On August 16, 2022, President Biden signed Public Law No. 117-169, “An Act to provide for reconciliation under Title II of S. Con. Res. 14.”, colloquially known as the Inflation Reduction Act 2022 (the “IRA”). The IRA contains several notable tax changes: an alternative minimum corporate tax based on financial statement earnings; an excise tax on share redemptions; a research credit in compensation for social charges for small businesses; a two-year extension of the limitation in section 461(l) on excessive business losses for non-corporate taxpayers; substantial increases in SRI funding levels; and significant changes to energy tax incentives, including the reinstatement of Superfund taxes on petroleum products in 2023. This client alert focuses on the new alternative minimum corporate tax and excise tax on redemption of shares. A separate client alert will discuss the new energy-related tax incentives.
Alternative Minimum Corporate Tax
New paragraph 55(b)(2), applicable to taxation years beginning after December 31, 2022, imposes a 15% alternative minimum corporate tax (“CAMT”) based on adjusted income from financial statements (“AFS Income”) of certain large corporations, defined as Applicable Corporations. Relevant corporations are generally defined as corporations with an average pre-tax net income of at least $1 billion reported in the consolidated financial statements of such corporations and measured over the three-year period preceding the tax year applies. For the sole purpose of determining whether a company is an Applicable Company, and not for the purpose of measuring the company’s CCT income, the income of a company is aggregated with the income of companies held in common at least 50% with that company, as determined under section 52 of the Code. Domestic corporations that are part of foreign-invested multinational groups with an average pre-tax net income of at least $1 billion are subject to a separate threshold of $100 million to qualify as an applicable corporation; that is, the national company (together with related national companies) must itself have an average revenue greater than $100 million for the relevant period.
The adjusted income of a company’s financial statements generally begins with the net income or net loss reported in the applicable financial statements of a company, as determined under section 451(b) of the Code and its regulations. . These rules generally treat all members of a US consolidated group as one corporation and provide rules for attributing consolidated financial statement income to non-group members. CAMT requires other notable adjustments to AFS revenue:
- With respect to non-affiliates (other than controlled foreign corporations – “CFCs”), only dividends received and gains and losses recognized in respect of such non-affiliates are considered.
- A partner in a partnership takes into account his distributive share of the AFS income or loss reported by the partnership.
- The owner of a skipped entity takes into account the AFS income of this entity.
- A U.S. shareholder of a SEC takes into account its pro rata share of the AFS income or loss of that SEC, without regard to exemptions under Subpart F, GILTI or Section 245A, except in the to the extent that the adjustment results in a loss for the year, in which case the amount of the loss is carried forward to the next taxation year.
- With respect to taxpayers who are foreign corporations, such foreign corporation determines its AFS income by applying the principles of Section 882 (i.e. taking into account only income which is actually related to a trade or to a company in the United States).
- AFS income is increased by US federal taxes paid as well as deductible foreign taxes, if the taxpayer chooses to credit those taxes.
- Finally, AFS revenues are reduced by accelerated depreciation under Articles 167 and 168 of the Code, and increased by depreciation claimed on taxpayers’ financial statements. This is a change from the previous version of CAMT and would significantly reduce a source of book tax disagreement that would have increased CAMT’s reach for taxpayers in capital-intensive industries.
CAMT liability is the amount by which the provisional minimum tax exceeds the taxpayer’s regular tax liability, including his BEAT liability under Code Section 59A. The Provisional Minimum Tax is equal to 15% of an applicable corporation’s adjusted AFS income.
CAMT would allow net operating losses in financial statements to reduce AFS revenue, which could be carried forward indefinitely. General business credits and foreign tax credits would be available to offset the amount of CCT, to the extent permitted by certain special rules. Finally, a credit would be given against ordinary tax for the previous year’s CAMT liability.
Linking a minimum tax to the income of the financial statements of a multinational corporation is inherently complex. At the very least, adjustments are needed to reflect a tax system based on entity, sources of income, and carry-backs and forwards. At the margin, these adjustments leave open the possibility of a shift. In addition to this, the new CAMT regime adds additional complexity by requiring adjustments for certain specific tax treaties, including accelerated depreciation to reduce income from adjusted financial statements and by allowing general trade credits and credits for foreign tax to reduce the CAMT obligation, among others. Introducing these adjustments, while favorably reducing the impact of CAMT in most cases, adds complexity. Not only do the adjustments themselves need to be taken into account, but implicitly introduce the need for collateral adjustments, including tax base and similar items, and transition rules, none of which have been specifically provided for in the law. Taxpayers should track these impacts over tax years. Even taxpayers not normally found in CAMT will need to track material transactions and other events, to ensure that they have identified any differences between taxable income and adjusted financial statement income.
The Treasury has a number of specific powers of regulatory authority and a broad general power of authority. It is the responsibility of taxpayers to raise questions and concerns when advice is needed and may be forthcoming.
Excise tax on redemption of shares
New Section 4501 imposes a 1% excise tax on the fair market value of shares redeemed by a target company. The amount of shares repurchased is reduced by the fair market value of shares issued by the target company during the tax year, or issued to employees or paid into a retirement or employee stock option plan.
A Covered Company is any domestic company whose stock is traded on an established stock exchange, as defined in Section 7704(b)(1), which includes domestic and foreign stock exchanges that meet certain regulatory requirements under of Treas. Reg. second. 1.7704-1(b).
A repurchase is generally defined as a refund under Section 317(b) or an economically similar transaction, as determined by the Treasury. Section 317(b) defines a buyout as any acquisition by a corporation of its own shares from a shareholder in exchange for property, whether the shares acquired are cancelled, withdrawn, or held as treasury shares. Under Section 317(a), property includes money, securities and any other property except shares of the company or rights to acquire its shares.
There are a number of special rules in the application of excise tax on share redemptions. Shares acquired by a specified affiliate of a target company, if purchased from a person who is not the target company or a specified affiliate, are subject to excise tax. A Specified Affiliate is a company 50% owned (by vote or value), directly or indirectly, by a Covered Company.
In addition, a redemption of shares by a domestic specified affiliate of an applicable foreign corporation is subject to excise tax. An applicable foreign company is any foreign company whose shares are traded on an established securities market. If the domestic specified affiliate acquires shares of the relevant foreign corporation, the specified affiliate will be considered a target corporation and the acquisition will be treated as a redemption of taxable shares. This will be a structural consideration in any share buybacks by foreign listed companies.
Last but not least, special rules apply to treat expatriate entities as covered companies in certain circumstances, for reversals occurring after September 20, 2021.
There are many exceptions to the application of excise tax, including if:
- the redemption is part of a tax-free reorganization (under section 368(a)), and no gain or loss is recognized by the shareholder as a result of the reorganization;
- the repurchased share is, or an amount of a share equal to the value of the repurchased share is, contributed to an employer-sponsored pension plan, employee stock ownership plan or similar plan;
- the total amount of redemptions during the year is less than $1 million;
- the redemption is made by a stockbroker in the ordinary course of business;
- the redemption is made by a regulated investment company or a real estate investment trust; Where
- the redemption is taxed as a dividend for the shareholder.
In general, since excise tax only applies to corporations whose shares are traded on a public market, the determination of what constitutes a redemption subject to excise tax and the amount of such tax should be easy to determine.
Uncertainties may arise in transactions involving non-traded shares where the transaction price may not establish fair market value. In these cases, assessments may be necessary.
In addition, the question of whether and to what extent a redemption constitutes a dividend may be difficult or impossible to determine in connection with certain transactions, including market transactions (lack of declaration by the selling shareholder), such as in evidenced by the decisions of the IRS on the matter.
In addition, transactions involving purchases of shares of foreign companies, whether expatriate entities or not, should be carefully reviewed to ensure that such purchases do not inadvertently fall within the rules.
Treasury guidelines will be needed to identify any other exceptions, such as withdrawal of preferred shares occurring in accordance with its terms, and definitional guidelines on what may constitute economically similar transactions.
