August 1, 2022

Back from the dead: Corporate minimum tax resurfaces at eleventh hour in Inflation Reduction Act of 2022

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Eversheds Sutherland (US) LLP

On July 27, 2022, the Senate announced agreement on a reconciliation package entitled the Inflation Reduction Act of 2022 (the IRA), the artist formerly known as the Build Back Better Act (the BBBA). Although months ago the $2 trillion BBBA was declared dead, Senators Joe Manchin and Chuck Schumer introduced the skinnied-down $739 billion proposal Wednesday, with its submission to the Senate Parliamentarian Wednesday evening and floor debate hopeful for next week. Among many revenue raisers, the IRA includes the 15% corporate minimum tax, prescription drug pricing reform, increased IRS tax enforcement and changes to the treatment of carried interest income. The initial proposal outlays a significant amount of such revenue to energy provisions to address the climate crisis as well as extending a number of Affordable Care Act health premium subsidies.

This alert provides a high-level overview of the corporate minimum tax as presented in this first cut of the IRA with preliminary observations and potential implications. However, details regarding operation of the corporate minimum tax are being discussed. For example, there is consideration of specific income that will be included in the financial statement income test and items for which credits will be allowed that would reduce such income. Moreover, questions are being addressed regarding the application of the corporate minimum tax to certain structures taking into account foreign entities as well as consolidated entities. Resolution of these issues will impact ultimate application of the corporate minimum tax.

Overview:

Section 10101 of the IRA imposes a 15% minimum tax on the adjusted financial statement income of corporations with profits in excess of $1 billion. Corporations would generally be eligible to claim net operating losses and tax credits against the minimum tax, and would be eligible to claim a tax credit against the regular corporate tax for minimum tax paid in prior years, to the extent the regular tax liability in any year exceeds 15% of the corporation’s adjusted financial statement income. The provision would be effective for taxable years beginning after December 31, 2022.

Eversheds Sutherland Observation: The corporate minimum tax is likely to face some of the same concerns that were raised following the Tax Cuts and Jobs Act’s enactment of Section 451(b), which aligns income recognition for Federal income tax purposes with revenue recognition for financial accounting purposes. Due to the disparate purposes of financial accounting (accurate reporting of information to creditors, shareholders and the financial markets) and tax accounting (equitable collection of revenue), relying on financial accounting information for tax purposes has not always been respected by the courts. For example, the United States Supreme Court found in Thor Power Tool Co. v. Commissioner, 439 US 522, 542-43 (1979) “[g]iven this diversity, even contrariety, of objectives, any presumptive equivalency between tax and financial accounting would be unacceptable.” Nonetheless, Congress has attempted to align financial statement and taxable income previously, as was the case from 1987-1989 with the business untaxed reported profits (BURP) tax. The BURP adjustment began to have a “detrimental effect on the quality of financial reporting” as noted by the Acting Assistant Secretary of Tax Policy John Wilkins in testimony before the Ways and Means Committee prior to the repeal of the BURP in 1989. For this reason, it will be important to consider adjustments that can be made to the proposal to minimize possible distortions between taxable income and financial statement revenue. There are a myriad of temporary differences (e.g., bad debt reserves, accrued employee bonuses, differences in book vs. tax depreciation and amortization) as well as permanent differences (e.g., 50% disallowance for meals, stock issuance costs, tax-exempt interest income, non-deductible fines and penalties), that exist between taxable income and financial statement revenue that hopefully will be considered as finishing touches are made to the proposed legislation. Beyond the potentially distortive impact that temporary and permanent differences present, frequently-used footnotes and supplemental corporate disclosures that may be material to taxpayer’s financial statements will be additionally complicating factors in drafting further guidance to effectuate this new tax.

As with most recent tax legislation, the devil will be in the details regarding the true impact of this new corporate minimum tax. For example, while headlines indicate the corporate minimum tax applies to corporations with an average annual adjusted financial statement income exceeding $1 billion, that threshold may not be as high for certain foreign-parented corporations. Solely for purposes of determining whether a corporation meets the average annual adjusted financial statement income test, in the case of any corporation which for any taxable year is a member of an international financial reporting group, such corporation includes in the adjusted financial statement income of such corporation for the taxable year the adjusted financial income of all foreign members of the group. Provided the foreign-parented group’s average annual adjusted financial statement income exceeds $1 billion, and the average annual adjusted financial statement income of the foreign-parented corporation by itself exceeds $100 million, then the corporate minimum tax applies.

Eversheds Sutherland Observation: This is an important clarification that bears noting, particularly for foreign-parented corporations, which by themselves may not approach the $1 billion threshold. To the extent that average annual adjusted financial statement income alone exceeds $100 million, and the foreign group’s average annual adjusted financial statement income exceeds $1 billion, the minimum corporate tax will apply. Consequently, foreign-parented corporations that are members of foreign groups with significant annual financial statement income, far exceeding their own, should carefully review the IRA’s final language to fully understand the applicability of the minimum corporate tax.

Additionally, to the extent a corporation has been in existence for less than three taxable years, the corporate minimum tax, as currently envisioned, applies the average annual adjusted financial statement income test on the basis of the period during which the corporation has been in existence. Further, for any taxable year of less than 12 months, adjusted financial statement income is required to be annualized. A corporation with less than three taxable years of history may find the financial statement income test produces unexpected results.

Eversheds Sutherland Observation: Due to this annualization provision as well as the application of the average annual adjusted financial statement income test to applicable corporations in existence for less than three taxable years, it will be important for companies that regularly complete mergers, acquisitions, dispositions, and reorganizations, to apply these nuanced provisions carefully to ensure whether an entity that may not have been in existence for the three-taxable year period is liable for the minimum corporate tax. Further, any short taxable years that are a product of such transactions need to be accurately considered in the minimum corporate tax calculation.

Eversheds Sutherland Observation: In addition, whether applying consolidated return principles to the calculation of adjusted financial statement income or the treatment of partnerships and consideration of certain items of foreign income, it will be important to thoroughly review the final version of the minimum corporate tax enacted. Further, the potentially taxpayer-favorable deduction for financial statement net operating losses as well as consideration of the corporate AMT foreign tax credit will bear close scrutiny. It is in these clarifying provisions and exceptions to the general rule where significant change can be anticipated between now and enactment.

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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.