Treasury and IRS Issue Final and Proposed Regulations Regarding Stock Repurchase Excise Tax Under Code Section 4501

Introduction

On April 12, 2024, the U.S. Department of the Treasury (the Treasury) and the U.S. Internal Revenue Service (IRS) published two sets of proposed regulations (the Proposed Regulations) regarding the 1% stock repurchase excise tax (the Excise Tax) imposed under Section 4501 of the U.S. Internal Revenue Code (the Code), with one set of Proposed Regulations addressing general aspects of the Excise Tax (the General Proposed Regulations) and one set of Proposed Regulations addressing procedural aspects of the Excise Tax (the Procedural Proposed Regulations). On July 3, 2024, the Treasury and the IRS published final regulations addressing procedural aspects of the Excise Tax (the Procedural Final Regulations), which replace the Procedural Proposed Regulations. Final regulations addressing general aspects of the Excise Tax have not yet been published.

In general, the Excise Tax is imposed on publicly traded U.S. corporations (Covered Corporations) and certain publicly traded non-U.S. corporations with respect to any stock repurchases or any “economically similar transactions” made after December 31, 2022. The Excise Tax is equal to 1% of the fair market value of the stock of a Covered Corporation that is repurchased by such Covered Corporation during the tax year. Under a netting rule that applies for purposes of determining the Excise Tax base, the amount of these repurchases generally is reduced by the fair market value of any issuances of the Covered Corporation’s stock during the tax year.

On January 17, 2023, the Treasury and the IRS published Notice 2023-2, 2023-3 IRB 374 (the Notice), which provided initial guidance regarding the application of the Excise Tax. The Proposed Regulations effectively replace the Notice, and, subject to certain exceptions, the Proposed Regulations generally are consistent with the guidance provided in the Notice. As noted above, the Procedural Final Regulations replace the Procedural Proposed Regulations. Certain key aspects of the General Proposed Regulations and Procedural Final Regulations are summarized below.

Leveraged Buyouts and Other Taxable Acquisitions

Under the Proposed Regulations, the Excise Tax generally applies to the portion of the consideration in a leveraged buyout or other taxable acquisition that is funded by a target Covered Corporation. The Preamble to the Proposed Regulations clarifies that consideration is sourced to a target Covered Corporation based on general U.S. federal income tax principles. Consideration sourced to an acquiror under general U.S. federal income tax principles presumably is not subject to the Excise Tax.

Reorganizations and Other Tax-Deferred Transactions

The Excise Tax applies not only to repurchases of the stock of a Covered Corporation, but also to “economically similar transactions” involving Covered Corporations. The Proposed Regulations provide an exclusive list of economically similar transactions, which includes reorganizations under Code Sections 368(a)(1)(A) (including forward and reverse subsidiary mergers under Code Sections 368(a)(2)(D) and 368(a)(2)(E), respectively), 368(a)(1)(C), 368(a)(1)(D), 368(a)(1)(E), 368(a)(1)(F), 368(a)(1)(G) (in certain circumstances), split-offs (i.e., a Code Section 355 transaction in which a distributing corporation distributes stock of a controlled corporation (and, if applicable, other property or money) to the distributing corporation’s shareholders in exchange for a portion of the shareholders’ stock in the distributing corporation), and complete liquidations to which both Code Sections 331 and 332 apply. The Excise Tax applies only to the extent of any “non-qualifying property” (i.e., taxable “boot”) received in such economically similar transactions. The Preamble to the Proposed Regulations provides that the Treasury and the IRS may identify new economically similar transactions on a prospective or retroactive basis.

Post-Closing Price Adjustments

The Proposed Regulations include rules addressing post-closing price adjustments in merger and acquisition transactions, including earnouts and indemnification payments. The Preamble to the Proposed Regulations clarifies that, for purposes of the Excise Tax, stock should be treated as issued when ownership of the stock transfers to the recipient under general U.S. federal income tax principles. If earnout shares or shares subject to an indemnification payment are treated as issued for purposes of the Excise Tax, then the Proposed Regulations treat the forfeiture of those shares as a repurchase for purposes of the Excise Tax at the time of such forfeiture. The Proposed Regulations do not include any special rules to determine the fair market value of shares issued as part of an earnout or potentially subject to forfeiture in connection with an indemnification obligation.

Acquisition of a Target That Owns Stock in an Acquiring Covered Corporation

The Proposed Regulations provide that so-called “constructive specified affiliate acquisitions” are treated as repurchases for purposes of the Excise Tax. Under the Proposed Regulations, a constructive specified affiliate acquisition generally includes an acquisition of a target corporation or partnership by a Covered Corporation if (1) the target corporation or partnership becomes an affiliate of the Covered Corporation, (2) at the time the target corporation or partnership becomes an affiliate of the Covered Corporation, it owns stock of the Covered Corporation that represents more than 1% of the fair market value of the target corporation or partnership as determined at such time, and (3) the target corporation or partnership acquired such stock after December 31, 2022. The constructive specified affiliate acquisition rule applies regardless of whether the acquisition is a taxable transaction or a tax-deferred acquisition. Acquirors that are Covered Corporations should seek to identify whether and the extent to which a prospective target holds stock of the acquiror in order to evaluate the potential impact of the Excise Tax with respect to the transaction.

Special Purpose Acquisition Companies (SPACs)

Although several commentators requested clarification regarding the application of the Excise Tax to SPAC-related redemptions and economically similar transactions, the Proposed Regulations do not contain any special rules for SPACs, as the Preamble to the Proposed Regulations states that the Treasury and the IRS are of the view that adopting any such rules would not be necessary or appropriate to carry out the Excise Tax. Although not specific to SPACs, the Proposed Regulations clarify that, in the case of a non-U.S. corporation that transfers its assets to a U.S. corporation in a Code Section 368(a)(1)(F) reorganization (i.e., an inbound F reorganization), the corporation is not treated as a U.S. corporation until the day after the reorganization. Correspondingly, in the case of a U.S. corporation that transfers its assets to a non-U.S. corporation in a Code Section 368(a)(1)(F) reorganization (i.e., an outbound F reorganization), the corporation is not treated as a non-U.S. corporation until the day after the reorganization.

Troubled Companies

The Proposed Regulations do not include any special rules with respect to troubled companies. As noted above, bankruptcy-related reorganizations under Code Section 368(a)(1)(G) generally are subject to the Excise Tax to the extent of any taxable boot.

Exception for “Additional Tier 1 Preferred Stock”

In general, for purposes of the Excise Tax, the Proposed Regulations define “stock” as any instrument that is treated as stock for U.S. federal tax purposes at the time of issuance, regardless of whether such stock is publicly traded. However, the Proposed Regulations provide a limited-scope exception for so-called “additional tier 1 preferred stock,” which is defined by reference to the U.S. federal banking regulations. Therefore, unless the exception for “additional tier 1 preferred stock” applies, the Excise Tax applies to preferred stock in the same manner as to common stock.

Funding Rule for Publicly Traded Non-U.S. Corporations

Under Code Section 4501(d)(1), the acquisition of stock of a publicly traded non-U.S. corporation by a U.S. subsidiary of such non-U.S. corporation generally is subject to the Excise Tax. The Proposed Regulations generally provide that if (1) a U.S. subsidiary of a publicly traded non-U.S. corporation funds by any means (including through distributions, debt, or capital contributions) the repurchase or acquisition of stock of such non-U.S. corporation and (2) such funding is undertaken with a principal purpose of avoiding the Excise Tax, then such repurchase or acquisition generally is subject to the Excise Tax. The Notice provides that such a principal purpose is deemed to exist if the funding (other than through distributions) occurs within two years of the funded entity’s repurchase or acquisition of the stock of the publicly traded non-U.S. corporation (the per se rule). The Proposed Regulations replace the per se rule with a rebuttable presumption that applies in limited circumstances.

Reporting Requirements

The Procedural Final Regulations provide that the Excise Tax must be reported on an IRS Form 720 (Quarterly Federal Excise Tax Return), due for every first full calendar quarter after the end of the Covered Corporation’s tax year, with an attached IRS Form 7208 (Excise Tax on Repurchase of Corporate Stock) with respect to any tax year in which the Covered Corporation makes a repurchase or is treated as making a repurchase. Under the Procedural Final Regulations, regulated investment companies (RICs) and real estate investment trusts (REITs) generally are exempt from the requirement to file an Excise Tax return because RICs and REITs qualify for a statutory exemption from the Excise Tax under Code Section 4501(e)(5).

Effective Dates

Subject to certain exceptions, if finalized, the General Proposed Regulations generally would apply to (1) repurchases of stock occurring after December 31, 2022 and (2) issuances of stock occurring during tax years ending after December 31, 2022. Taxpayers generally can rely upon the General Proposed Regulations until final regulations are issued.

The Procedural Final Regulations apply to Excise Tax returns (and to the extent relevant, claims for refund) required to be filed after June 28, 2024, and during tax years ending after June 28, 2024.

© Arnold & Porter Kaye Scholer LLP 2024 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.