Treasury and IRS provide interim guidance on stock repurchase excise tax: headline points
In Notice 2023-2 (the Notice), the US Department of the Treasury and the Internal Revenue Service announced their intention to issue proposed regulations (when issued, the Proposed Regulations) regarding the operation of the new 1 percent excise tax on certain stock repurchases by domestic public companies (the Excise Tax) under Section 4501 of the Internal Revenue Code (the Code).
Since its enactment in August 2022, the Excise Tax and its potential effects on capital markets have been widely discussed.
The Notice, issued on December 27. 2022, also provides interim guidance until such regulations are issued. This alert outlines the operation of the Excise Tax and the effect of the Notice.
Headlines from the Notice
- Limited (but still welcome) relief for SPACs. The Notice does not specifically address (or mention) SPACs. Nevertheless, the Notice provides that the complete liquidation of a covered corporation (which would include a SPAC) generally is exempt from the Excise Tax, as are repurchases and redemptions that occur in the same taxable year as the complete liquidation. SPAC stakeholders had been concerned that the imposition of the Excise Tax in a liquidation could reduce the funds in SPAC trust accounts and thus reduce the per-share amounts available to be distributed in liquidation. The Notice does not otherwise provide relief from the Excise Tax for other redemptions of SPAC stock, eg, as part of a de-SPAC transaction or in connection with an extension of a SPAC’s mandate. Instead, any such redemptions (if not otherwise made in the same year as a complete liquidation) would be subject to the Excise Tax, subject to the “netting” rule (discussed below). The Notice also did not expand the netting rule to cover stock issued by parties related to a SPAC in transactions such as a Section 351 double dummy acquisition or a typical up-C transaction.
- Spinoffs and splitoffs. The Notice provides that spinoffs and splitoffs that are tax deferred under Section 355 generally are not included in the base amount subject to the Excise Tax, except to the extent that cash and certain non-stock property (“boot”) is distributed in a non-pro rata splitoff.
- Payments of boot in tax-deferred reorganizations. The Notice would include in the base amount subject to the Excise Tax the amount of taxable boot paid in a tax-deferred reorganization, regardless of whether the acquiring or target corporation funds the payment.
- Taxable acquisitions funded by target. The Notice would include in the base amount subject to the Excise Tax amounts of consideration paid in fully taxable transactions where the source of the consideration was either cash on the target corporation’s balance sheet or cash borrowed by the target corporation (or a merger subsidiary merged into the target corporation).
- Non-stock instruments generally not addressed. The Notice does not provide any interim guidance with respect to financial instruments that are not stock, such as convertible or exchangeable debt, options, warrants, and equity-linked derivatives. Thus, repurchases and issuances of such instruments appear currently not to be subject to the Excise Tax. The Notice does specifically request taxpayer comments on the treatment of such instruments, and it is possible the Proposed Regulations could address scenarios where the use of such instruments affects a taxpayer’s liability for the Excise Tax.
- No exception for preferred stock. The Notice does not provide any exception from the Excise Tax for redemptions of preferred stock (although the Notice requests that taxpayers provide comments with respect to such instruments).
- Valuation of stock. In general, for purposes of the Excise Tax, the value of stock repurchased or issued is based on the market price of the stock on the date the stock is either repurchased or issued. The Notice also sets forth methods for measuring “market price” when the relevant stock is traded on an established market and when it is not.
Background on the Excise Tax
The Excise Tax is a non-deductible 1 percent tax on the value of fair market stock of a "covered corporation" that is either repurchased by, or acquired by certain affiliates of, such covered corporation during a taxable year. The statute applies to repurchases taking place after December 31, 2022 (without any grandfathering rule for repurchases pre-authorized on or prior to such date).
A "covered corporation" generally is a domestic (ie, US) corporation the stock of which is traded on an "established securities market." The Excise Tax generally does not apply to non-US corporations, including SPACs organized in the Cayman Islands or other non-US jurisdictions, other than certain non-US corporations treated for tax purposes as domestic corporations under the "inversion" rules. In addition, in limited circumstances, acquisitions of stock of certain publicly traded non-US corporations by their US subsidiaries will be treated as repurchases subject to the Excise Tax.
The value of stock treated as repurchased during the taxable year for purposes of computing the Excise Tax is reduced by the value of any new issuances of stock by the corporation during the same taxable year (the netting rule).
The statute defines "repurchase" broadly by reference to Section 317(b) of the Code, which generally includes any acquisition of stock by a corporation in exchange for cash or property other than the corporation's own stock or stock rights. The Excise Tax further expands this definition by including any other "economically similar" transaction, as determined by Treasury.
The Act excludes repurchases in the following circumstances from the Excise Tax (“statutory exclusions”):
- To the extent the repurchase is part of a tax-free reorganization under Section 368(a) of the Code, and no gain or loss is recognized by the shareholder by reason of the reorganization
- The repurchased stock, or an amount of stock equal to the value of such repurchased stock, is contributed to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan
- The total amount of repurchases within the taxable year does not exceed $1 million
- Under regulations prescribed by Treasury, the repurchase is by a dealer in securities in the ordinary course of business
- The repurchase is by a regulated investment company or a real estate investment trust
- To the extent the repurchase is treated as a "dividend" (as opposed to being treated as a "sale or exchange") for US federal income tax purposes.
In addition, Section 4501 authorizes Treasury to prescribe regulations and other guidance as are necessary to carry out, and to prevent avoidance of the Excise Tax, including to address special classes of stock and preferred stock.
Stock repurchase excise tax base
The Notice introduces the concept of the “stock repurchase excise tax base” (1 percent of which equals a covered corporation’s liability for the Excise Tax). A covered corporation’s stock repurchase excise tax base for a taxable year equals (A) the fair market value of all of the repurchases of the covered corporation’s stock during the year, reduced by the sum of (B) the aggregate fair market value of stock of the covered corporation repurchased during the year that qualifies for a “statutory exception” described in the Notice and (C) the aggregate fair market value of stock issued by the covered corporation during the year under the “netting” rule.
What is a repurchase?
The Notice excludes from the statute’s broad definition of repurchase (i) deemed redemptions under Section 304(a)(1) (in general, where one corporation acquires the stock of another corporation, where both corporations are under common control) and (ii) certain payments of cash in lieu of fractional shares in connection with a tax-deferred reorganization or splitoff. However, the acquisition of stock of a covered corporation by a “specified affiliate” (in general, a corporation or partnership directly or indirectly majority-owned by the covered corporation) is treated as a repurchase of the stock by the covered corporation.
The Notice provides an exclusive list of transactions deemed to be “economically similar” to a repurchase (and therefore are included in the stock repurchase excise tax base):
- Exchanges of stock by target shareholders of a covered corporation in certain “acquisitive reorganizations” (those being a merger pursuant to Section 368(a)(1)(A) (including a forward or reverse subsidiary merger qualifying under Section 368(a)(2)(D) or section 368(a)(2)(E)), or an asset reorganization pursuant to Section 368(a)(1)(C) or Section 368(a)(1)(D)).
- Exchanges of stock by shareholders recapitalizing their stock pursuant to Section 368(a)(1)(E) (“E reorganization”).
- Exchanges of stock by transferor corporation shareholders in a “mere change in form or jurisdiction” reorganization pursuant to Section 368(a)(1)(F) (“F reorganization”).
- Exchanges of stock by distributing corporation shareholders of their distributing corporation stock for controlled corporation stock in transactions such as splitoffs made pursuant to Section 355.
- Liquidations of a covered corporation where both Section 331 and Section 332(a) apply (which generally would be where the covered corporation is owned 80% or more by another corporation but still has other minority shareholders), in which case liquidating distributions made to the minority shareholders (but not to the parent corporation) would be included in the stock repurchase excise tax base.
The Notice also provides a non-exclusive list of transactions that are not “economically similar” to a repurchase (and therefore are excluded from the stock repurchase excise tax base)
- Complete liquidations that qualify under either Section 331 or Section 332(a) (but not both).
- Redemptions of shares that occurs in the same taxable year as a complete liquidation to which Section 331 applies.
- Distributions of controlled corporation stock in a transaction qualifying under Section 355 that is not a splitoff.
Further gloss on the Excise Tax’s statutory exceptions
As discussed above, the Notice’s list of transactions that are “economically similar” to repurchases is quite broad. However, the Notice scales this back to the extent such repurchases are subject to a statutory exception.
Qualifying property. For example, the fair market value of “qualifying property” issued in an acquisitive reorganization, an E reorganization, an F reorganization, or a splitoff, reduces a covered corporation’s stock repurchase excise tax base. Qualifying property generally is common stock consideration received without the recognition of gain or loss under Section 354 or Section 355. The upshot of this is that, although any of an acquisitive reorganization, an E reorganization, an F reorganization, or a splitoff is treated as economically similar to a repurchase for Excise tax purposes, the fair market value of common stock consideration transferred to the shareholders of the target corporation or the covered corporation, as applicable, is effectively backed out of the covered corporation’s stock repurchase excise tax base, leaving only the amount of any boot transferred or distributed in such transaction as potentially subject to the Excise Tax.
Stock contributions to an employer-sponsored retirement plan. Stock repurchased by a covered corporation (or an amount of stock equal to the fair market value of the stock repurchased) that is contributed to an employer-sponsored retirement plan reduces the covered corporation’s stock repurchase excise tax base. Further, if a covered corporation makes contributions of stock to an employer-sponsored retirement plan by the filing deadline for the Excise Tax (discussed below), the Notice permits the corporation to treat such stock as having been contributed in the prior taxable year.
Further gloss on the netting rule
The stock repurchase excise tax base with regard to a taxable year of a covered corporation is reduced by the aggregate fair market value of stock of the covered corporation that is (i) issued or provided to employees of the covered corporation (or a specified affiliate) or (ii) issued to other persons, in each case during the taxable year (which would include issuances made in connection with PIPEs). The Notice provides, however, that in connection with stock issued or provided to employees pursuant to compensation arrangements, any stock withheld to satisfy an employer’s income tax or payroll tax withholding obligations or to satisfy the exercise price of a net-exercised option is not treated as stock issued or provided to an employee.
In order to prevent double reductions in the stock repurchase excise tax base, the Notice disregards certain stock repurchases for purposes of the netting rule, such as (i) stock issued that qualifies for the “qualifying property” exception noted above, (ii) deemed issuances of stock in a Section 304(a)(1) transaction, (iii) deemed issuances of fractional shares where cash is paid in lieu of fractional shares, and (iv) target corporation stock issued by the target corporation to the merged corporation in a transaction qualifying under Section 368(a)(2)(E). Stock issued pursuant to a stock split, or to a specified affiliate of the covered corporation, also is excluded.
Importantly, the determination of a covered corporation’s stock repurchase excise tax basis is made separately for each taxable year of the covered corporation, and any reductions of the stock repurchase excise tax basis (either as a result of statutory exceptions or the netting rule) in excess of the amount of aggregate fair market value of all repurchases of the covered corporation’s stock by the covered corporation during its taxable year are not carried forward or backward to preceding or succeeding taxable years of a covered corporation.
Since the Excise Tax is tied to the fair market value of repurchased stock, the Notice sets forth guidance on making this determination. In general, the fair market value of repurchased stock is the market price of the stock on the date the stock is repurchased, even if this differs from the price at which the stock is actually repurchased. If repurchased stock is traded on an established securities market (or is of the same class and issue of stock that is so traded), the Notice provides four acceptable methods (daily VWAP, closing price, average of high and low prices, or trading price at time of repurchase) for determining the market price on the repurchase date, but the covered corporation must use only one of these methods for all of its repurchases during the relevant year. For non-traded stock, the Notice requires that Section 409A valuation principles apply.
Generally, stock is treated as repurchased either at the time the ownership of the stock transfers to the covered corporation (or applicable acquirer) or, for purposes of an economically similar transaction, at the time the shareholders of the covered corporation exchange their stock in the covered corporation.
Reporting of the Excise Tax
Section 4 of the Notice provides that Treasury and the IRS anticipate that the Proposed Regulations will provide that the Excise Tax will be reported on Form 720 (Quarterly Federal Excise Tax Return). Because Form 720 is filed quarterly but the Excise Tax is calculated annually, the Notice indicates that the Proposed Regulations will provide that the Excise Tax will be reported only once per taxable year on the Form 720 that is due for the first full quarter after the close of the taxpayer’s taxable year.
As an example, a taxpayer with a taxable year ending on December 31, 2023, would report its stock repurchase excise tax on Form 720 for the first quarter of 2024, which would be due on April 30, 2024. The Notice also provides that the IRS intends to issue an additional form that taxpayers will be required to attach to the Form 720 that specifically sets forth the calculation of the Excise Tax; the IRS issued a draft of this Form (Form 7028) on December 28, 2022. Treasury and the IRS expect the Proposed Regulations to provide that the deadline for payment of the Excise Tax is the same as the filing deadline, and that no extensions will be permitted for reporting or paying the tax owed.
The Notice provides that, until the issuance of Proposed Regulations (which the IRS anticipates will generally apply to repurchases made after December 31, 2022), taxpayers may rely on the rules set forth in the Notice.
Links to the text of Section 4501 and the Notice, as well as to draft IRS Form 7208, are below. If you have any questions about the Excise Tax or the Notice, feel free to reach out to the authors of this alert, or your DLA Piper tax contact.
 All Section references herein are to the Code.