Proposed Rule2024-07117
Excise Tax on Repurchase of Corporate Stock
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
April 12, 2024
Issuing agencies
Treasury DepartmentInternal Revenue Service
Abstract
This document contains proposed regulations that would provide guidance regarding the application of the new excise tax on repurchases of corporate stock made after December 31, 2022. The proposed regulations would affect certain publicly traded corporations that repurchase their stock or whose stock is acquired by certain specified affiliates. Another notice of proposed rulemaking (REG-118499-23) on this topic is published in the Proposed Rules section of this issue of the Federal Register to propose rules on procedure and administration applicable to this new excise tax.
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[Federal Register Volume 89, Number 72 (Friday, April 12, 2024)]
[Proposed Rules]
[Pages 25980-26067]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-07117]
[[Page 25979]]
Vol. 89
Friday,
No. 72
April 12, 2024
Part III
Department of the Treasury
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Internal Revenue Service
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26 CFR Parts 1 and 58
Excise Tax on Repurchase of Corporate Stock; Proposed Rule
Federal Register / Vol. 89 , No. 72 / Friday, April 12, 2024 /
Proposed Rules
[[Page 25980]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 58
[REG-115710-22]
RIN 1545-BQ59
Excise Tax on Repurchase of Corporate Stock
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations that would provide
guidance regarding the application of the new excise tax on repurchases
of corporate stock made after December 31, 2022. The proposed
regulations would affect certain publicly traded corporations that
repurchase their stock or whose stock is acquired by certain specified
affiliates. Another notice of proposed rulemaking (REG-118499-23) on
this topic is published in the Proposed Rules section of this issue of
the Federal Register to propose rules on procedure and administration
applicable to this new excise tax.
DATES: Written or electronic comments and requests for a public hearing
must be received by June 11, 2024.
ADDRESSES: Commenters are strongly encouraged to submit public comments
electronically. Submit electronic submissions via the Federal
eRulemaking Portal at <a href="https://www.regulations.gov">https://www.regulations.gov</a> (indicate IRS and
REG-115710-22) by following the online instructions for submitting
comments. Requests for a public hearing must be submitted as prescribed
in the ``Comments and Requests for a Public Hearing'' section. Once
submitted to the Federal eRulemaking Portal, comments cannot be edited
or withdrawn. The Department of the Treasury (Treasury Department) and
the IRS will publish for public availability any comment submitted
electronically or on paper to its public docket.
Send paper submissions to: CC:PA:01:PR (REG-115710-22), Room 5203,
Internal Revenue Service, P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044.
FOR FURTHER INFORMATION CONTACT: Concerning proposed Sec. Sec.
58.4501-1 through 58.4501-6, Samuel G. Trammell at (202) 317-6975;
concerning proposed Sec. 58.4501-7, Brittany N. Dobi at (202) 317-
5469; concerning proposed Sec. 1.1275-6(f)(12)(iii), Jonathan A.
LaPlante at (202) 317-3900; concerning submissions of comments and
requests for a public hearing, Vivian Hayes at (202) 317-6901 (not
toll-free numbers) or by email at <a href="/cdn-cgi/l/email-protection#3b4b4e59575258535e5a4952555c487b524948155c544d"><span class="__cf_email__" data-cfemail="5d2d283f31343e35383c2f34333a2e1d342f2e733a322b">[email protected]</span></a> (preferred).
SUPPLEMENTARY INFORMATION:
Background
This notice of proposed rulemaking proposes regulations under
section 4501 of the Internal Revenue Code (Code) that would implement
the new excise tax on repurchases of corporate stock (stock repurchase
excise tax) imposed by section 4501 for repurchases made after December
31, 2022. As proposed in this notice of proposed rulemaking, the
regulations are proposed to be added as proposed subpart A of new 26
CFR part 58 (Stock Repurchase Excise Tax Regulations), which is
proposed to be added to subchapter D of 26 CFR chapter I (Miscellaneous
Excise Taxes). This notice of proposed rulemaking also proposes to
amend regulations under section 1275 of the Code in 26 CFR part 1
(Income Tax Regulations) to implement the provisions of section 4501.
Another notice of proposed rulemaking published in the Proposed Rules
section of this issue of the Federal Register relating to the stock
repurchase excise tax proposes rules on procedure and administration
applicable to the reporting and payment of the stock repurchase excise
tax that would be added as proposed subpart B of 26 CFR part 58.
I. Overview of Section 4501
A. In General
Section 4501 was added to a new chapter 37 of the Code by the
enactment of section 10201 of Public Law 117-169, 136 Stat. 1818
(August 16, 2022), commonly referred to as the Inflation Reduction Act
of 2022 (IRA). Section 4501 imposes the stock repurchase excise tax on
each covered corporation for repurchases made after December 31, 2022.
The stock repurchase excise tax is equal to one percent of the fair
market value of any stock of the corporation that is repurchased by the
corporation during the taxable year. Section 4501(a). For purposes of
the stock repurchase excise tax, 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) of the
Code). Section 4501(b).
Section 4501(c)(1) provides that repurchases of covered corporation
stock to which the stock repurchase excise tax may apply include the
following two types of transactions. First, the term ``repurchase''
means a redemption within the meaning of section 317(b) of the Code
with regard to the stock of a covered corporation (section 317(b)
redemption). Section 4501(c)(1)(A). Second, the term ``repurchase''
also means any transaction determined by the Secretary of the Treasury
or her delegate (Secretary) to be economically similar to a section
317(b) redemption (economically similar transaction). Section
4501(c)(1)(B).
B. Specified Affiliates
For purposes of the stock repurchase excise tax, section
4501(c)(2)(A) provides a special rule that treats the acquisition of
stock of a covered corporation by a specified affiliate of the covered
corporation, from a person who is not the covered corporation or a
specified affiliate of the covered corporation, as a repurchase of the
stock of the covered corporation by the covered corporation. For this
purpose, the term ``specified affiliate'' means, with regard to any
corporation, (i) any corporation more than 50 percent of the stock of
which is owned (by vote or by value), directly or indirectly, by the
corporation, and (ii) any partnership more than 50 percent of the
capital interests or profits interests of which is held, directly or
indirectly, by the corporation. Section 4501(c)(2)(B).
C. Adjustment to Amount Taken Into Account Under Section 4501(a)
The stock repurchase excise tax is applied to the fair market value
of any stock of the covered corporation repurchased by the covered
corporation during its taxable year. However, the amount of these
repurchases is reduced by the fair market value of any issuances of the
covered corporation's stock during the covered corporation's taxable
year (netting rule).
Specifically, the netting rule provides that the amount taken into
account under section 4501(a) with respect to any stock repurchased by
a covered corporation is reduced by the fair market value of any stock
issued by the covered corporation during the taxable year, including
the fair market value of any stock issued or provided to employees of
the covered corporation or employees of a specified affiliate of the
covered corporation during the taxable year (whether or not the stock
is issued or provided in response to the exercise of an option to
purchase the stock). Section 4501(c)(3).
D. Special Rules for Certain Acquisitions and Repurchases of Stock of
Certain Foreign Corporations
Section 4501(d) provides special rules for the imposition of the
stock repurchase excise tax on acquisitions of
[[Page 25981]]
stock of applicable foreign corporations and covered surrogate foreign
corporations. For purposes of section 4501(d), the term ``applicable
foreign corporation'' means any foreign corporation the stock of which
is traded on an established securities market. Section 4501(d)(3)(A).
The term ``covered surrogate foreign corporation'' means any surrogate
foreign corporation (as determined under section 7874(a)(2)(B) of the
Code by substituting ``September 20, 2021'' for ``March 4, 2003'' each
place it appears) 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 that corporation
under section 7874(d)(1). Section 4501(d)(3)(B).
Section 4501(d)(1) applies in the case of an acquisition of stock
of an applicable foreign corporation by a specified affiliate of the
corporation (other than a foreign corporation or a foreign partnership
(unless the partnership has a domestic entity as a direct or indirect
partner)) from a person that is not the applicable foreign corporation
or a specified affiliate of the applicable foreign corporation. If
section 4501(d)(1) applies, then for purposes of determining the stock
repurchase excise tax: (i) the specified affiliate is treated as a
covered corporation with respect to the acquisition; (ii) the
acquisition is treated as a repurchase of stock of a covered
corporation by the covered corporation; and (iii) the adjustment under
section 4501(c)(3) (that is, the netting rule) is determined only with
respect to stock issued or provided by the specified affiliate to
employees of the specified affiliate.
Section 4501(d)(2) applies in the case of either a repurchase of
stock of a covered surrogate foreign corporation by the covered
surrogate foreign corporation, or an acquisition of stock of a covered
surrogate foreign corporation by a specified affiliate of such
corporation. If section 4501(d)(2) applies, then for purposes of
determining the stock repurchase excise tax: (i) the expatriated entity
(within the meaning of section 7874(a)(2)(A)) with respect to the
covered surrogate foreign corporation is treated as a covered
corporation with respect to the repurchase or acquisition; (ii) the
repurchase or acquisition is treated as a repurchase of stock of a
covered corporation by the covered corporation; and (iii) the
adjustment under section 4501(c)(3) is determined only with respect to
stock issued or provided by the expatriated entity to employees of the
expatriated entity.
E. Statutory Exceptions to the Application of Section 4501(a)
Section 4501(e) lists transactions that are statutorily excepted,
in whole or in part, from the application of section 4501(a), each
referred to as a ``statutory exception'' in this preamble. As a result
of the statutory exceptions, section 4501(a) does not apply to a
repurchase of a covered corporation's stock:
(1) To the extent that the repurchase is part of a reorganization
(within the meaning of section 368(a) of the Code) and no gain or loss
is recognized on the repurchase by the shareholder under chapter 1 of
the Code (chapter 1) by reason of the reorganization (section
4501(e)(1));
(2) In any case in which the stock repurchased is, or an amount of
stock equal to the value of the stock repurchased is, contributed to an
employer-sponsored retirement plan, employee stock ownership plan
(ESOP), or similar plan (section 4501(e)(2));
(3) In any case in which the total value of the stock repurchased
during the taxable year does not exceed $1,000,000 (section
4501(e)(3));
(4) Under regulations prescribed by the Secretary, in cases in
which the repurchase is by a dealer in securities in the ordinary
course of business (section 4501(e)(4));
(5) By a regulated investment company (RIC), as defined in section
851 of the Code, or by a real estate investment trust (REIT), as
defined in section 856(a) of the Code (section 4501(e)(5)); or
(6) To the extent that the repurchase is treated as a dividend for
purposes of the Code (section 4501(e)(6)).
F. Regulations and Other Guidance
Under section 4501(f), the Secretary is authorized to prescribe
such regulations and other guidance as are necessary or appropriate to
carry out, and to prevent the avoidance of, the purposes of the stock
repurchase excise tax. Regulations or other guidance described in
section 4501(f) may include guidance: (i) to prevent the abuse of the
statutory exceptions; (ii) to address special classes of stock and
preferred stock; and (iii) for the application of the special rules for
acquisitions of stock of certain foreign corporations under section
4501(d).
G. Applicability of Stock Repurchase Excise Tax Provisions
Except to the extent that a statutory exception applies, the stock
repurchase excise tax applies to repurchases after December 31, 2022,
subject to the netting rule. See section 10201(d) of the IRA.
In contrast to the December 31, 2022, effective date expressly
provided by section 10201(d) of the IRA with regard to repurchases, the
netting rule expressly takes into account any issuances by a covered
corporation during the entirety of its taxable year. See generally
section 4501(c)(3). Specifically, under the netting rule, the amount
taken into account under section 4501(a) with respect to any
repurchases is ``reduced by the fair market value of any stock issued
by the covered corporation during the taxable year. ''Section
4501(c)(3) (emphasis added). Therefore, a covered corporation with a
taxable year that both began before January 1, 2023, and ended after
December 31, 2022, may apply the netting rule to reduce the fair market
value of the covered corporation's repurchases of stock during the
portion of that taxable year beginning on January 1, 2023, by the fair
market value of all issuances of its stock during the entirety of that
taxable year.
H. No Deduction for Payment of Stock Repurchase Excise Tax
No deduction is allowed for the payment of the stock repurchase
excise tax. See section 275(a)(6) of the Code (as amended by section
10201(b) of the IRA to add a reference to chapter 37, which contains
section 4501).
II. Notice 2023-2
On January 17, 2023, the Treasury Department and the IRS published
Notice 2023-2, 2023-3 I.R.B. 374, to provide initial guidance regarding
the application of the stock repurchase excise tax. Specifically, the
Treasury Department and the IRS published Notice 2023-2 to facilitate
administration of the stock repurchase excise tax by describing rules
expected to be provided in forthcoming proposed regulations for
determining the amount of stock repurchase excise tax owed, along with
anticipated rules for reporting and paying any liability for the tax.
Under those rules, the amount of stock repurchase excise tax
imposed on a covered corporation equals the product obtained by
multiplying one percent by the stock repurchase excise tax base of the
covered corporation. The ``stock repurchase excise tax base'' is the
amount (not less than zero) obtained by: (i) determining the aggregate
fair market value of all repurchases of the covered corporation's stock
by the covered corporation during its taxable year; (ii) reducing that
amount by the fair market value of stock of the covered corporation
repurchased during its taxable year to the extent any statutory
[[Page 25982]]
exceptions apply; and then (iii) further reducing that amount by the
aggregate fair market value of stock of the covered corporation issued
or provided by the covered corporation during its taxable year under
the netting rule.
The Treasury Department and the IRS have received feedback on the
stock repurchase excise tax, including in response to Notice 2023-2.
Based on the feedback received, and based on further consideration of
section 4501 and Notice 2023-2, the Treasury Department and the IRS are
proposing these regulations under section 4501 to be added as a new
part 58 under the Miscellaneous Excise Taxes, as well as adding new
Sec. 1.1275-6(f)(12)(iii) to 26 CFR part 1.
The issues related to section 4501 and Notice 2023-2 with respect
to which stakeholders have provided feedback, as well as issues that
the Treasury Department and the IRS have considered after the
publication of Notice 2023-2, are discussed in the following
Explanation of Provisions.
Explanation of Provisions
Subpart A of new part 58 would provide operative rules under
section 4501. Proposed Sec. 58.4501-1 would provide an overview of the
stock repurchase excise tax, generally applicable definitions, the
scope of the regulations implementing that tax, and certain operating
rules applicable to those regulations. Proposed Sec. 58.4501-2 would
provide general rules regarding the application and computation of the
stock repurchase excise tax and proposed Sec. 58.4501-7 would provide
rules specifically relating to the application of section 4501(d).
Except as provided in proposed Sec. 58.4501-7, proposed Sec. 58.4501-
3 would provide rules regarding the application of the exceptions in
section 4501(e) (other than the de minimis exception described in
section 4501(e)(3) and to which proposed Sec. 58.4501-2(b)(2)
applies), and proposed Sec. 58.4501-4 would provide rules regarding
the application of section 4501(c)(3). Proposed Sec. 58.4501-5 would
provide examples that illustrate the application of section 4501, other
than the provisions of proposed Sec. 58.4501-7 (which are illustrated
by examples in Sec. 58.4501-7(p) and (q)), and proposed Sec. 58.4501-
6 would provide applicability dates (other than for the rules in Sec.
58.4501-7).
I. Statutory Effective Date; Transition Relief
A. Repurchases by a Fiscal-Year Taxpayer Prior to the Statutory
Effective Date
A covered corporation is not subject to the stock repurchase excise
tax with regard to a taxable year if, during that taxable year, the
aggregate fair market value of the covered corporation's repurchases of
its stock does not exceed $1,000,000 (de minimis exception). See
section 4501(e)(3); see also section 3.03(2)(a) of Notice 2023-2.
One stakeholder requested that the proposed regulations make clear
that repurchases of stock by a fiscal-year taxpayer prior to the
January 1, 2023, effective date of section 4501 are not taken into
account for purposes of applying the de minimis exception. According to
the stakeholder, the plain language of the statute requires that
repurchases by a fiscal-year taxpayer prior to January 1, 2023, not be
taken into account for any purpose under section 4501, including for
purposes of applying the de minimis exception.
The Treasury Department and the IRS have interpreted section 4501
in the same manner. The rule described in section 3.03(3)(b) of Notice
2023-2 provides that repurchases by a covered corporation before
January 1, 2023, are not included in the covered corporation's stock
repurchase excise tax base. The proposed regulations would clarify that
repurchases before January 1, 2023, are not taken into account for
purposes of applying the de minimis exception. See proposed Sec.
58.4501-2(c)(3).
B. Issuances by a Fiscal-Year Taxpayer Prior to the Effective Date
One stakeholder recommended that stock issued by a fiscal-year
taxpayer prior to January 1, 2023, should not be taken into account for
purposes of the netting rule, because such an approach would create a
mismatch between the treatment of issuances for purposes of the netting
rule and the treatment of repurchases for purposes of the de minimis
exception. See part I.A of this Explanation of Provisions. Another
stakeholder recommended that fiscal-year taxpayers be permitted to use
only net issuances (that is, issuances net of repurchases) from the
portion of their taxable year prior to January 1, 2023, because,
according to the stakeholder, taxpayers arguably should not be
permitted to offset gross issuances during the portion of a fiscal year
before January 1, 2023, against repurchases during the portion of a
fiscal year beginning on January 1, 2023.
The Treasury Department and the IRS disagree with the stakeholders'
recommendations. Section 4501(c)(3) expressly provides that the amount
taken into account under section 4501(a) with respect to any stock
repurchased by a covered corporation is reduced by the fair market
value of any stock issued by the covered corporation ``during the
taxable year.'' Moreover, although section 10201(d) of the IRA
expressly provides that the stock repurchase excise tax applies to
repurchases after December 31, 2022, it does not contain similar
language for issuances. Therefore, the Treasury Department and the IRS
are of the view that, in the case of a covered corporation that has a
taxable year that both begins before January 1, 2023, and ends after
December 31, 2022, that covered corporation may apply the netting rule
to reduce the fair market value of the covered corporation's
repurchases during that taxable year by the fair market value of all
issuances of its stock during the entirety of that taxable year. See
proposed Sec. 58.4501-4(b)(3). Thus, the proposed regulations would
not adopt these recommendations.
C. Contributions by Fiscal-Year Taxpayer to Employer-Sponsored
Retirement Plan Prior to Effective Date
A stakeholder also recommended that stock contributed by a fiscal-
year taxpayer to an employer-sponsored retirement plan prior to the
January 1, 2023, effective date of section 4501, should not be taken
into account for purposes of the statutory exception in section
4501(e)(2) because, according to the stakeholder, such an approach
would create a mismatch between this exception and the de minimis
exception. However, as discussed in part I.B of this Explanation of
Provisions, the effective date in section 10201(d) of the IRA expressly
applies to repurchases (and not to issuances or contributions).
Therefore, the Treasury Department and the IRS are of the view that
contributions to an employer-sponsored retirement plan during the 2022
portion of a taxable year beginning before January 1, 2023, and ending
after December 31, 2022, should be taken into account for purposes of
section 4501(e)(2). See proposed Sec. 58.4501-3(d)(5).
D. Trade Date or Settlement Date
A stakeholder asked whether the date of repurchase of stock occurs
on (i) the trade date for the sale or purchase of that stock (that is,
the date a broker executes the trade), or (ii) the settlement date with
regard to that stock (that is, the date the shares are delivered). The
[[Page 25983]]
stakeholder asked this question for purposes of determining whether a
repurchase occurs after the effective date of section 4501. The
stakeholder requested that the proposed regulations clarify that the
trade date for the sale or purchase of that stock constitutes the date
of repurchase.
The proposed regulations would clarify that the date of repurchase
for a regular-way sale of stock on an established securities market
(that is, a transaction in which a trade order is placed on the trade
date, and settlement of the transaction, including payment and delivery
of the stock, occurs a standardized number of days after the trade
date) is the trade date. See proposed Sec. 58.4501-2(g)(2). For rules
regarding the date of repurchase generally, see part III.B.1 of this
Explanation of Provisions.
E. Transition Relief for Certain Transactions Entered Into Prior to
Enactment Date
Several stakeholders requested transition relief (that is, an
exemption from the stock repurchase excise tax) for certain repurchases
that occur after the January 1, 2023, effective date of section 4501,
pursuant to a binding commitment entered into before the August 16,
2022, enactment date of section 4501. For example, one stakeholder
requested an exemption for redemptions of stock issued before the
enactment date and redeemed pursuant to the terms of the stock after
the effective date, on the grounds that the stock repurchase excise tax
did not exist when the terms of that stock were negotiated. Another
stakeholder suggested that candidates for transition relief could
include: (i) redemptions by, and liquidations of, a special purpose
acquisition company (SPAC) formed prior to the enactment date (to the
extent the SPAC is contractually obligated to offer redemption rights
to its shareholders as agreed prior to the enactment date); (ii)
payments in connection with merger and acquisition (M&A) transactions
pursuant to a binding commitment entered into prior to the enactment
date; (iii) redemptions of non-participating, non-convertible preferred
stock, and complete redemptions of tracking stock, issued prior to the
enactment date; (iv) repurchases pursuant to accelerated share
repurchase agreements if completed pursuant to a binding commitment
entered into prior to the enactment date; and (v) liquidating
distributions subject to section 331 of the Code pursuant to a plan of
liquidation adopted prior to the enactment date.
The plain language of section 10201(d) of the IRA provides that the
amendments made by section 10201 of the IRA apply to repurchases of
stock after December 31, 2022. That section contains no reference to
repurchases that occur pursuant to a binding commitment entered into
prior to the enactment date. As a result, the Treasury Department and
the IRS are of the view that transition relief would not be
appropriate. The proposed regulations accordingly would not adopt the
stakeholders' recommendation.
II. Application of the Stock Repurchase Excise Tax to Various Types of
Financial Instruments
A. Definition of ``Stock''
For purposes of Notice 2023-2, ``stock'' would be defined as any
instrument issued by a corporation that is stock or that is treated as
stock for Federal tax purposes at the time of issuance, regardless of
whether the instrument is traded on an established securities market.
See section 3.02(25) of Notice 2023-2.
The proposed regulations generally would maintain this definition
of ``stock.'' See proposed Sec. 58.4501-1(b)(29). However, the
proposed definition of ``stock'' would not include ``additional tier 1
preferred stock,'' which the proposed regulations would define to mean
preferred stock that qualifies as additional tier 1 capital (within the
meaning of 12 CFR 3.20(c), 217.20(c), or 324.20(c)) and does not
qualify as common equity tier 1 capital (within the meaning of 12 CFR
3.20(b), 217.20(b), or 324.20(b)). See proposed Sec. 58.4501-
1(b)(29)(ii). Therefore, unless the limited-scope exception regarding
additional tier 1 preferred stock applies, the stock repurchase excise
tax would apply to preferred stock in the same manner as to common
stock. Likewise, the stock repurchase excise tax would apply to
repurchases of instruments that are not in the legal form of stock but
that are treated as stock for Federal tax purposes at the time of
issuance. In contrast, the stock repurchase excise tax would not apply
to repurchases of instruments treated as debt for Federal tax purposes.
The proposed regulations would include the foregoing definition of
``stock'' for the following reasons. First, the plain language of
section 4501 repeatedly refers to ``stock'' and does not, for example,
refer solely to ``common stock.'' See, for example, section 4501(a)
(imposing an excise tax ``equal to 1 percent of the fair market value
of any stock of the corporation''); section 4501(b) (defining the term
covered corporation to mean ``any domestic corporation the stock of
which is traded on an established securities market''); section
4501(c)(1)(A) (defining the term repurchase to mean a redemption within
the meaning of section 317(b) ``with regard to the stock of a covered
corporation''). Second, if the stock repurchase excise tax were
implemented to be applicable solely to common stock, then taxpayers
could avoid the tax simply by repurchasing other classes of stock (or
other instruments treated as stock for Federal tax purposes).
Section 4501(f)(2) authorizes the Secretary to issue such
regulations and other guidance as are necessary or appropriate to carry
out, and to prevent the avoidance of, the purposes of the stock
repurchase excise tax, including guidance ``to address special classes
of stock and preferred stock.'' Accordingly, in section 6.01(1) of
Notice 2023-2, the Treasury Department and the IRS requested comments
on whether there are circumstances under which special rules should be
provided for redeemable preferred stock or other special classes of
stock or debt (including debt with features that allow the debt to be
converted into stock) and, if so, what objectively verifiable criteria
should be incorporated into such special rules to provide certainty for
taxpayers and the IRS.
1. Straight Preferred Stock; Mandatorily Redeemable Stock
Stakeholders recommended that the stock repurchase excise tax
should not apply to redemptions of preferred stock. Although two
stakeholders recommended an exception for redemptions of any type of
preferred stock, other stakeholders generally recommended an exception
only for redemptions of so-called ``straight preferred stock'' (that
is, preferred stock that is limited and preferred as to dividends, does
not participate in corporate growth to any significant extent, and is
not convertible into another class of stock). See section 1504(a)(4)(B)
and (D) of the Code. One stakeholder also argued against providing an
exception for redemptions of preferred stock other than straight
preferred stock. See part II.A.2 of this Explanation of Provisions.
The stakeholders uniformly contended that, although straight
preferred stock is treated as ``stock'' for Federal tax purposes,
repayments of such stock are akin to repaying debt and do not implicate
the policy concerns underlying the stock repurchase excise tax. The
stakeholders further contended that, if redemptions of straight
preferred
[[Page 25984]]
stock were subject to the stock repurchase excise tax, publicly traded
corporations might be incentivized to increase their leverage by
issuing debt in lieu of straight preferred stock.
One stakeholder also recommended a rule under which actual or
deemed issuances of straight preferred stock would not be taken into
account for purposes of the netting rule. The stakeholder further
recommended that exchanges of straight preferred stock for other stock
(that is, for stock to which the stock repurchase excise tax applies)
should be treated as economically similar transactions.
Alternatively, stakeholders recommended an exception to the stock
repurchase excise tax for the redemption of stock pursuant to a
mandatory redemption provision or a unilateral put option of the
shareholder. In the stakeholders' view, this exception would be
appropriate because such a redemption would not be within the control
of (and would not be susceptible to any timing manipulation by) the
issuing corporation.
As described in part II.A of this Explanation of Provisions, the
plain language of section 4501 consistently refers to ``stock'' without
providing any exceptions for particular types of stock. In addition,
the Treasury Department and the IRS are of the view that Treasury
regulations that utilize the broadly applicable term ``stock'' would
facilitate the IRS's ability to administer and enforce the stock
repurchase excise tax. Consequently, the Treasury Department and the
IRS also are of the view that adoption of the stakeholders' numerous
suggested exceptions would significantly hamper the IRS's ability to
administer and enforce that tax, as well as reduce taxpayer certainty
regarding its application. Therefore, except with regard to additional
tier 1 preferred stock, the proposed regulations would not incorporate
the stakeholders' suggested exceptions. See proposed Sec. Sec.
58.4501-1(b)(29), 58.4501-2(e)(2), and 58.4501-4(b)(1); see also
proposed Sec. 58.4501-1(b)(29)(ii) and part II.A.3 of this Explanation
of Provisions (discussion of additional tier 1 preferred stock).
2. Convertible Preferred Stock and Participating Preferred Stock
One stakeholder recommended that, even if straight preferred stock
is excluded from the stock repurchase excise tax, preferred stock that
is convertible into the issuer's common stock at the holder's option
(convertible preferred stock), and preferred stock with certain
dividend or liquidation participation rights that enable the holder to
participate in corporate growth to a significant extent (participating
preferred stock), should continue to be subject to the stock repurchase
excise tax. In the stakeholder's view, a redemption of such stock
generally is more akin to a redemption of common stock than to a
repayment of debt or a redemption of straight preferred stock (for
example, there are fewer outstanding shares of stock participating in
future corporate growth after such a redemption).
For the reasons stated in part II.A.1 of this Explanation of
Provisions, the Treasury Department and the IRS agree with the
stakeholder's recommendation. Accordingly, under the proposed
regulations, the repurchase of convertible or participating preferred
stock would be subject to the stock repurchase excise tax, and the
issuance of such stock would be taken into account for purposes of the
netting rule. See proposed Sec. Sec. 58.4501-1(b)(29), 58.4501-
2(e)(2), and 58.4501-4(b)(1).
3. Additional Tier 1 Preferred Stock
Several stakeholders noted that the issuance and redemption of
preferred stock is used routinely in certain industries as a way to
manage risk. One stakeholder recommended an exception to the stock
repurchase excise tax and the netting rule for redemptions or issuances
of preferred stock that qualifies as additional tier 1 capital for
purposes of regulatory requirements for regulated financial
institutions (additional tier 1 preferred stock).
According to the stakeholder, the issuing corporation may not
redeem or repurchase additional tier 1 preferred stock without prior
approval from regulators. Moreover, if such an instrument is callable
by its terms, (i) it may not be called for at least five years; (ii)
the issuing corporation must receive prior approval from regulators to
exercise the call option; and (iii) the issuing corporation must either
replace the instrument with other tier 1 capital or demonstrate to
regulators that it will continue to hold capital commensurate with
risk.
Based on the feedback received, the Treasury Department and the IRS
are of the view that the stock repurchase excise tax regulations should
not apply to additional tier 1 preferred stock. See proposed Sec.
58.4501-1(b)(29)(ii). Consequently, under the proposed regulations,
additional tier 1 preferred stock would not be subject to the stock
repurchase excise tax, and the issuance of additional tier 1 preferred
stock would not be taken into account for purposes of the netting rule.
4. Convertible Debt
Stakeholders have requested confirmation that redemptions of
convertible debt instruments are not subject to the stock repurchase
excise tax. One stakeholder contended that such transactions should not
be treated as ``economically similar'' to a section 317(b) redemption
because the definition of ``redemption'' in section 317(b) encompasses
only redemptions of stock, and because a redemption of a convertible
debt instrument does not reduce the number of a corporation's
outstanding shares. Another stakeholder contended that the
determination of whether an instrument constitutes debt or equity
should be made at the time of issuance. Therefore, if the convertible
debt instrument is characterized as ``debt'' at the time of issuance,
the subsequent redemption or cash settlement of that instrument should
not be treated as a repurchase. Likewise, the issuance of a convertible
debt instrument by a covered corporation should not be treated as an
issuance for purposes of the netting rule.
The Treasury Department and the IRS agree with these stakeholders.
Although Notice 2023-2 does not expressly address convertible debt
instruments, the Treasury Department and the IRS continue to be of the
view that, for purposes of the stock repurchase excise tax, whether an
instrument is debt or equity should be determined at the time of
issuance under Federal income tax principles, and that this
characterization should not be retested while the debt instrument is
outstanding. See proposed Sec. 58.4501-1(b)(29); see also part II.B of
this Explanation of Provisions. Such an approach would better
facilitate the IRS's ability to administer and enforce the stock
repurchase excise tax and enable taxpayers to apply the tax with
greater certainty. Moreover, the term ``repurchase'' includes only
section 317(b) redemptions with regard to ``stock'' of a covered
corporation as well as transactions that are ``economically similar''
to such redemptions. See section 4501(c)(1). Accordingly, the Treasury
Department and the IRS are of the view that no special rules are needed
for convertible debt. However, for a discussion of the application of
the netting rule to an instrument not in the legal form of stock, see
part XI.C.9 of this Explanation of Provisions.
5. Tracking Stock
Tracking stock is an instrument that tracks the performance of a
division of the parent corporation or a subsidiary (for example, by
providing dividend rights that are determined by reference
[[Page 25985]]
to the earnings of the tracked division or subsidiary). Because
tracking stock participates in corporate growth, a stakeholder
recommended treating the redemption of less than all shares of a class
of tracking stock in the same manner as the redemption of other common
stock--that is, as subject to the stock repurchase excise tax.
However, the stakeholder also suggested that an exemption may be
warranted for the redemption of an entire class of tracking stock in
connection with the disposition of the underlying tracked business,
because such a redemption (i) does not accrete to the interests of the
corporation's remaining shareholders in the corporation's remaining
assets, and (ii) may be equivalent to a distribution in partial
liquidation. (As discussed in part VI.B of this Explanation of
Provisions, the stakeholder recommended treating partial liquidations
as generally outside the scope of the stock repurchase excise tax.)
The Treasury Department and the IRS are of the view that the
treatment of tracking stock for purposes of the stock repurchase excise
tax should follow the general Federal tax treatment of tracking stock.
Accordingly, no special guidance regarding the proper treatment of
tracking stock is included in these proposed regulations.
B. Characterization of Instruments as Stock or Debt
One stakeholder requested confirmation that the determination of
whether an instrument is stock or debt for purposes of the stock
repurchase excise tax is made at the time of issuance under Federal tax
principles, and that this characterization is not retested subsequently
while the instrument is outstanding. The Treasury Department and the
IRS agree with this recommendation, because, as previously stated, such
an approach under which an instrument is tested only once would better
facilitate the IRS's ability to administer and enforce the stock
repurchase excise tax and enable taxpayers to apply the tax with
greater certainty. See proposed Sec. 58.4501-1(b)(29).
C. Options and Similar Financial Instruments
1. Overview
As discussed previously, Notice 2023-2 would define ``stock'' to
mean any instrument issued by a corporation that is stock or that is
treated as stock for Federal tax purposes at the time of issuance. See
section 3.02(25) of Notice 2023-2. This definition of ``stock''
generally excludes options other than options that are treated as stock
for Federal tax purposes at the time of issuance.
To the extent option contracts are not treated as stock at the time
of issuance, the acquisition of such contracts is not a repurchase
under Notice 2023-2 because such acquisition is neither a section
317(b) redemption nor included in the exclusive list of economically
similar transactions in section 3.04(4)(a) of Notice 2023-2.
Consequently, under Notice 2023-2, there is a repurchase or an issuance
of stock only at the time of exercise of a physically settled option
(when a covered corporation repurchases or issues the actual underlying
stock). In turn, the amount of such repurchase or issuance is equal to
the market price of the stock on the date the stock is repurchased or
issued. See sections 3.06(1)(a), 3.06(2), 3.08(2), and 3.08(5) of
Notice 2023-2; see also part III of this Explanation of Provisions
(discussion of valuation and timing).
Several questions have arisen regarding the application of the
stock repurchase excise tax to options and similar financial
instruments. In section 6.02(4) of Notice 2023-2, the Treasury
Department and the IRS requested comments on: (i) whether any
additional rules with regard to financial arrangements, such as options
or other similar financial instruments, should be added to prevent
avoidance of the stock repurchase excise tax; and (ii) how such
additional rules should apply consistently for purposes of determining
a covered corporation's repurchases and issuances.
2. Physical Settlement of Option Contracts
Stakeholders recommended that the fair market value of shares
acquired or issued (as appropriate) by a covered corporation upon
physical settlement of an option contract should be the fair market
value of the shares on the date of exercise, rather than the strike
price (that is, the price at which the option can be exercised). For
example (Example 1), assume that corporation X issues a call option to
individual A that entitles A to buy 100 shares of X stock for $100
($1.00 per share) from X for a limited time. The terms of the option
require physical settlement. On the date the option is issued, X stock
is trading at $1.00 per share. On the date the option is exercised, X
stock is trading at $1.30 per share. Upon settlement of the option, A
pays $100 to X, which issues 100 shares of X stock (worth $130) to A.
Alternatively (Example 2), assume the same facts as in Example 1,
except that X issues a put option to A that entitles A to sell 100
shares of X stock for $100 ($1.00 per share) to X, and that X stock is
trading at $0.70 per share on the date the option is exercised. To
settle the option, X purchases 100 shares of X stock (worth $70) for
$100 from A.
As another example (Example 3), assume that A issues a call option
to unrelated individual B that entitles B to buy 100 shares of X stock
for $100 ($1.00 per share) from A for a limited time. The terms of the
option require physical settlement. Subsequently, X purchases the
option contract from B. On the date the option is exercised, X stock is
trading at $1.30 per share. To settle the option, X pays $100 to A, who
delivers 100 shares of X stock (worth $130) to X.
The netting rule requires the stock repurchase excise tax base to
be reduced by ``the fair market value of any stock issued by the
covered corporation during the taxable year.'' See section 4501(c)(3).
Thus, according to stakeholders, the amount of the issuance in Example
1 should be $130 (the fair market value of the stock at the time of
issuance) even though A pays only $100 to excise the option.
Similarly, the stock repurchase excise tax applies to ``the fair
market value of any stock of the corporation which is repurchased by
such corporation during the taxable year.'' See section 4501(a).
Consequently, stakeholders suggested that the amount of the repurchase
in Example 2 should be $70, and that the $30 premium paid by X
represents the amount paid for a property right separate from the stock
being repurchased. Cf. Rev. Rul. 70-108, 1970-1 C.B. 78 (holding that
the right to purchase additional shares constitutes separate property
from the underlying shares). Consistent with this approach,
stakeholders also suggested that the amount of the repurchase in
Example 3 should be $130 (the fair market value of the stock on the
exercise date).
The Treasury Department and the IRS agree with the stakeholders
that the amount of the issuance in Example 1 should be $130 (the fair
market value of the issued stock on the exercise date) rather than $100
(the strike price paid by A). Similarly, the Treasury Department and
the IRS agree that the amount of the repurchase in Example 2 should be
$70 rather than $100, and that the amount of the repurchase in Example
3 should be $130 rather than $100.
The foregoing approach, which is consistent with Notice 2023-2, is
embedded in the proposed rules regarding the fair market value of
repurchased or issued stock. See proposed Sec. Sec. 58.4501-2(h)(1)
and
[[Page 25986]]
58.4501-4(e)(1), respectively. Thus, the Treasury Department and the
IRS are of the view that special rules are not needed with respect to
the fair market value of stock repurchased or issued upon the physical
settlement of an option. However, the proposed regulations would
include several examples to illustrate the proposed approach. See
proposed Sec. 58.4501-5(b)(26) and (28). For special rules for valuing
stock issued or provided to an employee or other service provider in
connection with the performance of services, see proposed Sec.
58.4501-4(e)(5) and part XI.G.7 of this Explanation of Provisions.
3. Cash Settlement of Option Contracts
As previously discussed in part II.C.2 of this Explanation of
Provisions, stakeholders recommended treating the physical settlement
of an option as a repurchase or an issuance (as appropriate) based on
the fair market value of the stock repurchased or issued on the date of
exercise. In contrast, a stakeholder recommended that the cash
settlement of a put option issued by a covered corporation should not
be treated as a repurchase by the covered corporation, because any
excess of the strike price over the fair market value of the underlying
stock should be viewed as payment for property that is separate from
the underlying stock. Cf. Rev. Rul. 70-108.
For example, assume that corporation X issues a put option to
individual A that entitles A to sell 100 shares of X stock for $100
($1.00 per share) to X, and that X stock is trading at $0.70 per share
on the date the option is exercised. The terms of the option require
net cash settlement; thus, X pays $30 to A to settle the option. The
stakeholder recommended not treating the net cash settlement as a
repurchase, even though the settlement could be construed as a purchase
by X of the 100 X shares from A for $100, immediately followed by an
issuance by X of 100 shares to A for $70.
For the cash settlement of a call option, the stakeholder generally
recommended either (i) treating the net cash settlement as a deemed
issuance of stock immediately followed by a repurchase of the same
stock (resulting in no net adjustment to the stock repurchase excise
tax base), or (ii) simply disregarding the cash settlement altogether
for purposes of the stock repurchase excise tax. For example, assume
that X issues a call option to A that entitles A to buy 100 shares of X
stock for $100 ($1.00 per share) from X, and that X stock is trading at
$1.30 per share on the date the option is exercised. The terms of the
option require net cash settlement; thus, X pays $30 to A to settle the
option.
The net cash payment in the foregoing example is the economic
equivalent of (i) A paying $100 to exercise the option, (ii) X issuing
100 shares (worth $130) to A, and then (iii) X immediately redeeming
those shares for $130 in cash. Thus, X could be deemed to have issued
and repurchased $130 of its shares in a transaction that fully offsets
for purposes of the stock repurchase excise tax. Alternatively, X's net
cash settlement could be disregarded altogether and simply treated as
the sale or exchange of an option. See section 1234(c)(2); Rev. Rul.
88-31, 1988-1 C.B. 302 (providing that the net cash settlement of a
price-protection contingent value right is treated as a cash settlement
of a put option subject to section 1234(c)(2)).
The Treasury Department and the IRS are of the view that, for
purposes of the stock repurchase excise tax, the net cash settlement of
an option should not be treated as involving a deemed issuance and
repurchase of shares in the interest of simplicity and
administrability. Accordingly, under the proposed regulations, the net
cash settlement of an option contract would result in neither the
repurchase nor the issuance of stock other than as discussed in part
II.C.4 of this Explanation of Provisions. This rule would apply to the
net cash settlement of an embedded option (for example, if the issuer
pays the investor solely in cash on exercise of the conversion right in
a convertible bond). See proposed Sec. Sec. 58.4501-2(e)(5)(v) and
58.4501-4(f)(12).
4. Deep-in-the-Money Options
Several stakeholders recommended that options that are treated as
constructively exercised at the time of their grant under Federal
income tax principles (commonly referred to as ``deep-in-the-money''
options) should be treated similarly for purposes of the stock
repurchase excise tax. For example, according to the stakeholders, if
the grant of an option is treated as the issuance of the underlying
stock as of the date of the grant for Federal income tax purposes, the
grant of the option should be treated as an issuance of stock for
purposes of the netting rule, and the cash settlement of the option
should be treated as a repurchase of stock in the year of the
settlement.
The stakeholders further recommended that the determination of
whether an option is deep in the money should be made only at the time
of grant and generally should not be revisited. Thus, if a corporation
grants a call option that is exercisable or convertible into the
corporation's stock and that is not constructively exercised at the
time of grant, the stock should not be treated as issued until the
option is exercised or converted into stock.
The Treasury Department and the IRS are of the view that, if a
deep-in-the-money option is determined to be constructively exercised
at the time of grant under Federal income tax principles, the cash
settlement of such an option would be a repurchase of the underlying
stock on the date of settlement under the proposed regulations. See
proposed Sec. 58.4501-2(e)(5)(v). However, for a discussion of the
application of the netting rule to deep-in-the-money options or other
instruments not in the legal form of stock, see part XI.C.9 of this
Explanation of Provisions.
5. Section 305(a) Warrants
A stakeholder recommended that, if an option to acquire a covered
corporation's stock is distributed in a distribution under section
305(a) of the Code (section 305(a) warrant), the adjustment to the
stock repurchase excise tax base upon settlement of the section 305(a)
warrant should be determined by reference to the strike price (and not
the value of the underlying stock) because the section 305(a)
distribution should be disregarded.
The Treasury Department and the IRS are of the view that the
treatment of warrants distributed in a section 305 distribution should
not deviate from the treatment of other types of financial instruments
under the proposed regulations. The Treasury Department and the IRS
view this approach as facilitating the IRS's ability to administer and
enforce the stock repurchase excise tax and enable taxpayers to apply
the tax with greater certainty. Accordingly, the proposed regulations
would not provide special rules for warrants distributed in a section
305 distribution. See proposed Sec. Sec. 58.4501-2(e)(5)(v) and
58.4501-4(f)(12); see also part II.C.3 of this Explanation of
Provisions (discussion of cash settlement of option contracts).
6. Integration of Qualifying Debt Instruments Under Sec. 1.1275-6
A stakeholder requested clarification on how section 4501 applies
to a synthetic debt instrument resulting from an integrated transaction
under Sec. 1.1275-6. In general, Sec. 1.1275-6 provides for the
integration of a qualifying debt instrument (as defined in Sec.
1.1275-6(b)(1)) with a Sec. 1.1275-6 hedge or combination of Sec.
1.1275-6
[[Page 25987]]
hedges in certain circumstances. The circumstances in which Sec.
1.1275-6 may apply involve a convertible debt instrument as well as one
or more options or other financial instruments involving underlying
stock, provided that the combined cash flows of the financial
instrument and the debt instrument permit the calculation of a yield to
maturity under section 1272 of the Code or the right to the combined
cash flows would qualify as a specified type of variable rate debt
instrument, and other conditions are satisfied.
Under Sec. 1.1275-6(f), except as otherwise provided in published
guidance, the synthetic debt instrument resulting from an integrated
transaction is recognized as a single debt instrument for Federal
income tax purposes for the period that the transaction qualifies as an
integrated transaction and is not subject to the Federal income tax
rules that would apply on a separate basis to the instruments
comprising the integrated transaction if the transaction were not
integrated.
Because an integrated transaction does not change the amount of
stock actually repurchased or issued, the Treasury Department and the
IRS are of the view that the determination of whether and when stock is
repurchased or issued for purposes of the stock repurchase excise tax
should be determined without regard to the integration of a qualifying
debt instrument with a Sec. 1.1275-6 hedge or combination of Sec.
1.1275-6 hedges under Sec. 1.1275-6. See proposed Sec. 1.1275-
6(f)(12)(iii).
D. Forfeiture or Clawback of Restricted Stock
One stakeholder recommended that the forfeiture of restricted stock
(that is, stock transferred to a service provider that is subject to a
substantial risk of forfeiture at grant) that was transferred to a
service provider in connection with the performance of services should
not be treated as a repurchase for purposes of the stock repurchase
excise tax to the extent no payment is made to the service provider in
connection with the forfeiture. Instead, the stakeholder recommended
treating the stock as repurchased only to the extent of any payment
received in connection with the forfeiture, with any excess of the
value of the stock over the amount paid treated as a forfeiture. In
other words, the stakeholder recommended using the amount paid rather
than market price to compute the amount of the repurchase in this
situation.
The stakeholder cited to Sec. 1.83-6(c) in support of its
recommendation. Section 1.83-6(c) provides that, if (under section
83(h) of the Code and Sec. 1.83-6(a)) a deduction, an increase in
basis, or a reduction of gross income was allowable to an employer in
respect of a transfer of property, and if such property subsequently is
forfeited, then the amount of such deduction, increase in basis, or
reduction of gross income is included in the employer's gross income
for the taxable year in which the forfeiture occurs. According to the
stakeholder, the fact that the employer does not recognize additional
income or gain suggests that the property forfeited, to the extent it
exceeds any amount paid by the employer to the forfeiting service
provider, is treated as a capital contribution to the employer under
section 118(a) rather than as a redemption.
Notice 2023-2 does not expressly address the forfeiture of
restricted stock. Under section 3.06(2) of Notice 2023-2, if property
is paid for the forfeited stock, the stock is treated as repurchased
for an amount equal to the market price on the date of repurchase
(regardless of the amount actually paid) because there is a section
317(b) redemption. If no property is paid in exchange for the forfeited
shares, the forfeiture is not treated as a repurchase, because the
forfeiture is neither a section 317(b) redemption nor treated as an
economically similar transaction. However, under both Notice 2023-2 and
these proposed regulations, there would be an issuance for purposes of
the netting rule when the ownership of the restricted stock transfers
to the recipient for Federal income tax purposes. See proposed Sec.
58.4501-4(d)(2).
The Treasury Department and the IRS are of the view that, if a
covered corporation takes into account an issuance of restricted stock
for purposes of the netting rule because a section 83(b) election has
been made, a forfeiture of such stock likewise should be treated as a
repurchase. Conversely, if a covered corporation does not take into
account an issuance of restricted stock for purposes of the netting
rule, a forfeiture of such stock should not be treated as a repurchase.
This approach is necessary to preserve consistency in the treatment of
issuances and repurchases. Moreover, the economic effect of a
forfeiture is similar to that of a repurchase, insofar as the shares
are retired (or held as treasury stock) in both cases.
Accordingly, the proposed regulations would treat a forfeiture of
restricted stock as a repurchase on the date of forfeiture (in an
amount equal to the fair market value of such stock on the date of
forfeiture) if such forfeited stock was treated as issued or provided
under the netting rule. See proposed Sec. 58.4501-2(e)(4)(vi); see
also part XII.D of this Explanation of Provisions (discussion of a
proposal to provide similar treatment with regard to forfeitures of
stock issued as part of an earnout or to satisfy an indemnification
obligation).
It is the view of the Treasury Department and the IRS that stock
received by a covered corporation or specified affiliate pursuant to a
clawback agreement (that is, a contractual provision that requires an
employee to return vested stock) is economically similar to restricted
stock forfeited to the covered corporation after failure to vest.
Accordingly, these proposed regulations also would provide that, if the
stock were treated as issued or provided under the netting rule, then
the clawed back stock would be treated as repurchased on the date of
clawback (in an amount equal to the fair market value of such stock on
such date). See proposed Sec. 58.4501-2(e)(4)(vi).
III. Valuation and Timing
A. Valuation
1. Overview
Under sections 3.06(2) and 3.08(5) of Notice 2023-2, the fair
market value of stock repurchased or issued (other than stock issued or
provided to an employee) is the market price of the stock on the date
the stock is repurchased or issued, respectively. Thus, if the price at
which the repurchased stock is purchased differs from the market price
of the stock on the date the stock is repurchased, the fair market
value of the stock is the market price on the date the stock is
repurchased.
The Treasury Department and the IRS continue to be of the view that
this approach is more consistent with the plain language of the
statute, and simpler for the IRS to administer and for taxpayers to
apply, than an approach that defines fair market value by reference to
the amount paid to repurchase stock. For example, under Notice 2023-2,
adjustments are not required for transaction costs or non-arm's-length
transactions, and special rules are not needed for situations in which
stock is redeemed for consideration other than cash (such as a non-
publicly traded note).
Section 3.08(3)(c) of Notice 2023-2 describes a special rule for
valuing stock issued or provided to employees. The fair market value of
such stock is the fair market value of the stock, as determined under
section 83, as of the date the stock is issued or provided to the
employee, as determined under section 3.08(3)(b)
[[Page 25988]]
of Notice 2023-2. See part XI.G.7 of this Explanation of Provisions
(discussion of valuing stock issued or provided to an employee or other
service provider).
In section 6.01(2) of Notice 2023-2, the Treasury Department and
the IRS requested comments on whether the fair market value of stock
repurchased or issued should be an amount other than the market price
of such stock. In section 6.01(6) of Notice 2023-2, the Treasury
Department and the IRS also requested comments on whether a method
should be provided for determining the market price of stock that is
traded on multiple established securities markets and, if so, what
modifications to the rules described in sections 3.06(2)(a)(i) and
3.08(5)(a)(i) of Notice 2023-2 (concerning acceptable methods for
determining the market price of repurchased or issued stock that is
traded on an established securities market) would be required.
2. Valuation in Arm's-Length Transactions
Consistent with the approach described in Notice 2023-2,
stakeholders generally recommended that the fair market value of stock
repurchased or issued should be the market price of the stock on the
day of the repurchase or issuance, respectively. However, one
stakeholder also recommended that covered corporations be required to
determine fair market value based on the actual price the covered
corporation pays or receives, if the repurchase or issuance is (i) from
or to an unrelated party, (ii) for cash or cash-equivalents, (iii)
negotiated at arm's length, and (iv) not pursuant to a pre-existing
option contract or other arrangement (for example, an accelerated share
repurchase agreement) that involves the delivery of stock at a price
other than the stock's market price at delivery.
Similarly, another stakeholder recommended an exception to the
general fair market value rule for repurchases that result from a
tender offer or other, similarly negotiated transaction that sets a
transaction price prior to the closing date. According to the
stakeholder, it is common for the transaction price and the market
price on the closing date to differ, and it is not clear why the value
of a repurchase should be determined based on the market price rather
than the transaction price.
The Treasury Department and the IRS continue to be of the view that
an approach that references the market price of stock on the date the
stock is repurchased or issued, respectively, is more consistent with
the plain language of the statute, and would be simpler to administer,
than an approach that references the amount paid to repurchase the
stock. Moreover, the Treasury Department and the IRS are of the view
that the two approaches likely would result in approximately similar
values for most repurchases of publicly traded stock. Consequently, the
proposed regulations would provide that the fair market value of stock
repurchased or issued is the market price of the stock on the date the
stock is repurchased or issued, respectively. See proposed Sec. Sec.
58.4501-2(h)(1) and 58.4501-4(e)(1).
3. Valuation in Bankruptcy or Insolvency Workouts
Another stakeholder recommended that, in the case of a bankruptcy
or insolvency workout, the fair market value of repurchased stock
should equal the value of the recovery shareholders are entitled or
permitted to receive under the bankruptcy or insolvency workout, rather
than the market price of the stock. The stakeholder recommended this
approach because the market price of the stock will take the debt
restructuring into account and, thus, may be much higher than the
recovery value.
However, the Treasury Department and the IRS are of the view that
the proposed regulations should not adopt special valuation rules for
financially troubled companies. As discussed in part XIII of this
Explanation of Provisions, the Treasury Department and the IRS are of
the view that distributions of cash or other non-qualifying property
(that is, property that is not permitted to be received under section
354 or 355 of the Code without the recognition of gain or loss) by
troubled companies to their shareholders in exchange for their stock
should be subject to the stock repurchase excise tax. Moreover, section
4501 contains no indication that special valuation rules for
financially troubled companies would be necessary or appropriate to
carry out the purposes of the stock repurchase excise tax. The Treasury
Department and the IRS are of this view because the exchange would be a
section 317(b) redemption and providing a special rule would not be
necessary or appropriate to carry out the purposes of section 4501.
4. Valuation of Publicly Traded Stock
a. In General
One stakeholder recommended that taxpayers be permitted (but not
required) to determine the market price of publicly traded stock based
on one or more commonly accepted valuation methods, such as daily
volume-weighted average price (VWAP), daily average high-low price, or
daily closing price. Under the stakeholder's recommendation, a taxpayer
would be required to consistently apply the taxpayer's chosen method to
all its repurchases and issuances throughout the taxpayer's taxable
year. According to the stakeholder, this approach would be consistent
with established Federal tax valuation standards for the fair market
value of publicly traded securities.
Sections 3.06(2)(a)(i) and 3.08(5)(a)(i) of Notice 2023-2 describe
an approach that would require taxpayers to determine the market price
of repurchased or issued stock, respectively, that is traded on an
established securities market by applying one of four methods: (i) the
daily volume-weighted average price as determined on the date the stock
is repurchased or issued; (ii) the closing price on the date the stock
is repurchased or issued; (iii) the average of the high and low prices
on the date the stock is repurchased or issued; and (iv) the trading
price at the time the stock is repurchased or issued. Sections
3.06(2)(a)(iii) and 3.08(5)(a)(iii) of Notice 2023-2 describe an
approach that would require the market price of such stock to be
determined by consistently applying one of the foregoing methods to all
repurchases and issuances throughout the covered corporation's taxable
year (other than stock issued to employees). Another stakeholder
expressed appreciation for the flexibility provided under the approach
described in sections 3.06(2)(a) and 3.08(5)(a) of Notice 2023-2.
The Treasury Department and the IRS agree that commonly accepted
valuation methods are an appropriate means of determining the fair
market value of publicly traded stock for purposes of repurchases and
issuances under section 4501. Accordingly, consistent with Notice 2023-
2, the proposed regulations would include four such methods: (i) daily
VWAP; (ii) daily closing price; (iii) daily average high-low price; and
(iv) trading price when stock is repurchased or issued. Consistent with
Notice 2023-2, to facilitate the IRS's ability to administer and
enforce the stock repurchase excise tax, the Treasury Department and
the IRS are of the view that taxpayers should be required (rather than
merely permitted) to use one of these methods. See proposed Sec. Sec.
58.4501-2(h)(2)(ii) and 58.4501-4(e)(2)(ii).
As reflected in sections 3.06(2)(a)(iii) and 3.08(5)(a)(iii) of
Notice 2023-2, the
[[Page 25989]]
Treasury Department and the IRS also agree with the stakeholder that
taxpayers should be required to consistently apply the chosen method to
all repurchases and issuances throughout the taxable year. See proposed
Sec. Sec. 58.4501-2(h)(2)(iv) and 58.4501-4(e)(2)(iv). For special
rules for valuing stock issued or provided to an employee or other
service provider in connection with the performance of services, see
proposed Sec. 58.4501-4(e)(5) and part XI.G.7 of this Explanation of
Provisions.
b. Stock Traded on Multiple Established Securities Markets
One stakeholder recommended that a covered corporation with a class
of stock that trades on multiple established securities markets should
be permitted to select both the valuation method and the exchange to be
used in determining the fair market value of the covered corporation's
stock. The stakeholder had considered an alternative approach based on
the market price of the shares on the exchange with the highest trading
volume on the applicable date, but the stakeholder did not recommend
such an approach due to the additional complexity it would create.
The Treasury Department and the IRS are of the view that a covered
corporation whose stock is traded on multiple exchanges should
determine the fair market value of the covered corporation's stock by
reference to trading on the exchange in the country in which the
covered corporation is organized, including a regional established
securities market that trades in that country. If the covered
corporation's stock trades on multiple exchanges in the country in
which the covered corporation is organized, fair market value is
determined by reference to trading on the exchange in that country with
the highest trading volume in that stock in the prior taxable year. See
proposed Sec. Sec. 58.4501-2(h)(2)(v) and 58.4501-4(e)(2)(v). It is
the view of the Treasury Department and the IRS that this approach
would better facilitate the IRS's ability to administer and enforce the
stock repurchase excise tax and enable taxpayers to apply the tax with
greater certainty.
5. Valuation of Privately Owned Stock
One stakeholder recommended that the market price of privately
owned stock should be determined under general valuation principles for
privately owned securities. Another stakeholder recommended that the
market price of privately owned stock should equal the amount paid for
such stock. According to this second stakeholder, valuation experts
often disagree, and the transaction price typically is viewed as the
best evidence of the value of privately owned stock. Further, allowing
corporations to use the amount paid in valuing privately traded stock
would relieve corporations from the need to evaluate whether there is a
difference between the amount paid and the market price of such shares
on the date on which ownership transfers for Federal income tax
purposes.
Under the approach described in sections 3.06(2)(b) and 3.08(5)(b)
of Notice 2023-2, stock that is not traded on an established securities
market would be valued on the date of repurchase or issuance under the
principles of Sec. 1.409A-1(b)(5)(iv)(B)(1). Section 1.409A-
1(b)(5)(iv)(B)(1) provides, in part, that the fair market value of
stock as of a valuation date means a value determined by the reasonable
application of a reasonable valuation method, and that the
determination of whether a valuation method is reasonable (or whether
an application of a valuation method is reasonable) is made based on
the facts and circumstances as of the valuation date. Section 1.409A-
1(b)(5)(iv)(B)(1) further provides that the amount paid is one factor
to be considered under a reasonable valuation method. The Treasury
Department and the IRS are of the view that the proposed regulations
should implement the approach described in Notice 2023-2 and should not
provide a separate rule that would permit taxpayers to use the amount
paid, in and of itself, in determining the value of privately traded
stock. See proposed Sec. Sec. 58.4501-2(h)(3) and 58.4501-4(e)(3). For
special rules for valuing stock issued or provided to an employee or
other service provider in connection with the performance of services,
see proposed Sec. 58.4501-4(e)(5) and part XI.G.7 of this Explanation
of Provisions.
As with publicly traded stock, the Treasury Department and the IRS
are of the view that repurchases and issuances of privately traded
stock should be valued consistently. Specifically, the proposed
regulations would provide that the same valuation method must be used
for all repurchases and issuances of privately owned stock belonging to
the same class throughout the covered corporation's taxable year,
unless the application of that method to a particular repurchase or
issuance would be unreasonable under the facts and circumstances as of
the valuation date. See proposed Sec. Sec. 58.4501-2(h)(3)(ii) and
58.4501-4(e)(3)(ii). For special rules for valuing stock issued or
provided to an employee or other service provider in connection with
the performance of services, see proposed Sec. 58.4501-4(e)(5) and
part XI.G.7 of this Explanation of Provisions.
6. Annual Valuation Convention
A stakeholder also questioned whether covered corporations should
be permitted to use an annual valuation convention to determine a
single, uniform value for all repurchases and issuances during a
taxable year. According to the stakeholder, an annual valuation
convention would eliminate the distortive effects of stock price
volatility. In addition, such approach would simplify netting because
the use of the same price for all repurchases and issuances in the
taxable year would allow netting to be computed based on the number of
shares repurchased versus issued.
However, the stakeholder also acknowledged that converting the
netting rule into such a ``share count'' rule would be in tension with
the statutory requirement to value shares based on fair market value.
The stakeholder also noted that volatility later in the year could
cause a covered corporation's stock repurchase excise tax liability to
rise or fall dramatically after issuances or repurchases earlier in the
year, and that other Code provisions typically do not allow values to
be averaged over such a long period.
The Treasury Department and the IRS agree with the stakeholder that
adoption of an annual valuation convention in the proposed regulations
would be inconsistent with the statutory requirement under section
4501(c)(3) to value shares based on fair market value. Accordingly, the
proposed regulations would not adopt the stakeholder's annual valuation
convention.
B. Timing of Issuances and Repurchases
1. In General
The approach described in sections 3.06(1)(a) and 3.08(2) of Notice
2023-2 generally provides that stock is treated as repurchased or as
issued or provided, respectively, at the time at which ownership of the
stock transfers for Federal income tax purposes. In turn, the approach
described in sections 3.06(2) and 3.08(5) of Notice 2023-2 provides
that the fair market value of stock repurchased or issued is the market
price of the stock on the date the stock is repurchased or issued,
respectively.
One stakeholder recommended that, consistent with the approach
described in section 3.08(2) of Notice 2023-2, stock generally should
be treated as issued for purposes of the netting rule
[[Page 25990]]
when tax ownership of the stock transfers to the recipient of the
stock, rather than when the stock is issued for corporate law or
financial statement purposes.
The Treasury Department and the IRS agree with the stakeholder's
general recommendation and continue to be of the view that stock
generally should be treated as repurchased when tax ownership of the
stock transfers to the covered corporation or to the specified
affiliate (as appropriate). Therefore, the proposed regulations
generally would retain this approach. See proposed Sec. Sec. 58.4501-
2(g)(1) and 58.4501-4(d)(1). For specific timing rules applicable in
particular situations, see proposed Sec. 58.4501-2(g)(2), (3), and
(4), and for special timing rules for stock issued or provided to an
employee or other service provider in connection with the performance
of services, see proposed Sec. 58.4501-4(d)(2) and part XI.G.6 of this
Explanation of Provisions.
2. Repurchase Pursuant to an Economically Similar Transaction
Under the rule described in section 3.06(1)(b) of Notice 2023-2,
stock repurchased in an economically similar transaction is treated as
repurchased when the shareholders of the covered corporation exchange
their stock in the covered corporation. Consistent with part III.B.1 of
this Explanation of Provisions and section 3.06(1)(b) of Notice 2023-2,
the proposed regulations would provide that stock repurchased in an
economically similar transaction described in proposed Sec. 58.4501-
2(e)(4) is treated as repurchased on the date the shareholders of the
covered corporation exchange their stock in such corporation. See
proposed Sec. 58.4501-2(g)(2).
3. Repurchase Pursuant to a Constructive Specified Affiliate
Acquisition
For a discussion of the timing rule for repurchases pursuant to a
constructive specified affiliate acquisition, see part XIV.D of this
Explanation of Provisions.
4. Accelerated Share Repurchase Agreements
Although Notice 2023-2 does not describe special rules for
accelerated share repurchase (ASR) agreements, section 3.09(15),
Example 15, of Notice 2023-2 illustrates the application of the timing
rules summarized in part III.B.1 of this Explanation of Provisions in
the context of an ASR agreement. That example explicitly is limited to
situations in which, based on the terms of the agreement and the facts
and circumstances, the date on which shares are delivered by the bank
to the covered corporation is the date on which tax ownership of the
shares is transferred for Federal income tax purposes. As a result, the
delivery date in the example is the repurchase date. The example
illustrates the general principle that the date on which tax ownership
of the shares is transferred for Federal income tax purposes, which is
generally based on the particular ASR agreement and the facts and
circumstances of a transaction, is the repurchase date.
Several stakeholders requested guidance regarding the treatment of
ASR agreements for purposes of the stock repurchase excise tax. In an
ASR agreement, a corporation that wants to repurchase its outstanding
shares from the market will make an initial cash payment to an
investment bank in exchange for a certain number of shares. To deliver
the shares to the corporation, (i) the investment bank first will
borrow shares from stock lenders, and then (ii) over the term of the
ASR agreement, the bank will purchase shares from the market and use
such shares to gradually return the stock owed to the stock lenders.
The price the corporation ultimately pays for its shares under the
ASR agreement generally is based on an averaging of the VWAP of the
shares on specified days over the term of the agreement. Upon final
settlement of the agreement, the bank may be required to deliver
additional shares or cash to the corporation, or the corporation may
owe additional purchase price to the bank, depending on the VWAP of the
shares over the term of the agreement.
Several stakeholders recommended treating the initial delivery of
shares by the bank to a covered corporation under an ASR agreement as a
repurchase at the time of delivery, rather than at the time the bank
purchases the shares from the market. Based on the plain language of
section 4501(a), one stakeholder also recommended determining the
amount of the repurchase by reference to the fair market value of the
shares delivered on the date of delivery, rather than by reference to
the initial payment amount under the ASR agreement. If the bank
delivers additional shares to the covered corporation (or the covered
corporation issues shares to the bank) upon final settlement of the ASR
agreement, the stakeholder recommended that such delivery (or issuance)
also should be considered as a repurchase (or an issuance) of shares
for purposes of the stock repurchase excise tax, with the fair market
value of the repurchase (or issuance) determined on that date.
The stakeholders' recommendations are consistent with Notice 2023-
2, including section 3.09(15), Example 15, to the extent that the ASR
agreement involved is one in which the date the shares are delivered by
the bank to the covered corporation is the date on which tax ownership
of shares is transferred for Federal income tax purposes. In such a
situation, the date the shares are delivered would be the repurchase
date. However, because the determination of the date on which tax
ownership of shares is transferred is an inherently factual question,
the Treasury Department and the IRS are of the view that no special
rule should be included in the proposed regulations to determine the
repurchase date for ASR agreements, and the proposed regulations would
retain the approach described in Notice 2023-2. See proposed Sec. Sec.
58.4501-2(h)(1), 58.4501-4(e)(1), and 58.4501-5(b)(15) (Example 15).
5. Other Forward Contracts
A stakeholder also requested guidance on how the stock repurchase
excise tax applies to other forward transactions (either variable or
fixed price) in which a corporation agrees to acquire or issue its
stock for delivery in a future trade. The stakeholder recommended that
the stock repurchase excise tax and the netting rule generally should
be applied based on the fair market value of the shares at the time of
their actual acquisition or issuance by the corporation. However, if
the stock underlying the transaction is treated as immediately acquired
or issued under Federal income tax principles (for example, if the
corporation effectively acquires the benefits and burdens of stock
ownership upon entering into the forward contract), the timing rules
for purposes of the stock repurchase excise tax (for example, the date
used for determining fair market value) should follow those Federal
income tax principles.
The Treasury Department and the IRS agree with these
recommendations as they relate to the determination of the date stock
is treated as repurchased and the fair market value of that stock. As
previously discussed, the proposed regulations generally would use
Federal income tax principles to determine the date on which stock is
treated as repurchased or issued. Additionally, under the proposed
regulations, the fair market value of stock repurchased or issued
generally would equal the market price of the stock on the date the
stock is repurchased or issued. See proposed Sec. Sec. 58.4501-2(h)(1)
and 58.4501-4(e)(1). For a discussion of the application of the netting
rule to forward contracts or other instruments not in the legal form
[[Page 25991]]
of stock, see part XI.C.9 of this Explanation of Provisions.
6. Stock Issued or Provided to an Employee or Other Service Provider
For a discussion of the timing rules for stock issued or provided
to an employee or other service provider, see part XI.G.6 of this
Explanation of Provisions.
IV. Definitions of ``Covered Corporation,'' ``Established Securities
Market,'' and ``Specified Affiliate''
A. Becoming or Ceasing To Be a Covered Corporation
1. Overview
In section 6.02(2) of Notice 2023-2, the Treasury Department and
the IRS requested comments on when a corporation should be treated as
becoming or ceasing to be a covered corporation, and how repurchases
and issuances by a corporation during a taxable year that are prior to
the date the corporation becomes a covered corporation or after the
date the corporation ceases to be a covered corporation should be
treated. For example, the Treasury Department and the IRS have
considered the extent to which the term ``covered corporation'' should
apply to a privately held corporation that goes public, or to a
publicly traded corporation that goes private, during a taxable year.
One stakeholder recommended that the stock repurchase excise tax
base of a corporation that becomes a covered corporation during its
taxable year (for example, because of an initial public offering (IPO))
should be increased only for section 317(b) redemptions and
economically similar transactions occurring on or after the date the
corporation becomes a covered corporation. The stakeholder further
recommended that only stock issued by a corporation on or after the
date it becomes a covered corporation should be taken into account for
purposes of the netting rule.
Similarly, another stakeholder recommended that a corporation's
status as a covered corporation should be determined immediately prior
to a repurchase transaction. Thus, for example, a public corporation
that becomes a private corporation in a repurchase would be a covered
corporation with respect to that transaction.
In contrast, another stakeholder recommended that any redemption
that occurs as part of a transaction should be exempt from the
definition of ``repurchase'' if the corporation's stock no longer is
traded on an established securities market immediately after the
transaction. Alternatively, the stakeholder recommended that a
corporation's status as a covered corporation be determined at the end
of the repurchase transaction.
2. General Rules
The Treasury Department and the IRS are of the view that, as a
general rule, a corporation should be treated as a covered corporation
starting at the beginning of the corporation's ``initiation date,''
which is the date on which stock of the corporation begins to be traded
on an established securities market. Based on the statutory language,
the Treasury Department and the IRS are of the view that the traded
instrument must be stock of the corporation (as opposed to, for
example, ``when-issued'' trading of interests in to-be-issued shares of
stock of the corporation). See, for example, section 4501(b) (defining
a covered corporation as a domestic corporation the stock of which is
traded on an established securities market). A covered corporation
generally would cease being treated as a covered corporation at the end
of the covered corporation's ``cessation date,'' which is the date on
which stock of the covered corporation ceases to be traded on an
established securities market.
The Treasury Department and the IRS are of the view that these
general rules would be consistent with the statutory language in
section 4501 and would facilitate the IRS's ability to administer and
enforce the stock repurchase excise tax. Accordingly, the proposed
regulations would incorporate these general rules. See proposed Sec.
58.4501-2(d)(1) and (d)(2)(i).
Under the proposed regulations, in the case of a privately held
domestic corporation that goes public, shares issued on or after the
initiation date would be counted for purposes of the netting rule under
the proposed regulations. In addition, the proposed regulations would
provide that any repurchases, issuances, or contributions to an
employer-sponsored retirement plan on or after that date would be taken
into account in computing the corporation's stock repurchase excise tax
base for that taxable year. In contrast, shares issued before the
initiation date would not be counted for purposes of the netting rule,
and any repurchases, issuances, or contributions to an employer-
sponsored retirement plan before that date would not be taken into
account in computing the corporation's stock repurchase excise tax base
for that taxable year. See proposed Sec. 58.4501-4(b)(2).
In the case of a publicly traded domestic corporation that goes
private, repurchases of stock on the cessation date would be subject to
the stock repurchase excise tax under the proposed regulations, unless
one of the statutory exceptions applies. However, any repurchases,
issuances, or contributions to an employer-sponsored retirement plan of
the corporation's stock after that date generally would not be taken
into account under the proposed regulations in computing the
corporation's stock repurchase excise tax base for that year.
3. Exception Regarding Cessation Transactions That Include Repurchases
Pursuant to the Transaction's Plan
The proposed regulations would contain an exception to the general
rule that a corporation should be treated as a covered corporation
starting at the beginning of its ``initiation date'' and ending at the
end of its ``cessation date.'' Under the proposed regulations, if a
corporation ceases to be a covered corporation pursuant to a plan that
includes a repurchase, and if the corporation's cessation date precedes
the date on which any repurchase undertaken pursuant to the plan
occurs, then the corporation would continue to be a covered corporation
until the end of the date on which the repurchase occurs. See proposed
Sec. 58.4501-2(d)(2)(ii). For example, under the proposed regulations,
all repurchases of stock of a target covered corporation in an
acquisitive reorganization would be subject to the stock repurchase
excise tax (if no exception applied), even if the target covered
corporation's stock ceased to be traded on an established securities
market prior to the repurchase of the target covered corporation's
stock in the acquisitive reorganization. Under this exception, a
covered corporation's final repurchase transaction pursuant to the plan
of reorganization would be included in the stock repurchase excise tax
base.
4. Inbound and Outbound F Reorganizations
A stakeholder requested clarification that, consistent with the
Federal income tax treatment of a foreign corporation that domesticates
in an F reorganization, such a corporation is not a domestic
corporation for purposes of the stock repurchase excise tax until the
day after that reorganization occurs. See Sec. 1.367(b)-2(f)(4)
(providing that, in the case of an F reorganization in which the
transferor corporation is a foreign corporation, the taxable year of
such corporation ends with the close of the date of the transfer).
According to the
[[Page 25992]]
stakeholder, this clarification is important for foreign special
acquisition holding companies, which typically domesticate when
combining with a domestic business.
The Treasury Department and the IRS agree with the stakeholder.
Accordingly, these proposed regulations would clarify that, for
purposes of the stock repurchase excise tax, a foreign corporation that
transfers its assets to a domestic corporation in an F reorganization
(as described in Sec. 1.367(b)-2(f)) is not treated as a domestic
corporation until the day after the reorganization. Similarly, the
proposed regulations would clarify that, for purposes of the stock
repurchase excise tax, a domestic corporation that transfers its assets
to a foreign corporation in an F reorganization (as described in Sec.
1.367(a)-1(e)) is not treated as a foreign corporation until the day
after the reorganization. See proposed Sec. 58.4501-2(d)(3).
5. Determination of Timing of Events or Transactions
The Treasury Department and the IRS have considered rules to
address uncertainty that could arise from the application of the stock
repurchase excise tax regulations to a series of transactions or events
that occurs across multiple time zones.
The Treasury Department and the IRS request comments on this issue,
including specific proposals to address the application of the stock
repurchase excise tax regulations to a series of transactions or events
that occurs across multiple time zones. The Treasury Department and the
IRS encourage comments regarding the extent to which a proposed
approach would facilitate taxpayer certainty and the IRS's ability to
administer and enforce the stock repurchase excise tax regulations.
B. Determining Specified Affiliate Status
If a specified affiliate of a covered corporation acquires stock of
the covered corporation from a person that is not the covered
corporation or another specified affiliate of the covered corporation,
the acquisition is treated as a repurchase of the stock of the covered
corporation by the covered corporation. See section 4501(c)(2)(A); see
also section 3.05(1) of Notice 2023-2.
Stakeholders have asked when specified affiliate status should be
determined. More specifically, stakeholders have asked when valuations
should be undertaken for purposes of the 50-percent vote-or-value test
in section 4501(c)(2)(B), and whether fluctuations in the value of the
(potential) specified affiliate's stock or partnership interests should
be ignored.
The Treasury Department and the IRS are of the view that the
determination of whether a corporation or partnership is a specified
affiliate should be made whenever such determination is relevant for
purposes of section 4501. For example, such a determination would be
relevant when the potential specified affiliate acquires stock of a
covered corporation or provides stock of the covered corporation to
employees of the potential specified affiliate. See proposed Sec.
58.4501-2(f)(2)(i).
C. Involvement Safe Harbor
As defined in section 4501(b), 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 rule described in section 3.02(13) of Notice 2023-2
further provides that the term ``established securities'' market has
the meaning provided in Sec. 1.7704-1(b).
Section 1.7704-1(b) provides, in part, that the term ``established
securities market'' includes ``[a]n interdealer quotation system that
regularly disseminates firm buy or sell quotations by identified
brokers or dealers by electronic means or otherwise'' (interdealer
system). See Sec. 1.7704-1(b)(5). However, Sec. 1.7704-1(d) provides
a safe harbor (involvement safe harbor) under which interests in a
partnership are not treated as traded on an established securities
market within the meaning of Sec. 1.7704-1(b)(5) (that is, a
partnership will not be a publicly traded partnership solely due to an
interdealer system), unless the partnership either (1) ``participates
in the establishment of the market or the inclusion of its interests
thereon,'' or (2) ``recognizes any transfers made on the market'' by
redeeming the transferor or admitting the transferee as a partner or
otherwise recognizing any rights of the transferee.
A stakeholder noted that shares of corporations may trade over the
counter (OTC) or on similar markets, even without the corporation's
involvement, and that certain of those OTC or similar markets may
qualify as an interdealer system. As a result, a corporation could be a
covered corporation due to independent shareholder actions without the
corporation engaging in an affirmative listing on an exchange. The
stakeholder requested confirmation that the involvement safe harbor in
Sec. 1.7704-1(d) applies for purposes of determining whether a
corporation is a covered corporation due to an interdealer system, with
adjustments as needed for application of this safe harbor to
corporations rather than partnerships.
The Treasury Department and the IRS are of the view that the
involvement safe harbor should not apply for purposes of the stock
repurchase excise tax. The Treasury Department and the IRS view the
relationship between a partnership and its partners (a contractual
relationship that allows a partnership to set the terms under which
interests in the partnership may be validly transferred) as different
from the relationship between a corporation and its shareholders (which
is determined by the corporate law governing the stock). Accordingly,
the proposed regulations would not incorporate the involvement safe
harbor.
D. Indirect Ownership of Specified Affiliates
As noted in part I.B of the Background section of this preamble,
section 4501(c)(2)(B) defines the term ``specified affiliate'' to mean,
with regard to any corporation, ``(i) any corporation more than 50
percent of the stock of which is owned (by vote or by value), directly
or indirectly, by such corporation, and (ii) any partnership more than
50 percent of the capital interests or profits interests of which is
held, directly or indirectly, by such corporation'' (emphasis added).
The proposed regulations would provide that, for purposes of
section 4501(c)(2)(B), ``indirect'' ownership means a corporation's
proportionate ownership in equity interests through other entities. See
proposed Sec. 58.4501-2(f)(2)(ii). For example, if P owns 60 percent
of the stock of Sub 1, which owns 60 percent of the stock of Sub 2,
then P indirectly owns 36 percent (0.6 x 0.6 = 0.36) of the stock of
Sub 2.
E. Foreign Securities Markets
In section 6.02(9) of Notice 2023-2, the Treasury Department and
the IRS requested comments on whether the definition of ``established
securities market'' should be revised to clarify the regulatory
requirements under the Securities Exchange Act of 1934 that are most
relevant to the determination of whether a foreign securities market is
treated as an established securities market and, if so, what type of
U.S. securities exchange (including which tier of a securities exchange
with multiple tiers) should be the baseline for comparison.
One stakeholder recommended including an exclusive list of foreign
securities markets that are treated as established securities markets,
on the grounds that tax advisors should not be required to determine
whether foreign securities markets have regulatory
[[Page 25993]]
requirements analogous to those under the Securities Exchange Act of
1934. See Sec. 1.7704-1(b).
The Treasury Department and the IRS appreciate the stakeholder's
recommendation. However, the Treasury Department and the IRS are of the
view that the development and maintenance of an exclusive list of
foreign securities markets that are treated as established securities
markets would be outside the scope of the proposed regulations. As a
result, the proposed regulations would not include such a list.
F. Depository Receipts
In section 6.02(10) of Notice 2023-2, the Treasury Department and
the IRS requested comments on how the trading of stock through
depository receipts should be treated for purposes of determining
whether a corporation is a covered corporation or whether repurchased
stock is traded on an established securities market. In response, one
stakeholder noted that some applicable foreign corporations with
domestic specified affiliates have American depository receipts (ADRs)
listed in the United States. The stakeholder requested guidance to
clarify that the foreign parent's ADRs would not cause the domestic
specified affiliate to be treated as if the domestic specified
affiliate's stock were traded on an established securities market in
the United States.
The Treasury Department and the IRS are of the view that no special
rules are needed in response to this request. Section 4501(b)
specifically defines the term ``covered corporation'' to mean ``any
domestic corporation the stock of which is traded on an established
securities market'' (emphasis added). Moreover, although Notice 2023-2
does not expressly address ADRs, the definition of ``stock'' is defined
with respect to an instrument issued by the corporation. See section
3.02(25) of Notice 2023-2. The proposed regulations would maintain this
definition of ``stock.'' See proposed Sec. 58.4501-1(b)(29).
ADRs that provide full voting rights with respect to the underlying
corporate stock, entitle ADR holders to receive any dividends paid on
the stock, and permit an ADR holder to surrender an ADR at any time in
exchange for the underlying stock, may be treated as direct ownership
of the underlying stock. See Rev. Rul. 65-218, 1965-2 C.B. 566. If an
ADR is not treated as direct ownership of the underlying stock, it
would be characterized in accordance with its substance. In either
case, because ADRs are not issued by a domestic specified affiliate,
they would not be treated as stock of the domestic specified affiliate.
Publicly available information indicates that many foreign issuers
treat ADRs for Federal income tax purposes as direct ownership of their
stock. On that basis, under the definition of ``stock'' in these
proposed regulations, ADRs would be treated as stock of the issuer and
would be relevant to determining whether the issuer has stock that is
traded on an established securities market. Similarly, global
depositary receipts (GDRs) for the stock of domestic corporations that
are traded on foreign exchanges may be relevant in determining whether
the issuer has stock that is traded on an established securities
market. Because the ADRs and GDRs are not issued by a domestic
specified affiliate, they would not be treated as stock of the domestic
specified affiliate.
Additionally, Congress specifically wrote rules to address
situations involving a publicly traded foreign corporation with a
domestic specified affiliate, and those rules do not include any
provisions treating the domestic specified affiliate as publicly traded
as a result of the foreign corporation's stock trading on an
established securities market in the United States. See section
4501(d); see also part XVI of this Explanation of Provisions
(discussion of feedback relating to section 4501(d)).
V. Section 301 Distributions
Section 301(a) of the Code generally provides that a distribution
of property (as defined in section 317(a)) made by a corporation to a
shareholder with respect to its stock is treated in the manner provided
in section 301(c). Section 301(c)(1) provides that the portion of the
distribution that is a dividend (as defined in section 316) is included
in gross income. Section 301(c)(2) provides that the portion of the
distribution that is not a dividend is applied against and reduces the
adjusted basis of the stock. Section 301(c)(3) generally provides that
the portion of the distribution that is not a dividend is treated as
gain from the sale or exchange of property to the extent that it
exceeds the adjusted basis of the stock.
For purposes of this discussion, an actual distribution subject to
section 301(c)(2) or (3) refers to a distribution of property to a
shareholder with respect to the corporation's stock that does not
include an exchange of such stock. In contrast, an ``in-form''
redemption treated as a distribution subject to section 301(c)(2) or
(3) refers to a distribution of property to a shareholder in exchange
for the corporation's stock.
A. Actual Distributions Subject to Section 301(c)(2) or (3)
Stakeholders asked whether an actual distribution (that is, a
distribution that does not involve a redemption in form) to which
section 301(c)(2) or (3) applies is subject to the stock repurchase
excise tax. Stakeholders contended that the stock repurchase excise tax
should not apply to such a distribution, because (i) it is not a
section 317(b) redemption, and (ii) it is not economically similar to a
section 317(b) redemption (for example, it does not decrease the number
of shares outstanding). Instead, such a distribution more closely
resembles a dividend, which is excluded from the stock repurchase
excise tax (see section 4501(e)(6)).
The Treasury Department and the IRS agree that an actual
distribution subject to section 301(c)(2) or (3) is not a repurchase
(and, therefore, is not subject to the stock repurchase excise tax)
because such a distribution is neither a section 317(b) redemption nor
economically similar to such a redemption. Accordingly, and consistent
with section 3.04(4)(a) of Notice 2023-2 (which does not include such
distributions in the list of economically similar transactions), the
proposed regulations would provide that an actual distribution subject
to section 301(c)(2) or (3) is not subject to the stock repurchase
excise tax. See proposed Sec. 58.4501-2(e)(5)(iv).
B. Redemptions Treated as Distributions Subject to Section 301(c)(2) or
(3)
Stakeholders also asked whether the stock repurchase excise tax
applies to an in-form redemption that is treated as a distribution to
which section 301(c)(2) or (3) applies. See section 302(d). One
stakeholder recommended applying the stock repurchase excise tax to a
non-pro rata, in-form redemption that is treated as a distribution to
which section 301(c)(2) or (3) applies. However, the stakeholder
contended that the stock repurchase excise tax should not apply to a
pro rata, in-form redemption that is treated as a distribution to which
section 301(c)(2) or (3) applies, because such a redemption is more
akin to an actual section 301 distribution than a typical section
317(b) redemption. In contrast, another stakeholder recommended that
the stock repurchase excise tax should apply to such a transaction
because it is a redemption within the meaning of section 317(b) (for
example, such a redemption decreases the number of outstanding
[[Page 25994]]
shares even though the redemption is pro rata).
The Treasury Department and the IRS agree that an in-form section
317(b) redemption treated as a distribution to which section 301(c)(2)
or (3) applies is a repurchase based on the plain language of the
statute, regardless of whether the redemption is pro rata. Accordingly,
and consistent with section 3.04(3) of Notice 2023-2 (which does not
include such transactions in the list of section 317(b) redemptions
that are not repurchases), an in-form section 317(b) redemption treated
as a distribution to which section 301(c)(2) or (3) applies would be
subject to the stock repurchase excise tax under the proposed
regulations. See proposed Sec. 58.4501-2(e)(3) (providing an exclusive
list of section 317(b) redemptions that are not repurchases).
C. Exclusion for Pro Rata Distributions
One stakeholder recommended a general exclusion from the stock
repurchase excise tax for distributions made to all shareholders of a
covered corporation on a wholly pro rata basis (100 percent pro rata
distribution), regardless of whether such distributions involve a
redemption in form. According to the stakeholder, such distributions do
not implicate most of the policy considerations underlying the tax.
However, the stakeholder noted that adopting this recommendation
would require the Treasury Department and the IRS to consider (i) how
to determine whether a distribution is 100 percent pro rata if the
covered corporation has multiple classes of stock, and (ii) the impact
of such distributions on options or convertible debt instruments (to
the extent such instruments thereby accrete their proportionate
interests in the covered corporation).
The Treasury Department and the IRS disagree with the stakeholder's
recommendation. A redemptive 100 percent pro rata distribution is a
repurchase because the distribution (i) constitutes a section 317(b)
redemption or (ii) is an economically similar transaction. Accordingly,
the proposed regulations would not provide an exclusion for 100 percent
pro rata distributions, except in the case of pro rata distributions in
a complete liquidation to which section 331 or 332 (but not both)
applies.
VI. Complete and Partial Liquidations
A. Complete Liquidations
Section 331(a) of the Code provides that amounts received by a
shareholder in a distribution in complete liquidation of a corporation
are treated as in full payment in exchange for the stock. Section 332
of the Code provides an exception to the general rule in section
331(a). If the requirements of section 332 are met, no gain or loss is
recognized upon the receipt by one corporation of property distributed
in complete liquidation of another corporation.
Section 332 applies only if the corporation receiving property in
the liquidation satisfies the requirements of section 332(b), including
the requirement that the corporation own stock in the liquidating
corporation meeting the 80-percent voting and value requirements of
section 1504(a)(2) of the Code (80-percent distributee). See section
332(b)(1).
1. Application of Stock Repurchase Excise Tax
Several stakeholders recommended that a complete liquidation by a
covered corporation should not be subject to the stock repurchase
excise tax because the complete liquidation terminates the covered
corporation's existence. For support, these stakeholders contended that
a complete liquidation provides no opportunity for the liquidating
corporation to reinvest cash in the corporation's enterprise, which
stakeholders stated Congress may have intended to encourage through the
enactment of section 4501. In addition, these stakeholders emphasized
that a complete liquidation provides no opportunity for a covered
corporation to manipulate the corporation's earnings per share (EPS) or
other similar metrics, which these stakeholders stated Congress may
have intended to discourage through the enactment of section 4501.
As reflected in section 3.04(4)(b)(i)(A) of Notice 2023-2, the
Treasury Department and the IRS are of the view that a distribution in
complete liquidation of a covered corporation to which either section
331 or 332 (but not both) applies is not a repurchase. Accordingly, the
Treasury Department and the IRS are of the view that such distributions
should not be subject to the stock repurchase excise tax. See proposed
Sec. 58.4501-2(e)(5).
2. Determination of Complete Liquidation or Dissolution
Stakeholders also asked whether a distribution is in ``complete
liquidation'' of a corporation for purposes of section 331 if some
classes of the liquidating corporation's stock do not receive a
distribution. Section 331 does not define the term ``complete
liquidation.'' Instead, this term is defined in section 346(a) of the
Code, which provides that, for purposes of subchapter C of chapter 1,
``a distribution shall be treated as in complete liquidation of a
corporation if the distribution is one of a series of distributions in
redemption of all of the stock of the corporation pursuant to a plan''
(emphasis added).
Stakeholders have questioned whether the definition of ``complete
liquidation'' in section 346(a) requires a distribution on all classes
of stock in order for a dissolution of a corporation to qualify as a
distribution in complete liquidation to which section 331 applies.
These stakeholders based their question on the language of section
332(b)(2), which provides that a distribution is considered in
``complete liquidation'' within the meaning of section 332 only if
``the distribution is by [the liquidating corporation] in complete
cancellation or redemption of all its stock.'' In addition, these
stakeholders referenced Treasury regulations and judicial opinions. See
Sec. 1.332-2(b) (``Section 332 applies only to those cases in which
the recipient corporation receives at least partial payment for the
stock which it owns in the liquidating corporation.''); Spaulding
Bakeries Inc. v. Comm'r, 252 F.2d 693, 697 (2d Cir. 1958) (emphasizing
that ``[s]ection 112(b)(6)(C) [of the Internal Revenue Code of 1939
(the predecessor statute to section 332)] requires for its application
a distribution in complete cancellation or redemption of all stock of
the dissolved corporation''), aff'g 27 T.C. 684 (1957); H.K. Porter Co.
v. Comm'r, 87 T.C. 689 (1986) (agreeing with the rationale of the
Second Circuit's decision in H.K. Porter and holding that section 332
did not apply to a dissolution because a distribution was made on the
dissolving corporation's preferred stock but not its common stock).
As stated previously, the Treasury Department and the IRS are of
the view that a distribution in complete liquidation of a covered
corporation to which section 331 or 332(a) applies should not be
treated as a repurchase. In addition, the Treasury Department and the
IRS are of the view that a redemption by a covered corporation pursuant
to a corporate dissolution of the covered corporation should not be
treated as a repurchase. To clarify the intent of Notice 2023-2, the
proposed regulations would provide that a distribution in complete
liquidation of a covered corporation to which either section 331 or
332(a) (but not both) applies, a distribution pursuant to a plan of
dissolution of a covered
[[Page 25995]]
corporation that is reported on the original (but not a supplemented or
an amended) IRS Form 966, Corporate Dissolution or Liquidation (or any
successor form), or a distribution pursuant to a deemed dissolution of
the covered corporation (for instance, pursuant to a deemed liquidation
under Sec. 301.7701-3), is not a repurchase and, therefore, is not
subject to the stock repurchase excise tax. See proposed Sec. 58.4501-
2(e)(5)(i). For the treatment of liquidations to which both sections
331 and 332 apply, see proposed Sec. 58.4501-2(e)(4)(v)(A) and the
discussion in part VI.A.3 of this Explanation of Provisions.
3. Liquidations to Which Both Sections 331 and 332 Apply
The rules described in section 3.04(4)(a)(v) of Notice 2023-2
provide that, if sections 331 and 332 both apply to a complete
liquidation, then (i) the distribution to the 80-percent distributee is
not subject to the stock repurchase excise tax, but (ii) each
distribution to which section 331 applies (that is, the surrender of
covered corporation stock by each minority shareholder) is subject to
the stock repurchase excise tax. The Treasury Department and the IRS
have arrived at this view because the 80-percent distributee is the
successor to the transferor corporation (that is, the liquidating
subsidiary) following the complete liquidation to which section 332
applies. See section 381(a)(2). In contrast to the 80-percent
distributee, minority shareholders that receive liquidating
distributions to which section 331 applies terminate their investment
in the transferor corporation's business (that is, are not successors
to the transferor corporation).
Moreover, a complete liquidation to which sections 331 and 332 both
apply is substantively similar to an upstream reorganization of the
liquidating subsidiary into the 80-percent distributee in which the
minority shareholders receive only non-qualifying property in exchange
for their stock in the liquidating subsidiary. Because such an exchange
in an upstream reorganization would constitute a ``repurchase'' under
the proposed regulations, the Treasury Department and the IRS are of
the view that the same treatment should apply to liquidating
distributions to minority shareholders subject to section 331. See
proposed Sec. 58.4501-2(e)(4)(v)(A).
4. Distributions During Taxable Year of Complete Liquidation or
Dissolution
The rule described in section 3.04(4)(b)(i)(B) of Notice 2023-2
provides that, if a covered corporation or a covered surrogate foreign
corporation (as appropriate) completely liquidates and dissolves
(within the meaning of Sec. 1.331-1(d)(1)(ii)) during a taxable year,
no distribution by that corporation during that taxable year is a
repurchase. See also proposed Sec. 58.4501-2(e)(5)(ii) (incorporating
this provision into the proposed regulations). Stakeholders have
requested clarification regarding how this provision interacts with the
rule described in section 3.04(4)(a)(v) of Notice 2023-2, which (as
previously discussed in part VI.A.3 of this Explanation of Provisions)
provides that, in a complete liquidation to which sections 331 and 332
both apply, each distribution to which section 331 applies is subject
to the stock repurchase excise tax. The proposed regulations would
clarify the intent of Notice 2023-2 by providing that the rule in
proposed Sec. 58.4501-2(e)(5)(ii) does not apply if the complete
liquidation or dissolution is a transaction to which sections 331 and
332 both apply.
B. Partial Liquidations
Section 302(b)(4) of the Code provides that a distribution in
redemption of stock held by a shareholder who is not a corporation and
in partial liquidation of the distributing corporation receives
exchange treatment under section 302(a). For purposes of section
302(b)(4), a distribution will be treated as in partial liquidation of
a corporation if the distribution (i) is not essentially equivalent to
a dividend (determined at the corporate level rather than at the
shareholder level), and (ii) is pursuant to a plan and occurs within
the taxable year in which the plan was adopted or within the succeeding
taxable year. See section 302(e)(1). A partial liquidation may involve
a redemption of stock under section 317(b) in which the shareholder
actually, in-form surrenders stock of the corporation in exchange for
property (redemptive partial liquidation). A partial liquidation also
may involve a constructive redemption of stock in which the shareholder
is deemed to surrender stock of the corporation in exchange for
property, and that deemed surrender satisfies the redemption
requirement of sections 302 and 317(b) (constructive partial
liquidation). See H.R. Conf. Rep. No. 760, 97th Cong., 2nd Sess. 530
(1982) (``Under present law, a distribution in partial liquidation may
take place without an actual surrender of stock by the shareholders . .
. [and a] constructive redemption of stock is deemed to occur in such
transactions. . . . The conferees intend that the treatment of partial
liquidations under present law section 346(a)(2) and (b) is to continue
for such transactions under new section 302(e).'').
1. Partial Liquidations Involving an Actual Redemption of Stock
Several stakeholders requested guidance on whether a redemptive
partial liquidation is treated as a repurchase. One stakeholder
recommended that a redemptive partial liquidation by a covered
corporation should be subject to the stock repurchase excise tax
because a non-pro rata redemptive partial liquidation could achieve
consequences similar to those that the stakeholder hypothesized section
4501 was intended to counteract. For example, the stakeholder observed
that, if a corporation distributes proceeds from the sale of one of its
businesses to its shareholders, the corporation has chosen to make that
distribution rather than reinvest the proceeds in its business. Another
stakeholder agreed that non-pro rata redemptive partial liquidations
should be treated as repurchases but contended that 100-percent pro
rata redemptive partial liquidations should not be so treated.
The Treasury Department and the IRS are of the view that redemptive
partial liquidations should be treated as repurchases because those
transactions qualify as section 317(b) redemptions. Moreover, as
discussed in part V.C of this Explanation of Provisions, the Treasury
Department and the IRS are of the view that no special exception should
be provided for 100-percent pro rata redemptions, particularly because
section 4501 does not provide such an exception. In addition, such an
exception would complicate the IRS's ability to administer and enforce
the stock repurchase excise tax. Accordingly, the proposed regulations
would not incorporate these stakeholder recommendations.
2. Partial Liquidations Involving a Constructive Redemption of Stock
Several stakeholders requested guidance on whether a constructive
partial liquidation is treated as a repurchase. The stakeholders
recommended that constructive partial liquidations should not be
treated as repurchases because such transactions neither have the form
of an actual redemption nor affect shareholders' proportionate
interests. In addition, those stakeholders asserted that the treatment
of constructive partial liquidations as constructive redemptions is
imputed in revenue rulings to provide beneficial tax treatment to
individual shareholders.
[[Page 25996]]
The stakeholders further contended that such redemptions are not
motivated by, and do not produce, the economic effects that they
contend the stock repurchase excise tax was designed to discourage.
The Treasury Department and the IRS decline to adopt the
stakeholders' recommendation in the proposed regulations. Section
302(b)(4) applies to a distribution ``in redemption of stock,'' and
section 317(b) defines a ``redemption'' for purposes of section 302.
Regardless of whether a redemption is constructive rather than actual,
the redemption comprises a section 317(b) redemption to which section
302(b)(4) may apply. Therefore, the Treasury Department and the IRS are
of the view that a constructive partial liquidation is a repurchase
subject to the stock repurchase excise tax, and the proposed
regulations would not provide any special exceptions for such
transactions.
3. Dividend Exception and Partial Liquidation Look-Through Rule
For a discussion of the dividend exception and the partial
liquidation look-through rule in section 302(e)(5), see part X.F.3 of
this Explanation of Provisions.
VII. Taxable Transactions
A. LBOs and Other Taxable ``Take Private'' Transactions
Under the approach described in Notice 2023-2, unless a statutory
exception applies, the target-corporation-funded portion of the
consideration in an LBO or other taxable acquisition of the stock of a
target corporation would be treated as a repurchase for purposes of
computing the target corporation's stock repurchase excise tax base.
See section 3.09(3) and (4) of Notice 2023-2. This approach tracks
longstanding Federal income tax treatment by the IRS of such
transactions, particularly that cash received by the minority
shareholders in such transactions is subject to the provisions and
limitations of section 302. See, for example, Rev. Rul. 78-250, 1978-1
C.B. 83 (elimination of minority shareholders' interest in target
corporation through the merger of a transitory subsidiary into target
corporation treated as a redemption because target corporation was the
source of the cash consideration).
Several stakeholders recommended that payments funded (or deemed
funded) by the target corporation in a taxable acquisition of target
corporation stock should not be treated as a repurchase. Another
stakeholder recommended that any redemption that occurs as part of a
transaction should be exempt from the definition of ``repurchase'' if,
immediately after the transaction, the target corporation's stock no
longer is traded on an established securities market. See part IV.A of
this Explanation of Provisions (discussing the stakeholder's
recommendation). Alternatively, the stakeholder recommended that a
target corporation's status as a covered corporation be determined at
the end of the repurchase transaction. Similarly, another stakeholder
recommended that an exemption be created for redemptions undertaken in
connection with fully taxable stock dispositions in which target
corporation shareholders completely terminate their interest under
section 302(b)(3), and as described in Zenz v. Quinlivan, 213 F.2d 914
(6th Cir. 1954).
According to the stakeholders, deemed redemptions by a target
corporation that is a covered corporation in an LBO or other taxable
``take private'' transaction do not implicate their view of the
congressional policies underlying the stock repurchase excise tax
because the purpose of such a transaction is to cash out completely the
target corporation's existing shareholders. For support, these
stakeholders highlighted that taxable ``take private'' transactions do
not present an opportunity to manipulate EPS or other financial
metrics, which (i) become irrelevant after the target corporation
ceases to be a publicly traded entity, and (ii) the stakeholders viewed
as a practice that Congress intended to discourage through enactment of
the stock repurchase excise tax.
Moreover, in the stakeholders' view, imposing the stock repurchase
excise tax on a fully taxable stock acquisition based solely on the
source of the consideration received by the target corporation's
shareholders would create arbitrary distinctions driven by factors that
may be commercially focused, such as the target corporation's desired
capital structure and its ability to obtain third-party financing. The
stakeholders further noted that, if the application of the stock
repurchase excise tax to fully taxable stock acquisitions hinges solely
on the actual or deemed source of consideration, then parties easily
may avoid the tax by borrowing at the acquiring-entity level, buying
the target corporation's shares, and then having the target corporation
assume or satisfy the debt after the acquisition.
The Treasury Department and the IRS disagree with the stakeholders'
recommendations. The treatment of such target corporation-funded
payments as a redemption within the meaning of section 317(b) follows
longstanding Federal income tax principles and guidance. The Treasury
Department and the IRS are of the view that there is no compelling
reason to deviate from such long-standing principles and guidance or
from the express language of section 4501(c)(1), which defines a
repurchase, in part, as ``a redemption within the meaning of section
317(b) with regard to the stock of a covered corporation.'' The
Treasury Department and the IRS are of the view that integrating long-
standing Federal income tax principles and guidance into the proposed
regulations would facilitate taxpayer compliance, as well as the
ability of the IRS to administer and enforce the stock repurchase
excise tax. Accordingly, the proposed regulations would not adopt the
stakeholders' recommendations regarding taxable stock acquisitions.
Several stakeholders offered alternative recommendations in the
event the proposed regulations do not exclude taxable stock
acquisitions from the stock repurchase excise tax. One stakeholder
agreed with the approach described in Notice 2023-2, under which a
taxable stock acquisition is treated as a section 317(b) redemption
only to the extent of the consideration sourced from the target
corporation. The stakeholder recommended that, for purposes of the
stock repurchase excise tax, sourcing should be guided by the same
principles that apply to determine the identity of the borrower for
Federal income tax purposes. The proposed regulations would retain the
approach described in Notice 2023-2.
Another stakeholder recommended that issuances by the target
corporation in the same taxable year as the ``take private''
transaction, including issuances that occur after the ``take private''
transaction, should be taken into account for purposes of the netting
rule. The Treasury Department and the IRS disagree with this
recommendation. As previously discussed, the Treasury Department and
the IRS are of the view that, to be consistent with the statutory
language in section 4501, stock issued by a corporation after it ceases
to be a covered corporation should not be taken into account under the
netting rule. See part IV.A of this Explanation of Provisions.
Accordingly, the proposed regulations would take into account stock
issued by the target corporation in the same taxable year as the ``take
private'' transaction only if that stock was issued during the period
in which the target corporation was a covered corporation, as
determined under these
[[Page 25997]]
proposed regulations. See proposed Sec. Sec. 58.4501-2(d)(1) and
58.4501-4(b)(2).
B. Section 304 Transactions
1. Section 304(a)(1) Transactions
Section 304(a)(1) of the Code applies if one corporation purchases
stock of another corporation from a shareholder or shareholders in
control of both corporations in exchange for cash or other property
(section 304(a)(1) transaction). If section 304(a)(1) applies, the cash
or other property paid to the controlling shareholder or shareholders
is treated as a distribution in redemption of the stock of the
acquiring corporation. To the extent that the distribution is treated
as a distribution to which section 301 applies, (i) the selling
shareholder or shareholders are treated in the same manner as if they
had transferred the acquired stock to the acquiring corporation in a
transaction to which section 351(a) of the Code applies, and then (ii)
the acquiring corporation is treated in the same manner as if it had
redeemed the stock it was treated as issuing in the transaction.
The approach described in sections 3.04(3)(a) and 3.08(4)(e) of
Notice 2023-2, respectively, provides that a deemed redemption
resulting from the application of section 304(a)(1) is neither a
repurchase nor an issuance for purposes of the stock repurchase excise
tax. Stakeholders generally agreed with this approach, for several
reasons.
First, stakeholders noted that section 304(a)(1) transactions
involve no actual contraction in the number of shares of acquiring
corporation stock. Second, stakeholders observed that, to the extent
the deemed redemption is treated as a distribution to which section 301
applies, the section 304(a)(1) transaction would consist of an
offsetting issuance and repurchase of acquiring corporation stock.
However, those stakeholders correctly noted that the deemed redemption
would be statutorily excluded from the computation of the acquiring
corporation's stock repurchase excise tax base under section 4501(e)(6)
to the extent that the deemed redemption is treated as a dividend under
section 301(c)(1). As a result, the Federal income tax treatment
mandated by section 304(a)(1), combined with the statutory exclusion
for dividends under section 4501(e)(6), would manufacture an automatic
net issuance.
Finally, one stakeholder claimed that it could be difficult for
taxpayers to determine whether section 304(a)(1) applies to public
company M&A transactions because publicly traded corporations do not
know the identity of their shareholders. For that reason, the
stakeholder also contended that it could be difficult for the IRS to
administer and enforce the stock repurchase excise tax with respect to
section 304(a)(1) transactions.
However, several stakeholders expressed concern that an exemption
for all section 304(a)(1) transactions may exclude transactions that
(i) satisfy the statutory requirements for section 304 qualification,
and (ii) are economically similar to a conventional stock repurchase.
As an illustration, the stakeholders presented the following fact
pattern. Individual A owns 50 percent of the stock of two public
corporations. Individual A sells a portion of its stock in one
corporation (that is, the target corporation) to the other corporation
(that is, the acquiring corporation). The stakeholders explained that
section 304(a)(1) would apply to the sale, but individual A may qualify
for sale or exchange treatment under section 302(a) depending on
individual A's actual and constructive ownership of the target
corporation following the transaction. According to the stakeholder,
applying the stock repurchase excise tax may be appropriate in this
situation and in other situations in which control of the target and
acquiring corporations is not widely dispersed and both corporations
remain publicly traded after the transaction.
The Treasury Department and the IRS are of the view that the
complexity of regulations applying the stock repurchase excise tax with
regard to section 304(a)(1) transactions would outweigh significantly
any benefit of applying this tax to those transactions. In addition,
the Treasury Department and the IRS are of the view that applying the
stock repurchase excise tax to section 304(a)(1) transactions would
create significant difficulty for the IRS to administer and enforce the
tax, as well as for taxpayers to calculate and report their tax with
certainty. Accordingly, the Treasury Department and the IRS are of the
view that the stock repurchase excise tax should not apply to a
redemption that is deemed to occur by virtue of section 304(a)(1). See
proposed Sec. Sec. 58.4501-2(e)(3)(i) and 58.4501-4(f)(4).
2. Section 304(a)(2) Transactions
Section 304(a)(2) applies if one corporation (that is, the
acquiring corporation) purchases stock of another corporation (that is,
the target corporation) from a shareholder of the target corporation in
exchange for cash or other property and that target corporation
controls the acquiring corporation (section 304(a)(2) transaction). If
section 304(a)(2) applies, that property is treated as a distribution
in redemption of the stock of the target corporation. The approach
described in Notice 2023-2 does not exempt section 304(a)(2)
transactions from the application of the stock repurchase excise tax.
See generally section 3.04(3) of Notice 2023-2 (excepting solely
section 304(a)(1) transactions).
One stakeholder noted that the application of the stock repurchase
excise tax to section 304(a)(2) transactions generally is clear and is
analogous to the rule treating an acquisition of stock of a covered
corporation by a specified affiliate as a repurchase to which the stock
repurchase excise tax applies. The Treasury Department and the IRS
agree with the stakeholder. Accordingly, the proposed regulations would
not exempt section 304(a)(2) transactions from the application of the
stock repurchase excise tax.
VIII. Reorganizations
A. Acquisitive Reorganizations
1. Overview
The approach described in Notice 2023-2 treats an exchange of
target corporation stock by the target corporation's shareholders in an
acquisitive reorganization as an economically similar transaction. See
section 3.04(4)(a)(i) of Notice 2023-2. The notice defines an
``acquisitive reorganization'' as a transaction that qualifies as a
reorganization under section 368(a)(1)(A) of the Code (including by
reason of section 368(a)(2)(D) or (E)), section 368(a)(1)(C), or
section 368(a)(1)(D) (D reorganization) (if the reorganization
satisfies the requirements of section 354(b)(1) of the Code). See
section 3.02(1) of Notice 2023-2.
Under the approach described in Notice 2023-2, the effect of an
acquisitive reorganization on a target corporation's stock repurchase
excise tax base is computed by first including in that tax base the
fair market value of all target corporation stock exchanged in the
transaction, regardless of the type of consideration for which the
stock is exchanged. The stock repurchase excise tax base then is
reduced under the statutory exception in section 4501(e)(1)
(reorganization exception) by the fair market value of the target
corporation stock exchanged for property permitted to be received by
the target corporation shareholders without recognition of gain or loss
under section 354 (that is, qualifying property). Thus, under the
approach described in Notice 2023-2,
[[Page 25998]]
the target corporation generally is subject to the stock repurchase
excise tax only to the extent of the fair market value of target
corporation stock exchanged for property that is non-qualifying
property.
For purposes of this preamble, the term ``acquisitive
reorganization'' includes each transaction described as an acquisitive
reorganization in Notice 2023-2 as well as a transaction that qualifies
as a reorganization under section 368(a)(1)(G) (if the reorganization
satisfies the requirements of section 354(b)(1)).
Under Federal income tax principles, acquisitive reorganizations
involve the following two elements. First, the target corporation
transfers all or a portion of its assets to the acquiring corporation
in exchange for consideration from the acquiring corporation. Second,
the target corporation distributes the consideration received from the
acquiring corporation to the target corporation's shareholders in
exchange for their target corporation stock in an actual or deemed
liquidation of the target corporation (target redemptive distribution).
See, for example, section 361(a) and (c) of the Code (providing for
nonrecognition of gain or loss for the target corporation's transfer of
assets in exchange for stock or securities of a party to the
reorganization and the target corporation's distribution of that stock
or securities pursuant to a plan of reorganization); section
368(a)(1)(C) and (a)(2)(G) (to similar effect).
2. Feedback Received
a. In General
Several stakeholders recommended that acquisitive reorganizations
should not be subject to the stock repurchase excise tax, to any
extent. These stakeholders contended that, although a target redemptive
distribution in an acquisitive reorganization resembles a section
317(b) redemption, such a transaction should not be subject to the
stock repurchase excise tax even if non-qualifying property is
provided. See parts VIII.A.2.b and c of this Explanation of Provisions.
b. Stakeholders Contend Acquisitive Reorganizations Are Not
Economically Similar Transactions
Some stakeholders asserted that acquisitive reorganizations are
economically distinguishable from a section 317(b) redemption and
therefore should not be treated as economically similar transactions.
According to these stakeholders, the basic economic nature of an
acquisitive reorganization (at least in situations in which the parties
to the transaction are unrelated) is a two-company acquisitive
transaction in which the target corporation shareholders sell the
target corporation to the acquiring corporation. In contrast, a section
317(b) redemption is a transaction in which a single corporation
acquires its own stock from its shareholders.
Several stakeholders stated that an acquisitive reorganization
between unrelated parties is motivated primarily by bona fide
investment and strategic business purposes and does not give rise to
any abuse that the stakeholders hypothesized Congress may have intended
to discourage through enactment of the stock repurchase excise tax.
These stakeholders acknowledged that the exchange of target corporation
stock for non-qualifying property in a target redemptive distribution
either constitutes or resembles a section 317(b) redemption. However,
the stakeholders questioned whether this exchange under Federal income
tax principles provides an adequate basis for designating the
transaction as ``economically similar.'' The stakeholders further
questioned why a distribution in complete liquidation as part of a
reorganization (that is, the target redemptive distribution) should
give rise to an economically similar transaction under the approach
described in Notice 2023-2 even though a distribution in complete
liquidation subject to either section 331 or 332 (but not both) would
not.
With regard to the latter point, several stakeholders noted that
the exchange between the target corporation and its shareholders in a
forward merger that failed to qualify as a reorganization would not be
subject to the stock repurchase excise tax. See Rev. Rul. 69-6, 1969-1
C.B. 104 (treating such an exchange as a distribution in complete
liquidation to which section 331 applies). One stakeholder suggested
that the application of this tax should be based upon the substantive
Federal income tax characterization of the steps of the transaction,
rather than upon the overall Federal income tax characterization of the
transaction as a reorganization. For support, the stakeholder contended
that their recommendation would mitigate the potential for a more
onerous result under the stock repurchase excise tax if the components
of such a transaction qualify for reorganization treatment.
Several stakeholders also recommended that transactions that
qualify as a reorganization described in either section 368(a)(1)(B) (B
reorganization) or 368(a)(1)(A) by reason of section 368(a)(2)(E)
(reverse triangular merger) should not be subject to the stock
repurchase excise tax. The stakeholders contended that those types of
reorganizations should not be subject to the stock repurchase excise
tax based on their view that such transactions, both in substance and
in form, involve an acquisition of stock by a third party rather than a
repurchase or redemption of target corporation stock.
c. Effect of the Statutory Exception in Section 4501(e)(1)
Stakeholders acknowledged that the inclusion of the statutory
exception in section 4501(e)(1) (that is, the reorganization exception)
is subject to several interpretations. Several stakeholders
acknowledged that the inclusion of this exception in section 4501 could
be construed as reflecting congressional intent that all stock
exchanged for non-qualifying property in a reorganization should be
treated as economically similar to a section 317(b) redemption.
However, the stakeholders recommended that the Treasury Department and
the IRS not adopt that interpretation.
In contrast, one stakeholder contended that the inclusion of the
reorganization exception does not necessarily indicate that Congress
intended all non-qualifying property received in any acquisitive
reorganization to be subject to the stock repurchase excise tax.
Rather, the stakeholder asserted that the application of this statutory
exception requires (i) identifying a transaction as a section 317(b)
redemption or an economically similar transaction that occurs as part
of a reorganization, (ii) applying this statutory exception to exempt
the target corporation stock exchanged for qualifying property, and
then (iii) subjecting the target corporation stock exchanged for non-
qualifying property to the stock repurchase excise tax to the extent
gain or loss is recognized. Similarly, several stakeholders contended
that the reorganization exception could be given effect by applying
this exception only to reorganizations that most closely resemble
section 317(b) redemptions, such as split-offs (as defined in part IX
of this Explanation of Provisions) with non-qualifying property, or E
reorganizations involving an exchange of the recapitalizing
corporation's stock for newly issued stock and non-qualifying property.
d. Response to Stakeholder Feedback
The Treasury Department and the IRS are of the view that the
recommendations of the stakeholders
[[Page 25999]]
would be contrary to the statutory language of section 4501. The
reorganization exception provides that section 4501(a) does not apply
``to the extent that the repurchase is part of a reorganization (within
the meaning of section 368(a)) and no gain or loss is recognized on
such repurchase by the shareholder under chapter 1 by reason of such
reorganization.'' Section 4501(e)(1). The Treasury Department and the
IRS are of the view that the presence of the reorganization exception
in section 4501(e)(1) indicates that exchanges of target corporation
stock occurring as part of an acquisitive reorganization are subject to
the stock repurchase excise tax. Indeed, this statutory exception would
have no effect if the exchange of target corporation stock for non-
qualifying property in reorganizations were exempt from the stock
repurchase excise tax. Moreover, the Treasury Department and the IRS
are of the view that the proposed regulations should not reduce the
statutorily mandated scope of the reorganization exception, but rather
should give full effect to its language mandating that the
reorganization exception applies to all reorganizations ``within the
meaning of section 368(a).''
The Treasury Department and the IRS also are of the view that
implementation of the reorganization exception by reliance on sections
354 and 356 of the Code would provide bright-line rules that taxpayers
could apply and the IRS could administer and enforce with certainty.
Specifically, every acquisitive reorganization involves a target
redemptive distribution to a target corporation shareholder to which
section 354 or 356 is applied.
Accordingly, the proposed regulations would treat acquisitive
reorganizations as economically similar transactions. See proposed
Sec. 58.4501-2(e)(4)(i); see also proposed Sec. 58.4501-3(c)
(reorganization exception); part X.A of this Explanation of Provisions
(discussion of reorganization exception). However, the proposed
regulations would not subject B reorganizations to the stock repurchase
excise tax. See proposed Sec. Sec. 58.4501-1(b)(1) and 58.4501-
2(e)(4)(i).
Lastly, the Treasury Department and the IRS view the distinction
between taxable forward mergers and forward mergers qualifying as
reorganizations as appropriate because there is a successor to the
target corporation in an acquisitive asset reorganization (see section
381(a)). In contrast, the target corporation in a complete liquidation
subject to section 331 ceases to exist for Federal income tax purposes.
B. Sourcing Approach to Acquisitive Reorganizations
Several stakeholders recommended that, if the proposed regulations
do not wholly exempt acquisitive reorganizations from the stock
repurchase excise tax, this tax should apply to acquisitive
transactions solely to the extent that any non-qualifying property is
sourced from the target corporation (sourcing approach). According to
the stakeholders, to the extent that the consideration used to
repurchase target corporation stock is attributable to the acquiring
corporation or another third party, the transaction does not represent
the target corporation's redemption of its own stock and therefore
should not be subject to the stock repurchase excise tax.
However, another stakeholder contended that the approach in Notice
2023-2 arguably facilitates the administration of the stock repurchase
excise tax by treating all exchanges of target corporation stock in a
reorganization as a repurchase, irrespective of the type of
reorganization, and regardless of the source of consideration.
Nonetheless, for the reasons previously discussed in this part VIII.B,
the stakeholder contended that a sourcing approach strikes a better
balance with the statutory language and with the stakeholder's opinion
that Congress enacted the stock repurchase excise tax to curtail
single-entity corporate contractions.
Another stakeholder acknowledged that a sourcing approach could
raise issues of administrability, particularly due to the fungible
nature of cash and the fact that the operations of the target
corporation and the acquiring corporation often are integrated
following an acquisition. The stakeholder noted that these difficulties
arguably would be compounded in situations in which a target operating
corporation is merged directly into an acquiring operating corporation,
although other forms of post-merger integration could present similar
challenges.
Notwithstanding these administrative difficulties, these
stakeholders contended that a sourcing approach could be administered
effectively. One stakeholder stated that the challenges presented by a
sourcing approach are not meaningfully different from other issues that
have been addressed by longstanding authorities concerning
reorganizations. For instance, a sourcing approach is used to determine
whether funds distributed to the target corporation's shareholders
prior to a B reorganization are properly treated as non-qualifying
property. See, for example, Rev. Rul. 70-172, 1970-1 C.B. 77 (dividend
distribution of property sourced from the target corporation treated as
separate and distinct from an immediately subsequent B reorganization).
With regard to reverse triangular mergers, these stakeholders noted
that funds sourced from the target corporation are taken into account
for purposes of the ``substantially all'' test in section
368(a)(2)(E)(i), but not for purposes of measuring the acquisition of
``control'' under section 368(a)(2)(E)(ii). See Sec. 1.368-2(j)(3)(i)
and (iii).
The stakeholders also questioned the different treatment under
Notice 2023-2 of acquisitive reorganizations and taxable stock
acquisitions. These stakeholders observed that, under Notice 2023-2,
the stock repurchase excise tax would apply to all consideration
consisting of non-qualifying property in an acquisitive reorganization.
In contrast, the rules described in Notice 2023-2 provides that the
stock repurchase excise tax is imposed in a taxable stock acquisition
only to the extent of the consideration sourced from the target
corporation. In the stakeholders' view, this inconsistent treatment is
difficult to justify as a policy matter because taxable and tax-free
transactions may be economically similar.
The Treasury Department and the IRS are of the view that the
stakeholders' recommendation is not supported by the statutory language
of the reorganization exception. The plain language of the
reorganization exception contains no reference to the source of the
consideration for which the target corporation shareholders exchange
their stock in a target redemptive distribution. Instead, the
application of the reorganization exception to a target redemptive
distribution in an acquisitive reorganization depends only on whether
``gain or loss is recognized on such repurchase by the shareholder
under chapter 1 by reason of such reorganization.'' In other words,
under the reorganization exception, the source of the consideration for
which the target corporation shareholders exchange their stock in a
target redemptive distribution is irrelevant in determining the
application of the stock repurchase excise tax to acquisitive
reorganizations. Lastly, the Treasury Department and the IRS are of the
view that an extra-statutory sourcing rule recommended by the
stakeholders would be neither necessary nor appropriate to carry out
the purposes of the stock repurchase excise tax.
[[Page 26000]]
For the foregoing reasons, the proposed regulations would not
incorporate a sourcing approach to determine the application of the
stock repurchase excise tax to acquisitive reorganizations. Rather,
under the proposed regulations, the stock repurchase excise tax would
apply to a repurchase that is part of a reorganization to the extent a
shareholder exchanges their stock for non-qualifying property.
C. Commissioner v. Clark
One stakeholder recommended that the stock repurchase excise tax
should not apply to any hypothetical deemed issuance and redemption
under Clark v. Commissioner, 489 U.S. 726 (1989), because such a
transaction either (i) is a fictional transaction that is not within
the scope of the tax, or (ii) results in a net zero adjustment pursuant
to the netting rule in the case of domestic covered corporations.
Another stakeholder also noted that the deemed issuance under Clark
would offset the deemed redemption.
The Treasury Department and the IRS are of the view that Clark
should not apply in determining the applicability of the stock
repurchase excise tax to non-qualifying property furnished in a
reorganization, other than to determine the applicability of the
dividend exception (see the discussion in part VIII.F of this
Explanation of Provisions). This view was incorporated into Notice
2023-2, and the proposed regulations likewise would not provide any
special rules based on an analogical application of Clark.
D. E Reorganizations
1. Treatment of E Reorganizations Under Notice 2023-2
Under the approach described in Notice 2023-2, E reorganizations
are treated as economically similar transactions in the same manner as
other reorganizations for purposes of the stock repurchase excise tax.
Accordingly, a recapitalizing corporation has a repurchase to the
extent of the fair market value of the shares exchanged by its
shareholders in the transaction. See section 3.04(4)(a)(ii) of Notice
2023-2. However, the fair market value of the repurchased shares that
are exchanged for qualifying property reduces the corporation's stock
repurchase excise tax base. See section 3.07(2)(b) of Notice 2023-2
(applying the statutory exception in section 4501(e)(1) to E
reorganizations). As a result, the recapitalizing corporation is
subject to the stock repurchase excise tax only to the extent of the
fair market value of its shares that are repurchased with non-
qualifying property (if any).
Additionally, the stock issued by the recapitalizing corporation in
the transaction is disregarded for purposes of the netting rule under
the ``no double benefit rule.'' See section 3.08(4)(d) of Notice 2023-
2; see also part XI.C.2 of this Explanation of Provisions for a
discussion of the no double benefit rule.
2. Feedback Received
Several stakeholders recommended that an exchange of stock for
qualifying property in an E reorganization should not be subject to the
stock repurchase excise tax. However, the stakeholders recommended that
shares that are repurchased with non-qualifying property in an E
reorganization should be subject to the stock repurchase excise tax
because the exchange is substantially similar to the redemption of
stock for cash, unless the receipt of non-qualifying property is
treated as a separate transaction under Sec. 1.301-1(j).
3. Exchange of Stock for Qualifying Property in an E Reorganization
The Treasury Department and the IRS disagree with the stakeholders'
recommendation that an exchange of stock for qualifying property in an
E reorganization should not be included in the recapitalizing
corporation's stock repurchase excise tax base. As discussed in part
VIII.A.2.d of this Explanation of Provisions, the Treasury Department
and the IRS are of the view that the reorganization exception would be
most appropriately implemented by (i) treating all exchanges of stock
between a corporation and its shareholders occurring as part of a
reorganization as an economically similar transaction, and then (ii)
removing from the corporation's stock repurchase excise tax base the
amount of target corporation stock for which the target corporation
shareholders receive qualifying property. The Treasury Department and
the IRS also are of the view that adopting uniform treatment for
reorganizations would implement the reorganization exception in a
manner most consistent with its statutory language (as set forth in
section 4501(e)(1)). Lastly, the Treasury Department and the IRS are of
the view that this approach would facilitate the IRS's ability to
administer and enforce the stock repurchase excise tax and enable
taxpayers to apply the tax with greater certainty.
Accordingly, the proposed regulations would include the stock-for-
qualifying property portion of an exchange occurring as part of an E
reorganization in the stock repurchase excise tax base, and then
exclude that portion in a later step of the stock repurchase excise tax
base computation. See proposed Sec. Sec. 58.4501-2(e)(4)(ii) and
58.4501-3(c). The Treasury Department and the IRS request comments on
the proposed treatment of E reorganizations.
E. F Reorganizations
1. Treatment of F Reorganizations Under Notice 2023-2
Under the approach described in Notice 2023-2, F reorganizations
are treated as economically similar transactions in the same manner as
other reorganizations for purposes of the stock repurchase excise tax.
Accordingly, the transferor corporation has a repurchase to the extent
of the fair market value of the shares exchanged by its shareholders in
the transaction. See section 3.04(4)(a)(iii) of Notice 2023-2. However,
the fair market value of the repurchased shares that are exchanged for
qualifying property reduces the corporation's stock repurchase excise
tax base. See section 3.07(2)(c) of Notice 2023-2 (applying the
statutory exception in section 4501(e)(1) to F reorganizations). As a
result, the transferor corporation is subject to the stock repurchase
excise tax only to the extent of the fair market value of its shares
that are repurchased with non-qualifying property (if any).
A distribution of non-qualifying property by the transferor
corporation in an F reorganization is treated as a separate transaction
(for example, under section 302). See Sec. 1.368-2(m)(1)(iii)
(providing that any distribution of money or other property from either
the transferor corporation or the resulting corporation, including any
money or other property exchanged for shares, in an F reorganization is
treated as an unrelated, separate transaction from the reorganization).
2. Feedback Received
Several stakeholders recommended that F reorganizations should not
be subject to the stock repurchase excise tax because the stock issued
in an F reorganization does not qualify as ``property'' within the
meaning of section 317(a). These stakeholders contended that no
``redemption'' could occur within the meaning of section 317(b), and
therefore the stock repurchase excise tax should not apply.
For the same rationale as other reorganizations, the Treasury
Department and the IRS continue to be of the view that F
reorganizations should be treated as economically similar transactions
for purposes of the stock repurchase excise tax. See parts
[[Page 26001]]
VIII.A and D of this Explanation of Provisions (discussing acquisitive
reorganizations and E reorganizations). Moreover, the Treasury
Department and the IRS are of the view that adopting uniform treatment
for reorganizations would reduce complexity for taxpayers and
facilitate the IRS's ability to administer and enforce the stock
repurchase excise tax. The proposed regulations reflect this view. See
proposed Sec. Sec. 58.4501-2(e)(4)(iii) and 58.4501-3(c). The Treasury
Department and the IRS request comments on the proposed treatment of F
reorganizations.
F. Downstream Reorganizations and Other Related-Party Reorganizations
Several stakeholders recommended that, if reorganizations generally
are not subject to the stock repurchase excise tax under the proposed
regulations, related-party reorganizations (such as an acquisition of a
publicly traded parent corporation's stock by a specified affiliate, or
a reorganization between two covered corporations under common control)
nonetheless should be subject to the stock repurchase excise tax to the
extent of the non-qualifying property received by shareholders. One
stakeholder suggested that the receipt of non-qualifying property in
such transactions is economically identical to a conventional stock
repurchase.
The Treasury Department and the IRS agree with stakeholders that
such transactions should be subject to the stock repurchase excise tax.
However, because reorganizations generally would be subject to the
stock repurchase excise tax under the proposed regulations, no special
rules are needed to address related-party reorganizations. Accordingly,
the proposed regulations would not adopt the stakeholders'
recommendation.
G. Reverse Acquisitions Involving Investment Companies
One stakeholder suggested that, if the proposed regulations
generally do not apply the stock repurchase excise tax to acquisitive
reorganizations, the proposed regulations should apply this tax to
certain reverse acquisitions involving a publicly traded acquiring
corporation. According to the stakeholder, if the historical business
of a publicly traded acquiring corporation has declined in value to the
point that the corporation's stock is trading based on the net value of
its cash and other investment assets, and if the target corporation
shareholders as a group will obtain more than 50 percent of the fair
market value of the acquiring corporation's stock in an acquisitive
reorganization, then any non-qualifying property received by the target
corporation shareholders in the reorganization may resemble a
repurchase. Although the stakeholder noted that such transactions are
rare, the stakeholder recommended that the Treasury Department and the
IRS consider designating such transactions as economically similar.
The Treasury Department and the IRS are of the view that no special
rules are required to address these types of transactions because the
proposed regulations would not exclude acquisitive reorganizations from
the stock repurchase excise tax. Accordingly, the proposed regulations
do not incorporate the stakeholder's suggested provision.
IX. Section 355 Transactions
Under the approach described in Notice 2023-2, a section 355
transaction in which a distributing corporation (within the meaning of
section 355(a)(1)(A) of the Code) distributes stock of a controlled
corporation (within the meaning of section 355(a)(1)(A)) and, if
applicable, other property or money to the distributing corporation's
shareholders in exchange for a portion of the shareholders' stock in
the distributing corporation (split-off) is treated as an economically
similar transaction. Accordingly, the distributing corporation has made
a repurchase to the extent of the fair market value of the distributing
corporation shares exchanged by its shareholders in the transaction.
See section 3.04(4)(a)(iv) of Notice 2023-2.
However, the fair market value of the repurchased shares that are
exchanged for qualifying property reduces the distributing
corporation's stock repurchase excise tax base, regardless of whether
the distribution was carried out as part of a D reorganization. See
section 3.07(2) of Notice 2023-2. As a result, the distributing
corporation is subject to the stock repurchase excise tax only to the
extent of the fair market value of its shares that are repurchased with
non-qualifying property (if any). A distribution by a distributing
corporation of stock of a controlled corporation qualifying under
section 355 that is not a split-off is not a repurchase subject to the
stock repurchase excise tax. See section 3.04(4)(b)(ii) of Notice 2023-
2.
A. In General
Several stakeholders recommended that a spin-off (that is, a
distribution of stock of a controlled corporation (Controlled) by the
distributing corporation (Distributing) to Distributing's shareholders)
to which section 355 applies should not be treated as a repurchase
because spin-offs do not involve an exchange of Controlled stock for
Distributing stock. The stakeholders also recommended that a split-up
(that is, a liquidating distribution in which Distributing distributes
the stock of more than one Controlled) or split-off to which section
355 applies, and in which only Controlled stock (and no non-qualifying
property) is distributed, should not be treated as a repurchase. For
example, one stakeholder found it significant that a split-off without
non-qualifying property generally would not reduce the number of shares
outstanding or enhance the EPS of Distributing.
In contrast, stakeholders recommended that any non-qualifying
property distributed in a split-off to which section 355 applies should
be treated as a repurchase to the same extent as if that non-qualifying
property were distributed in a redemption under section 302(a), because
the source of the cash and the form of the transaction frequently are
the same as in a conventional stock buyback. One stakeholder also
recommended treating a split-up with non-qualifying property as a
repurchase in the same manner.
The Treasury Department and the IRS are of the view that spin-offs
and split-ups should not be subject to the stock repurchase excise tax.
See proposed Sec. 58.4501-2(e)(5)(iii)(A). With regard to a spin-off,
the Treasury Department and the IRS are of this view because
Distributing does not provide consideration to Distributing's
shareholders in exchange for their Distributing stock (that is, no
repurchase could be treated as having occurred). With regard to a
split-up, the Treasury Department and the IRS are of this view because
Distributing completely liquidates as a result of Distributing's
distribution of consideration to its shareholders in exchange for their
Distributing stock. The proposed treatment of spin-offs and split-ups
is consistent with the proposed treatment of non-redemptive
distributions under section 301 and distributions in complete
liquidation, which are analogous to spin-offs and split-ups,
respectively. Cf. proposed Sec. Sec. 58.4501-2(e)(5)(iv) (exempting
certain non-redemptive distributions under section 301 from the stock
repurchase excise tax); 58.4501-2(e)(5)(i) (exempting distributions in
complete liquidation that are exclusively under section 331 or 332 from
the stock repurchase excise tax).
However, the proposed regulations would clarify that a distribution
by Distributing of non-qualifying property
[[Page 26002]]
in exchange for Distributing stock in pursuance of a spin-off or a
split-up would be a repurchase. See proposed Sec. 58.4501-
2(e)(5)(iii)(B).
The Treasury Department and the IRS also continue to be of the view
that split-offs should be subject to the stock repurchase excise tax.
See proposed Sec. 58.4501-2(e)(4)(iv). Accordingly, Distributing would
have a repurchase to the extent of the fair market value of the
Distributing stock exchanged by Distributing's shareholders in the
transaction. However, the fair market value of the repurchased
Distributing stock that is exchanged for qualifying property would be
subject to the reorganization exception, regardless of whether the
split-off occurred as part of a D reorganization. See proposed Sec.
58.4501-3(c). As a result, Distributing would be subject to the stock
repurchase excise tax only to the extent of the fair market value of
its stock that is repurchased with non-qualifying property (if any).
B. Exchange of Controlled Securities in a Split-Off to Which Section
355 Applies
Notice 2023-2 does not explicitly address whether a distribution by
Distributing of Controlled securities to Distributing shareholders in
exchange for their Distributing stock in a split-off is treated as a
repurchase. However, Controlled securities that are exchanged for
Distributing stock would not constitute qualifying property under the
rules described in Notice 2023-2. As a result, the exchange of
Controlled securities for Distributing stock in a split-off would be
subject to the stock repurchase excise tax under the rules described in
Notice 2023-2.
A stakeholder recommended that, to the extent the Treasury
Department and the IRS view a distribution of Controlled securities as
a substitute for cash, the distribution of Controlled securities in
exchange for Distributing stock in a split-off to which section 355
applies should be treated as a repurchase.
The Treasury Department and the IRS continue to be of the view that
Controlled securities that are exchanged for Distributing stock should
not constitute qualifying property for purposes of the stock repurchase
excise tax. The Treasury Department and the IRS have reached this
position based on the rationale that, unlike an exchange of
Distributing stock for Controlled stock, an exchange of Distributing
stock for Controlled securities generally would achieve an outcome more
analogous to an exchange of Distributing stock for non-qualifying
property. Accordingly, the Treasury Department and the IRS are of the
view that no special rules are needed to address this issue.
C. Clarification of Examples 13 and 14 in Notice 2023-2
Section 3.09 of Notice 2023-2 contains Examples 13 and 14. These
examples are based on Example 11 of Notice 2023-2, in which
Distributing distributes Controlled stock and cash to Distributing's
shareholders in exchange for their Distributing stock. The facts in
Example 13 are the same as in Example 11, except that Example 13
provides that ``Distributing distributes the Controlled stock to its
shareholders pro rata without the shareholders exchanging any
Distributing stock (Spin-Off).'' The facts in Example 14 are the same
as in Example 13, except that the ``Spin-Off is carried out as part of
a transaction qualifying as a D reorganization.''
A stakeholder recommended that the proposed regulations incorporate
revisions to Examples 13 and 14 to clarify whether the cash
distribution described in those examples constitutes a distribution in
exchange for Distributing stock. The stakeholder interpreted Examples
13 and 14 to provide clearly that no Distributing stock is surrendered
by Distributing's shareholders in the ``Spin-Off'' in both examples,
but nonetheless questioned whether any Distributing stock could have
been surrendered for the cash distributed by Distributing with the
Controlled stock. Therefore, the stakeholder recommended that Examples
13 and 14 explicitly state whether or not Distributing stock is
surrendered in exchange for the cash distributed as well as the stock
distributed.
The Treasury Department and the IRS have revised Example 13 to
explicitly state that no stock of Distributing is exchanged in the
``Spin-Off'' for distributed cash or distributed Controlled stock. This
clarification would confirm the interpretation of stakeholders and the
intent of the Treasury Department and the IRS. See proposed Sec.
58.4501-5(b)(13).
Additionally, the Treasury Department and the IRS have modified the
facts of Example 14 to clarify the treatment of an exchange of
Distributing stock for non-qualifying property in pursuance of a spin-
off. See proposed Sec. 58.4501-5(b)(14). For the treatment of the
exchange of Distributing stock in pursuance of a spin-off, see proposed
Sec. 58.4501-2(e)(5)(iii)(B) and the discussion in part IX.A of this
Explanation of Provisions.
X. Statutory Exceptions
A. Repurchase as Part of a Reorganization
1. In General
Section 4501(e)(1) provides an exception (that is, the
reorganization exception) to the application of the stock repurchase
excise tax ``to the extent that the repurchase is part of a
reorganization (within the meaning of section 368(a)) and no gain or
loss is recognized on such repurchase by the shareholder . . . by
reason of such reorganization.'' To facilitate the IRS's ability to
administer and enforce the stock repurchase excise tax, and to enable
taxpayers to apply the tax with greater certainty, Notice 2023-2 adopts
a consideration-based approach to the reorganization exception. As
described in section 3.07(2) of Notice 2023-2, the fair market value of
stock repurchased by a covered corporation in transactions listed in
that section is a reduction for purposes of computing the covered
corporation's stock repurchase excise tax base, to the extent that the
repurchase is in exchange for property permitted by section 354 or 355
to be received without the recognition of gain or loss (that is,
qualifying property). These transactions consist of a repurchase by:
(i) a target corporation as part of an acquisitive reorganization; (ii)
a recapitalizing corporation as part of an E reorganization; (iii) a
transferor corporation as part of an F reorganization; and (iv) a
distributing corporation as part of a split-off (whether or not part of
a D reorganization).
Stakeholders have suggested three general approaches to implement
the reorganization exception. Under the stakeholders' first approach,
the reorganization exception would apply only if no gain or loss is
recognized by a shareholder on a repurchase that occurs as part of a
reorganization under section 368(a). As a result, if a shareholder
receives both qualifying property and non-qualifying property in an
actual or deemed redemption that occurs as part of a reorganization,
the reorganization exception would not apply to any of the
consideration received if the shareholder recognized any built-in gain
or loss in the target corporation stock exchanged for that
consideration.
Under the stakeholders' second approach, the reorganization
exception would exclude an actual or deemed redemption that occurs as
part of a reorganization under section 368(a) to the extent a
shareholder does not recognize gain or loss. At least one
[[Page 26003]]
stakeholder recommended this approach because the stakeholder found it
significant that a target corporation shareholder's non-taxable receipt
of acquiring corporation stock (that is, qualifying property) does not
result in the termination or ``cashing out'' of the target corporation
shareholder's proprietary interest in the target corporation.
Another stakeholder provided a variation to this second approach
that would incorporate a rebuttable presumption. Under this variation,
the reorganization exception would apply to a repurchase solely to the
extent that stock of the target corporation is exchanged by target
corporation shareholders for qualifying property. In other words, all
shareholders of the target corporation that receive non-qualifying
property in exchange for target corporation stock would be presumed to
recognize gain or loss to the full extent of the non-qualifying
property received. The stakeholder recommended allowing a target
corporation to rebut this presumption to the extent the target
corporation could demonstrate that its shareholders did not recognize
gain or loss in the reorganization. However, the stakeholder found it
questionable as a policy matter that, under this variation of the
second approach, a target corporation that provides solely non-
qualifying property to the target corporation shareholders in exchange
for target corporation stock would not be treated as repurchasing the
target corporation shareholders' stock if the target corporation rebuts
the presumption of gain or loss recognition.
Under the stakeholders' third approach, the reorganization
exception would apply to a repurchase solely to the extent that stock
of the target corporation is exchanged by target corporation
shareholders for qualifying property, regardless of whether the target
corporation shareholder recognizes any gain or loss. One stakeholder
recommended this third approach based on the stakeholder's rationale
that shareholder-level gain should not be taken into account for
determining whether a repurchase occurred for purposes of the stock
repurchase excise tax. In addition, the stakeholder contended that any
approach that requires computation of each shareholder's gain or loss
would be difficult for the IRS to administer, and for taxpayers to
apply with certainty, because the shareholder-level data necessary to
determine such gain or loss would be difficult to obtain.
The Treasury Department and the IRS continue to be of the view that
the third approach recommended by stakeholders would strike the most
appropriate balance between implementing the plain language of the
reorganization exception and providing a rule that facilitates the
ability of the IRS to administer and enforce the stock repurchase
excise tax. Under this approach, the touchstone consideration of
whether a target corporation shareholder receives qualifying or non-
qualifying property in exchange for target corporation stock will
enable target corporations to readily determine the extent to which the
reorganization exception applies to the exchange. Moreover, the
Treasury Department and the IRS are of the view that only in rare
instances would such a shareholder not recognize gain or loss if the
shareholder received non-qualifying property in exchange for target
corporation stock. Accordingly, the proposed regulations would retain
the approach described in Notice 2023-2. See proposed Sec. 58.4501-
3(c).
2. Section 355 Transactions That are Not Part of a D Reorganization
Stakeholders recommended applying the reorganization exception to
split-offs and split-ups without regard to whether the section 355
transaction occurs as part of a D reorganization. According to the
stakeholders, Congress intended to convey through the reorganization
exception that transactions that qualify for non-recognition treatment
should not be subject to the stock repurchase excise tax, and that the
same treatment should extend to all section 355 transactions--
regardless of whether carried out as part of a D reorganization.
The Treasury Department and the IRS continue to be of the view that
the exception in section 4501(e)(1) should apply to split-offs to which
section 355 applies without regard to whether such transactions occur
as part of a D reorganization. See proposed Sec. 58.4501-3(c). As
previously discussed in part IX.A of this Explanation of Provisions,
split-ups are not treated as repurchases. Consequently, the exception
in section 4501(e)(1) is not relevant to split-ups.
B. Contributions to Employer-Sponsored Retirement Plans
In general, under section 3.07(3)(a) of Notice 2023-2, the fair
market value of stock repurchased by a covered corporation is a
reduction for purposes of computing the covered corporation's stock
repurchase excise tax base if the stock that is repurchased, or an
amount of stock equal to the fair market value of the stock
repurchased, is contributed to an employer-sponsored retirement plan.
1. Timing of Contributions Under Section 4501(e)(2)
Section 4501(e)(2) provides that the stock repurchase excise tax
does not apply in any case in which the stock repurchased, or an amount
of stock equal to the value of the stock repurchased, is contributed to
an employer-sponsored retirement plan, ESOP, or similar plan (stock
contribution exception).
Under section 3.07(3)(d) of Notice 2023-2, a covered corporation
may treat stock contributions to an employer-sponsored retirement plan
under the stock contribution exception as having been made in the prior
taxable year if the stock is contributed by the filing deadline for the
IRS Form 720, Quarterly Federal Excise Tax Return, that is due for the
first full quarter after the close of the taxpayer's taxable year and
on account of that taxable year within the meaning of section 404(a)(6)
of the Code. The rule described in section 3.07(3)(d) of Notice 2023-2
also provides stock contributions that are treated as having been
contributed in the taxable year to which the Form 720 applies may not
be treated as having been contributed for any other taxable year.
One stakeholder indicated that the reference to the stock
contribution being ``on account of'' the taxable year within the
meaning of section 404(a)(6) raises questions about the timing of the
offset for the stock repurchase excise tax and the income tax deduction
under section 404(a). Specifically, the stakeholder requested
clarification as to whether a covered corporation is required to deduct
a stock contribution to a plan under section 404(a) in the same taxable
year for which the contribution is taken into account for purposes of
the stock contribution exception.
The Treasury Department and the IRS are of the view that a stock
contribution is not required to be treated as ``on account of'' the
preceding taxable year within the meaning of section 404(a)(6). Thus,
for example, a covered corporation may claim the income tax deduction
in the taxable year in which the stock is contributed to the employer-
sponsored retirement plan but claim an offset for the stock
contribution to the plan for purposes of the stock repurchase excise
tax in the preceding taxable year (provided that the rules in these
proposed regulations are satisfied).
Accordingly, these proposed regulations would provide that, for
purposes of the reduction in the stock repurchase excise tax base, a
covered corporation may treat stock
[[Page 26004]]
contributions to an employer-sponsored retirement plan made after the
close of the covered corporation's taxable year as having been
contributed during that taxable year if two conditions are satisfied.
First, the stock must be contributed to the employer-sponsored
retirement plan by the filing deadline for the form on which the stock
repurchase excise tax must be reported that is due for the first full
quarter after the close of the taxpayer's taxable year. Second, the
stock must be treated by the employer-sponsored retirement plan in the
same manner that the plan would treat a contribution received on the
last day of the preceding taxable year. See proposed Sec. 58.4501-
3(d)(4)(ii).
2. Definition of ``Employer-Sponsored Retirement Plan''
For purposes of Notice 2023-2, the term ``employer-sponsored
retirement plan'' means a retirement plan maintained by a covered
corporation that is qualified under section 401(a) of the Code,
including an ESOP (as defined in section 4975(e)(7) of the Code). See
section 3.02(12) of Notice 2023-2. In section 6.01(4) of Notice 2023-2,
the Treasury Department and the IRS requested comments regarding
whether the definition of an ``employer-sponsored retirement plan''
should include plans other than plans that are qualified under section
401(a). In response, one stakeholder recommended expanding this
definition to include foreign-based plans and plans funded through a
secular trust. The stakeholder reasoned that the statutory language of
section 4501(e)(2), along with the underlying policy considerations,
support expanding the definition to these types of plans. However, the
stakeholder did not specify which types of foreign-based plans or plans
funded through a secular trust should be included in the definition of
an ``employer-sponsored retirement plan.''
The Treasury Department and the IRS are of the view that certain
broad-based foreign plans that are funded through a secular trust or
another type of funded arrangement may be considered ``similar plans,''
and thus may be included in the definition of an ``employer-sponsored
retirement plan'' for purposes of the stock contribution exception.
However, the Treasury Department and the IRS have not yet determined
which types of broad-based foreign plans should be included in this
definition. Accordingly, the Treasury Department and the IRS request
comments regarding the types of foreign-based plans that should be
included in the definition of an ``employer-sponsored retirement
plan.''
Another stakeholder expressed concern that the stock contribution
exception could be used to encourage excessive executive compensation
and requested that the definition of ``similar plan'' be defined to
specifically exclude executive compensation arrangements. The Treasury
Department and the IRS agree that the stock contribution exception
should not be used to encourage executive compensation arrangements.
The definition of an ``employer-sponsored retirement plan'' described
in Notice 2023-2 is limited to plans that are qualified under section
401(a) (including ESOPs). The Treasury Department and IRS are of the
view that this definition is sufficient to exclude executive
compensation arrangements from the stock contribution exception. Thus,
these proposed regulations similarly would limit the definition of
``employer-sponsored retirement plan'' to plans that are qualified
under section 401(a).
However, these proposed regulations would expand the definition of
``employer-sponsored retirement plan'' described in Notice 2023-2 to
include qualified plans under section 401(a) that are maintained by
specified affiliates of covered corporations. Section 3.02(12) of
Notice 2023-2 defined ``employer-sponsored retirement plan'' with
regard to qualified plans maintained by covered corporations. These
proposed regulations would provide that the definition of ``employer-
sponsored retirement plan'' includes not only qualified plans
maintained by covered corporations, but also qualified plans maintained
by a specified affiliate of a covered corporation. See proposed Sec.
58.4501-1(b)(11).
3. Valuation of Stock Contributions
As noted previously, the stock contribution exception in section
4501(e)(2) provides that the stock repurchase excise tax will not apply
in any case in which (i) the stock repurchased (first clause), or (ii)
an amount of stock equal to the value of the stock repurchased (second
clause), is contributed to an employer-sponsored retirement plan, ESOP,
or similar plan.
Section 3.07(3)(c)(i) of Notice 2023-2 addressed the first clause
by providing that, if a covered corporation repurchases stock and
contributes to an employer-sponsored retirement plan stock of the same
class, then the amount of the reduction under the stock contribution
exception is equal to the aggregate fair market value of the stock
repurchased during the taxable year, divided by the number of shares
repurchased, and multiplied by the number of shares contributed.
However, the amount of the reduction may not exceed the aggregate fair
market value of stock of the same class repurchased during the taxable
year.
Section 3.07(3)(c)(ii) of Notice 2023-2 addressed the second clause
by providing that, if a covered corporation contributes to an employer-
sponsored retirement plan stock of a different class than the class of
stock that was repurchased, then the amount of the reduction under the
stock contribution exception is equal to the fair market value of the
stock at the time the stock is contributed to the employer-sponsored
retirement plan. However, the amount of the reduction may not exceed
the aggregate fair market value of stock of a different class
repurchased during the taxable year.
One stakeholder requested that the value of stock for purposes of
the stock contribution exception be based on the greater of the value
at the time of repurchase or at the time of contribution to an
employer-sponsored retirement plan. The stakeholder stated that the
word ``or'' between the first clause and the second clause offers
statutory support for allowing covered corporations to choose between
using the first clause or the second clause for any given year.
The Treasury Department and the IRS disagree with the stakeholder.
With regard to the first clause, the focus of the language is on the
stock repurchased. Because the stock repurchase excise tax does not
apply to the repurchase of the stock that is contributed, the amount of
the offset is the fair market value of the shares of stock at the time
of the repurchase. Any change in value after the date of repurchase is
irrelevant for purposes of determining the amount of the repurchase
under section 4501(a) and, thus, the offset amount under the stock
contribution exception.
Moreover, if covered corporations contribute stock of a different
class than the stock repurchased, the contribution will not reflect a
contribution of the stock repurchased. For this reason, it is
inconsistent with the statutory language of section 4501(e)(2) to allow
covered corporations to apply the first clause if contributing a
different class of stock to an employer-sponsored retirement plan.
With regard to the second clause, because the statutory language
focuses on an amount of stock equal to the value of the stock
repurchased, and not on the shares of stock themselves, the value of
the offset amount is determined by the value of the stock contributed
to the retirement plan, instead of the value of the stock at the time
of the repurchase.
Accordingly, these proposed regulations would incorporate the
[[Page 26005]]
valuation provisions described in section 3.07(3)(c) of Notice 2023-2,
including the rule that the reduction cannot exceed the aggregate fair
market value of the stock repurchased. Additionally, these proposed
regulations would add language to coordinate the application of the
stock contribution exception with the application of other statutory
exceptions. See proposed Sec. 58.4501-3(d)(3).
4. Special Rule for Leveraged ESOPs
As defined in section 4975(e)(7), an ESOP is a type of defined
contribution plan that is qualified under section 401(a) and is
designed to invest primarily in qualifying employer securities (within
the meaning of section 409(l) of the Code). An ESOP also must meet
other applicable requirements described in section 409.
An ESOP may be leveraged or non-leveraged. Leveraged ESOPs use the
proceeds of an exempt loan (as defined in section 4975(d)(3)) from the
sponsoring employer or another party (typically with the employer's
guarantee) to purchase qualifying employer securities from the
sponsoring employer or shareholders or on a securities market. The
purchased securities are held in a suspense account (within the trust
that forms a part of the plan) as collateral for the loan. The
sponsoring employer makes cash contributions to the ESOP, which in turn
uses the cash to make loan repayments. Dividends paid on shares held as
collateral in the ESOP loan suspense account and on shares allocated to
participants' accounts also may be used to repay an exempt loan. As
loan repayments are made, securities are released from the suspense
account and allocated to ESOP participants' accounts in accordance with
the terms of the plan, which must comply with plan qualification and
fiduciary requirements.
Non-leveraged ESOPs do not have a loan and, thus, do not have a
suspense account that releases securities to ESOP participants'
accounts as contributions of cash are used to repay a loan. Rather,
employers contribute employer securities directly to the non-leveraged
ESOP, and the contributed shares are allocated to ESOP participants'
accounts as of the plan year to which the contribution applies.
Employer contributions to a non-leveraged ESOP fit squarely within
the stock contribution exception because employer contributions to a
non-leveraged ESOP are made in shares of stock. Although employer
contributions of cash to a leveraged ESOP are not described in section
4501(e)(2), such contributions result in the allocation of shares of
stock from a suspense account to ESOP participants' accounts. In other
words, contributions of stock to a non-leveraged ESOP and contributions
of cash to a leveraged ESOP that is used to repay an exempt loan
produce a comparable result--namely, the allocation of employer stock
to participants' accounts. Accordingly, the Treasury Department and the
IRS are of the view that leveraged ESOPs and non-leveraged ESOPs should
be treated similarly for purposes of the stock contribution exception.
Thus, these proposed regulations would provide that, if a covered
corporation maintains a leveraged ESOP, stock that is released from a
suspense account (as a result of cash contributions by the employer
maintaining the plan) and allocated to ESOP participants' accounts is
treated as a stock contribution for purposes of the stock contribution
exception as of the date stock attributable to repayment of the exempt
loan is released from the suspense account and allocated to
participants' accounts. Because dividends on employer stock held in the
ESOP and used to repay an exempt loan are not employer contributions,
stock released from the suspense account that is attributable to
repayment of the loan with dividends would not be treated as a stock
contribution for purposes of the stock contribution exception. See
proposed Sec. 58.4501-3(d)(1)(ii).
C. De Minimis Exception
Section 4501(e)(3) provides an exception (that is, the de minimis
exception) to the application of the stock repurchase excise tax with
regard to a taxable year ``in any case in which the total value of the
stock repurchased during the taxable year does not exceed $1,000,000.''
See section 4501(e)(3); see also section 3.03(2)(a) of Notice 2023-2.
Under section 3.03(2)(b) of Notice 2023-2, the determination of whether
the de minimis exception applies with regard to a taxable year is made
before applying any other statutory exception or any adjustments under
the netting rule. As discussed in part XIV.A.3 of this Explanation of
Provisions, the Treasury Department and the IRS are of the view that
applying the de minimis exception before the other statutory exceptions
is consistent with the statutory language and structure of section
4501.
The proposed regulations would retain the approach described in
Notice 2023-2. See proposed Sec. 58.4501-2(c)(3). Additionally, for
the same rationale underlying the approach described in Notice 2023-2,
the proposed regulations would clarify that repurchases prior to
January 1, 2023, are not taken into account for purposes of the stock
repurchase excise tax (including for purposes of applying the de
minimis exception). See proposed Sec. 58.4501-2(c)(4); see also part
I.A of this Explanation of Provisions (discussion of repurchases by a
fiscal-year taxpayer prior to the effective date).
D. Repurchases by Dealers in Securities
Section 4501(e)(4) provides an exception to the application of the
stock repurchase excise tax ``under regulations prescribed by the
Secretary, in cases in which the repurchase is by a dealer in
securities in the ordinary course of business.'' Pursuant to the
authority granted in section 4501(e)(4), section 3.07(4) of Notice
2023-2 describes an exception to the application of the stock
repurchase excise tax for certain repurchases by a dealer in securities
in the ordinary course of the dealer's business of dealing in
securities.
More specifically, section 3.07(4)(a) of Notice 2023-2 describes,
in part, that the fair market value of stock repurchased by a covered
corporation that is a dealer in securities (within the meaning of
section 475(c)(1) of the Code) is a reduction for purposes of computing
the covered corporation's stock repurchase excise tax base to the
extent the stock is acquired in the ordinary course of the dealer's
business of dealing in securities. However, under section 3.07(4)(b) of
Notice 2023-2, this reduction applies solely to the extent that: (i)
the dealer accounts for the stock as securities held primarily for sale
to customers in the dealer's ordinary course of business; (ii) the
dealer disposes of the stock within a period of time that is consistent
with the holding of the stock for sale to customers in the dealer's
ordinary course of business, taking into account the terms of the stock
and the conditions and practices prevailing in the markets for similar
stock during the period in which the stock is held; and (iii) the
dealer does not sell or otherwise transfer the stock to certain
specified persons other than in a sale or transfer to a dealer that
also satisfies the requirements of section 3.07(4) of Notice 2023-2.
No feedback was received on this exception in Notice 2023-2. The
proposed regulations would retain the approach described in Notice
2023-2. See proposed Sec. 58.4501-3(e).
E. Repurchases by RICs and REITs
Section 4501(e)(5) provides an exception to the application of the
stock
[[Page 26006]]
repurchase excise tax for ``repurchases by a regulated investment
company (as defined in section 851) or a real estate investment
trust.'' Under section 3.07(5) of Notice 2023-2, a repurchase by a
covered corporation that is a RIC or a REIT is a reduction for purposes
of computing the covered corporation's stock repurchase excise tax
base. The proposed regulations would retain the approach described in
Notice 2023-2.
A stakeholder recommended that the exception for RICs be extended
to all funds registered under the Investment Company Act of 1940, even
if those funds do not qualify as RICs for tax purposes. The stakeholder
suggested that the organizational structure, operations, applicable
securities laws, and accounting standards are the same for those funds
as for funds that are RICs for tax purposes.
The Treasury Department and the IRS disagree with the stakeholder's
recommendation. Section 4501(e)(5) provides a specific and limited
exception for RICs as defined in section 851, and nothing in the
statutory language of section 4501 suggests that entities that do not
qualify as RICs are intended to be exempt from the stock repurchase
excise tax. Accordingly, the proposed regulations would not adopt this
recommendation.
F. Dividend Exception
Section 4501(e)(6) provides an exception (dividend exception) to
the application of the stock repurchase excise tax ``to the extent that
the repurchase is treated as a dividend for purposes of [the Code].''
To implement section 4501(e)(6), the rule described in section
3.07(6)(a) of Notice 2023-2 generally provides that the fair market
value of stock repurchased by a covered corporation is a reduction for
purposes of computing the covered corporation's stock repurchase excise
tax base to the extent the repurchase is treated as a distribution of a
dividend under section 301(c)(1) or 356(a)(2). Under the notice, there
is a rebuttable presumption that a repurchase to which section 302 or
356(a) applies is subject to section 302(a) or 356(a)(1), respectively
(and, therefore, is ineligible for the foregoing exception). See
section 3.07(6)(b)(i) of Notice 2023-2. A covered corporation may rebut
this presumption with regard to a specific shareholder solely by
establishing with sufficient evidence that the shareholder treats the
repurchase as a dividend on the shareholder's Federal income tax
return. See section 3.07(6)(b)(ii) of Notice 2023-2.
1. Substantiation for Dividend Exception
Stakeholders provided several recommendations regarding
substantiation for the dividend exception in section 4501(e)(6).
a. Reliance on Filings With the U.S. Securities and Exchange Commission
One stakeholder requested guidance as to how corporations should
apply the constructive ownership rules of section 318(a) of the Code in
determining the extent to which redemptions are treated as in part or
full payment in exchange for stock under section 302(a) or as
distributions to which section 301 applies. The stakeholder recommended
that such guidance: (i) should permit corporations to rely on filings
with the U.S. Securities and Exchange Commission (SEC) and similar
filings to determine ownership (as in the case of determining whether
an ownership change has occurred for purposes of section 382 of the
Code (see Sec. 1.382-2T(k)(1)(i))); (ii) should clarify the requisite
level of due diligence to determine the constructive ownership of any
shareholders not required to report their ownership in SEC filings; and
(iii) should address whether any safe harbors or presumptions are
available.
The Treasury Depa
[…truncated; see source link]Indexed from Federal Register on April 12, 2024.
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