The recently-enacted Inflation Reduction Act of 2022 includes a new, non-deductible, 1% excise tax on “repurchases” of the stock of “covered corporations” which occur after December 31, 2022.
- A “covered corporation” generally is a domestic corporation the stock of which is traded on an established securities market (within the meaning of IRC Section 7704(b)(1)).
- A “repurchase” is defined as a redemption (within the meaning of IRC Section 317(b)) of stock of the covered corporation and any other transaction determined by the Secretary of the Treasury to be economically similar to such a redemption. IRC Section 317(b) defines a redemption as an acquisition by a corporation of its stock from a shareholder in exchange for cash or other property (other than stock, or rights to acquire stock, of the corporation). For this purpose, a redemption and, thus, repurchase, clearly would include open market repurchases, other ordinary stock buybacks, and any other acquisition of stock by the issuing corporation from its shareholders in exchange for property. As discussed below, though, its scope is potentially materially broader than this.
- Repurchases include not only stock acquisitions by the covered corporation itself, but also stock acquisitions by “specified affiliates” of the covered corporation. A “specified affiliate” includes any corporation more than 50% of whose stock is owned (by vote or value), or any partnership more than 50% of the capital or profits interests of which is held, directly or indirectly by the covered corporation.
- Similar rules would apply to repurchases of stock (i) of a publicly-traded foreign corporation by certain specified affiliates of such foreign corporation and (ii) by certain foreign corporations that have engaged in material acquisitions of U.S. businesses on or after September 20, 2021 and are treated as “surrogate foreign corporations” under the U.S. “anti-inversion” rules or their specified affiliates.
The 1% excise tax generally applies to the fair market value of the stock that is repurchased during the taxable year. However, a netting concept applies whereby the fair market value of the stock deemed repurchased is reduced by the fair market value of any stock issued by the covered corporation during the taxable year, including stock issued to employees (whether pursuant to compensatory grants, exercise of stock options or otherwise). Moreover, the following transactions are specifically excepted from the 1% excise tax: (i) a repurchase by a REIT or a regulated investment company; (ii) a repurchase that is part of a reorganization (within the meaning of IRC Section 368(a)) in which no gain or loss is recognized on such repurchase by the shareholder by reason of such reorganization; (iii) any repurchase in cases where the total value of the stock of the covered corporation which is repurchased during the taxable year does not exceed $1,000,000; (iv) a repurchase that is treated as a dividend for tax purposes; and (v) a repurchase in cases where the stock repurchased is, or an amount of stock equal to the value of the stock repurchased is, contributed to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan.
Notwithstanding the foregoing exceptions, the potential transactions to which the 1% excise tax applies could, based on the literal language of the statute, be quite broad and would appear to include certain transactions that do not appear to be stock buybacks in the traditional sense or raise the same policy issues implicated by traditional stock buybacks. Such transactions potentially include the following:
- Redemptions and buy-backs of a covered corporation’s non-publicly traded stock, such as closely-held preferred stock. In particular, the language in the statute appears to include repurchases of any stock of publicly-traded corporations, regardless of whether the particular class of stock being redeemed is publicly traded.
- Split-offs that are wholly tax-free, but technically are not part of a reorganization (within the meaning of IRC Section 368(a)).
- Mergers and asset transfers that constitute reorganizations described in IRC Section 368(a) where some amount of taxable cash or other boot is paid to the target shareholders (in addition to stock of the acquiring corporation or its parent company).
- Cash paid for fractional shares or upon satisfaction of dissenters' rights in a merger or other reorganization described in IRC Section 368(a).
- Taxable acquisitions of stock of a target covered corporation by an unrelated party where part of the consideration for the acquisition is funded with existing cash of, or from borrowings by or pushed down to, the target corporation (e.g., through an LBO or similar structure).
- Redemptions of SPAC shareholders in connection with de-SPAC transactions in which a SPAC acquires the business of a target company (to the extent the value of the stock redeemed exceeds the stock issued in connection with the transaction or otherwise during the taxable year).
- Distributions upon complete or partial liquidation of a covered corporation.
We will provide further updates on the 1% excise tax as guidance is issued by Treasury and the IRS. In the meantime, Baker Botts would be pleased to assist you in your analysis of this tax, as well as on other provisions of the Inflation Reduction Act.
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