance.

Unlike the specified affiliate rules discussed above with respect to covered corporations, the Buyback Tax as applied in the context of applicable foreign corporations would apply to the specified affiliate itself—not the foreign parent. This disparate treatment makes sense from a policy and compliance perspective because the US government generally has taxing authority over the US subsidiaries, rather than foreign corporations.

Covered Surrogate Foreign Corporations and Section 7874. The Buyback Tax contains rules that apply to US corporations that have entered into or will enter into an inversion transaction after September 20, 2021. In general, an inversion transaction that is subject to the rules of section 7874 occurs when a foreign corporation (FC) acquires the stock or assets of a US corporation (USC), and (1) if at least 60% of the stock of FC is owned, following the acquisition, by the former shareholders of USC by reason of their previous ownership of USC, and (2) the corporate group controlled by FC following the acquisition does not have business activities in FC’s country of incorporation that are substantial when compared to the total business activities of the group from a worldwide perspective. For purposes of the Buyback Tax, FC—provided that FC’s stock is traded on an established securities market for the applicable period—would be a “covered surrogate foreign corporation” and USC would be an “expatriated entity” with respect to FC.

Under the Buyback Tax, if publicly traded FC (a covered surrogate foreign corporation) repurchases its own stock, or a specified affiliate of FC acquires the stock of FC, then (1) USC (the expatriated entity with respect to FC) is treated as a covered corporation with respect to the repurchase or acquisition, (2) the repurchase or acquisition is treated as a repurchase of stock of a covered corporation by such covered corporation, and (3) the Adjustment is determined only with respect to the stock issued or provided by USC to employees of USC.

Eversheds Sutherland Observation: By reason of applying the Buyback Tax to covered surrogate foreign corporations, Congress further reduces the benefits of entering into an inversion transaction.

The Buyback Tax as applied in the context of covered surrogate foreign corporations would apply to the expatriated entity itself—not the foreign parent. As noted above, this treatment makes sense from a policy and compliance perspective because the US government generally has taxing authority over the US company.

Treasury Regulations

The Buyback Tax tasks Treasury and the IRS with issuing Treasury Regulations as necessary or appropriate to carry out and prevent the avoidance of the purposes of the Buyback Tax. Congress specifically mentioned the promulgation of Treasury Regulations to (1) prevent the abuse of the Buyback Tax exceptions, (2) address special classes of stock and preferred stock, and (3) regarding the application of the Buyback Tax to foreign corporations.

Eversheds Sutherland Observation: The plain language of the Buyback Tax states that the 1% tax is imposed on each covered corporation in an amount equal to the fair market value of “any stock” of the covered corporation which is repurchased by such corporation during the taxable year. Thus, the Buyback Tax applies to the repurchase of any stock of a covered corporation, regardless of whether such stock is traded on an established securities market. For example, if a covered corporation has two classes of stock, one class of which is traded on an established securities market and the other class of which is not (Class B), and the covered corporation executes a repurchase of the outstanding Class B stock, the Buyback Tax seemingly applies to such repurchase because the Buyback Tax applies to a repurchase of “any stock” of a covered corporation during the taxable year. Until Treasury and the IRS issue Treasury Regulations or other guidance addressing covered corporations with multiple classes of stock, some of which are traded on an established securities exchange and others which are not, the plain language of the Buyback Tax appears to apply to repurchases of all stock of a covered corporation.
___________

1. All section references herein are to the Internal Revenue Code of 1986, as amended (the Code), or the Treasury Regulations promulgated thereunder, unless otherwise indicated.

[View source.]

Send Print Report

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Eversheds Sutherland (US) LLP | Attorney Advertising

Written by:

Eversheds Sutherland (US) LLP
Eversheds Sutherland (US) LLP
Contact
more
less

Eversheds Sutherland (US) LLP on:

Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign Up Log in
*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
- hide
- hide