Highlights
- Following the release of initial guidance in the form Notice 2023-2, the U.S. Department of the Treasury (Treasury) and IRS issued proposed regulations (the Proposed Regulations) under the Section 4501 stock repurchase excise tax. Comments on the Proposed Regulations are due by June 11, 2024.
- As relevant to foreign-parented U.S. corporations (otherwise referred to as "inbound" corporations"), the Proposed Regulations provide for a more limited application of the funding rule originally proposed in Notice 2023-2.
- This Holland & Knight alert breaks down the application of the Proposed Regulations to inbound corporations.
Following the release of initial guidance in the form Notice 2023-2, the U.S. Department of the Treasury (Treasury) and IRS issued proposed regulations (the Proposed Regulations) under the Section 4501 stock repurchase excise tax (the Excise Tax). Comments on the Proposed Regulations are due by June 11, 2024.
When Does the Excise Tax Apply?
Effective Jan. 1, 2023, Section 4501 imposes the Excise Tax on
covered corporations in an amount equal to 1 percent of the fair
market value of stock of the corporation, which is repurchased by
such corporation during the taxable year. A "covered
corporation" is any domestic corporation, the stock of which
is traded on an established securities market. The acquisition of
stock of a covered corporation by a specified affiliate of such
covered corporation, from a third party, is treated as a repurchase
of the stock of the covered corporation by such covered
corporation. A "specified affiliate" is any corporation
more than 50 percent of the stock of which is owned (by vote or by
value), directly or indirectly, by a covered corporation, and any
partnership more than 50 percent of the capital interests or
profits interests of which is held, directly or indirectly, by such
corporation.
Relevant for inbound companies, Section 4501(d) applies the Excise
Tax in the case of an acquisition of stock of an applicable foreign
corporation (any foreign corporation the stock of which is traded
on an established securities market) by a specified affiliate of
the corporation – other than, generally, a foreign
corporation or a foreign partnership – from a person who is
not the applicable foreign corporation or a specified affiliate of
the applicable foreign corporation. Alternatively stated, the
Excise Tax generally applies to the repurchase of foreign parent
stock by a U.S. subsidiary.
Notice 2023-2
Notice 2023-2 drew sharp criticism for its inclusion of the "funding rule," which provided that an applicable specified affiliate is treated as acquiring stock of an applicable foreign corporation if the applicable specified affiliate funds by any means (including through distributions, debt or capital contributions) the acquisition or repurchase of stock of the applicable foreign corporation by the applicable foreign corporation or a specified affiliate that is not also an applicable specified affiliate, and such funding is undertaken for a principal purpose of avoiding the Excise Tax. The notice further provided for a "per se rule" under which payments (other than a dividend) were to be deemed as having been undertaken to avoid the Excise Tax solely where such payments were made within two years of an acquisition or repurchase of foreign parent stock by such foreign parent.
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Proposed Regulations
The Proposed Regulations largely retains Notice 2023-2's funding rule. Specifically, under the Proposed Regulations, an applicable specified affiliate of an applicable foreign corporation is treated as acquiring stock of the applicable foreign corporation to the extent the applicable specified affiliate 1) funds by any means (including through distributions, debt or capital contributions), directly or indirectly, a repurchase or an acquisition of stock of an applicable foreign corporation by a specified affiliate of an applicable foreign corporation that is not an applicable specified affiliate of the applicable foreign corporation, and 2) with a principal purpose of avoiding the Excise Tax. If a principal purpose of a funding is to fund, directly or indirectly, a covered purchase, then there is a principal purpose of avoiding the tax.
The Proposed Regulations depart from Notice 2023-2 and do away with the per se rule in favor of a rebuttable presumption providing that a principal purpose presumed to exist if the applicable specified affiliate funds by any means, directly or indirectly, a downstream relevant entity, and the funding occurs within two years of a covered purchase by or on behalf of the downstream relevant entity. For this purpose, a relevant entity means a specified affiliate of an applicable foreign corporation that is not an applicable specified affiliate of the applicable foreign corporation. A downstream relevant entity means a relevant entity that is 1) 25 percent or more of the stock of which is owned (by vote or by value), directly or indirectly, by, individually or in aggregate, one or more applicable specified affiliates of an applicable foreign corporation, or 2) 25 percent or more of the capital or profits interests in which are held, directly or indirectly, by, individually or in aggregate, one or more applicable specified affiliates of an applicable foreign corporation. The presumption can be rebutted only if facts and circumstances clearly establish that there was not a principal purpose to avoid tax.
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The Proposed Regulations also clarify that certain statutory exceptions to the Excise Tax apply with respect to applicable foreign corporations. To the extent that one of the below exceptions applies, the repurchase is not subject to the funding rule and rebuttable presumption.
Exception to Excise Tax |
Application to Applicable Foreign Corporations |
Reorganizations |
Applies to repurchases and acquisitions made by applicable foreign corporations to the extent that the transaction qualifies no gain or loss treatment under sections 354 or 355 regarding certain reorganizations. |
Employee plans |
Applies to repurchases and acquisitions of stock of an applicable foreign corporation contributed to an employer-sponsored retirement plan of the covered corporation. The Proposed Regulations provide that "issuing or providing stock to an employee refers solely to stock of the applicable foreign corporation or covered surrogate foreign corporation, as applicable, that is issued or provided by a Section 4501(d) covered corporation to an employee in connection with the employee's performance of services in the employee's capacity as an employee of the Section 4501(d) covered corporation." |
De Minimis ($1 million) |
Applies with respect to repurchases made by an applicable foreign corporation, in the aggregate. |
Dealer |
Applies to any repurchasing or acquiring entity that is a dealer in securities, whether such entity is an applicable foreign corporation or specified affiliate. |
Real Estate Investment Trust |
Does not apply, as a repurchase by a regulated investment company (RIC) or real estate investment trust (REIT) is not subject to Section 4501(d). |
Dividends |
Applies to the extent that the applicable foreign corporation repurchase is treated as divided under section 301(c)(1) or 356(a)(2), but a rebuttable presumption applies. Under the rebuttable presumption, an applicable foreign corporation repurchase to which section 302 or 356(a) applies is presumed to be subject to section 302(a) or 356(a)(1), respectively (and, therefore, is presumed ineligible for the exception). A taxpayer can rebut this presumption with regard to a specific shareholder of an applicable foreign corporation solely by establishing with sufficient evidence that the shareholder treats the applicable foreign corporation repurchase as a dividend on the shareholder's federal income tax return, or for a shareholder who does not have a federal income tax filing obligation with respect that the applicable foreign corporation repurchase would properly treat the applicable foreign corporation repurchase as a dividend if the shareholder filed a federal income tax return. |
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