On December 27, 2022, the US Treasury Department and the Internal Revenue Service (“IRS”) issued Notice 2023-2 (the “Notice”), which provides taxpayers interim guidance on certain aspects relating to the new 1% excise tax on stock buy-backs. The 1% excise tax was enacted last summer as part of the Inflation Reduction Act and generally applies to any US corporation whose stock is traded on an established securities market and that “repurchases” more than $1 million of stock over the course of a tax year. Among other things, the Notice provides important clarifications relevant to common M&A and capital markets transactions.
- Acquisitions structured as tax-free reorganizations would be subject to the excise tax only to the extent of taxable cash or other non-stock property (“boot”) paid in the reorganization (with an exception for payment of cash in lieu of fractional shares assuming certain requirements are met).
- Tax-free spin-offs and split-offs are excluded from the excise tax, except to the extent cash or “boot” is received as part of a non-pro rata split-off.
- Taxable acquisitions (e.g., an all-cash merger) would be treated as involving a “repurchase” subject to the excise tax to the extent the target (or a transitory merger sub that merges into the target in a reverse subsidiary merger) incurs debt to fund part of the merger consideration. Alternative structures where leverage is placed at the level of the acquiror company may avoid the tax.
- The Notice confirms in an example that redemption of mandatorily redeemable preferred stock may be subject to the excise tax (notably, even if the stock had been issued prior to the enactment of the Inflation Reduction Act). However, the Notice requests comments on whether special exceptions are warranted for preferred stock.
- The Notice provides that liquidations of corporations that are fully taxable under Section 331 of the Internal Revenue Code (the “Code”) are not subject to the excise tax. It would appear this may protect from the tax dissolutions of special purpose acquisition companies (“SPACs”), but more clarity would be welcome on certain technical points.
- Even though the excise tax generally only applies to stock repurchases by US public companies, stock repurchases by non-US public companies may become subject to the excise tax if a US affiliate funds by any means such acquisition and the funding is undertaken for “a principal purpose of avoiding the stock repurchase excise tax.” Notably, the principal purpose is deemed to exist if the repurchase occurs within two years of the funding by the US affiliate (other than a funding through distributions).
- The Notice provides guidance on the valuation of repurchased stock for the purpose of computing the excise tax base. The fair market value of the stock is determined by its market price on the date of repurchase. If the stock is traded on an established securities market, the market price is determined using one of four specified methods under the Notice. For the repurchase of non-traded stock of a public company, the market price is determined using principles under Code § 409A.
- The Notice clarifies certain aspects of the “netting rule,” i.e., reduction of the excise tax base by the amount of stock issued by the corporation in the tax year. For example, restricted stock issued to employees is only treated as issued for purposes of the netting rule upon vesting or if the employee had filed an election under Code §83(b).
While the Notice provided welcome guidance, several important questions remain unanswered. The Notice requests comments on a number of these open issues including, for example, whether special rules should be provided for repurchases of options or other equity-linked financial instruments or for financially distressed companies.
For more details, see our Legal Update “1% Stock Buyback Tax: US Treasury, IRS Release Interim Guidance.”