On August 12, 2022, the U.S. Congress passed the Inflation Reduction Act of 2022, HR 5376 (the Act), which imposes a new 15% corporate minimum tax on certain large corporations (the Corporate AMT). President Biden is expected to sign the Act into law this week. As described below, corporations subject to this new law will need to give significant consideration to the Corporate AMT, including assessing its application in connection with various merger-and-acquisition (M&A) transactions.
The Corporate AMT, among other things, is intended to incorporate into U.S. law the newly established international consensus concerning a global minimum tax regime (commonly known as Pillar Two), as reflected in the discussions among the G-20, the Organization for Economic Cooperation and Development, and other countries. It applies only to certain corporations (or a group of corporations treated as a single employer) that have significant “book income” to “tax income” differences and meet a book income threshold of $1 billion, as described in detail below). The Corporate AMT is a tax of 15% on “adjusted financial statement income” (as described in detail below) as opposed to adjusted taxable income — a significant departure from the general approach to U.S. tax policy. The new Corporate AMT will apply to tax years beginning after December 31, 2022. Details of the Corporate AMT, as well as a discussion of some general observations of its potential application to M&A transactions and a description of where further guidance is needed, follows below.
The Corporate AMT
Which Companies Are Subject to the Corporate AMT?
The Corporate AMT applies to “applicable corporations,” which include any U.S. corporation,1 other than an S corporation, a regulated investment company (e.g., a mutual fund), or a real estate investment trust, that meets an “average annual adjusted financial statement income test” (the AFSI Test).2 It also applies to any foreign-parented multinational groups that include at least one U.S. domestic corporation (Foreign Group) that meets a modified AFSI Test as described below.
The AFSI Test is met with respect to a particular tax year only if the average AFSI for the three-taxable-year period ending with such tax year exceeds $1 billion. The AFSI means, for any given tax year, the net income or loss set forth on the taxpayer’s “applicable financial statement” for such tax year, as adjusted for certain specified items such as increases to AFSI due to accelerated depreciation taken for tax purposes (but not for book purposes). Additionally, in cases where an applicable corporation’s AFSI is negative for a taxable year ending after December 31, 2019, such book net operating losses may be carried forward indefinitely to offset future AFSI applying rules similar to those that apply to net operating losses under Code Section 172(a)(2)(B). The statute instructs the Department of the Treasury to issue regulations or other guidance that Treasury deems necessary to carry out the purpose of the Corporate AMT, in particular to prevent the omission or duplication of any item in calculating AFSI. Applicable financial statements include financial statements required to be filed with the Securities and Exchange Commission (SEC) or (if no financial statement is filed with the SEC) any U.S. federal agency for nontax purposes or, for applicable corporations that do not file such financial statements, financial statements that are filed with a foreign equivalent of the SEC.
The AFSI Test differs for corporations that are U.S.-parented domestic or multinational groups (“U.S. Group”), compared to those that are Foreign Groups. For a U.S. Group, the AFSI Test is met if the average AFSI for the three-taxable year period ending with the tested taxable year is greater than $1 billion. For a Foreign Group, the AFSI Test is met if both of the following are met:
(a) The average AFSI of all members of the group (both U.S. and foreign) for the three-taxable-year period ending with the tested taxable year is greater than $1 billion.
(b) The average AFSI for the foreign parent for the three-taxable-year period ending with the tested taxable year is greater than $100 million.
How Is the Corporate AMT Computed?
The Corporate AMT for a given tax year is the excess, if any, of
(a) 15% of the AFSI for such year over
(b) the relevant allowed foreign tax credit for purposes of the Corporate AMT
If an applicable corporation’s income tax on taxable income exceeds the Corporate AMT, then the Corporate AMT for the applicable tax year is zero.
What Are the Exceptions to the Corporate AMT?
The statute prescribes that once a corporation (or group of corporations) becomes an applicable corporation, such corporation is treated as such for all future taxable years (even if its AFSI falls below the $1 billion threshold in any such future years), unless
(a) such corporation experiences a change in ownership or
(b) (i) such corporation does not satisfy the AFSI Test for a specified number of consecutive years and (ii) it would no longer be appropriate to treat such a corporation as an applicable corporation, in each case as determined by the Secretary of the Treasury.
Some Initial Observations
- The new Corporate AMT is designed as a minimum tax. That means it applies only if it is greater than the regular corporate tax. Thus, as mathematical matter, a corporation will be subject to the Corporate AMT only if the ratio of taxable income for U.S. tax purposes to AFSI is greater than the ratio of the regular corporate tax rate (21%) to the Corporate AMT tax rate (15%); put differently, the Corporate AMT will apply only if the corporation’s AFSI is more than 140% of its taxable income (assuming its taxable income is positive).
- As a result, managing this ratio will now become an additional task of the corporate finance and/or tax departments of applicable corporations.
- M&A activity will affect this ratio.
- Suppose Corporation A has taxable income and AFSI of $1,000, so that it pays only regular corporate tax (i.e., $210). Corporation B has $400 of taxable income and $1,000 of AFSI. As a result, Corporation B pays Corporate AMT in an amount equal to $150. If A and B stay separate, the aggregate tax is $360 ($210 regular tax plus $150 of Corporate AMT). If A and B combine, the tax of the combined corporation will be reduced to $300 of Corporate AMT (i.e., 15% x 2,000 of AFSI because the regular corporate tax would be only $294 (i.e., $1,400 x 21%)).
- The details of how acquisitions and dispositions of businesses will be reflected under generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS) will become highly relevant in this context. The same applies for valuation allowances resulting from new facts relating to prior acquisitions.
- Representations concerning income taxes and financial statements in M&A agreements will need to be carefully reviewed in light of the new Corporate AMT.
- Differences in purchase price allocations for tax and GAAP purposes, if any, could become more significant and need to be reviewed in relevant cases.
- The focus on the single ratio described above is an oversimplification because the regular corporate tax provides for more than a single corporate tax rate of 21% due to the special global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII) regimes (which currently tax foreign income at a 10.5% rate).3
- In various circumstances, the Corporate AMT will operate as an effective tax increase on GILTI because it applies a higher tax rate (15% rather than 10.5% or, after 2025, 13.25%) to a higher tax base (no exempt 10% net deemed tangible income return).
- This practical increase of the effective tax rate on GILTI seems to be a key goal of the legislation given that this is in line with, and required by, the international consensus on a global minimum tax regime and the fact that some large corporations have low effective tax rates based on book income.4
- Basing the new Corporate AMT on GAAP or IFRS income assumes that such income is less likely to be distorted by tax planning that is perceived to be aggressive. This is because publicly traded corporations’ stock price is heavily affected by the “earnings per share” metric, which is derived from GAAP or IFRS income. In addition, a significant portion of a corporation’s senior management’s compensation is often tied to the stock price performance.
- While it will be interesting to see whether this assumption turns out to be true in the context of publicly traded corporations, it is less likely to hold in the case of privately held large corporations.
- Because of the high hurdle of the AFSI Test, the new Corporate AMT applies only to public or privately held large corporations and corporate groups. It is noteworthy that this hurdle is based solely on net book income; thus, listing on a stock exchange, number of shareholders, gross assets, and net book value are irrelevant.
- As a result, managing the AFSI Test will now become an additional task of the corporate finance and/or tax departments of larger corporations.
- This test can be affected by M&A and spinoff activities.
- The acquisition of growth companies by established large corporations is likely to reduce AFSI because growth companies often have large annual revenue growth rates but little or no net income for GAAP or IFRS purposes.
- Spinoffs and other corporate breakups (i.e., taxable or tax-free dispositions of noncore assets) will also reduce AFSI.
- It is noteworthy that, for purposes of the AFSI Test, the various portfolio companies of a typical private equity fund partnerships are not aggregated and treated as a single corporation. As a result, most portfolio companies of private equity funds should not be subject to the new Corporate AMT.
- The introduction of the new Corporate AMT will impose auditing challenges on the Internal Revenue Service (IRS) because it will require expertise in financial accounting at the level of its audit personnel.
- It remains to be seen whether the IRS will build up such expertise in house or whether it will rely on a “battle of experts” regarding financial accounting questions that affect the application of the Corporate AMT.
- If the IRS prevails on a Corporate AMT challenge based on GAAP or IFRS accounting treatment of a particular item, does a corporation then need to restate its GAAP financial statements, or does it matter that the SEC has signed off on that particular GAAP treatment in question? Any such IRS victory may take considerable time such that possible restatements could cover a large number of years. This possibility could, as a practical matter, cause corporations to concede the issue rather than delay resolution for many years. The unique interplay between GAAP reporting and tax reporting, particularly in the case of IRS audits of the Corporate AMT, will be an area of particular interest as Treasury works to implement this new rule.