Tax

The Inflation Reduction Act of 2022 imposes a one percent excise tax (the “Excise Tax”) on the repurchase of corporate stock under Section 4501 of the Internal Revenue Code (“Section 4501” and the “Code”, respectively[1]) by a publicly traded U.S. corporation (a “covered corporation”) beginning after December 31, 2022. For purposes of the Excise Tax, the term covered corporation means any domestic corporation whose stock is traded on an established securities market (within the meaning of Section 7704(b)(1)). A covered corporation also includes any corporation that becomes a surrogate foreign corporation under Section 7874(a)(2)(B) after September 20, 2021.

On December 27, 2022, in Notice 2023-2 (the “Notice”), the Department of the Treasury and the IRS announced that they intend to issue proposed regulations addressing the application of the Excise Tax to repurchases of corporate stock. The Notice provides taxpayers with interim guidance until such regulations are published. The Notice contains (i) a summary of the underlying relevant law, (ii) certain operating rules and identifies transactions that are considered repurchases of stock for purposes of Section 4501, (iii) a description of anticipated rules for reporting and the payment of excise tax liability, (iv) rules regarding the timing and fair market value of repurchased stock, and (v) examples.

Section 4501(c)(1) states that repurchases of stock of a covered corporation to which the Excise Tax may apply include the following two types of transactions:

• Redemptions within the meaning of Section 317(b) with regard to the stock of a covered corporation (a “317(b) redemption”).
• Any transaction determined by the Secretary of the Treasury or her delegate to be economically similar to a 317(b) redemption.

As described further below, under the “Netting Rule”, the amount of stock repurchases subject to the Excise Tax for a taxable year is generally reduced by the fair market value of certain stock issued by the covered corporation in that taxable year. Stock issuances occurring in one taxable year will not qualify for the Netting Rule with respect to stock repurchases occurring in other taxable years.

Redemptions and economically similar transactions:

Certain 317(b) redemptions not treated as repurchases of corporate stock for purposes of the Excise Tax.

Section 4501 generally provides for the application of the Excise Tax to any 317(b) redemption. However, Section 3.04(3) of the Notice provides an exclusive list of transactions that are not treated as repurchases (and therefore not subject to the Excise Tax) despite being treated as 317(b) redemptions.

• Section 304(a)(1) transactions. If a corporation under common control with the issuing corporation acquires for property stock of the issuing corporation in a transaction subject to Section 304(a)(1), the deemed distribution in redemption of the issuer’s stock is not treated as a repurchase for purposes of the Excise Tax.
• Payments of cash by covered corporations in lieu of fractional shares. If a payment of cash is made as part of a reorganization that qualifies under Section 368(a) or as a distribution to which Section 355 applies (or pursuant to the settlement of an option or similar financial instrument) in lieu of fractional shares and certain conditions are satisfied, then the payment of cash in lieu of fractional shares is not treated as a repurchase for purposes of the Excise Tax.

Certain repurchases of corporate stock treated as economically similar to a 317(b) redemption for purposes of the Excise Tax:

Section 3.04(4) of the Notice, provides an exclusive list of repurchases that are treated as economically similar to a 317(b) redemption:

Acquisitive reorganizations (i.e., “A” reorganizations, “C” reorganizations, forward/reverse triangular mergers). In the case of an acquisition of a target corporation that is a covered corporation (or covered surrogate foreign corporation) in an acquisitive reorganization, the exchange by the target corporation’s shareholders of their target stock for reorganization consideration is considered a repurchase by the target corporation, and, subject to the Qualifying Property Exception, such repurchase is generally subject to the Excise Tax.

Weil Observation. Based on Examples 6 and 19 of the Notice, regardless of whether boot is included in any such acquisitive reorganization, the transaction will be considered economically similar to a 317(b) redemption. However, any resulting Excise Tax liability may be reduced or eliminated by virtue of the application of the Qualifying Property Exception, as described below. Boot paid in a Section 368 reorganization will not be covered by the Qualifying Property Exception but will not otherwise render the Qualifying Property Exception inapplicable.

Reorganizations under 368(a)(1)(E) (i.e., recapitalizations). In the case of a recapitalization of a covered corporation (or a covered surrogate foreign corporation) (each, a “recapitalizing corporation”) that qualifies as a reorganization under Section 368(a)(1)(E) (an “E reorganization”), an exchange by the recapitalizing corporation’s shareholders of their recapitalizing corporation stock is treated as a repurchase of stock by the recapitalizing corporation for purposes of the Excise Tax (but the Qualifying Property Exception will often reduce or eliminate any Excise Tax liability).

Reorganizations under 368(a)(1)(F). In the case of a transaction that qualifies as a reorganization under Section 368(a)(1)(F) (an “F reorganization”) in which the target corporation is a covered corporation (or a covered surrogate foreign corporation), the exchange by the target corporation’s shareholders of their target corporation stock as part of the F reorganization is treated as a repurchase by the target corporation for purposes of the Excise Tax (but the Qualifying Property Exception will often reduce or eliminate any Excise Tax liability).

Weil Observation. Based on Example 10 of the Notice, regardless of whether cash is received in an unrelated, separate transaction from the F reorganization, the F reorganization itself will nevertheless be considered economically similar to a 317(b) redemption. However, any resulting Excise Tax liability may be reduced or entirely eliminated through the application of the Qualifying Property Exception, as described below. Any cash paid, as in Example 10, will not be covered by the Qualifying Property Exception but will not otherwise render the Qualifying Property Exception inapplicable.

Split-offs. In the case of a split-off by a distributing corporation that is a covered corporation (or a covered surrogate foreign corporation), the exchange by the distributing corporation’s shareholders of their distributing corporation stock for controlled corporation stock and, if applicable, other property (including securities of the controlled corporation) or money, is treated as a repurchase by the distributing corporation for purposes of the Excise Tax (but the Qualifying Property Exception will typically reduce or eliminate any Excise Tax liability).

Weil Observation. The Notice does not specifically reference Section 355 in the context of split-offs for purposes of economically similar transactions but does refer to divisive transactions under Section 355 (other than split-offs) for purposes of not economically similar transactions, as discussed below.

Complete liquidations to which both Sections 331 and332 apply. In the case of a complete liquidation of a covered corporation (or a covered surrogate foreign corporation) to which both Sections 331 and 332(a) apply to component distributions of the complete liquidation, (A) each distribution to which Section 331 applies is a repurchase by the covered corporation (or the covered surrogate foreign corporation), and (B) the distribution to which Section 332(a) applies is not a repurchase by the covered corporation (or the covered surrogate foreign corporation). Such a transaction would occur, for example, if a liquidating domestic corporation had 20 percent or less of its stock widely held and publicly traded and 80 percent or more of its stock owned by a single domestic corporate shareholder.

Certain repurchases of corporate stock treated as not economically similar to a 317(b) redemption for purposes of the Excise Tax:

If a transaction is neither a 317(b) redemption nor economically similar to a 317(b) redemption, it will not be subject to the Excise Tax. Section 3.04(4)(b) of the Notice provides a nonexclusive list of transactions that are deemed not to be economically similar to a 317(b) redemption.

Complete liquidations. A distribution in complete liquidation of a covered corporation (or a covered surrogate foreign corporation) to which either Section 331 or Section 332(a) (but not both) applies is not a repurchase by the covered corporation (or the covered surrogate foreign corporation). If a covered corporation (or a covered surrogate foreign corporation) completely liquidates and dissolves (within the meaning of Treas. Reg. Section 1.331-1(d)(1)(ii)) during a taxable year (that is, there is a final distribution in complete liquidation to which Section 331 applies during that taxable year), no distribution by that covered corporation (or covered surrogate foreign corporation) during that taxable year is treated as a repurchase for purposes of the Excise Tax.

Weil Observation. It is unclear whether a dissolution of a special purpose acquisition company (a “SPAC”) is subject to the Excise Tax and the Netting Rule (as discussed herein) if the SPAC dissolution is not a Section 331 liquidation because holders of founders’ shares do not receive distributions (given that a Section 331 liquidation requires that each class of stock receive a distribution).

Divisive transactions under Section 355 (that are not split-offs). A distribution by a distributing corporation of stock of a controlled corporation, other than a split-off qualifying under Section 355, is not a repurchase for purposes of the Excise Tax. This includes a spin-off, whether or not a part of a D reorganization.

Importantly, the Netting Rule or Qualifying Property Exception (as applicable) effectively negate in many circumstances the treatment of the transactions described above as purchases.

Statutory exceptions

Section 3.07 of the Notice contains a list of certain statutory exceptions to the Excise Tax. These exceptions generally include the Qualifying Property Exception (as defined herein), stock repurchases to facilitate contributions to employer-sponsored retirement plans, repurchases by dealers in securities in the ordinary course of business, repurchases by a RIC or REIT, and repurchases treated as a dividend.

Qualifying Property Exception. For purposes of computing the covered corporation’s stock repurchase Excise Tax base, the fair market value of the stock repurchased by a covered corporation in a Qualifying Property Repurchase (as defined herein) is reduced to the extent that such repurchase is for property permitted by Sections 354 or 355 to be received without the recognition of gain or loss (the “Qualifying Property Exception”). Such repurchases include (i) a repurchase by a target corporation as part of an acquisitive reorganization; (ii) a repurchase by a covered corporation (or a covered surrogate foreign corporation) as part of an E reorganization; (iii) a repurchase by a transferor corporation as part of an F reorganization; and (iv) a repurchase by a distributing corporation as part of a split-off (whether or not part of a D reorganization) (each a “Qualifying Property Repurchase”).

Netting Rule

As mentioned earlier, under the Netting Rule, the amount of stock repurchases subject to the Excise Tax with regard to a taxable year of a covered corporation is reduced by the aggregate fair market value of stock of the covered corporation (i) issued or provided to employees of the covered corporation or employees of certain related parties during the covered corporation’s taxable year, and (ii) issued by the covered corporation to persons other than those described in clause (i) during the covered corporation’s taxable year.

Section 3.08(4) of the Notice provides an exclusive list of certain issuances that are disregarded for purposes of applying the Netting Rule. These issuances include, but are not limited to, distributions by a covered corporation of its own stock, stock issuances by a covered corporation to certain related parties, certain stock issuances to which the Qualifying Property Exception applies, deemed issuances pursuant to Section 304(a)(1), and issuances by a target corporation in transaction qualifying under Section 368(a)(2)(E).

Weil Observation. The Department of Treasury and the IRS in the Notice did not provide relief in the “double-dummy” or “up-C” context by expanding the Netting Rule to allow netting of redemptions of a covered corporation against new issuances by certain parties that are related to the covered corporation (such as a new holding company acquiring the covered corporation in a “double dummy” transaction).

Timing

Generally, stock is treated as repurchased either at the time the ownership of the stock transfers to the covered corporation (or applicable acquirer) or, for purposes of an economically similar transaction, at the time the shareholders of the covered corporation (or covered surrogate foreign corporation) exchange their stock in the covered corporation (or covered surrogate foreign corporation).

Examples

Several examples in the Notice shed light on other transactions that may or may not be subject to the Excise Tax. For example, leveraged buyouts or acquisitions partially funded by the target corporation generally would be expected to implicate the Excise Tax to the extent funded by the target because the target’s deemed repurchase of its shareholders’ stock with the debt proceeds is considered a 317(b) redemption.

Reporting

The Department of Treasury and the IRS anticipate that the forthcoming regulations will provide that the Excise Tax be reported on IRS Form 720. Although this is a quarterly form, the Department of Treasury and the IRS expect that the Excise Tax will be reported once per taxable year on the Form 720 that is due for the first full quarter after the close of the taxpayer’s taxable year. For example, a taxpayer with a taxable year ending on December 31, 2023, would report its Excise Tax on the Form 720 for the first quarter of 2024, due on April 30, 2024.

[1] Unless otherwise noted, section references herein are to the Internal Revenue Code of 1986, as amended.