On August 7, the Senate passed HR 5376, the Inflation Reduction Act of 2022 (the Act). If approved by the House of Representatives, as expected, the bill will be sent to President Joe Biden for signature. The bill passed by the Senate includes three revisions to the Internal Revenue Code of 1986, as amended (the Code) that deserve our attention:1
1. Minimum corporate tax of 15%
The law adds a minimum “applicable corporation” tax equal to 15% of the corporation’s “adjusted financial statement income” (AFSI). The minimum tax would apply only to the extent that it exceeds the ordinary corporate income tax plus the Base Erosion and Anti-Abuse Tax (BEAT).
An applicable corporation is a corporation (other than an S corporation, regulated investment corporation or real estate investment trust) whose average AFSI for any taxation year ending after December 31, 2021 and the two years of previous taxation exceeds $1 billion.
AFSI is the net income or net loss on the applicable financial statements of the taxpayer (as defined in section 451(b)(3) or as specified by the Secretary of the Treasury), calculated by applying, among other things, the following rules:
- The AFSI of a company includes the AFSIs of the ignored entities and, where applicable and without duplication, the other members of the consolidated group which includes this company.
- AFSI attributable to a subsidiary of a company that is not part of the company’s consolidated group is included only to the extent of dividends received from, and other amounts that may be included in gross income (other than inclusions of Subpart F and GILTI) or deductible as a loss by the company in respect of that subsidiary.
- The AFSI of a partnership or controlled foreign company in which the company has an equity interest is only taken into account to the extent of the share attributable to the company of this AFSI (AFSI losses of foreign companies companies being applied as a deferral to reduce the AFSI of that controlled foreign company). companies in subsequent years).
- Financial statement amortization is replaced by tax amortization.
- Up to 80% of the AFSI is reduced by net operating loss carryforwards in financial statements generated in tax years beginning after December 31, 2019 (similar to the limitation on use net operating losses for federal income tax purposes).
- In the case of a foreign corporation, only AFSI consisting of income actually connected with a trade or business in the United States is subject to the minimum tax. Further, only such effectively related income is likely to be considered in calculating the $1 billion threshold for non-foreign parent group members (described below) and the $100 million threshold for members of a foreign parent group (also described below). It is less clear whether this ECI-based limitation applies when calculating a company’s share of the AFSI of controlled foreign companies.
To determine whether a company is a applicable company (but not for the purpose of calculating the amount of AFSI that is subject to tax), the company’s AFSI is aggregated with the AFSI of all persons treated as a sole employer under section 52(a) or 52(b). Although a minimum amendment to this provision has been added with the aim of avoiding or minimizing the application of tax to portfolio investments held by investment funds, uncertainty remains in this regard. (For a discussion of how these aggregation rules might apply to investment funds for the purposes of the CARES Act retention credit, see here.)
The test differs for foreign parent groups, which are groups (i) that include at least one domestic corporation or at least one foreign corporation engaged in a trade or business in the United States, (ii) that are included in the same financial statements applicable for those taxable years and (iii) whose common parent corporation is a foreign corporation (or is deemed by the Secretary of the Treasury to have such a parent corporation for these purposes). A domestic corporation or foreign corporation with a trade or business in the United States that is a member of a foreign parent group must include the AFSI (with some modifications) of all group members when applying the test $1 billion, including AFSI that is not effectively connected with a trade or business in the United States, but is an applicable corporation only if its three-year average AFSI calculated under the rules otherwise applicable summed up above (including ECI-based limitations) exceeds $100 million.
Once a corporation meets the income test for one tax year, it is treated as an applicable corporation for all subsequent tax years, even if its average AFSI falls below the $1 billion threshold. However, a corporation would no longer be considered an applicable corporation if (a) either (i) there is a change in ownership or (ii) that corporation does not meet the income test for a certain number of tax years (to be determined by the Secretary of the Treasury) and (b) the Secretary of the Treasury determines that it would not be appropriate to continue to treat such corporation as an applicable corporation.
The bill allows corporate minimum tax to be deducted from direct foreign income tax, the corporation’s proportionate share of a foreign partnership’s deductible foreign tax, as well as tax income paid by controlled foreign companies (subject to a cap of 15% of the company’s pro rata share of the net income or net loss of such controlled foreign companies (calculated on an aggregate basis), plus foreign income tax).
It is not yet clear how the minimum corporate tax may interact with the second pillar rules of the Organization for Economic Co-operation and Development (OECD), although it is not expected that the minimum corporate tax corporations or a “supplementary national minimum tax” (i.e. a national minimum tax calculated according to the same rules as the income inclusion rule (IIR) and the undertaxed payments rule (UTPR) of the OECD).
The corporate minimum tax would be in effect for tax years beginning after December 31, 2022.
2. 1% excise tax on redemptions of corporate shares
The law imposes a non-deductible excise tax equal to 1% of the fair market value of any shares “redeemed” by a “covered company” during the tax year (over and above the fair market value of shares issued by that company during that year) . A Covered Company is a company whose stock is traded on an established stock exchange within the meaning of the publicly traded partnership rules set forth in Section 7704. (Companies may consider imposing transfer restrictions similar to those that exist in many partnership agreements to avoid publicly listed status for these purposes, although a compensating consideration is that shareholders often desire maximum transferability of their shares.)
The term “redemption” generally means both a redemption (as defined in section 317(b)) of the Covered Company’s stock and any transaction identified by the Secretary of the Treasury as economically similar to such a transaction. The term also includes acquisitions of shares of a Covered Company by a “Specified Affiliate” thereof from a person who is neither the Covered Company nor such Specified Affiliate. The term “specified affiliate” means (i) any company more than 50% of whose voting rights and value are held, directly or indirectly, by the target company, and (ii) any partnership of which more than 50% capital or profits whose interests are held, directly or indirectly, by the target company.
Special rules would apply to acquisitions of shares by certain foreign corporations. If shares of a target foreign corporation are acquired by a specified affiliate (other than a foreign corporation or a foreign partnership that does not have a domestic entity as its direct or indirect partner) from a person who is not the relevant foreign company or a subsidiary thereof, then the specified affiliate will be treated as a covered company, the acquisition will be treated as a buyout and the discount for share issues will apply only to shares issued or provided by that specified affiliate to its employees. These special rules would also apply to purchases of shares of certain listed companies that expatriate after September 20, 2021.
Excise tax exceptions include the following:
- Redemptions that are part of a reorganization within the meaning of section 368 in respect of which no gain or loss is recognized by the shareholders (note that, as written, this exception would not apply even if a small amount of gain or loss is accounted for).
- Buyouts where the shares redeemed (or a quantity of shares equal to the value of the shares redeemed) are paid into an employer-sponsored retirement, employee stock or similar plan.
- Redemptions where the total value of shares redeemed during the tax year does not exceed $1 million.
- Redemptions by securities dealers in the ordinary course of business (under regulations to be promulgated by the Secretary of the Treasury).
- Takeovers by regulated investment companies and REITs.
- Redemptions Treated as Dividends for Code Purposes. (While it is unclear why dividends are favored over buybacks as a political issue, the effect of this rule is that companies will be more likely to pay dividends (perhaps associated with a consolidation of shares to reduce free float) than to engage in share buybacks. )
The Secretary of the Treasury is authorized to promulgate regulations that prevent the evasion of the new excise tax, including with respect to the exceptions noted above.
Excise tax would apply to redemptions made after December 31, 2022.
3. Extension of limitation on use of excess business losses of unincorporated taxpayers
Section 461(l) prohibits a taxpayer from deducting any excess business loss (generally, a net loss attributable to a taxpayer’s trades or businesses in excess of certain thresholds) and instead treats that loss as an operating loss (NOL) for the purpose of determining NOL carryovers to subsequent tax years. This prohibition was to expire for tax years ending on or after January 1, 2027. The law would extend the ban to tax years ending before January 1, 2029.
1. References to articles refer to the Code.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.