Key points to remember:
- Over the weekend, the Senate passed the Reducing Inflation Act of 2022, which includes an alternative minimum corporate tax of 15% for a corporation with financial statement income over $1 billion and a 1% excise tax on share buybacks by listed companies. The bill is expected to be considered by the House later this week.
- The bill includes useful changes from previous proposals that would have increased the holding period for deferred interest to qualify as long-term capital gains and aggregated the income of certain corporations under common ownership for purposes of applying the alternative minimum corporate tax.
On August 7, 2022, the Senate passed the Inflation Reduction Act of 2022 (the “IRA”). Although the IRA has not yet passed the House, it is expected to be. The IRA introduces a wide range of provisions aimed at curbing climate change and reducing healthcare costs. The IRA largely retains the framework of a minimum corporate tax of 15% on book income of large corporations included in earlier legislative proposals and introduces a 1% excise tax on share redemptions companies.
Notably, the IRA does not include the changes to the taxation of deferred interest that were originally proposed. However, changing the taxation of deferred interest remains a priority for the Democratic Party, and the treatment of deferred interest under the Internal Revenue Code could still be changed in future legislation.
The changes to the tax laws are proposed to come into effect for taxation years beginning after December 31, 2022.
ALTERNATIVE MINIMUM CORPORATE TAX
Companies subject to tax
- The IRA imposes a minimum tax on a “applicable corporation” equal to the excess of (i) 15% of its applicable financial statement income (less a foreign tax credit) over (ii) its regular corporation tax for the year.
- An applicable corporation is a corporation (other than an S corporation, regulated investment company, or real estate investment trust) with an average applicable financial statement revenue that exceeds $1 billion for any three-year period ending in 2022 or later. Special rules apply to new corporations, short taxation years and successor corporations.
Comment: The $1 billion threshold is not indexed to inflation, and the IRA leaves it open to future IRS guidance rules that would allow corporations that experience a change in ownership or decline in revenue to escape to minimum tax.
- The rules generally apply to a US subsidiary of a foreign parent group if the group has more than $1 billion in average applicable revenues in the financial statements and the US subsidiary has at least $100 million in average applicable revenues in the financial statements over a three-year period.
- Aggregation rules apply to determine the $1 billion threshold between related entities.
Comment: Proposed versions of the minimum tax included additional aggregation language that would have taken into account the income of separate corporations held by a single investment fund or other partnership. This language was removed from the final version of the IRA.
- Minimum tax begins with the net income or loss shown on the “applicable financial statements”. The adjustments allocate financial statement income from consolidated financial statements to members of a consolidated tax group, and require a corporation to consider its share of book income from partnerships, disregarded entities, and controlled foreign corporations (” SEC”) whose taxable income “rolls up” in his federal tax liability.
Comment: The rules adjust applicable financial statement income to include a US corporation’s share of its CFC accounting income. Accounting losses of a CFC are not taken into account and are instead carried forward to reduce the inclusions of the CFC’s accounting income in subsequent years. The effect of these provisions may affect the 10.5% rate under the GILTI regime and the participation exemption of Article 245A.
Comment: Although the methodology used to determine the minimum tax shares some of the characteristics of the overall 15% minimum tax provided for by the OECD second pillar rules, there are important differences in the operation of the two regimes. These differences could lead to attempts by other countries to impose their own top-up second pillar taxes on US groups.
Comment: The IRA also does not include changes to the GILTI regime, including country-by-country minimum corporate tax calculations, and other U.S. international tax provisions that were proposed last fall in the Build Back Better Act and which would have brought these rules more in line with the second pillar framework.
- The applicable financial statement used for the calculation gives precedence to a taxpayer’s GAAP financial data used in a 10-K filing, or, if not applicable, audited GAAP financial data used for reporting or any other substantial non-tax purpose, or filed with a federal agency. If the taxpayer does not use GAAP financial statements, the IFRS financial statements take precedence. If the taxpayer is not using either GAAP or IFRS, financial statements filed with any other regulatory or government agency specified by the Treasury would be used.
Comment: While insurance groups often prepare consolidated financial statements under GAAP or IFRS, US insurance companies prepare stand-alone financial statements using statutory accounting, and taxable income is generally based on statutory income. Thus, differences between GAAP and statutory income could have a significant impact on the calculation of minimum tax for these groups. For example, certain arrangements such as “funds withheld” reinsurance can create volatility for GAAP accounting against statutory income.
- The new rules provide for a minimum carry forward of the tax credit. Therefore, if a relevant company generates a high book income relative to taxable income (resulting in a deferred tax liability), the company pays minimum tax currently and is entitled to a credit in future years if the reversal of the deferred tax liability causes the effective tax rate to be lower than the minimum rate.
Comment: Affected companies should consider potential sources of timing differences between accounting income and taxable income, which could create an unanticipated outflow of funds under minimum tax and potential pressure on the balance sheet if the company is required to hold a valuation allowance (or similar restriction) on any resulting earnings. deferred tax asset for the future minimum tax credit. Permanent differences between the financial statement result and taxable income (such as employee stock options and lower corporate tax rates on dividends) can result in a permanent loss of tax benefits.
- If a company has an accounting loss, it is allowed to carry forward the loss to reduce the minimum tax base of the financial statements for future years. In accordance with the use of net operating losses against ordinary tax, accounting losses can only be used to offset 80% of accounting income in subsequent years. Rollbacks are not allowed.
Comment: Only balance sheet losses from 2020 and subsequent years are taken into account, which limits the protection of taxpayers with significant historical losses and tax deferrals.
- The minimum tax calculation includes an adjustment to exclude the tax impact of depreciation of tangible assets, preserving the tax preference for capital investment. Intangible assets, including goodwill resulting from an acquisition, are not protected in the same way, with the exception of wireless spectrum acquired by wireless carriers before the enactment of the IRA.
Comment: In M&A acquisitions structured as asset purchases, partnership acquisitions, or stock acquisitions that are treated as asset purchases pursuant to an election under Section 338 or 336( e), the parties generally agree on an allocation of the purchase price between the categories of assets acquired and the goodwill. Whereas previously the exact allocation could only affect the depreciation period for a purchaser, the different treatment of depreciation of tangible assets versus goodwill and intangible assets under minimum tax could affect significantly the importance of the agreed asset values.
EXCISE TAX ON REDEMPTION OF SHARES
- The IRA imposes a 1% non-deductible excise tax on the fair market value of shares redeemed by publicly traded companies or their specified affiliates. The rules cover takeovers by US public companies and US subsidiaries of foreign public companies. An offset rule reduces the excise tax base by the fair market value of shares issued in the same tax year, including shares issued or provided to employees.
Comment: The excise tax applies to any redemption transaction by a publicly traded target company, even if the particular shares redeemed are not publicly traded. Therefore, along with share buybacks in the normal course of business, a number of business transactions may be subject to this excise tax.
- Excise tax does not apply to any distribution or redemption treated as a dividend for federal income tax purposes. It also does not apply to redemptions (1) that are part of a tax-free reorganization, (2) if the redeemed shares or an equivalent value of shares are contributed to a retirement or employee share ownership, (3) less than $1 million per year, (4) as required by regulation, by an investment dealer in the ordinary course of business, or (5) by regulated investment companies or trusts real estate investment.
Comment: Companies subject to excise tax could pay dividends instead of engaging in share buybacks to avoid excise tax. However, the impact of share buybacks on financial metrics such as earnings per share and share price may mean that the companies involved continue to buy back shares.
- The IRA provides that the IRS will prescribe anti-abuse rules, as well as rules designed to deal with special classes of stock and preferred stock.
Comment: Regulation will be of particular interest in the market for private investments in public equities (“PIPE”). PIPEs are generally structured as preferred stock that will be repaid via a buyback, and the rules apply without excluding existing investments.