The “Inflation Reduction Act” introduced Section 4501,1 which contains a new one percent excise tax on certain stock repurchases and economically similar transactions undertaken by publicly traded U.S. corporations and certain foreign corporations (referred to as “covered corporations”). The excise tax generally applies to transactions effected on or after January 1, 2023, and the applicable tax base is reduced by the fair market value of stock issuances made by covered corporations during the taxable year (referred to as the “netting rule”). For detailed prior coverage of the excise tax, see Wilson Sonsini Tax Alert dated August 16, 2022.
In addition to reductions that may occur pursuant to the netting rule, there are also several potential exceptions to the excise tax, including: i) certain non-recognition repurchases that are part of a “reorganization” within the meaning of Section 368(a); ii) repurchases that are accompanied by contributions to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan; iii) a de minimis exception if the total value of the stock repurchased during the taxable year does not exceed $1 million; and iv) repurchases that are treated as a “dividend” for U.S. federal income tax purposes.
On December 27, 2022, the U.S. Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued administrative guidance (referred to as Notice 2023-2, or the “Notice”) in which they announced their intention to issue forthcoming proposed regulations related to the implementation of the excise tax.2 The Notice serves as interim guidance that can be relied upon by taxpayers pending the issuance of final regulations. This alert summarizes certain key aspects of the Notice that may be of particular importance to Wilson Sonsini’s clients.
I. Guidance on the Scope of Covered Repurchases Relevant to M&A Transactions
1. Tax-free reorganizations and split-offs
Pursuant to the Notice, in the case of certain acquisitive tax-free reorganization transactions under Section 368(a) (including direct or “two-step” forward triangular mergers and reverse triangular mergers), the delivery of cash or other non-stock consideration (commonly referred to as “boot”) to the target shareholders is generally treated as a repurchase by the target corporation subject to the excise tax. As a result, a new and potentially material transaction cost will apply to most common types of tax-free reorganization that include some amount of boot consideration.
The Notice also provides that in the case of a non-pro-rata “split-off” by a publicly-traded distributing corporation, the exchange of distributing corporation stock for cash or other property is generally treated as a repurchase by the distributing corporation subject to the excise tax. The Notice does not subject a pro-rata “spin-off” to the excise tax.
In addition, under the Notice, shares issued by the acquiror are not counted for purposes of the acquiror’s netting rule calculations. The Notice further provides that cash paid in lieu of fractional shares in connection with either an acquisitive reorganization or a split-off is generally not treated as a repurchase. The Notice does not address the treatment of any cash that may be paid to dissenting shareholders.
2. Acquisitions funded with target cash and leveraged buyouts
To the extent that an acquisition of a publicly-traded target corporation is partially funded with the proceeds of a loan or cash from the target corporation, in certain circumstances the target corporation is treated as if it redeemed a portion of its outstanding stock. In such situations, the Notice provides that the deemed redemption is a repurchase that is generally subject to the excise tax.
3. Special-Purpose Acquisition Companies (SPACs) and complete liquidations
Although the Notice does not provide any specific guidance regarding SPACs or de-SPAC transactions, the Notice does provide that a complete taxable liquidation of a corporation pursuant to Section 331 is not considered a repurchase for purposes of the excise tax. However, because Section 331 generally requires that something of value must be received by a shareholder in a liquidating distribution, it is unclear whether the winding-up of a SPAC that is effected prior to the consummation of a de-SPAC transaction is subject to the excise tax if not all holders of SPAC shares, including sponsor shares, receive some amount of consideration in exchange for their shares in the dissolution. Further, non-liquidating shareholder redemptions that may occur in connection with an initial de-SPAC transaction would generally be subject to the excise tax. It also appears that in connection with a de-SPAC transaction, the resulting combined entity may not be able to take into account the amount of any stock consideration issued to the target shareholders for purposes of the netting rule in a case where the target corporation’s shares are already publicly traded (other than possibly transactions under Section 351 or reorganizations under Section 368(a) that do not involve any amount of boot).
II. Guidance on the Scope of Covered Repurchases Relevant to Capital Market Transactions
1. Mandatorily redeemable stock
The Notice provides, by way of an example, that a redemption by a covered corporation of its mandatorily redeemable preferred stock is a repurchase for purposes of the excise tax, even if such redemption is pursuant to an agreement entered into before January 1, 2023. Accordingly, there does not appear to be any exception from the excise tax for stock with debt-like features, such as non-convertible preferred stock. There is also no grandfathering rule for redemptions that may occur pursuant to a binding contract that was in effect prior to January 1, 2023.
2. Accelerated share repurchase (ASR) transactions
In an ASR transaction, the dealer will deliver a number of shares to the issuing corporation on the prepayment date and may deliver additional shares to the issuing corporation on the termination date. Prior to issuance of the Notice, there had been some uncertainty regarding whether an ASR is treated as two separate repurchases, one occurring on the prepayment date and one occurring on the termination date, or one aggregate repurchase occurring on the termination date. In an example, the Notice clarifies that an ASR program will generally be treated as consisting of two separate repurchases, one on the prepayment date and one on the termination date, provided that the facts and circumstances indicate that share ownership transferred from the counterparty to the issuing covered corporation on the original prepayment date for U.S. federal income tax purposes.
III. Guidance on the Netting Rule
1. Netting for fiscal year taxpayers
The Notice clarifies that for fiscal year taxpayers with a taxable year that begins before and ends after January 1, 2023, the covered corporation may apply the netting rule to reduce the amount of covered repurchases by the amount of all issuances of its stock during the entirety of its taxable year (including any issuances before January 1, 2023), even though the excise tax only applies to repurchases on or after January 1, 2023.
2. Netting in respect of stock provided to employees
Section 4501(c) provides that stock issued or provided to employees of a covered corporation or of a specified affiliate of the covered corporation is considered an issuance for purposes of the netting rule. The Notice explains that stock is considered to be issued to an employee as of the date on which the employee is treated as the beneficial owner of the stock for U.S. federal income tax purposes. Accordingly, stock issued to an employee that is not “substantially vested” is treated as issued on the date on which the stock becomes substantially vested within the meaning of Treas. Reg. Section 1.83-1(b), and stock transferred to an employee that is not substantially vested but for which the employee makes an election under Section 83(b) is treated as issued to the employee on the date of transfer. Further, stock transferred pursuant to an option or stock appreciation right is treated as issued when the employee exercises the option or right.
In addition, the Notice provides that if a covered corporation or specified affiliate withholds shares to satisfy an employee’s exercise price or withholding obligations, such shares are not treated as issued for purposes of the netting rule. However, if the employee sells shares to a third party to cover the employee’s exercise price or withholding obligations, such shares are treated as issued under Section 4501.
IV. Determination of Fair Market Value
In general, the fair market value of repurchased stock is the market price of the stock on the date the stock is repurchased, which may differ from the actual price at which the repurchased stock is purchased. If repurchased stock is traded on an established securities market (or if any stock of the same class and issue of stock is so traded), the market price of the stock can be determined using any of the following methods: i) the daily volume-weighted average price on the repurchase date; ii) the closing price on the repurchase date; iii) the average of the high and low prices on the repurchase date; or iv) the trading price at the time of the repurchase. If repurchased stock is not traded on an established securities market, the market price of the stock is determined using a reasonable valuation method and applying the principles of Treas. Reg. Section 1.409A-1(b)(5)(iv)(B)(1). A consistent valuation method must be used for all stock repurchases and stock issuances that occur during a taxpayer’s taxable year for purposes of calculating the excise tax.
V. Guidance on the Statutory Exception for Repurchases Treated as a Dividend
The Notice creates a rebuttable presumption that a repurchase is not treated as a dividend that might otherwise be exempt from the excise tax. However, a covered corporation may rebut the presumption with regard to a specific shareholder by establishing with sufficient evidence that the shareholder will treat the repurchase as a dividend on the shareholder’s U.S. federal income tax return, including i) by furnishing information reporting (as applicable) to the redeemed shareholder providing that the repurchase constitutes a dividend, and ii) obtaining certification from the shareholder that the repurchase constitutes a redemption treated as a Section 301 distribution or that the repurchase has the effect of the distribution of a dividend under Section 356(a)(2).
VI. Reporting of the Excise Tax
Pursuant to the Notice, Treasury and the IRS anticipate that the forthcoming proposed regulations will require that the excise tax be reported as an attachment to IRS Form 720, “Quarterly Federal Excise Tax Return.” Although the Form 720 is generally filed quarterly, Treasury and the IRS anticipate that the excise tax will be reported once per taxable year on the Form 720 due for the first full quarter following the end of a taxpayer’s applicable taxable year. Treasury and the IRS have also issued a draft of the attachment, IRS Form 7208, “Excise Tax on Repurchase of Corporate Stock” (see draft IRS Form 7208).
Contact Us
For further information regarding the contents of this client alert, please contact Dave Strong, Myra Sutanto Shen, or any member of the tax practice at Wilson Sonsini.
[1] All “Section” references are to the Internal Revenue Code of 1986, as amended.
[2] The Notice provides that the forthcoming proposed regulations are expected to become effective for stock repurchases made after December 31, 2022, and for stock issuances made during a taxable year ending after December 31, 2022.
