Key takeaways

• "Repurchase" is broadly defined for purposes of imposing the excise tax − care should be taken in any transaction where stock of a publicly traded corporation is redeemed or purchased by an affiliate of the public corporation.
• The excise tax generally applies to SPAC redemptions and to redemptions of nonpublicly traded stock (such as preferred stock issued in a private issuance by a public company), although an exemption for redemptions made in a taxable year where the redeeming corporation liquidates will limit the imposition of the excise tax on certain redemptions.
• Tax-free reorganization acquisition structures benefit from a statutory exemption from the excise tax to the extent the reorganization provisions prevent the recognition of gain or loss.
• Additional diligence is needed when acquiring companies to confirm compliance with the excise tax.
• The excise tax provides another reason to consider foreign holding companies for private acquisitions where the expected exit is an IPO.

In more detail

Background

On 10 September 2021, Senator Sherrod Brown (D-OH) and Senate Finance Committee Chairman Ron Wyden (D-OR) released the Stock Buyback Accountability Act, which proposed to impose a 2% excise tax on the amount spent by a publicly traded company on buying back its own stock. A modified version of the Stock Buyback Accountability Act was incorporated into the IRA in the form of Code section 4501.

Code section 4501 imposes a 1% excise tax on a publicly traded US corporation ("covered corporation") for the value of any of its stock that is repurchased by the corporation or by a more than 50% owned subsidiary or partnership of the corporation ("specified affiliate") during the taxable year. The term "repurchase" means a redemption of stock under section 317(b) with regard to a covered corporation, an acquisition of covered corporation stock by a specified affiliate from someone other than the covered corporation or a specified affiliate, and any other economically similar transaction as determined by the Secretary of the Treasury. A redemption under section 317(b) includes any acquisition by a corporation of its stock in exchange for any property other than its stock or rights to acquire its stock.

Further, the acquisition of stock of a foreign publicly traded corporation by a domestic specified affiliate of the foreign corporation from unrelated shareholders (generally, a US corporate subsidiary of the foreign public corporation purchasing publicly traded stock) is treated as a repurchase of covered corporation stock by a covered corporation. 

On 27 December 2022, Treasury issued initial guidance (Notice 2023-2) clarifying some details on the scope of the excise tax and how it would be applied. Treasury announced that it intends to issue proposed regulations and is soliciting comments from the public over the 60 days following publication of Notice 2023-2 (an actual date may be ascertained upon publication in the Internal Revenue Bulletin) on issues that taxpayers feel are unclear or that should be further addressed in those regulations. Until then, taxpayers may rely on the rules provided in Notice 2023-2.

Definition of Stock

Under Notice 2023-2, stock means "any instrument issued by a corporation that is stock or that is treated as stock for US federal income tax purposes at the time of issuance, regardless of whether the instrument is traded on an established securities market."

Observation: Though the excise tax applies only to a publicly traded corporation or certain affiliates, Notice 2023-2 clarifies that the excise tax applies to repurchases of any stock of such a corporation, including a class of stock that is not publicly traded. Thus, for example, nonpublicly traded preferred stock with a redemption/repurchase feature is ostensibly within the excise tax’s scope.

Scope

Notice 2023-2 provides that the excise tax, which is not a deductible expense for US federal income tax purposes, will apply to all section 317(b) redemptions (an acquisition of stock from a shareholder in exchange for property) except for deemed redemptions in section 304(a)(1) transactions and certain payments of cash in lieu of fractional shares.

It also provides an exclusive list (see below) of economically similar transactions that could trigger an excise tax liability. Whether or not an excise tax liability is triggered depends on to what extent, if any, a statutory exemption applies to the transaction. The following are exempt:

• In an acquisitive reorganization under sections 368(a)(1)(A), 368(a)(1)(C), or 368(a)(1)(D), the exchange by target corporation shareholders of their target corporation stock.
• In a reorganization under section 368(a)(1)(E), the exchange by the recapitalizing corporation shareholders of their recapitalizing corporation stock.
• In a reorganization under section 368(a)(1)(F), the exchange by the transferor corporation shareholders of their transferor corporation stock.
• In a “split-off” that qualifies under section 355, the exchange by the distributing corporation shareholders of their distributing corporation stock for controlled corporation stock and, if applicable, other property or money.
• In a complete liquidation to which both sections 331 and 332(a) apply, the distribution to which section 331 applies (distribution to minority shareholders) is treated as a repurchase, but not the distribution to which section 332(a) applies (distribution to the controlling corporation).

Notice 2023-2 also includes a nonexclusive list of transactions that would not be considered economically similar and thus would not be treated as repurchases. These include:

• A distribution in a complete liquidation to which either, but not both, section 331 or 332(a) applies.
• A distribution by a distributing corporation of controlled corporation stock qualifying under section 355 if it is not a split-off.

Observation: The list of economically similar transactions includes various transactions for which a statutory exemption is available, primarily the statutory exemption for tax-free reorganizations where no gain or loss is recognized on such repurchase by a shareholder "by reason of [the] reorganization." The significance of treating these transactions as economically similar transactions is that the portion of the transactions that is not granted nonrecognition treatment by reason of the reorganization becomes subject to the excise tax. 

As noted above, acquisitions of parent stock by subsidiaries or partnerships can, in certain circumstances, be treated as repurchases that are subject to the excise tax. Notice 2023-2 expands on the arrangements that can be treated as repurchases by stating that the acquisition of foreign publicly traded corporation stock by the foreign publicly traded corporation through funding "by any means" from an applicable specified affiliate (such as a loan from a US corporate subsidiary to its foreign publicly traded parent to support the parent's repurchase of stock) is a repurchase of covered corporation stock if the funding is undertaken for a principal purpose of avoiding the excise tax. Notice 2023-2 includes a per se rule that deems all funding, except distributions, from an applicable specified affiliate as being undertaken with a principal purpose if the repurchase is done within two years of the date of such funding. 

Observation: A domestic or foreign subsidiary of a publicly traded US corporation that performs the buyback for its US parent triggers the 1% excise tax to the US parent. Additionally, a US subsidiary of a foreign publicly traded corporation that buys back its foreign parent’s stock is subject to the excise tax, and certain movements of funds from a US subsidiary to a foreign publicly traded parent to facilitate the repurchase of stock by the foreign publicly traded parent or a non-US subsidiary of such parent could expose the repurchase to the excise tax. There is a two-year lookback rule on cash movements to determine if this provision would apply. The two-year lookback rule puts pressure on foreign publicly traded companies to trace cash coming from their US subsidiaries to avoid the imposition of the excise tax on a repurchase of stock by a foreign publicly traded corporation. It is not clear if the two-year lookback will include years prior to 2023.

Observation: Unless funded by a specified affiliate, repurchases of stock by a foreign subsidiary that buys back its foreign publicly traded parent’s stock and by a foreign publicly traded corporation that buys back its own stock are not subject to the excise tax. Given that repurchases of stock by foreign publicly traded corporations are not subject to the excise tax, the excise tax provides another reason (i) to consider foreign holding companies for private acquisitions where the expected exit is an IPO and (ii) for SPACs to be formed outside of the US.

The excise tax does not apply to certain repurchases to the extent: 

• The repurchase is part of a tax-free reorganization under section 368 and no gain or loss is recognized on such repurchase by the shareholder by reason of such reorganization.
• The repurchased stock or its value is contributed to an employer-sponsored retirement plan, employee stock ownership plan (ESOP), or similar plan.
• The total amount of stock repurchases within the year is less than USD 1 million.
• The purchase is by a dealer in securities in the ordinary course of its business.
• The repurchase is treated as a dividend under US tax rules.
• The repurchase is by a regulated investment company (RIC) or real estate investment trust (REIT).

Notice 2023-2 provides clarifying guidance with respect to these exceptions. In particular:

• The reorganization exception includes a corporation’s acquisition of its stock for stock of a controlled corporation in a “split-off” under section 355, even if such split-off is not part of a reorganization under section 368(a)(1)(D).
• The employer-sponsored retirement plan exception applies only to a contribution to a plan that is qualified under section 401.
• The dividend exception applies only to repurchases treated as a dividend under section 301(c)(1) or 356(a)(2). A repurchase to which section 302 or 356 applies is presumed not to be a dividend-equivalent repurchase unless the covered corporation rebuts the presumption by providing information reporting to the applicable shareholder and obtaining certification from the shareholder.
• The USD 1 million de minimis exception applies before the application of these statutory exceptions and the netting rule.

Observation: Notice 2023-2 does not provide any exception with respect to SPACs. Accordingly, redemptions of stock by US SPACs (and potentially some non-US SPACs) are still subject to the excise tax unless an exemption for liquidations applies, whether those redemptions are initiated by the SPAC or by the shareholders that want out prior to a de-SPAC transaction. This will continue to put pressure on SPAC sponsors, as it is an additional potential cost for SPAC investors to consider when investing in SPAC shares.

Observation: Notice 2023-2 does not provide any exception with respect to common situations in which a buyback provision is embedded in the terms of a security, such as preferred stock with a call provision.

Conclusion

As outlined above, the excise tax does not only apply to stock buyback programs but also impacts other transactions, including M&A deals. Publicly traded entities should monitor their activities to avoid inadvertently triggering an excise tax liability.