Proposed regulations clarify application of the excise tax on stock repurchases
April 2024
In brief
What happened?
Two sets of proposed regulations addressing the application of the Section 4501 excise tax on certain repurchases of corporate stock (the excise tax) were published on April 12 in the Federal Register (the proposed regulations). With some notable exceptions, these rules adopt much of the preliminary guidance set forth in Notice 2023-2 (the notice), while also providing long-awaited compliance rules on the filing and payment of the excise tax.
Why is it relevant?
In the extensive guidance included in this package of proposed regulations, Treasury and the IRS clarified a number of issues but declined to include certain rules requested by commenters. Instead, they often followed the approach in the notice of directing taxpayers to general US federal tax principles for determining what constitutes a repurchase or issuance of stock, when repurchases and issuances occur, and the value of the repurchased or issued shares. Significantly, the proposed regulations retain the general structure of the funding rule provided in the notice for foreign-parented multinationals, but with substantial modifications, including eliminating the per se rule and adding a narrow rebuttable presumption rule for certain transactions.
Action to consider:
Taxpayers that are publicly traded corporations (whether foreign or domestic) should consider the effect of these proposed rules and their potential excise tax liability. Because many of the provisions in the proposed regulations rely on US federal tax principles applied in other areas of the Code, taxpayers often will need to determine such treatment before determining their treatment for purposes of applying the excise tax rules. To the extent a corporation has a filing obligation or tax liability, the proposed regulations provide that stock repurchase excise tax returns for tax years ending after December 31, 2022, and on or before final regulations are published, are due with the Form 720 for the first full calendar quarter after the date the final regulations are published.
In detail
Background
The excise tax imposes a 1% tax on publicly traded US corporations on the value of any of its stock that is repurchased by the corporation (or certain of its affiliates) during the tax year, effective for certain stock repurchases made after December 31, 2022. The notice provided interim guidance on which taxpayers could rely in computing their excise tax liability until the issuance of proposed regulations.
Acquisitions of foreign corporation stock by applicable specified affiliates
The statutory language of the excise tax generally provides for its application to repurchases of stock by publicly traded domestic corporations and their affiliates. The statutory text also provides that the excise tax applies when a domestic subsidiary of a publicly traded foreign corporation acquires the foreign corporation's stock from a person that is not the foreign corporation or an affiliate. The notice set forth a broad rule through which a domestic affiliate of a publicly traded foreign corporation could be subject to the excise tax. Under the notice, if the domestic affiliate was treated as funding the repurchase by any means, and such funding was done with a principal purpose of avoiding the excise tax, then the domestic affiliate would be treated as having repurchased the stock and would be subject to the excise tax (the funding rule). The notice also included a per se rule providing that a principal purpose is deemed to exist if the repurchase occurs within two years of the funding (other than a funding through a distribution) (the per se rule).
The proposed regulations eliminate the per se rule set forth in the notice but clarify that if a principal purpose of a funding (including distributions) is to fund, directly or indirectly, a repurchase, then with respect to that funding, there is a principal purpose of avoiding the excise tax. The proposed regulations also establish a rebuttable presumption that a funding is made with a principal purpose of avoiding the excise tax if it is (1) made by a domestic affiliate of publicly traded foreign corporation to an entity in which the domestic affiliate has a material direct or indirect interest (a downstream relevant entity), and (2) that affiliate repurchases stock of the foreign parent (or a repurchase is made on its behalf) within two years of the funding.
Observation: While the elimination of the per se rule provides welcome relief to publicly traded foreign corporations, the clarification of the funding rule means that such corporations still will need to consider the excise tax when engaging in transactions with their domestic affiliates and with respect to intercompany transactions between their foreign and domestic affiliates. Under the proposed regulations, if a domestic affiliate makes a distribution to its publicly traded foreign parent with a principal purpose of funding a repurchase by the foreign parent, the domestic affiliate will be subject to the excise tax.
Repurchases subject to the excise tax
The proposed regulations mostly retain the approach described in the notice related to the types of repurchases subject to the excise tax. While Treasury received a number of comments requesting that repurchases of preferred stock be excluded from the application of the excise tax, the proposed regulations generally retain that rule, with the limited exception of preferred stock that qualifies as additional Tier 1 capital under certain banking provisions.
For purposes of determining the fair market value of the stock repurchased, the proposed regulations retain the approach of using the market value of the stock, pursuant to which taxpayers are required to apply one of four accepted valuation methods. The proposed regulations generally provide that the date of repurchase is determined based on when ownership of the stock is transferred for US federal tax purposes. This generally depends on the facts and circumstances; however, the proposed regulations state that the repurchase date is the trade date in the case of a regular-way sale of stock in which a trade order is placed on a trade date with the settlement date a standardized number of days from the trade date.
The notice provided that various merger and acquisition transactions were treated as repurchases, including leveraged buyouts, acquisitive reorganizations, and split-off transactions. While commenters recommended that Treasury revise this approach, including excluding acquisitive reorganizations from the excise tax, the proposed regulations reject most of those recommendations. The proposed regulations do provide clarification on when a corporation becomes, and ceases to be, a covered corporation, whether distributions paid with respect to stock are treated as repurchases, and how the statutory exceptions related to distributions and reorganizations apply.
Observation: The extent to which the excise tax applies under the proposed regulations depends heavily on how corporate transactions are treated under general US federal income tax principles. Taxpayers engaging in merger and acquisition transactions involving publicly traded corporations or other routine transactions will need to continue to consider whether their transactions expose them to potential excise tax liability.
Reduction for contributions to employer-sponsored retirement plans
The proposed regulations expand on the statutory reduction to the excise tax repurchase base for contributions of covered corporation stock to an ‘employer-sponsored retirement plan’ (a US tax-qualified retirement plan including ESOPs, or a similar plan) maintained by a covered corporation. These expansions include:
- A first-year transition for fiscal year taxpayers similar to that in the notice for the netting rule. The netting rule offsets the value of shares repurchased against the value of shares issued within the same taxable year.
- Adding to the definition of an employer-sponsored retirement plan a plan maintained by a specified affiliate of the covered corporation, and ’broad-based foreign plans‘ that are funded through a secular trust or another type of funded arrangement. However, the preamble states that Treasury has not yet determined which types of such foreign plans should be included in this definition and requests comments.
- Adding a special rule for ESOPs with an exempt loan (leveraged ESOPs).
- Clarifying that an applicable specified affiliate treated as having repurchased stock may avail itself of the reduction for stock contributions to an employer-sponsored retirement plan with specific limitations.
The proposed regulations provide various other clarifications regarding determining the amount of such reductions, as well as how contributions not made during the relevant tax year may be treated as on account of the relevant tax year.
Observation: Contributions of employer stock to tax-qualified retirement plans including ESOPs can result in a significant reduction to the excise tax repurchase base, and the proposed regulations illustrate Treasury’s flexibility regarding this particular statutory reduction.
Application of the netting rule
The proposed regulations largely retain the substance of the rules outlined in the notice on the netting rule with respect to equity-based compensation with clarifications on, and in some cases narrowing of, what may be treated as an issuance. These include providing that stock compensation provided to nonemployee service providers of a specified affiliate is not eligible for the netting rule and that an issuance from a covered corporation to a specified affiliate is not taken into account when the specified affiliate then provides stock to its employees (which can be taken into account). Numerous other clarifications are provided, including with respect to net withholding which relates to shares held back and not treated as an issuance, and rules to avoid ‘double-dipping’ between the employer-sponsored retirement plan reduction and netting rule.
Observation: The extent to which the netting rule applies to service providers under the proposed regulations depends heavily on determinations under general US federal income tax principles. The proposed regulations do not change the approach of the notice in this regard. For example, by providing that netting is not permitted for equity provided to nonemployee service providers of specified affiliates in both the domestic and foreign contexts, Treasury further emphasizes the requirement to determine the common law employees of the relevant entities.
Reporting and payment of the excise tax
As in the notice, the proposed regulations provide that the excise tax generally must be reported and paid with the Form 720 (Quarterly Federal Excise Tax Return) for the first full calendar quarter after the end of the tax year. Therefore, a calendar-year taxpayer’s deadline generally would be April 30 of the following year.
In June, the IRS announced that no taxpayer would be required to report or pay the excise tax until guidance was provided in forthcoming regulations. The proposed regulations clarify that, for tax years ending before the final excise tax regulations are published, taxpayers are not required to report or pay the excise tax until the deadline for the Form 720 for the first full calendar quarter after the final regulations are published. Therefore, if the final regulations are published in September 2024 (i.e., the third calendar quarter), then a calendar-year taxpayer’s deadline for its 2023 tax year would be January 31, 2025 (the due date of the Form 720 for the fourth calendar quarter) and its deadline for its 2024 tax year would be April 30, 2025 (its usual due date going forward).
Observation: The extension of the deadline to file and pay the excise tax until after final regulations are issued will provide taxpayers with additional time to understand the new rules and update their computations before needing to report and pay the excise tax. However, taxpayers may want to be proactive in assessing their potential tax liability, so that they are keeping the proper documentation and are prepared to file and pay the tax when required. Further, depending on the date of publication of the final regulations and the taxpayer’s fiscal year end, multiple prior years of reporting will be included on the initial Form 720 filing. According to the proposed regulations, if a taxpayer has more than one tax year ending after December 31, 2022, and on or before the date of publication of the final regulations, the taxpayer should file a single Form 720 with separate Forms 7208 (Excise Tax on Repurchase of Corporate Stock) for each tax year attached. This situation already applies to taxpayers with fiscal years ending in the first or second quarter of 2024 and could expand depending on the date of publication of the final regulations.
Observation: The proposed regulations provide that a taxpayer is expected to file the Form 720, including Form 7208, in each year the taxpayer makes a stock repurchase as defined in the guidance. In other words, a tax liability is not required to have an excise tax filing obligation.
Observation: The proposed regulations include both technical and procedural provisions. While there are similar procedural provisions to a number of existing federal excise tax regulations, the new procedural rules were drafted for the excise tax. Taxpayers should be cognizant of this difference and follow the procedural rules applicable to the particular excise tax when reporting other taxes for the same period and on the same form.
Effective dates
Except as discussed below with respect to acquisitions or repurchases of stock of certain foreign corporations, the proposed regulations generally apply to:
- Repurchases of stock occurring after December 31, 2022, and during tax years ending after December 31, 2022, and
- Issuances and provisions of stock occurring during tax years ending after December 31, 2022.
However, certain rules not described in the notice are proposed to be effective as of April 12, 2024 (i.e., the date of publication of the proposed regulations in the Federal Register). In addition, if a corporation consistently follows the provisions of the notice, corporations may choose to rely on the notice with respect to periods prior to April 12, 2024.
A different effective date rule is provided for acquisitions or repurchases of stock of certain foreign corporations. The proposed regulations generally apply to such transactions occurring after April 12, 2024. For funding rule transactions prior to April 12, 2024, taxpayers can apply either the funding rule described in the notice or the funding rule as set forth in the proposed regulations. However, they must consistently apply the proposed regulations to elect the latter approach.
Observation: Because the proposed regulations narrowed the funding rule by eliminating the per se rule, many domestic corporations owned by publicly traded foreign corporations may choose to follow the approach described in the proposed regulations rather than the approach described in the notice (assuming the funding rule as described in the proposed regulations is finalized in substantially the same form).
Comments and public hearing
Comments and requests for a public hearing on the proposed rules on the general application of, and exceptions to, the excise tax are due by June 11, 2024. Comments and requests for a public hearing on the procedure and administration guidance are due by May 13, 2024.
See also
Policy on Demand: Stock buyback regulations: Welcome guidance, some surprises (April 2024)
Tax Insight: IRS delays filing and payment obligations for excise tax on stock repurchases (June 2023)
Tax Insight: Initial guidance from Treasury on stock repurchase provisions (January 2023)
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