New Guidance from the Treasury Department on 1% Corporate Stock Buyback Tax
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
- 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.
- 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.
- 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.
- 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.
- 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.
