Overview

On August 12, 2022, the U.S. House of Representatives approved H.R. 5376, the "Inflation Reduction Act" (the Act), which was signed into law by President Biden on August 16, 2022. The approval and subsequent enactment follow the prior passage of the Act by the Senate on August 7, 2022. The Act imposes a one percent non-deductible excise tax on repurchases of stock that are made by publicly-traded U.S. corporations and certain publicly-traded non-U.S. corporations on or after January 1, 2023. In addition, pending the issuance of any regulatory, administrative, or other guidance, the provisions of the excise tax are sufficiently broad such that a wide variety of other common corporate transactions that are not typically perceived as "stock repurchases" may also be subject to the tax. Set forth below is a brief summary of selected aspects of the excise tax and related considerations for convertible bond hedge transactions and accelerated share repurchase programs (ASRs). For a more detailed discussion of the excise tax, including future planning considerations and recommended best practices, see The New One-Percent Excise Tax on Stock Repurchases and Its Potential Implications for Common Corporate Transactions.

General Implications for Stock Repurchases

In general, the excise tax will impose an incremental cost of one percent on all forms of stock repurchase transactions, including open market repurchases, privately negotiated purchases, and purchases in registered self-tender offers. The excise tax will also generally apply to any equity securities that are puttable by the holder, callable by the issuer, or mandatorily redeemable by their terms (such as mandatorily redeemable preferred stock), even if such equity securities were originally issued prior to the enactment of the new statute.

However, certain repurchases are specifically exempted from the excise tax, including, among others: i) repurchases that are accompanied by a contribution of the repurchased stock (or an amount of stock equal to the value of the stock repurchased) to an employer-sponsored retirement plan, employee stock ownership plan, or similar plan; ii) repurchases during a taxable year that do not exceed $1 million in the aggregate; and iii) repurchases that are treated as a "dividend" for U.S. federal income tax purposes. The new legislation also provides for an annual adjustment (or "netting") mechanism that reduces the amount of any stock repurchases subject to the excise tax by the fair market value of any stock issued by the corporation during the same taxable year.

Convertible Bond Hedge Transactions

Corporate issuers that raise capital with convertible debt often enter into hedging transactions (typically referred to as "call spread" or "capped call" structures) that are designed to minimize the potential impacts of dilution upon the ultimate occurrence of a conversion event. These hedging transactions may also be "tax integrated," which can enable the full cost of the bond hedge element of a call spread, or the net cost of a capped call, to be effectively amortized by the corporate issuer over the term of the underlying debt as "original issue discount" for U.S. federal income tax purposes, provided that certain requirements are satisfied.

To the extent that such bond hedging transactions are settled in shares of the corporate issuer (rather than being settled in cash), the excise tax would generally apply, subject to any adjustment (or "netting") that might occur by reason of a concurrent issuance of shares to the holders of the debt. However, if a hedging transaction does not settle at the same time as a conversion of the underlying debt (which may, for example, sometimes be the case with non-tax-integrated capped call arrangements), and instead settles in a later taxable year, then for purposes of the excise tax a share settlement of such hedging transaction would not be able to be adjusted (or "netted") by the shares issued at the time the debt was converted.

Accelerated Share Repurchase (ASR) Programs

An ASR program is a privately negotiated contract between a company and an equity derivatives dealer. A typical ASR is structured as follows: on the "prepayment date" (one-to-three business days after the contract is executed), the company will make an upfront payment to the dealer for the dollar amount of stock the company commits to repurchase. The dealer in turn will deliver a number of shares (obtained by borrowing from institutional stock lenders), determined by dividing an agreed upon percentage (e.g., 70-85 percent) of the company's upfront payment by the price per share at execution. Such shares are generally retired by the company or classified as treasury shares. On the "termination date" (which may be accelerated by the dealer), the total number of shares repurchased under the ASR is determined based on i) the arithmetic average of a published daily volume weighted average price of the company's common stock over the term of the ASR minus ii) a specified, negotiated discount. If the total number of shares repurchased by the company under the ASR at the final price per share is more than the number of shares initially delivered by the dealer to the company, the dealer will be required to deliver additional shares to the company to cover the difference. However, if the price of the company's common stock increases significantly during the term, the company may be obligated to deliver either cash or shares (at the company's election) to the dealer upon termination, although in practice this is unlikely to occur.

The form of the ASR is that a repurchase occurs on the prepayment date to the extent of the 70-85 percent delivered at the time, which would be subject to an excise tax if it occurs on or after January 1, 2023. This treatment is consistent with the fact that the delivered shares are canceled upon delivery and are generally not considered issued and outstanding (e.g., they are removed for purposes of calculating earnings per share). A second repurchase would occur on the termination date if the dealer delivers additional shares. If, on the other hand, the company delivers additional shares to the dealer, this would be an additional issuance. If the termination date is in the same taxable year as the prepayment date, the adjustment / netting rules described above should apply to reduce the excise tax on the initial repurchase. However, if the termination date is in a different taxable year, the additional issuance would not offset the initial repurchase, although it could perhaps net against other repurchases in the year of the termination date. It is not clear how a delivery of cash by the company would be treated for purposes of the excise tax. Alternatively, it is possible that the excise tax would not apply until the number of shares that is repurchased is fixed, i.e., upon settlement on the termination date. In that case, an ASR that terminated on or after January 1, 2023, would be subject to the excise tax in its entirety based on the amount of stock finally repurchased, even if the ASR was executed prior to January 1, 2023 (unless regulations issued by the Secretary of the Treasury provide a grandfathering exception).