Overview
The Inflation Reduction Act of 2022 includes an excise tax that, if enacted, will make share repurchases by publicly traded companies more costly starting in 2023.[1] The proposed tax is meant to be a significant revenue-raiser, partially filling a revenue gap created by the removal of the carried interest provisions from the bill and modifications to the proposed book minimum tax.[2] Although the excise tax may seem straightforward when viewed at a high level, the text of the provision reveals some unexpected results.[3]
In Depth
OVERVIEW
The tax on share repurchases is imposed at a 1% rate on the total value of shares repurchased during the company’s tax year. The tax applies to most types of share repurchases made by US publicly traded companies, irrespective of whether a particular share repurchase is or is not part of a share buyback program. Because the new tax is an excise tax, it applies at a flat rate without regard to whether the repurchasing company has taxable income or loss during the year. The tax is imposed on the repurchasing corporation and is a nondeductible expense.[4]
When computing the tax base, the amount of repurchased shares is reduced by the value of any newly issued shares. In this way, the tax may be thought of as a tax on the net number of shares that are retired during the year. Companies are, in effect, given credit for new shares that are issued in a primary or secondary offering, shares issued to satisfy option exercises and shares issued to provide stock-based compensation.[5]
If enacted as is, the tax would apply to repurchases that take place after December 31, 2022. The cutoff for the effective date turns on whether a particular share repurchase was consummated after that date. In contrast, the date when a particular share repurchase plan was announced or approved is irrelevant. There is no grandfather rule or transition relief for shares that are repurchased in 2023 pursuant to a share repurchase program that was authorized in 2022 or earlier.
The tax also applies to repurchases in 2023 irrespective of whether the corporation happens to be on a fiscal or calendar year for tax purposes.[6]
A de minimis threshold prevents the tax from being imposed if the total share repurchases during the year does not exceed $1 million.
APPLIES TO US PUBLICLY TRADED COMPANIES
The excise tax applies almost exclusively to US publicly traded corporations. Share repurchases by foreign parented corporate groups generally escape taxation, even repurchases of American Depositary Receipts or shares that are publicly traded on US exchanges.
A company is considered “publicly traded” for this purpose if its shares are traded on any established securities market. This includes companies with shares that are traded on a regional or local market, not just companies that are listed on the New York Stock Exchange or the Nasdaq Stock Market. The tax also applies to US companies with shares that are traded on non-US exchanges, such as the London Stock Exchange, Euronext N.V. and Toronto Stock Exchange.
In the case of a foreign publicly traded corporation, the excise tax applies in limited circumstances. The excise tax may apply to a foreign parented publicly traded group if, for example, a controlled US subsidiary happens to purchase the foreign publicly traded parent’s shares. This aspect of the tax could pose a trap for the unwary in the mergers and acquisitions sector, but it will be easy enough for the well-advised to navigate around.
The provision includes a protective measure designed to prevent the excise tax from being an incentive to invert. In general, if a US corporation inverts in a transaction after September 20, 2021, share repurchases by its new foreign parent are potentially subject to the tax. This is the case if the US corporation inverted in a transaction in which the foreign parent is treated as a surrogate foreign corporation.[7] In such a case, the excise tax applies to the publicly traded foreign parent’s share repurchases if they are made within a 10-year applicable period following the inversion.
“REPURCHASES” ARE BROADLY DEFINED
Although the provision is colloquially referred to as a tax on “buybacks,” it is computed based on the value of shares “repurchased” by the publicly traded company. A repurchase is further defined for this purpose as a “redemption” of stock within the meaning of section 317(b). This definition expands the scope of the provision to include several types of transactions that are not considered “buybacks” in the traditional sense.
For example, a repurchase for this purpose may include an acquisition by the issuer of its own stock for cash, irrespective of whether the purchase is made on the open market or in a private transaction. Shares that are repurchased by the issuer to effectuate a “bootstrap” acquisition or leveraged buyout could be caught in the net of the excise tax.[8] The same could be true for cash that is issued for fractional shares in an acquisition.[9] A “repurchase” could, in theory, even include the mere repayment of preferred stock at its maturity.[10]
A repurchase for this purpose includes both direct purchases of stock by the publicly traded parent and indirect purchases effectuated by a controlled corporate subsidiary or a controlled partnership.[11] A corporation generally is “controlled” for this purpose if more than 50% of its stock is owned, directly or indirectly, by vote or value by the publicly traded parent.
The excise tax only applies to repurchases of stock and so a mere repayment of debt, including long-term debt that is considered a “security” for subchapter C purposes, will not be subject to the tax. Similarly, the repurchase of an unexercised option or warrant should not constitute a repurchase of stock.[12] Also, a transaction in which the issuer’s own stock is the only consideration exchanged for the repurchased stock ought not to be subject to the tax because an issuer’s own shares are not considered “property” under section 317.[13]
The provision includes a grant of regulatory authority to expand the application of the tax further, permitting the US Department of the Treasury (Treasury) to include within the definition of “repurchase” transactions that it determines are “economically similar to” redemptions.[14]
CERTAIN ACQUISITIONS THAT ARE NOT “REPURCHASES”
The provision provides a limited number of exceptions to the scope of the tax. The provision provides an exception for repurchases “to the extent” the transaction is “part of a section 368 reorganization and no gain or loss is recognized on such purchase by the shareholder.”[15] This should provide partial or total protection for section 368(a)(1)(E) recapitalizations and acquisitive reorganizations to the extent that the shareholders obtain tax-free treatment.[16]
A significant exception also applies to “any case” in which the repurchased shares, or an equal amount of stock, is “contributed to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan.” Thus, a public company can repurchase shares from the public and use them to satisfy stock options or make equity contributions to a retirement plan without being subject to the tax.
The provision also excepts repurchases “to the extent that the repurchase is treated as a dividend for purposes of this title.” Dividend-equivalent redemptions under section 302(d) should be excluded as a result, provided that the distribution is treated as a dividend and not a return of capital. This may allow for some share repurchases from large shareholders to be excluded for purposes of the tax. In most cases, however, purchases from small public shareholders will be considered sale or exchange transactions under section 302(a) and ineligible for the exception.[17]
CALCULATING THE FAIR MARKET VALUE OF REPURCHASED SHARES
Much remains to be seen about how the Treasury will implement the provision in regulations and how the Internal Revenue Service will enforce the provision on audit. For example, the tax is applied to the amount of repurchased shares by reference to their “fair market value.” This raises the question of how fair market value will be determined and how publicly traded corporations can comply with the proposed statute given the typically large volume of share repurchases in buyback programs and fluctuations in public share prices over the course of a tax year. One step that the Treasury might consider taking in this regard would be to use its regulatory authority to permit taxpayers to rely on their US Securities and Exchange Commission (SEC) reporting when computing the tax. Under SEC rules, publicly traded companies typically must disclose, on a monthly basis, the total number of shares purchased and the average price paid per share. These amounts typically appear in schedular form in a company’s 10-Q.[18]
CONCLUSION
Share buyback programs will continue to be popular with publicly traded companies, even if the proposed legislation is enacted. The structural incentives for share buyback programs will continue to outweigh the cost of the proposed excise tax. The tax will, however, have an impact on the margins, affecting the decisions of most US publicly traded companies when determining how best to redeploy cash. Companies will also have an incentive to accelerate future share repurchases into calendar year 2022 before the proposed legislation takes effect.
