Excise Tax on Repurchase of Corporate Stock – Application to Foreign Corporations

The Department of the Treasury and the IRS on December 27, 2022 issued Notice 2023-2 announcing that they intend to issue proposed regulations addressing the application of the new excise tax on the repurchase of corporate stock under IRC Section 4501, which was introduced by the Inflation Reduction Act (IRA) on August 16, 2022. 

To provide interim guidance until the publication of the forthcoming proposed regulations, the notice describes rules and procedures that Treasury and the IRS intend to include in those regulations. Until the issuance of the forthcoming proposed regulations, the notice provides, taxpayers may rely on such guidance.  

The key provisions of Section 4501 and the guidance concerning the repurchase of stock of foreign corporations are discussed below. For additional coverage of Notice 2023-2, see BDO’s IRS, Treasury Issue Interim Guidance on Stock Repurchase Excise Tax | BDO

New Excise Tax

Section 4501 imposes on each “covered corporation” a tax equal to 1% of the fair market value of any stock of the corporation that is “repurchased” by the corporation. The term covered corporation means any domestic corporation the stock of which is traded on an established securities market within the meaning of Section 7704(b)(1). The term repurchase is defined as a redemption within the meaning of Section 317(b) with regard to the stock of a covered corporation and any transactions determined by the Secretary of the Treasury to be economically similar to a redemption of such stock.

The acquisition of stock of a covered corporation by a “specified affiliate” of that corporation from a person who is not the covered corporation or a specified affiliate of such covered corporation is treated as a repurchase of the stock of the covered corporation by such corporation.  A specified affiliate with respect to any corporation is (i) any corporation more than 50% of the stock of which is owned (by vote or value), directly or indirectly, by such corporation and (ii) any partnership more than 50% of the capital interests or profit interests of which is held, directly or indirectly, by such corporation.

The amount of the repurchases for a taxable year is reduced by the fair market value of stock issued by the covered corporation during the taxable year (netting rule) and exempt repurchases as described in Section 4501(e).  

Rules Applicable to Acquisitions of Stock of Certain Foreign Corporations

The new excise tax may apply to the acquisition of stock of a foreign corporation in two circumstances: (1) the acquisition of stock of an “applicable foreign corporation” and (2) the repurchase or acquisition of stock of a “covered surrogate foreign corporation.”

Acquisition of Stock of Applicable Foreign Corporation

If an “applicable specified affiliate” of an applicable foreign corporation acquires stock of the applicable foreign corporation from a person that is not the applicable foreign corporation or another specified affiliate of such applicable foreign corporation, the applicable specified affiliate is treated as a covered corporation with regard to the transaction, and the acquisition is treated as a repurchase of stock of a covered corporation by the covered corporation.  An applicable foreign corporation is any foreign corporation the stock of which is traded on an established securities market.  An applicable specified affiliate is a specified affiliate of an applicable foreign corporation other than a foreign corporation or a foreign partnership (unless the partnership has a domestic entity as a direct or indirect partner).

The following examples will help illustrate the application of the guidance in practice.

Example 1. ForCo is a foreign corporation the stock of which is traded on an established security market.  ForCo owns all the stock of DomCo, a domestic corporation. DomCo acquires stock of ForCo, an applicable foreign corporation. DomCo is an applicable specified affiliate. As a result of the acquisition, DomCo will be treated as a covered corporation, and the acquisition of ForCo’s stock by DomCo will be treated as the repurchase of stock of a covered corporation by the covered corporation.

An applicable specified affiliate is treated as acquiring stock of an applicable foreign corporation if the applicable specified affiliate funds by any means 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.  A principal purpose is deemed to exist if the funded entity acquires or repurchases the stock of the applicable foreign corporation within two years of the funding (other than funding through distributions). 

Example 2. The facts are the same as in Example 1, except that to avoid the excise tax DomCo makes a distribution to ForCo, the proceeds of which ForCo uses to repurchase its shares. DomCo will be treated as acquiring the stock of ForCo.

Repurchase or Acquisition of Stock of Covered Surrogate Foreign Corporation

If a covered surrogate foreign corporation repurchases its stock, or if a specified affiliate of the covered surrogate foreign corporation acquires stock of the covered surrogate foreign corporation, the expatriated entity with respect to the covered surrogate foreign corporation is treated as a covered corporation with respect to the repurchase or acquisition, and the repurchase or acquisition is treated as a repurchase of stock of a covered corporation by the covered corporation. A covered surrogate foreign corporation is any surrogate foreign corporation within the meaning of Section 7874(a)(2)(B) (if it completes its domestic entity acquisition after September 20, 2021), the stock of which is traded on an established securities market but only with respect to taxable years that include any portion of the applicable period with respect to such corporation under Section 7874(d)(1).

Example 3. DomCo is a domestic corporation. On January 1, 2022, its shareholders transferred their stock to ForCo, the stock of which was traded on an established securities market, in exchange for 70%  of the stock of ForCo. As a result of the transaction, DomCo is an expatriated entity with respect to which ForCo is a surrogate foreign corporation under Section 7874. On March 1, 2023, ForCo repurchased stock. ForCo is a covered surrogate foreign corporation. DomCo will be treated as a covered corporation, and the repurchase will be treated as a repurchase of stock of a covered corporation by the covered corporation.

Applicability Dates

The proposed regulations will apply generally to repurchases of stock of a covered corporation made after December 31, 2022.  

How BDO Can Help

The rules in Notice 2023-2 regarding the acquisition or repurchase of stock of foreign corporations are complex. BDO can help multinational enterprises navigate these rules to ensure compliance with the new rules and minimize exposure to the new excise tax.