May 10, 2024 Proposed regulations on stock repurchase excise tax have implications for brokers and IRC Section 302 certifications
Proposed regulations on the stock repurchase excise tax (the excise tax),1 which were recently released by the IRS and Treasury Department, could significantly affect brokers that distribute IRC Section 302 certifications. Background The excise tax of IRC Section 4501 was enacted as part of the Inflation Reduction Act of 2022 and generally taxes "covered corporations" at a rate of 1% of the fair market value (FMV) of any stock of the covered corporation that is repurchased during its tax year by the corporation or its majority-owned or controlled subsidiary, minus the aggregate FMV of stock issued by the taxpayer during that year. The IRS provided initial guidance on the excise tax in Notice 2023-2 (see Tax Alert 2023-0054) and has now updated that guidance in proposed regulations (see Tax Alerts 2024-0785 and 2024-0786). Dividend exception IRC Section 4501 contains exceptions to application of the excise tax, including if a repurchase is treated as a dividend for US tax purposes.2 Under the proposed regulations, the FMV of repurchased stock would be reduced for purposes of computing the covered corporation's stock repurchase excise tax base to the extent the repurchase was treated as a distribution of a dividend under IRC Section 301(c)(1) or IRC Section 356(a)(2).3 Although the proposed regulations include a presumption that a repurchase to which IRC Section 302 or IRC Section 365(b) applies would not be treated as a dividend, a covered corporation could rebut the presumption with respect to a specific shareholder by establishing, with sufficient evidence, that the shareholder treats the repurchase as a dividend on its federal income tax return.4 Each shareholder could be treated differently under IRC Section 302. Whether the amount received by a shareholder would be treated for tax purposes as the proceeds of a sale or a dividend would depend primarily on whether the shareholder had completely terminated its interest in the corporation, or whether the shareholder's proportionate interest in the corporation decreased as a result of the transaction, taking into account the attribution rules under IRC Section 318 and the number of shares outstanding before and after the transaction. The covered corporation generally would not be able to prove that a shareholder received a dividend without the shareholder's cooperation. If the corporation did not have sufficient earnings and profits, the amount would not be treated as a dividend; a shareholder that otherwise would be seen as receiving a dividend would instead be treated as receiving a return of capital, which would not reduce the excise tax. Evidence of a dividend To prove that the shareholder should be treated as receiving a dividend, the covered corporation would have to (1) obtain a certification from the shareholder, including certain information (the excise tax certification); (2) treat the repurchase consistent with the excise tax certification; (3) have no knowledge of facts that would indicate that the excise tax certification is incorrect; and (4) demonstrate sufficient earnings and profits to treat the repurchase as a dividend.5 Excise tax certification The proposed regulations would require the excise tax certification to include the following information:
After receiving the excise tax certification, the covered corporation would have to add a signed statement saying, under penalties of perjury, that it (1) agrees to treat the repurchase consistent with the excise tax certification and (2) has no knowledge of facts that would indicate that the excise tax certification is incorrect.7 A covered corporation would have to keep the excise tax certification and make it available for inspection to the IRS if it becomes material in the administration of any tax law. The covered corporation would also have to retain records of all information necessary to document and substantiate all content of the excise tax certification.8 IRC Section 302 certifications Brokers may obtain and rely on a certification from a non-US shareholder of sale or exchange treatment if certain conditions are met (302 certification). This certification appears to be based on proposed regulations from 2007, on which brokers rely to minimize withholding on foreign shareholders, which may be taxed up to 30% on US-source dividends but are not taxed on sale proceeds or returns of capital. While a broker must generally presume that a redemption payment made to a non-US shareholder is a dividend subject to withholding tax,9 the 2007 proposed regulations permit brokers to obtain and rely on 302 certifications.10 Brokers typically solicit these 302 certifications from non-US shareholders when making payments connected with equity tender offers, cash-out mergers and potential IRC Section 304 transactions. EY observes: While commentators requested coordination between the differing presumptions in the excise tax and withholding tax contexts, Treasury and the IRS note in the Preamble to the proposed regulations that they do not believe special rules are needed to coordinate the presumptions. They did include a rule, however, to coordinate the proposed excise tax certification requirements with the proposed 302 certification requirements. If a non-U.S. shareholder held shares through a broker and certified dividend treatment on the excise tax certification, the proposed regulations would require the excise tax certification to state that a copy of the certification has been provided to the shareholder's broker.11 The proposed regulations appear to contemplate that a broker would request 302 certifications from foreign shareholders while the covered corporation could request excise tax certifications from both domestic and foreign shareholders without necessarily coordinating with the broker's certification efforts. The only coordination under the proposed regulations would be to require a foreign shareholder not to take a position favorable to the covered corporation while simultaneously taking a position that eliminates withholding on the payment. The proposed regulations are not clear on whether a broker may treat a copy of an excise tax certification from a foreign shareholder as equivalent to a 302 certification; they might, however, reinforce treating the payment as a dividend for withholding tax purposes. Market experience indicates that most shareholders participating in a transaction will be entitled to sale or exchange treatment. It may not make sense for issuers to undertake the expense of asking for and processing certifications from thousands of shareholders. The certification approach may make the most sense when there are a small number of large shareholders that are not reducing their interests in the covered corporation and may be particularly motivated to help the corporation reduce its excise tax liability. Finally, the excise tax certification may cause confusion for US taxpayers. Brokers typically report IRC Section 302 distributions to US taxpayers on Form 1099-B without soliciting a 302 certification, which is used only in the withholding tax context. A US taxpayer may receive an excise tax certification from a covered corporation for a repurchase event and may certify that the repurchase is a dividend. That US taxpayer will likely receive a Form 1099-B from its broker for that distribution, which could lead to uncertainty in reporting the distribution on its tax return. Comments on the proposed regulations must be received by June 11, 2024. Given these uncertainties, brokers should consider submitting comments on the coordination between rules governing excise tax certifications and 302 certifications.
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