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More Foreign Companies Than Expected May Be Subject to 1% Buyback Tax

S.J. Steinhardt
Published Date:
Apr 14, 2023


More foreign companies with American subsidiaries than anticipated may be subject to the new 1 percent tax on stock buybacks, because of interim guidance issued by the Treasury Department and the IRS, The Wall Street Journal reported.

The tax, which went into effect on Jan. 1, may apply under certain circumstances, following the interim guidance, which was issued in late December: if a U.S. subsidiary of a foreign company makes ordinary business payments to its parent, and then the foreign parent buys back shares within a two-year period of that payment.

Thousands of foreign companies have one or more U.S. subsidiaries, according to data provider Dealogic, as reported by the Journal.

The guidance introduced a funding rule with a so-called principal purpose test, meaning that, if a U.S. subsidiary provides funding to a foreign company that then repurchases its own shares, the buyback is subjected to the tax if the principal purpose of the funding was to avoid the tax, according to Paul Seraganian, a partner in the U.S. tax, pensions and employment group at law firm Clifford Chance LLP.

“If that was all they did, I think a lot of people would be relatively OK with that, because it is anchored to this concept that whatever is going on is going on because there’s a principal purpose of avoiding the statute,” he told the Journal. “It’s the next leap that really has triggered all the pain and concerns,” he said, referring to what is known in the guidance as the per se rule.

That rule states that a “principal purpose described in section 3.05(2)(a)(ii)(A) of this notice is deemed to exist if the applicable specified affiliate funds by any means, other than through distributions, the applicable foreign corporation or a specified affiliate that is not also an applicable specified affiliate, and such funded entity acquires or repurchases stock of the applicable foreign corporation within two years of the funding.”

The per se rule "practically eliminates a multinational corporation’s ability to undertake ordinary course transactions within its group without triggering the Excise Tax," Paul Hoogsteden, head of North American tax at Danish pharmaceutical company Novo Nordisk, said in a March 10 comment to Treasury.

“These ordinary course transactions are necessary to operate a global business and are certainly not intended to have a principal purpose to avoid the excise tax, although the per se rule would inappropriately deem them to be,” he said. He recommended that the Treasury Department should get rid of both the funding and per se rules.

The tax could hurt the competitiveness of the United States, as it might diminish foreign direct investment and may provoke major trading partners to reciprocate, said Nancy McLernon, president and chief executive of the Global Business Alliance, a trade group that represents international companies.

“I imagine other nations will not appreciate the U.S. imposing its domestic tax policy on them, and act accordingly,” she told the Journal, pointing out that Canada is set to implement a 2 percent stock buyback excise tax on certain corporations starting in 2024, “so it would be easy for them to reciprocate and capture all U.S.-headquartered firms operating there.”

The scope of the tax may change as the government considers the public comments to its guidance.

“Treasury’s initial guidance is intended to provide basic rules for taxpayers while more detailed regulations are developed and proposed,” a Treasury spokeswoman told the Journal. “Consistent with the law and congressional intent, the guidance includes important guardrails to prevent large corporations from avoiding the tax.”