Tax

I. Introduction

On August 7, 2022, the U.S. Senate passed legislation (H.R. 5376) that includes significant tax law changes (the Inflation Reduction Act or the Act). The Inflation Reduction Act is a reconciliation bill; all 50 Senate Democrats voted for the legislation and all 50 Senate Republicans voted against it, with Vice President Harris casting the tie-breaking vote in favor of the Act.

As noted above, the Inflation Reduction Act includes several tax revenue raising provisions, although the Act is significantly smaller than the reconciliation bill passed in November 2021 by the U.S. House of Representatives (the House), known as the “Build Back Better Act.” The House passed the Inflation Reduction Act on Friday, August 12, on a 220-207 partisan vote. President Biden signed the Act into law on August 16, 2022.

A selection of the most significant provisions of the Inflation Reduction Act are discussed below.

II. Excise Tax on Stock Repurchases

A. Description of the Law

The Act introduces a new 1% excise tax on the fair market value of stock “repurchased” by publicly traded U.S. corporations. For purposes of this excise tax, a “repurchase” is defined broadly and covers transactions beyond the traditional, open-market stock buybacks. More specifically, the term “repurchase” generally means a “redemption” within the meaning of Section 317(b)¹ and essentially includes any transaction where the corporation acquires its stock from a shareholder in exchange for property (including cash) other than the corporation’s own stock or rights to acquire its own stock. The Act also gives the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) authority to determine “economically similar” transactions that should be covered by the excise tax.

There are, however, several exceptions to the application of this new tax. These include: (i) repurchases by real estate investment trusts and regulated investment companies; (ii) repurchases treated as dividends; (iii) repurchased stock that is contributed to an employee pension fund, ESOP or similar plan; (iv) repurchases that are part of a tax-free reorganization, provided the shareholder does not recognize any gain or loss by reason of such reorganization; (v) repurchases where the total value of the stock repurchased during the tax year does not exceed $1 million; and (vi) repurchases by dealers of securities in the ordinary course of business under regulations to be issued by Treasury and the IRS.

Additionally, the excise tax is subject to a netting rule, under which the amount subject to the excise tax is reduced by the fair market value of any stock issued by the corporation during the taxable year of the applicable repurchase transaction.

Although the excise tax primarily applies to U.S. corporations, certain publicly-traded foreign corporations may also be subject to such tax. Specifically, the excise tax would apply to repurchases by foreign corporations if they are “surrogate foreign corporations” after September 20, 2021.

Broadly speaking, under Section 7874, a “surrogate foreign corporation” is a foreign corporation that directly or indirectly acquires substantially all of the assets of a domestic corporation or partnership if the former shareholders or partners, as the case may be, own at least 60% of the stock of such foreign corporation, as determined subject to certain exceptions and special rules.

The excise tax applies to repurchases after December 31, 2022, even if the repurchase occurs as part of an already authorized stock repurchase plan or deal signed, but not closed, before January 1, 2023.

B. Weil Observations

The excise tax has broad application and covers many types of financing and M&A transactions in addition to all forms of stock buybacks. Potential transactions subject to the excise tax include transactions involving (i) redeemable preferred stock; (ii) reorganizations with cash or other boot; (iii) redemptions in connection with de-SPAC transactions; (iv) taxable and certain tax-free split-offs; (v) certain acquisition transactions, including leveraged buy-out transactions, in which cash is sourced or funded out of cash of the target corporations or debt proceeds that the target corporation assumes; (vi) partial liquidations and liquidations that do not qualify under Section 332; (vii) forward mergers with cash; (viii) certain Section 304 transactions; and (ix) exercise of dissenter rights and cash in lieu of fractional shares.

It is also unclear what effect the excise tax will have on return of capital strategies and whether it would alter stock buy-back activity. Will companies substitute buy-backs with dividends? Will they reinvest the buy-back funds organically? Will the excise tax even matter? What is clear, however, is that the excise tax is another cost that needs to be considered by companies undergoing affected transactions and strategies.

III. Corporate Alternative Minimum Tax

A. Description of the Law

The Act introduces a new 15% corporate alternative minimum tax (the Corporate AMT) on the “adjusted financial statement income” (AFSI) of an “applicable corporation.” Generally, an “applicable corporation” is any corporation or group of corporations treated as a single employer (other than any real estate investment trust, regulated investment company or S corporation) whose average annual AFSI in the three tax years ending prior to the current taxable year and after December 31, 2021, exceeds $1 billion. The $1 billion threshold is reduced to $100 million for corporations that are part of a foreign-parented multinational group with AFSI exceeding $1 billion. Once a corporation is treated as an applicable corporation, it will remain an applicable corporation for all future years, absent certain limited exceptions.

Generally, the AFSI calculation starts with the net income or loss reported in the corporation’s “applicable financial statement,” which is defined by reference to Section 451(b)(3) and would generally include financial statements prepared under GAAP or IFRS and reported to a governmental agency. The Act includes various provisions that adjust AFSI, including by allowing the use of tax depreciation (rather than financial statement depreciation), financial statement net operating loss carryovers, and foreign tax credits and general business credits (but not foreign taxes paid) to reduce AFSI and excluding amortizable goodwill (with a limited exception) and stock compensation expenses. The Act also includes special provisions addressing income and losses of foreign subsidiaries (including controlled foreign corporations) and income and losses earned through partnerships.

Treasury and the IRS are provided with broad authority to write regulations addressing adjustments to AFSI.

B. Weil Observations

By using financial statement income to calculate a corporation’s tax liability, the Corporate AMT represents a departure from existing U.S. tax rules. Accordingly, there are some ambiguities with respect to how to calculate the Corporate AMT. For example, the Corporate AMT does take a country-by-country approach, such that high tax foreign tax credits may be available to taxpayers to lower AFSI. Additionally, it seems that AFSI may be reduced by interest expense. Less clear is the effect of defining “applicable financial statement” by reference to Section 451, which generally provides rules for taxing income no later than when it is included for financial statement purposes. Finally, although the Corporate AMT rules seem to make clear that applicable corporations include dividends from subsidiaries only to the extent that they are not consolidated for tax purposes (with special rules for subsidiaries that are controlled foreign corporations), it is unclear if AFSI includes some portion of the income of a financial statement-consolidated (but not tax-consolidated) subsidiary. We expect Treasury and the IRS to work to promptly issue guidance clarifying certain aspects of the application of the Corporate AMT, including the rules related to the calculation of AFSI.

IV. Increase in IRS Resources

A. Description of the Law

The Act increases IRS funding by $76.6 billion, including approximately $46.6 billion for tax enforcement activities, $25.3 billion for operations support, $4.75 billion for upgrading technology and business systems services, and $3.2 billion for taxpayers services. These additional funds would be disbursed over 10 years, during which the Congressional Budget Office estimates the increases in funding for enforcement activities will bring in nearly $204 billion in lost revenues. The IRS Commissioner stated the additional funding for enforcement activities will focus on large corporations and global high-net worth taxpayers.

B. Weil Observations

The stated reason for the funding boost is to help the IRS operationally, which has had staffing shortages and funding cuts in the past. The ultimate impact of this increase in resources is unclear.

V. Climate Change Related Provisions

A. Description of the Law

The Act includes many of the same, or similar, incentives for clean energy investments that were proposed in the Build Back Better Act. These incentives include (i) a new annual production tax credit for “qualified clean hydrogen” produced and sold after December 31, 2022, (ii) an expansion of existing tax credits to promote carbon capture, use and sequestration projects, (iii) removing the investment tax credit and production tax credit sunset for renewable energy facilities placed in service after 2021, and extending the eligibility of these credits for solar and wind facilities (onshore and offshore) that begin construction before 2034, (iv) expanding the investment tax credit to stand-alone energy storage facilities, (v) the provision of certain credits for clean technology manufacturing facilities, (vi) making certain credits refundable for tax years, and (vii) providing credits for purchases of new and used electric vehicles, as well as revising the mechanisms for eligibility for such credits.

B. Weil Observations

These changes were generally applauded by the green technology industry. However, the new provisions are complicated and will require Treasury and the IRS to issue guidance incorporating these changes with existing provisions and developing the necessary compliance protocols.