This past summer under the Inflation Reduction Act, Congress enacted new Internal Revenue Code ("Code") Section 4501, which imposes an excise tax on certain corporate redemptions or repurchases by a corporation of its own stock. Essentially, Section 4501 only applies to "Covered Corporations", which more or less translates to corporations whose stock is publicly traded. The excise tax is calculated at 1% of the fair market value of the stock repurchased (the "Excise Tax").
Interestingly, the Excise Tax is not limited solely to redemptions under Section 317(b) of the Code. Rather, the Excise Tax also applies to "transactions economically similar" to Section 317(b) redemptions and purchases from special affiliated corporations. Given the broad wording in the statute, many practitioners were concerned as to whether this new Excise Tax would apply to reorganizations under Section 368 or spin-offs under Section 355. The short answer? It depends.
Thankfully, on December 27, the IRS issued Notice 2023-02 (the "Notice"), which not only confirms the U.S. Treasury Department intends to issue proposed regulations under Section 4501, but also provides initial guidance on the Excise Tax's application to other transactions. While the Notice offers some much-welcomed clarification, the answer, however, will vary on a case-by-case basis, even when the same Code section applies to two different transactions.
In the context of certain tax-free reorganizations and spins, corporations who furnish cash to shareholders in exchange for fractional shares will not trigger the Excise Tax, so long as: 1) the shareholder receiving the cash did not separately bargain for the consideration, 2) the payment was carried out for the sole purpose of administrative convenience, and 3) the amount of cash received does not exceed the value of one full share of stock. The Notice also makes clear that the new Excise Tax does not apply to deemed redemptions as well, such as those occurring pursuant to section 304 transactions. Liquidations under sections 331 and 332, generally will not be regarded as repurchases, so long as it is a complete liquidation.
However, as mentioned above, the statute also provides that the excise tax can also apply to transactions similar in economic substance to a redemption. Section 3.04(a) of the Notice gives what is (for now) an exhaustive list of such transactions:
- Acquisitive reorganizations where the target corporation's shareholders exchange their target corporation stock pursuant to the reorganization;
- Certain recapitalizations under Section 368(a)(1)(E);
- F reorganizations where the transferor corporation's shareholders transfer their stock back to the corporation;
- Split offs where the distributing corporation exchanges shares of controlled or boot with its shareholders in exchange for its own stock; and
- Liquidations that are not complete liquidations as defined in the Section 331 regulations.
As with any initial guidance, the Notice may only be relied upon until the Treasury issues the proposed Section 4501 regulations. Practitioners with publicly traded clients contemplating transactions economically similar to a repurchase but not yet on the list above, may want to consider carrying them out before the new regulations are promulgated in the event the Treasury expands its list to other economically similar transactions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.