New Guidance From The Treasury Department On 1% Corporate Stock Buyback Tax – Shareholders

In Short

The Situation: On April 9, 2024, the U.S.
Treasury Department (“Treasury”) issued proposed
regulations (which can be found here) and reporting requirements (which
can be found here) providing further guidance on the
non-deductible 1% excise tax that was enacted on August 16, 2022
(as Section 4501 of the Internal Revenue Code) (the “Stock
Buyback Tax”) and applies to most domestic “traded”
corporations and to domestic subsidiaries of a foreign
“traded” corporation. For this purpose, a
“traded” corporation is a corporation whose stock is
traded on an established securities market (including any national,
regional, local, or foreign stock exchange, as well as any
interdealer quotation system).

The Result: The proposed regulations largely
follow Treasury’s prior guidance in Notice 2023-2 issued on
December 27, 2022 (the “Notice”), which provided rules
for determining the applicability and reporting requirements
related to the Stock Buyback Tax (our prior coverage of the Notice
can be found here), with various changes that impact
the scope and calculation of the Stock Buyback Tax. If final
regulations, when issued, adopt the rules in these proposed
regulations, a domestic traded corporation repurchasing its stock
after December 31, 2022, in any redemption, merger, split-off,
leveraged buyout (“LBO”), or take-private transaction,
will have at least a reporting obligation. It is likely they also
will be subject to the Stock Buyback Tax for those repurchases and
domestic subsidiaries of a foreign traded corporation that are
treated as funding, directly or indirectly, a stock repurchase by
that foreign corporation, will be similarly subject to these
rules.

Looking Ahead: All traded
corporations—both domestic and foreign—should review
their stock repurchases and other transactions since January 1,
2023, and evaluate their contemplated repurchase programs and other
transactional planning, to determine whether they are subject to
the Stock Buyback Tax or its reporting requirements.

Corporations and Transactions Affected by the Stock Buyback
Tax

The Stock Buyback Tax generally applies to stock repurchases and
certain other redemptive transactions undertaken by domestic traded
corporations, as well as domestic subsidiaries of a foreign traded
corporation that purchase stock of such foreign traded corporation
or—under the proposed regulations—directly or
indirectly fund purchases of foreign traded corporation stock by
foreign group members.

The proposed regulations generally adopt and expand upon the
Notice. Notably:

• Calculation of the Stock Buyback Tax: The
  annual Stock Buyback Tax is equal to the 1% rate, times a base
  amount, which is generally equal to the aggregate fair market value
  of all repurchases (generally, all redemptions and
  “economically similar” transactions, other than certain
  liquidating distributions, distributions of stock in tax-free
  spin-off transactions, certain non-redemptive distributions, and
  certain net cash settled contracts on stock) in any single tax
  year, reduced by excluded repurchases (which include stock
  surrendered in certain tax-free reorganizations and tax-free
  split-off transactions, repurchased stock contributed to certain
  employer-sponsored retirement plans, repurchases by a regulated
  investment company or real estate investment trust, and repurchases
  treated as dividends) and certain stock issuances in that tax
  year.




• Take-Private and other Taxable Acquisitions:
  Take-private and LBO transactions continue to be subject to the
  Stock Buyback Tax to the extent funded by the target corporation,
  including with cash on hand or new debt.




• Spins and Splits: Tax-free spin-offs and
  split-ups generally remain exempt from the Stock Buyback Tax,
  except to the extent a shareholder receives cash or other non-stock
  consideration (so-called “boot”) in exchange for stock of
  the distributing corporation. While a split-off (in which
  shareholders exchange distributing corporation stock for controlled
  corporation stock) is a “repurchase” for purposes of the
  Stock Buyback Tax, the exchange is generally not subject to the
  tax, except to the extent the distributing corporation shareholders
  exchange their distributing corporation stock for boot.




• Mergers and Reorganizations: Cash or other
  boot received in an otherwise qualifying tax-free reorganization is
  subject to the Stock Buyback Tax, regardless of whether the payment
  is funded by the target or the acquiring corporation. While cash
  paid in lieu of fractional shares generally will not be subject to
  the Stock Buyback Tax, cash paid to dissenting shareholders may be
  subject to the Stock Buyback Tax.




• Foreign Traded Corporations: Under the
  statute, a purchase of foreign traded corporation stock by its
  domestic subsidiary is subject to the Stock Buyback Tax. The Notice
  introduced a “funding rule” under which a domestic
  subsidiary is also subject to the tax if that subsidiary
  “funds by any means” a purchase of the foreign traded
  corporation’s stock by any member of the foreign traded
  corporation’s group with “a principal purpose” of
  avoiding the Stock Buyback Tax. The Notice contained a per
  se rule under which a funding that occurs within two years of
  the purchase is presumed to have a principal purpose of avoiding
  the tax. The proposed regulations eliminate the per se
  rule on a going forward basis, but retain the “principal
  purpose” standard. The meaning of “funds by any
  means” can be viewed to include lending transactions,
  distributions, and similar events that move cash from domestic
  subsidiaries to their foreign group members, including possibly
  domestic to foreign cash pooling arrangements. Other ordinary
  course transactions also may be a funding, including domestic to
  foreign member royalty payments and purchases of inventory or raw
  materials.




• Options and Similar Instruments. The proposed
  regulations generally adopt the Notice’s approach to options
  and similar instruments, excluding any acquisition of options from
  the Stock Buyback Tax, except where the instrument would, at the
  time of its issuance, be treated as stock for tax purposes. Thus, a
  repurchase or issuance of stock under an option generally only
  occurs at the time of a physically-settled exercise. The
  regulations also provide that net cash settlement of an option or
  similar instrument is generally not subject to the Stock Buyback
  Tax.




• Compensatory Shares. The proposed regulations
  contain extensive rules regarding the treatment, valuation, and
  timing with respect to compensatory share issuances and repurchases
  for purposes of the Stock Buyback Tax.

Effective Date & Payment: The Stock Buyback
Tax applies to stock repurchases occurring after December 31, 2022.
Under the proposed regulations, the tax is reported and paid
annually on IRS Form 720 due for the first full calendar quarter
after the end of the taxpayer’s taxable year (i.e., the last
day of the month following the close of such quarter). Thus, for
example, the due date for a calendar year taxpayer to report and
pay its 2024 excise tax would be April 30, 2025 (for a fiscal year
taxpayer having a tax year end of January 31, 2025, the due date
would be July 31, 2025). The proposed regulations contain a
transition rule for taxable years ending after December 31, 2022,
but on or before publication of final regulations. For such tax
years, the tax is reported and paid on the IRS Form 720 for the
first full calendar quarter after the publication of final
regulations. For example, if final regulations are published in
September 2024, a calendar year taxpayer would report and pay its
excise tax for 2023 by January 31, 2025. The IRS will finalize new
IRS Form 7208 (to be included as an attachment to IRS Forms 720) to
report the taxpayer’s calculation of the Stock Buyback Tax.

Five Key Takeaways

1. The proposed regulations generally follow the Notice with
   respect to the application of the Stock Buyback Tax. LBOs and other
   take-private transactions are subject to the Stock Buyback Tax to
   the extent funded by the target corporation. Also consistent with
   the Notice, tax-free reorganizations and split-offs generally do
   not result in a Stock Buyback Tax, except to the extent
   shareholders receive cash or other boot in exchange for their
   stock.




2. For foreign traded companies, the proposed regulations adopted
   the Notice’s general principal purpose funding rule, and
   eliminate the per se rule on a going forward basis.




3. Foreign traded corporations with domestic subsidiaries that
   engage in cash pooling arrangements or cross-border intercompany
   lending, make distributions to foreign group members, or engage in
   ordinary course routine cross-border transactions, are encouraged
   to consider whether such transactions could be deemed to
   “fund” a buyback of the foreign traded corporation’s
   stock.




4. When the reporting requirements commence, all domestic traded
   corporations that repurchase their stock (and all domestic
   subsidiaries of foreign traded corporations that purchase their
   foreign parent corporation stock or who are treated as funding such
   purchases), will be required to report such repurchases, whether
   any Stock Buyback Tax is owed or not.




5. Although no reporting or Stock Buyback Tax is due currently,
   upon the issuance of final regulations, impacted domestic
   corporations will be required to file an IRS Form 720 and remit the
   Stock Buyback Tax, if any, for all applicable stock repurchases
   occurring after December 31, 2022. Under the transition rule, for
   tax years ending before the final regulations are issued, the tax
   will be due with the IRS Form 720 for the first full calendar
   quarter after the date on which final regulations are issued, i.e.,
   the last day of the month following the close of the first full
   calendar quarter after the final regulations are issued.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.