The U.S. Treasury finalized regulations (the “Regulations”), providing rules for public companies subject to the 1% excise tax on certain redemptions of their publicly traded stock (the “Stock Repurchase Excise Tax”).
The Stock Repurchase Excise Tax, which was enacted under the Inflation Reduction Act of 2022 and is generally applicable to repurchases occurring after December 31, 2022, applies to certain issuers (“Covered Corporations”) of publicly traded stock (described further in Section I below). The Stock Repurchase Excise Tax applies to publicly traded equity and does not apply to bonds, notes or other debt instruments that may be publicly traded. The tax is equal to 1% of the fair market value of any stock that the Covered Corporation repurchases (or is deemed to repurchase pursuant to an economically similar transaction) in a given year, subject to certain adjustments.
Details about repurchases, exceptions and related adjustments are discussed in the below Sections II through IV.
The application of this tax to certain corporate transactions is discussed in Section V, followed by a discussion of considerations relevant to specific types of issuers, including special purpose acquisition companies (“SPACs”), broker dealers, registered investment companies (“RICs”). real estate investment companies (“REITs”) and foreign corporations engaged in the international operation of vessels (“foreign maritime issuers”) in Sections VI, VII, VIII and IX. Section X provides a summary of record keeping and return filing obligations of any Covered Corporation that redeems its own stock.
I. Covered Corporations and Specified Affiliates
The Regulations define a “Covered Corporation” as any domestic corporation whose equity is traded on an established securities market. An “established securities market” generally includes domestic exchanges registered under the Securities Exchange Act of 1934 (“Exchange Act”), including the New York Stock Exchange and NASDAQ, and any foreign exchange that, under the law of the jurisdiction where it is organized, satisfies regulatory requirements that are analogous to the regulatory requirements under the Exchange Act.
Acquisitions by a specified affiliate (other than a foreign corporation or foreign partnership) of a Covered Corporation traded on an established securities market are treated the same as acquisitions by a Covered Corporation. A “specified affiliate” is any corporation or partnership that is majority owned, directly or indirectly, by the issuer.
Therefore, a foreign corporation, regardless of whether it is traded on a domestic or foreign exchange, that does not have any U.S. subsidiaries should not be a Covered Corporation for purposes of the Stock Repurchase Excise Tax.
II. Repurchases: A Term of Art
Not every stock buyback is a “repurchase” for purposes of the Stock Repurchase Excise Tax. Redemptions characterized as dividends for U.S. federal income tax purposes are not considered a repurchase for Stock Repurchase Excise Tax purposes. In addition, the purchase by a securities dealer of its own stock in connection with its broker-dealer business is not considered a repurchase.
III. De Minimis Threshold
Covered Corporations are not subject to the Stock Repurchase Excise Tax if the aggregate fair market value of stock repurchased and deemed repurchased does not exceed one million dollars ($1,000,000) in a given taxable year. The Regulations clarify that this de minimis exception is determined before taking any netting rules or other statutory exception into account.
IV. Netting Rules
The Stock Repurchase Excise Tax is calculated by subtracting the fair market value of stock issued by the Covered Corporation from the fair market value of repurchased stock during that taxable year. Issued stock includes both compensatory stock (including non-statutory options and incentive stock options) and non-compensatory stock issuances. If compensatory stock options may be settled on a cashless basis, the stock that is sold or deemed sold is treated as issued for purposes of this netting rule.
Restricted stock for which a Section 83(b) election has been made is treated as issued in the year the restricted stock is granted (not vested). Similarly, if the restricted stock, for which an 83(b) election was made, fails to vest and is forfeited, such stock is treated as repurchased.
Certain stock transfers are disregarded from the netting rule calculations. For example, stock dividends of a Covered Corporation’s own stock, certain transfers of stock to affiliates, including ESOPs, and certain transfers in connection with tax-free reorganizations are not netted against repurchases.
V. Application to Certain Corporate Transactions
Generally, payments funded by a target corporation for the taxable acquisition of its stock will be treated as a repurchase. There are, however, several circumstances under which corporate transactions are not subject to the Stock Repurchase Excise Tax. Stock that is repurchased in connection with or pursuant to: (i) an acquisitive corporate tax-free reorganization (so long as target shareholders do not receive taxable non-qualifying property (“boot”) in the transaction), (ii) a tax-free split-off transaction, regardless of whether or not the transaction also qualifies as a “D” reorganization for U.S. federal income tax purposes, (iii) stock repurchases in connection with tax-free recapitalization transactions and (iv) transactions that merely change the identity, form or place of incorporation of an issuer are all generally excepted from the Stock Repurchase Excise Tax (except, in the case of clauses (ii)-(iv), to the extent of the fair market value of the corporation’s shares that are repurchased with boot, if any).
Finally, in a tax-free reorganization, cash paid in lieu of fractional shares is generally not treated as a repurchase for purposes of the Stock Repurchase Excise Tax.
VI. Considerations for SPACs
Although the Treasury contemplated special rules for SPACs, the Regulations do not provide any special treatment of SPACs. Therefore, non-liquidating redemptions of shares in a de-SPAC transaction or in connection with an extension of a SPACs business combination deadline could potentially be subject to the Stock Repurchase Excise Tax.
VII. Considerations for Broker Dealers
Publicly traded brokerage firms should not be subject to the Stock Repurchase Excise Tax when an affiliated broker-dealer is buying the broker’s own stock in market transactions. Likewise, the sale of that stock by the broker-dealer affiliate would not count for purposes of the netting rules described above. If the Covered Corporation bought back its own stock (i.e., not through its broker-dealer subsidiary), that buy-back could potentially be subject to the Stock Repurchase Excise Tax.
VIII. Considerations for RICs and REITs
Public RICs and REITs are generally excepted from the Stock Repurchase Excise Tax. The Regulations further confirm that stock repurchases by a RIC or REIT are excepted from the Stock Repurchase Excise Tax and are not required to file excise tax returns, as discussed below.
IX. Considerations for Foreign Maritime Issuers
Foreign maritime issuers should generally not be subject to the Stock Repurchase Excise Tax. A foreign maritime issuer would only be subject to the Stock Repurchase Excise Tax if it has a specified domestic affiliate that is funding the repurchase of the foreign issuer’s stock. In our experience, most foreign maritime corporate structures do not include a Covered Corporation, and, therefore, would not be subject to this tax.
X. Record Keeping and Return Filing Obligations
The Regulations require Covered Corporations to maintain certain records, even Covered Corporations that do not have any liability to pay the Stock Repurchase Excise Tax. Covered Corporations must keep complete and detailed records sufficient to accurately establish the number and value of shares repurchased, adjustments or exceptions that may be shown on its stock repurchase excise tax return. This record keeping obligation applies to RICs and REITs, despite being exempt from the excise tax return filing obligation.
A Stock Repurchase Excise Tax return must be filed with respect to any taxable year in which the covered Corporation repurchased or is treated as repurchasing its own stock. The Stock Repurchase Excise Tax is reported annually on Form 720 (Quarterly Federal Excise Tax Return). Despite being labeled as a quarterly return, the Stock Repurchase Excise Tax return is filed annually by due date of Form 720 for the first full quarter of the succeeding taxable year in which there is a stock repurchase. A new Form 7208 (Excise Tax on Repurchases of Corporate Stock) will be attached to the Form 720. Penalties may be imposed for unreasonable understatements of the Stock Repurchase Excise Tax liability.
Final Remarks
Seward & Kissel LLP actively monitors tax changes that may impact its clients. For additional information on the Stock Repurchase Excise Tax, please contact a member of Seward & Kissel’s Tax Practice or Capital Markets Practice.
