Practical advice on current issues.

• Author: Brosseau, Alexander J.

Unless otherwise noted, contributors are members of or associated with Deloitte Tax LLP.

For additional information about these items, contact Mr. Brosseau at 202-661-4532 or abrosseau@deloitte.com.

In This Department

CORPORATIONS & SHAREHOLDERS

New stock repurchase excise tax; p. 7.

CREDITS AGAINST TAX

The research credit: Funded research; p. 11.

EXPENSES & DEDUCTIONS

Uncertainties remain in analyzing success-based fees; p. 15.

FOREIGN INCOME & TAXPAYERS

Corporate AMT: Unanswered questions about its foreign tax credit; p. 18.

PRACTICE & PROCEDURES

More than three dozen IRS letter rulings allow late QOF self-certifications; p. 22.

PROCEDURE & ADMINISTRATION

Protecting contingent refund claims; p. 26.

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Corporations & Shareholders

New stock repurchase excise tax

The Inflation Reduction Act, P.L. 117-169, was signed into law on Aug. 16, 2022. The act included a new Sec. 4501 that imposes an excise tax on certain repurchases of stock by publicly traded corporations.

In general, and before considering exceptions, the amount of the excise tax is equal to 1% of (1) the aggregate fair market value (FMV) of stock repurchased by a corporation, over (2) the aggregate FMV of stock issued by the corporation, in each case, during the tax year. The excise tax applies to repurchases of stock by corporations beginning after Dec. 31, 2022. The excise tax is not deductible for purposes of computing U.S. federal income tax (Sec. 275(a)(6)).

The Inflation Reduction Act did not include any legislative history that describes the underlying policy for the excise tax. Based on prior draft legislation proposing an identical excise tax, the apparent policy is to disincentivize publicly traded corporations from using available cash to repurchase stock (including any savings resulting from the lowering of the U.S. federal corporate income tax rate to 21%), which may increase earnings per share and benefit corporate executives who have stock-based compensation as well as other shareholders (see, e.g., Press Release for Proposed Stock Buyback Accountability Act (Sept. 10, 2021); President Biden Announces the Build Back Better Framework (Oct. 28, 2021) ("[I]ncludes a 1% surcharge on corporate stock buy-backs, which corporate executives too often use to enrich themselves rather than investing [in] workers and growing their businesses")).

Regulatory authority

Sec. 4501(f) provides that the IRS will prescribe such Treasury regulations and other guidance as are necessary or appropriate to carry out, and to prevent the avoidance of, the purposes of this section, including regulations and other guidance (1) to prevent the abuse of the exceptions provided by Sec. 4501(e); (2) to address special classes of stock and preferred stock; and (3) for the application of the rules with respect to foreign corporations under Sec. 4501(d).

Notice 2023-2

On Dec. 27, 2022, Treasury and the IRS released Notice 2023-2, which announced that they intend to issue proposed regulations with respect to the excise tax. The notice provides interim guidance that Treasury and the Service generally intend to include in the proposed regulations, including several examples that illustrate the application of the rules set forth in the notice. Treasury and the IRS anticipate that the proposed regulations will be consistent with the guidance provided in the notice. In addition, until the issuance of the proposed regulations, taxpayers are permitted to rely on the operating rules set forth in Section 3 of the notice. The proposed regulations are anticipated to apply to repurchases of stock made after Dec. 31, 2022, and to issuances of stock made during a tax year ending after Dec. 31, 2022.

Contrary to the apparent underlying policy for the excise tax described above, the notice contains rules that result in a broad application of the excise tax. The notice requests comments, including on aspects of the excise tax not discussed in the notice. Thus, the proposed regulations could have additional rules or rules different from those set forth in the notice.

Although the application of the excise tax to foreign corporations is beyond the scope of this item, Sec. 4501(d) generally provides that the excise tax applies to acquisitions of stock of a publicly traded foreign corporation by certain U.S. affiliates. The notice significantly expands this statutory rule, whereby the excise tax can apply where the U.S. affiliate does not acquire, but is treated as funding the acquisition of, stock of the publicly traded foreign corporation, and the principal purpose of such funding is to avoid the excise tax (including a "per se rule," where a principal purpose is deemed to exist if stock acquisitions occur within two years of certain fundings). In addition, except as described here, compensation-related aspects of the excise tax are beyond the scope of this item.

Corporations subject to the excise tax

The excise tax applies to a "covered corporation" that repurchases its stock (Sec. 4501(a)). A covered corporation means any domestic corporation the stock of which is traded on an "established securities market" within the meaning of Sec. 7704(b)(1) (Sec. 4501(b)). Notice 2023-2 defines the term "established securities market" by reference to Regs. Sec. 1.7704-l(b), which includes, among other things, (1) a national securities exchange that is registered under the Securities Exchange Act of 1934 (e.g., NYSE and NASDAQ); and (2) an interdealer quotation system that regularly disseminates firm buy or sell quotations by identified brokers or dealers by electronic means or otherwise (which could include over-the-counter (OTC) markets).

Although covered corporation status requires a corporation's class of stock to be traded on an established securities market, the notice provides that "stock" means any instrument issued by a corporation that is treated as stock for U.S. federal income tax purposes. Thus, repurchases of nontraded classes of stock of a covered corporation would be taken into account for purposes of the excise tax (see the notice, Section 3.09, Example 1, where the excise tax applies to a redemption by a covered corporation of mandatorily redeemable preferred stock that is not traded on an established securities market). As mentioned above, the regulatory authority set forth in Sec. 4501(f) included guidance to address preferred stock; however, the notice, as evidenced by the example, did not contain any exceptions for preferred stock, including where the covered corporation had the obligation (and not the option) to redeem the preferred stock.

In addition, Sec. 4501(c)(2) provides that purchases of covered corporation stock by a "specified affiliate" are treated as repurchases by the covered corporation. For this purpose, "specified affiliate" means (1) any corporation more than 50% of the stock of which is owned (by vote or by value), directly or indirectly, by the covered corporation; and (2) any partnership more than 50% of the capital interests or profits interests of which is held, directly or indirectly, by the covered corporation (Sec. 4501(c) (2)(B)). However, purchases of covered corporation stock by a specified affiliate from the covered corporation or another specified affiliate of such covered corporation are not treated as repurchases (Sec. 4501(c)(2)(A)).

Computation of the excise tax

Notice 2023-2 sets forth a computation for the excise tax that is consistent with the 1% computation set forth in Secs. 4501(a) and (c) but allows for the administration of the rules and constructs contained in the notice. In this regard, the notice provides that the amount of the excise tax imposed on a covered corporation is equal to 1% times the stock repurchase excise tax base. "Stock repurchase excise tax base" is defined as an amount (not less than zero) equal to the FMV of all repurchases (as defined in Section 3.04 of the notice) of the covered corporation's stock during the tax year (as measured and determined under Section 3.06 of the notice), subject to reduction in the following order:

* The FMV of any repurchases that are subject to one of the "statutory exceptions" under Sec. 4501(e); and

* The FMV of any stock issued by the covered corporation under the "netting rule"under Sec. 4501(c).

The notice provides that any excess reductions under the statutory exception and/or the netting rule may not be carried back or carried forward to other tax years.

Transactions subject to the excise tax

A "repurchase" of stock is defined as any (1) redemption within the meaning of Sec. 317(b); and (2) transaction determined by the IRS to be economically similar to a redemption of stock ("economically similar transactions") (Sec. 4501(c)(1)(A)). Under Sec. 317(b), a redemption of stock means an acquisition by a corporation of its own stock from a shareholder in exchange for property other than the corporation's own stock or rights to acquire such stock. Notice 2023-2 provides for two limited and exclusive exceptions with respect to Sec. 317(b) redemptions. The first exception is for the deemed redemption of acquiring corporation stock that occurs as a result of the application of Sec. 304(a)(1) to a related-party stock acquisition. The second exception is for deemed redemptions where cash is received in lieu of fractional shares (and certain conditions are met).

Thus, the...