April 25, 2024

Treasury, IRS Issue Inbound Corporation Stock Repurchase Excise Tax Proposed Regulations

Holland & Knight Alert
Joshua David Odintz | Mary Kate Nicholson

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.

 

Holland & Knight Insight

The per se rule is so broad that it applies to routine business transactions, including the acquisition of inventory by a U.S. subsidiary from a related foreign corporation if a foreign parent repurchased its stock within two years of the purchase of such inventory.

In the preamble to the Proposed Regulations, the Treasury and the IRS recognized that the per se rule of Notice 2023-2 was overbroad. However, the Treasury and the IRS maintained that the funding rule is necessary to "prevent avoidance of" the Excise Tax and is a "an appropriate and permissible exercise of the broad grant of authority in Section 4501(f) to prescribe regulations and other guidance as necessary or appropriate to carry out, and to prevent the avoidance of, the purposes of the stock repurchase excise tax."

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.

 

Holland & Knight Insight

Several comments filed in response to Notice 2023-2 requested that the Treasury and the IRS provide exceptions to the application of the funding rule due to its overbroad nature and potential to capture ordinary course business transactions, including inventory purchases, interest payments, cash pooling and other common intercompany transactions. The Treasury and the IRS stated that "the elimination of the per se rule and the targeted nature of the rebuttable presumption appropriately address the concerns reflected in the feedback requesting these [ordinary course] exclusions" and that exception for "repurchases or acquisitions by a dealer in securities would apply" further addresses these concerns.

 

Holland & Knight Insight

The rebuttable presumption applies to repurchases occurring after April 13, 2024. For repurchases occurring before April 13, 2024, taxpayers can elect to adopt the Proposed Regulations to transactions occurring after Dec. 31, 2022, to avoid the application of the per se rule.

Even though the Treasury and the IRS agree the per se rule is too broad, they are leaving it in place unless taxpayers adopt proposed that would otherwise not apply to repurchases before April 13, 2024.

 

Holland & Knight Insight

Under the new per se test, an improper purpose to avoid the Excise Tax is deemed to exist if the U.S. subsidiary makes a payment to a foreign related party to fund a dividend. For example, foreign parent announces a stock repurchase and the U.S. subsidiary pays a dividend to the foreign parent for the repurchase. The U.S. subsidiary is deemed to have a principal purpose to avoid the Excise Tax because it funded the foreign purchase. This rational applies even if it is illegal under local corporate law for a subsidiary to own foreign parent stock (hook stock) or the U.S. subsidiary never had a plan to repurchase foreign parent stock.

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.

 

Holland & Knight Insight

Even with the revisions to the Excise Tax guidance provided in the Proposed Regulations, dividends, interest and other transactions may be caught under the funding rule and rebuttable presumption.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.

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