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.
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.
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.