Beginning in 2023, publicly-traded U.S. corporations are subject to a 1% excise tax on the fair market value of the stock repurchases made during the taxable year. The enacting statute also applies the excise tax when a U.S. company repurchases stock of its foreign listed parent. 

Despite receiving comments to the contrary, IRS proposed regulations retain a broad interpretation of this rule, potentially applying the excise tax to many stock buybacks performed by foreign issuers when they are funded by a U.S. affiliate.

Description of §4501(d) of the Internal Revenue Code

Under §4501(d), the acquisition of stock of a foreign listed corporation (an applicable foreign corporation) by any affiliated domestic corporation or partnership (or by a foreign partnership having a US entity as a direct or indirect partner) (an applicable specified affiliate) from a person who is not the applicable foreign corporation or any entity whose more than 50% of the stock is owned, directly or indirectly, by the applicable foreign corporation (a specified affiliate) falls in the scope of the excise tax. 

The purpose of §4501(d) is to expand the excise tax to stock repurchases that Congress considered economically equivalent to stock repurchases made by a U.S. issuer. That being said, it is rare as a commercial matter for a U.S. subsidiary to directly purchase its foreign parent’s stock, as this would create “hook” ownership.

Considering possible abuses of §4501(d) (e.g., interposing a foreign subsidiary in the chain of repurchase) and the need to establish application rules, § 4501(f)(1) empowered the Treasury to prescribe regulations and interpretations of this provision.

Initial December 2022 guidance provided a very broad anti-abuse rule

On 27 December 2022, the IRS and the Treasury issued initial interim guidance on the excise tax (Notice 2023-2), in advance of the publication of proposed regulations.

This Notice proposed a funding rule whereby an applicable specified affiliate is treated as acquiring stock of an applicable foreign corporation if the applicable specified affiliate funds by any means (including through distributions, debt, or capital contributions) the acquisition or repurchase of stock of the applicable foreign corporation by the foreign corporation itself or another specified affiliate that is not also an applicable specified affiliate (a covered purchase), and such funding is undertaken for a principal purpose of avoiding the excise tax (a covered funding). According to the Notice, a principal purpose of avoiding the excise tax is deemed to exist if the applicable specified affiliate funds by any means, other than through distributions, the applicable foreign corporation itself or a specified affiliate that is not also an applicable specified affiliate, and such funded entity acquires or repurchases stock of the foreign listed corporation within two years of the funding (so-called per se rule).

Taxpayers criticized the per se rule as overbroad. The general rule was viewed as appropriate since it required an abusive purpose.

Revised April 2024 guidance narrowed the per se rule but created new problems

On 9 April 2024, the IRS and the Treasury published proposed regulations, which partially address the above concerns by maintaining the funding rule but replacing the per se rule by a rebuttable presumption that applies in very limited circumstances, namely where the U.S. subsidiary funds a downstream foreign subsidiary to make the prohibited purchase. 

Unfortunately, the proposed regulations unexpectedly added an interpretation to the general “principal purpose” rule that appears to sweep in many common transactions. An improper purpose is present, according to the proposed regulations, whenever the goal is to fund the stock buyback, even in the case where no “hook” ownership is created. This appears to go beyond the statutory mandate and has again been harshly criticized for that reason. Unless this rule is narrowed, it could apply to many “innocent” movements of cash from the U.S. subsidiary to the foreign parent.

In light of the above, foreign issuers having U.S. affiliates should therefore pay specific attention to how their stock repurchase program is funded, and closely monitor the release of the final regulations by the IRS and the Treasury.

Adrien Soumagne is an associate at Bredin Prat on secondment at Cravath.