President Biden will sign the Inflation Reduction Act, H.R. 5376 (IRA) into law shortly following House passage earlier today. Under budget reconciliation procedures which permitted Senate Democrats to pass the legislation in the Senate without Republican support, the IRA is the last partisan bill that will be enacted in this Congress.
Items left out, including the extension of close to 40 tax provisions that expired at the end of last year, natural disaster relief for 2021 and various adjustments to the 2017 tax reform legislation (including a return to expensing of R&D expenditures), will be left to a possible post-election omnibus package to fund US government operations.
A number of major priorities that had been contemplated for reconciliation have been left in doubt for future action including changes to the limitations on the deduction for state and local taxes and the enactment of a global minimum corporate tax that emerged from negotiations in the OECD.
The adopted IRA contains certain significant tax changes in relation to the IRA originally proposed by the House of Representatives. Notably, the adopted IRA no longer contains changes to the carried interest provisions, modifies the implementation the corporate minimum tax and adds a new provision that taxes stock buybacks.
These provisions of the adopted IRA are discussed in greater detail as follows:
Corporate minimum tax
The IRA codifies a corporate book minimum tax (CMT) similar to the proposal originally contained in the House Ways and Means Committee’s Build Back Better Act.
As discussed in our previous tax alert, the CMT proposal imposes a 15-percent minimum tax on “applicable corporations.” Generally, the CMT will equal the excess of 15 percent of the applicable corporation’s adjusted financial statement income for the taxable year, over its regular tax liability plus any base erosion and anti-abuse tax imposed under section 59A for the taxable year.
For purposes of the CMT, an “applicable corporation” is any corporation (other than an S corporation, regulated investment company or real estate investment trust) whose average annual adjusted financial statement income (AFSI) exceeds $1 billion over any consecutive three-tax-year period preceding the current taxable year (the Income Test). For purposes of the Income Test, multiple corporations that are considered a single employer are aggregated for purposes of meeting the $1 billion threshold. Notably, the adopted IRA imposes a limitation on the aggregation of certain subsidiaries that are owned by private equity firms when assessing the CMT. This change is intended to exempt small businesses from application of the CMT.
Generally, the CMT will apply to foreign-parented multinational groups where at least one entity is a domestic corporation and another entity is a foreign corporation, and the common parent of such entities is a foreign corporation. However, a modified Income Test is applied to determine the applicability of the CMT to such foreign-parented multinational groups. The Income Test, as described above, still requires that the foreign-parented multinational group have average AFSI in excess of $1 billion over any consecutive three-tax-year period preceding the current taxable year, but imposes an additional $100 million AFSI test that only takes into account the foreign-parented multinational group’s US-based AFSI (i.e., US ECI-related financial statement profits of foreign corporations and AFSI of domestic corporations).
As mentioned above, the Income Test is based on an applicable corporation’s AFSI for each tax year in the preceding three-tax-year period. A corporation’s AFSI will generally be based off its net income or loss on its “applicable financial statement” (AFS) subject to certain adjustments. Thus, the starting point for the computation of AFSI will based on book income, without taking into account any US federal income taxes or creditable foreign taxes under section 901.
However, where a taxpayer elects to claim foreign tax credits under sections 901 and 960, such taxpayer is allowed to reduce its AFSI by its “corporate AMT foreign tax credit.” The corporate AMT foreign tax credit is sum of: (i) the lesser of a corporation’s pro-rata share of section 901 creditable foreign taxes paid or accrued by its CFCs that are taken into account on the AFS of such CFCs, or (ii) 15 percent of the corporation’s pro-rata share of aggregate CFC AFSI (thus, effectively preventing any cross-crediting of high-taxed CFC AFSI with low-taxed CFC AFSI); and the total amount of section 901 creditable foreign taxes paid or accrued and taken into account on the taxpayer’s AFS. Notably, the corporate alternative minimum tax credit does not cross-reference the section 904 foreign tax credit limitation rules, the overall foreign loss rules or the overall domestic loss rules.
In addition, the adopted IRA calculates the AFSI of a corporation utilizing tax depreciation deductions allowed under section 167 on tangible property rather than financial statement depreciation. This adjustment exempts companies taking advantage of accelerated depreciation. However, it does not take into account amortization expenses related to intangible property under section 197, with the exception of amortization expenses related to qualified wireless spectrum used in telecommunications.
As discussed in the previous DLA tax alert, the CMT will allow corporations to benefit from general business credits. Further, financial statement net operating losses (FSNOLs) can be utilized to offset up to 80 percent of a taxpayer’s AFSI in a subsequent taxable year. As adopted, the IRA permits the carry-forward of FSNOLs indefinitely. However, FSNOLs can only be carried forward to the extent generated in taxable years ending after December 31, 2019. Note that FSNOLs are not taken into accounting in assessing the AFSI for purposes of the Income Test.
The CMT proposal will apply to taxable years beginning after December 31, 2022.
Stock buyback excise tax
In exchange for dropping the changes originally proposed to the carried interested provisions, the adopted IRA imposes a 1-percent excise tax on “covered corporations” on the fair market value of any stock of the corporation which is repurchased by the corporation during the tax year (i.e., a stock buyback). For this purpose, a “covered corporation” is any domestic corporation the stock of which is traded on an established securities market.
The 1-percent excise tax would also apply to stock repurchases of the covered corporation made by specified affiliates. Generally, a specified affiliate is any corporation more than 50 percent of the stock of which is owned (by vote or value), directly or indirectly, by such covered corporation and any partnership more than 50 percent of capital or profits interests of which are held, directly or indirectly, by such corporation. The 1-percent excise tax also applies to repurchases by applicable foreign corporations (i.e., any foreign corporation, the stock of which is traded on an established securities market) and covered surrogate foreign corporations (i.e., certain entities that complete 80 percent or greater inversion transactions under section 7874).
The adopted IRA does contain certain exceptions to the application of the 1-percent excise tax. Notably, the 1-percent excise tax 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 by reason of such reorganization
- 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 or similar plan
- in any case in which the total value of the stock repurchased during the tax year does not exceed $1 million
- under regulations prescribed by the IRS, in cases in which the repurchase is by a dealer in securities in the ordinary course of business
- to repurchases by a regulated investment company (as defined in section 851) or a real estate investment trust or
- to the extent that the repurchase is treated as a dividend.
Although there is an exception for repurchases of stock that occurs as part of reorganizations, it appears that tax-free section 355 split-offs (i.e., non-pro rata distributions of a controlled subsidiary in exchange for stock of distributing) would not be exempted. Additionally, often in exchanges as part of tax-free reorganizations, shares are usually repurchased in exchange for cash in order to avoid having to issue fractional shares. Such fractional share repurchases often exceed $1 million in the aggregate and involve gain recognition by the exchange shareholders. Accordingly, such repurchases appear to be subject to the 1-percent excise tax.
This proposal was originally presented in the House Ways and Means Committee’s Build Back Better Act. This new tax will apply to repurchases of stock after December 31, 2022.