Stock Buybacks and International Tax

The debates in international tax about last year’s Inflation Reduction Act have mostly centered on its green energy credits and the corporate alternative minimum tax. (Or, ughhh, “Camtee.”)

But one provision that’s easy to overlook may have unexpectedly broad implications in this field–the 1% excise tax on stock buybacks.

You probably wouldn’t expect this one to be too complicated. It’s a low, simple, easy-to-value tax on what you’d think would be a pretty clear transaction. Early guidance from the U.S. Treasury Department released in December, however, reveals how broadly the tax could apply.

It’s a good reminder that anything affecting international taxes will prove to have unintended implications, and that capturing all possible avoidance routes inevitably requires making finely-grained distinctions that create exponentially-increasing compliance headaches.

Stock buybacks were a once-obscure corporate maneuver that has been dragged more and more in the spotlight. This is especially due to tax reform–critics claimed that companies were more likely to burn new cash buying back their own stock, thus taking it off the market and increasing the stock price, than to make new investments. Before long, lawmakers called for buybacks to be banned or disincentivized.

Whether they deserve to be in the cross-hairs may be debatable. But the small excise tax is here, and likely to be the site of further political debate for years to come. (President Biden has already called for it to be raised to 4%.)

Treasury’s notice of initial guidance outlines some of the ways the department plans to use its wide statutory latitude to prevent abuse of the rule. It indicates that they plan to target transactions “economically similar” to stock repurchases, as well as other ways that a company might try to maneuver around the rule.

These include what practitioners are calling the “funding rule,” that applies whenever a U.S. subsidiary “funds by any means” the repurchase of stock of the foreign parent. The funding rule also only applies when the purpose of the transaction is to avoid the excise tax–the kind motive-based tax law that can cause a lot of subjectivity in practice. Adding another wrinkle, the “per se rule” deems the above purpose test satisfied if the foreign parent acquires stock within two years of being funded by the U.S. subsidiary.

As KPMG noted in a March report, “the language ‘funds by any means’ is naturally susceptible to a broad interpretation, and it seems intended to have a broad reach.” The inherent subjectivity of connecting a funding stream to the purchase of stock could end up capturing many routine transactions that aren’t really akin to stock buybacks, the firm noted.

Crossborder mergers and acquisitions could also run afoul of these rules--they will often involve on entity buying most or all of another one's shares, in ways that could trigger Treasury's definitions. (Although they also included exemptions aiming to avoid capturing transactions like that.)

One particular area of concern noted by many practitioners is “cash pooling,” when companies move money on a daily basis between departments to cover expenses. Those transactions are often categorized as intercompany loans, which are clearly covered by the funding rule. So those routine daily transfers could conceivably trigger both the funding and per se rules, making any stock repurchase by the foreign parent a potential tax liability.

The mention of cash pooling will make any veteran of international taxes quiver with PTSD.

That was also a major issue with the Section 385 regulations issued by the Obama administration in 2016, and finalized (though significantly scaled back) in 2020. The 385 rules were part of Treasury’s efforts to combat inversions, when a company establishes offshore residency through a corporate reorganization and (usually) a merger with a smaller foreign entity. Intercompany debt was seen as a major driver of these exits, because while Subpart F stops most U.S. companies from recording excess interest deductions through self-lending, those rules didn’t apply to foreign corporations.

The 385 rules disallowed some of those transactions, while also creating new documentation requirements for a broader set of intercompany loans. But Treasury soon learned, companies engage in a lot of internal financing arrangements, many of which are considered routine and not primarily intended for tax avoidance. Cash pooling was just one prominent example, but the department eventually found a way to exempt those while still targeting more aggressive transactions. (This all became largely moot when the 2017 Tax Cuts and Jobs Act enacted hard limits on interest deductibility, but the rules survived in skeletal form, never quite killed off by Trump’s Treasury.)

That was a time that Treasury dusted off an old, seldom-used statute to tackle a perceived problem. Now, it’s carrying out something that Congress recently passed, delegating broad powers to the department to ensure that it is carried out in full. This once again puts the career staffers in an awkward spot, forced to deal with potential gaps in the law and questions of interpretation with wide leeway that could veer into political landmines.

This was just an early release that was likely meant to generate feedback. By the time that the rules are finalized, they may well avoid the major pitfalls. But companies that assume they're in the clear--because they're not engaging in typical buyback schemes--could get caught unawares. It's yet another reminder of the quicksand traps lying throughout the perilous world of international taxes.

DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• The big news of the week was the Organization for Economic Cooperation and Development’s “Outcome Statement,” signed by 138 countries, outlining progress that has been made on the global tax project and agreeing to delay any unilateral digital services taxes for another year, until 2025. That gives negotiators some breathing room, but doesn’t resolve the big hurdle–the lack of any pathway for the U.S. Congress to sign off on Pillar One of the agreement, with Republicans in full opposition. The lack of text for the “multilateral convention” that participants would use to alter existing tax treaties is also a bit troubling. Still, this is at least something, more than many observers were expecting. The big surprise, though, was that Canada–long a strong supporter of the OECD and the multilateral process–refused to sign the statement, moving ahead with its own planned DST next year. The country’s finance minister said they were just sticking to an agreement made back in 2021. Canada has been bullish about reining in the big U.S. tech companies recently, also passing a law last month requiring Facebook to pay news sites for links. There are too many moving parts in this to get a good sense of where it’s going, or if Canada’s objection will have broader effects on the process. There have been other holdouts, but this is the first time the dissent is coming from within the OECD itself. Whatever happened to that old boys club of rich Western nations?
• Just like its exchange rates, interest in crypto taxes issues tends to vary wildly. Sometimes it seems to fade into the background, but in an instant they resurface to generate intense discussion. The top Republican lawmakers on the Senate Finance Committee solicited input from stakeholders on Tuesday on several tax issues relating to cryptocurrencies and digital assets. Those include the sourcing and valuation of crypto “mining,” always a tricky issue as these assets, by definition, exist only in the ethereal online space. They also asked about reporting obligations on foreign-held assets under the Foreign Account Tax Compliance Act (FATCA) and the Report of Foreign Bank and Financial Accounts (FBAR) requirements under the Bank Secrecy Act. Those are important issues that haven’t been totally worked out by Treasury and the IRS, so stay tuned.
• Despite all of this hoopla, lawmakers are still plugging away at forging some type of double taxation agreement with Taiwan. The Senate Finance Committee released Wednesday a “discussion draft” of legislation to provide double tax relief for those engaging in trade between the U.S. and Taiwan–sort of a treaty-without-the-treaty. (As the bipartisan group of House and Senate lawmakers noted Wednesday, Taiwan’s “very unique status” prevents it from entering into a traditional treaty.) The discussion draft includes a summary and technical explanation.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

Every week, a new character from the Golden Age of Superheroes who's fallen out of use.

Kid Eternity, first appearing in Hit Comics #25 in 1942. After a German U-Boat nearly sent the boy to heaven before his time, the celestial powers returned him to Earth and granted him superpowers to compensate for the apparent mix-up. By shouting "Eternity" the Kid can become invisible and fly limited distances--but his main (rather confusing) superpower is the ability to summon anyone from "mythology or history," although he mostly just calls the publication's other superheroes.

Contact the author at amparkerdc@gmail.com.