Excise Taxes and Stock Buybacks in Corporate America

Only Buybacks in the Building University of Chicago, Federal Tax Conference November 4, 2022 Moderator: Lead presenter: Panel: Karen Gilbreath Sowell, EY Marc A. Countryman, EY Colin D. Campbell, Department of the Treasury Jodi J. Schwartz, Wachtell, Lipton, Rosen & Katz

Excise taxes Generally, simple and clear in application Revenue raisers or behavior deterrents 2

What does section 4501 do? Section 4501 imposes an excise tax on publicly traded US corporations equal to 1 percent of the value of its stock that is repurchased during the tax year. A repurchase is a redemption within the meaning of section 317(b), and transactions determined by Treasury to be economically similar to a redemption. Section 317(b) provides that there is a redemption if the corporation acquires its stock from a shareholder in exchange for property . That s very broad and many corporate transactions are treated as section 317(b) redemptions, even if not commonly thought of as a redemption. 3

What has Congress said? Senator Schumer: I hate stock buybacks. . . . I think they re one of the most self- serving things that corporate America does. Instead of investing in workers and in training and in research and in equipment, they simply they don t do a thing to make their company better and they artificially raise the stock price by just reducing the number of shares. Senator Merkley: [Describes corporate executives receiving stock options.] Now, if you have a stock option and then your company buys back stock, every share gets more valuable; you make a massive amount of money. This is a corrupt system. It does nothing to further the investment of the company and the productivity of America. It does nothing to increase the R&D-research and development-that goes into new products. Senator Wyden: I just heard about [tax lawyers concluding that SPACs will be subject to the excise tax on any redemptions/liquidations] in the last couple days . . . . I m looking at it; lawyers have lots of opinions. 4

Does Congress really hate . . . Bootstrap acquisitions Take private transactions effected via reverse subsidiary merger (but only if debt financing is incurred for tax purposes at the target) Asset reorganizations with boot (but unclear if it is all of it, or just the boot, or only if there is gain in the shares) Stock reorganizations with boot (but only if the boot is, or appears to be, sourced from the target) Section 304 transactions (but only if the acquiror is public) Public company complete liquidations Minimal cash issued in lieu of fractional shares (in otherwise stock-based transactions) Split-offs 5

Thats dramatic. Are there no limits? There is general regulatory authority in section 4501(f), which provides: The Secretary shall prescribe such regulations and other guidance as are necessary or appropriate to carry out, and to prevent the avoidance of, the purposes of this section, including regulations and other guidance (1) to prevent the abuse of the exceptions provided by [section 4501(e)], (2) to address special classes of stock and preferred stock, and (3) for the application of the rules under [section 4501(d)] Additionally, section 4501(e) provides a handful of specific exceptions, the most relevant in this context being, to the extent that the repurchase is part of a reorganization (within the meaning of section 368(a)) and no gain or loss is recognized on such repurchase by the shareholder under chapter 1 by reason of such reorganization . 6

Scope of investigation What we re investigating The scope of transactions that appear to be the target of the excise tax under section 4501 The transactions that could be ensnared by section 4501 but that are not/should not be the focus of the tax Developing a proposal that is flexible enough to address a variety of transactions What we re not The politics and whether buybacks should be discouraged Generally, what non-stock and other financial instruments should be in scope Rules regarding stock acquisitions by specified affiliates and those involving foreign corporations Netting and computational rules/issues 7

So, what buybacks should be in the building? Traditional Public Company Stock Buybacks: Public company that conducts business buys back common stock from some, but not all, of its shareholders for cash Buyback is not in connection with an M&A transaction As a result, the EPS of the remaining shareholders increases (preserving/enhancing stock price) Public Shareholders Shares $ Public Company 8

Is that too narrow for section 4501? The statute is broad, and there is no legislative history, but there are lots of clues regarding the intended scope: Apparent focus of the legislation Tax related effects of typical stock buybacks Other recent buyback proposals Congressional commentary regarding section 4501 The revenue estimate for section 4501 9

Apparent focus of legislation Public company stock buybacks have increased in the past 40 years, from less than $10B in 1980 to over $800B in 2018 and 2021. Based on commentary from Congress, traditional public company stock buybacks appear to: Transfer cash to the public corporation s shareholders in a selective and tax efficient manner; Enhance stock price/EPS and therefore benefit continuing shareholders and executives; and Not directly benefit the underlying business through growth (organic or via transactions), innovation, compensation for workers, etc. 10

Buyback-related proposal timeline Stock Buyback Accountability Act (S.2758) Changed to apply to domestic corporations the stock of which is traded on an established securities market (section 7704(b)(1)) the acquisition by a corporation of the right to acquire its stock treated as redemption Revised reorganization exception Added exception for dividends Temporary Ban on Stock Buybacks During COVID (H.R. 6339) Section 1 would provide: It shall be unlawful for any issuer, the securities of which are traded on a national securities exchange, to purchase securities of the issuer during the period beginning on the date of enactment of this Act and ending 120 days after the end of the COVID 19 emergency period. Reward Work Act (S. 2605) Section 2, Prohibition on Stock Buybacks on the Open Market, would provide: no issuer may purchase an equity security of the issuer on a national securities exchange. Build Back Better Act (H.R.5376) Substantially the same as section 4501 2/12/2019 9/10/2021 10/28/2021 3/22/2018 3/23/2020 9/20/2021 11/19/2021 Original Brown/Wyden Bill Would impose 2% tax on repurchases, defined as section 317(b) redemptions (and any similar transaction with regard to foreign corporation stock) Applies to domestic publicly held corporations under section 162(m)(2) No exceptions for dividends or RIC/REIT buybacks Sen. Rubio s Plan Would have ended preferential tax treatment of buybacks by taxing them like dividends Rules Committee Print Substantially the same as section 4501 11

The revenue estimate The revenue estimate and historical stock buyback data suggest that the excise tax is only expected to apply to Traditional Public Company Stock Buybacks. JCT estimated revenue from section 4501 for repurchases of stock after 12/31/2022 to be $5.7 billion in 2023, and to average about $8.5 billion per year from 2024-2031, totaling about $73.7 billion over 10 years. (JCX-18-22, August 9, 2022) PR Newswire S&P 500 Buybacks Set Quarterly and 12-Month Records - Again June 16, 2022: 2018 buybacks of $806.41B; 2019 buybacks of $728.74B; 2020 buybacks of $519.76B; and 2021 buybacks of $881.72B. The 3-year average (ignoring 2020) is about $805.6B. New Tax on Stock Buybacks Would Have Raised Over $8 Billion in 2021, Study Says (WSJ.com September 9, 2022) The 1% tax on stock buybacks signed into law last month would have raised about $8.4 billion from the biggest publicly traded U.S. companies if it had been in effect last year, absorbing the equivalent of nearly a half-percentage-point of net income overall, a new analysis finds. The approximate $8.5 billion per year average revenue estimate from section 4501 for 2024-2031 is roughly in line with average share buybacks by S&P 500 companies in recent years. 12

The Proposal Start with the statute guidance would provide that the excise tax only applies to share repurchases that constitute: a redemption within the meaning of section 317(b) , or an acquisition explicitly described in guidance issued prior to the date of the applicable transaction. Exercise section 4501(f) authority and utilize the Factor-Based Approach to provide adjustments and modifications to properly limit share repurchases for purposes of section 4501 to only stock repurchases that resemble a Traditional Public Company Stock Buyback 13

The Factor-Based Approach Evaluate a share repurchase (or deemed share repurchase) using an application rule, and two operative rules Application rule: Aggregate Repurchasing Corporation Rule Only applies to certain reorganizations or section 351 exchanges that appear to be more of a single-corporation transaction, where the operative rules are more appropriately applied to the target and acquiring corporations on a single-entity basis. Operative rules: Factors Test Share repurchase must possess all five attributes of a Traditional Public Company Stock Buyback to be treated as a share repurchase subject to the excise tax. Purpose Exception Even if all five attributes are present, it will not be a share repurchase subject to the excise tax if the nature or context of the transaction shows that the share repurchase does not resemble a Traditional Public Company Stock Buyback. 14

Aggregate Repurchasing Corporation Rule The Aggregate Repurchasing Corporation Rule applies if: 1. The acquiring corporation (or its sub) acquires a. assets of a publicly traded corporation in a transaction in which the acquiring corporation (or its sub) succeeds to attributes of the public target under section 381(a), OR b. stock of the public target in an exchange to which any of sections 351, 354, or 356 apply, and the acquiring corporation (or its sub) is not a specified affiliate of the public target immediately before such stock acquisition; The acquiring corporation is publicly traded or becomes publicly traded in connection with the acquisition; AND At least 80% of the value of the stock of the acquiring corporation is received by former shareholders of the public target in exchange for stock of the public target. 2. 3. If so, the acquiring corporation (including its sub, if applicable) is essentially a mere continuation of the public target corporation for this purpose, and the corporations would be properly treated as a single corporation for purposes of applying the Factors Test and the Purpose Exception. 15

Aggregate Repurchasing Corporation Rule Public Acquiror SHs Public Acquiror SHs Public Target SHs Public Target SHs 85% of Public Acquiror stock + $ 85% 15% Public Target stock Public Acquiror Public Acquiror Public Target Public Target Public Target 16

Factors Test A repurchase is only a repurchase for purposes of section 4501 if all five factors are present with respect to the repurchase (see following slides). If, taking into account the Aggregate Repurchasing Corporation Rule, one (or more) of the factors is not present, the repurchase is not a repurchase for purposes of section 4501. If all of the factors are present, the repurchase is a repurchase for purposes of section 4501 unless the Purpose Exception applies to exempt the repurchase. For purposes of applying the Factors Test (and the Purpose Exception), an exchange of shares of a repurchasing corporation for newly issued regular preferred shares of the corporation would be treated as an exchange of shares for property. 17

Factors 1 & 2 The repurchase: 1. Is made by a corporation that is publicly traded before and after the repurchase Not a snapshot; takes into account ceasing to be publicly traded in connection with the repurchase 2. Is in the context of a single-corporation transaction (i.e., not in an acquisitive or divisive transaction) A transaction would generally be considered acquisitive if either: (i) a person acquires all or part of the assets of the repurchasing corporation and the repurchasing corporation ceases to exist in connection with the asset acquisition; or (ii) the repurchasing corporation remains in existence and at least 50% of the total value of the stock of the repurchasing corporation is acquired in a transaction that is not subject to section 4501(c)(2) or (d). A transaction is divisive to the extent the repurchase occurs in a distribution by the repurchasing corporation to which section 355 applies (regardless of whether it is part of section 368(a)(1)(D)), or that constitutes a partial liquidation as defined in section 302(e) and without regard to whether section 302(b)(4) applied to any distribute. 18

Factors 3 & 4 The repurchase: 3. Consists of shares other than regular preferred stock 4. Is not pro rata Pro rata repurchase is different from traditional public company stock buyback, as each shareholder experiences a proportionate tax event and reduction in ownership Non-pro rata portion of repurchase measured based on shareholder s proportionate ownership by value and that shareholder s participation in the repurchase Regular preferred shares are ignored in determining the extent to which repurchase is not pro rata. Simplifying rule: Non-reporting shareholders and non-insiders are aggregated and treated as single shareholder (i.e., effectively excluded in determining whether repurchase is pro rata). Thus, non-pro rata portion of a repurchase will be based on the extent to which reporting shareholders and insiders participate in the repurchase. 19

Factor 5 The repurchase: 5. Is made by a corporation that conducts, directly or indirectly, operations that generate material revenues and expenses at the time of the share repurchase Apply section 355(b)(3) separate affiliated group principles for purposes of determining what the corporation directly or indirectly conducts Apply section 355(b) active trade or business principles for purposes of evaluating the extent to which the operations generate revenues and expenses 20

Purpose Exception Under the Purpose Exception, even if all five factors in the Factors Test are present, a repurchase of shares would not be treated as a repurchase for purposes of section 4501: To the extent it is a payment in lieu of fractional shares (provided the payment doesn t exceed [X%] of the value); To the extent the acquisition is not subject to section 4501(c)(2) or (d) and, taking the Aggregate Repurchasing Corporation Rule into account, it results in a redemption solely due to section 304(a)(1); To the extent the share repurchase constitutes an intercompany transaction to which Reg. 1.1502-13 applies; If it can be shown that the principal purpose for the share repurchase is to facilitate another transaction; OR If it is of a class that is not publicly traded and not convertible into shares that are publicly traded. 21

Does the Aggregate Repurchasing Corporation Rule Apply? (reorg or 351 that is not really acquisitive ) YES NO Is there a 317(b) redemption (or an economically similar acquisition of shares)? NO YES No share repurchase for the excise tax NO Treat the target and acquiring corporations as a single entity. THE FACTORS TEST (are all 6 factors present) YES Does the Purpose Exception Apply? YES NO Share repurchase for the excise tax 22

Testing the Proposal: acquisitions, divisions, and liquidations 23

Private buyer stock acquisition with target leverage 1. Does the Aggregate Repurchasing Corporation Rule apply? 2. Is there a Section 317(b) redemption? Public Target SHs 3. Are the factors present? $ Factor Target $ Buyer Is made by a corporation that is publicly traded before and after the repurchase NO Is in the context of a single-corporation transaction (i.e., not in an acquisitive or divisive transaction) NO Consists of shares other than regular preferred stock YES Lender Merger Sub Public Target Is not pro rata ? $ Merger Is made by a corporation that conducts, directly or indirectly, operations that generate material revenues and expenses at the time of the share repurchase YES 4. What if Buyer is public? 24

Public company section 304 transaction with bootstrap redemption 1. Does the Aggregate Repurchasing Corporation Rule apply? 2. Is there a Section 317(b) redemption? Public Group 1 Public Group 2 3. Are the factors present? Factor Target Buyer $ $ Is made by a corporation that is publicly traded before and after the repurchase NO YES shares Public Target shares Is in the context of a single-corporation transaction (i.e., not in an acquisitive or divisive transaction) NO YES Public Target Consists of shares other than regular preferred stock Public Buyer YES ? Is not pro rata ? YES Is made by a corporation that conducts, directly or indirectly, operations that generate material revenues and expenses at the time of the share repurchase YES YES Public Target 4. Does the Purpose Exception apply? 25

Asset reorganization with boot 1. Does the Aggregate Repurchasing Corporation Rule apply? Public Target SHs 2. Is there a Section 317(b) redemption? 3. Are the factors present? Acquiror Stock + $ Factor Target Is made by a corporation that is publicly traded before and after the repurchase NO Is in the context of a single-corporation transaction (i.e., not in an acquisitive or divisive transaction) NO Acquiror Public Target Consists of shares other than regular preferred stock YES Merger Is not pro rata ? Is made by a corporation that conducts, directly or indirectly, operations that generate material revenues and expenses at the time of the share repurchase YES 26

Section 355 split-off 1. Does the Aggregate Repurchasing Corporation Rule apply? Public SHs 2. Is there a Section 317(b) redemption? D stock C stock 3. Are the factors present? D Factor D Is made by a corporation that is publicly traded before and after the repurchase YES Is in the context of a single-corporation transaction (i.e., not in an acquisitive or divisive transaction) NO Business A C Consists of shares other than regular preferred stock YES Is not pro rata ? Is made by a corporation that conducts, directly or indirectly, operations that generate material revenues and expenses at the time of the share repurchase YES Business B 27

Complete liquidation 1. Does the Aggregate Repurchasing Corporation Rule apply? Public Target SHs 2. Is there a Section 317(b) redemption? Assets 3. Are the factors present? Factor PubCo Public Company Is made by a corporation that is publicly traded before and after the repurchase NO Is in the context of a single-corporation transaction (i.e., not in an acquisitive or divisive transaction) YES Consists of shares other than regular preferred stock YES Is not pro rata NO Assets Is made by a corporation that conducts, directly or indirectly, operations that generate material revenues and expenses at the time of the share repurchase YES 28

Holding company formation 1. Does the Aggregate Repurchasing Corporation Rule apply? Public Target SHs 2. Is there a Section 317(b) redemption? Incorporator $ + New HoldCo shares 3. Are the factors present? Factor Target/ Holdco Public Target New HoldCo Is made by a corporation that is publicly traded before and after the repurchase YES Is in the context of a single-corporation transaction (i.e., not in an acquisitive or divisive transaction) YES Merger Merger Sub Consists of shares other than regular preferred stock YES Is not pro rata ? Is made by a corporation that conducts, directly or indirectly, operations that generate material revenues and expenses at the time of the share repurchase YES 4. Does the Purpose Exception apply? 29

SmallCo acquisition of BigCo 1. Does the Aggregate Repurchasing Corporation Rule apply? Public Acquiror SHs Public Target SHs 85% of Public Acquiror stock + $ 2. Is there a Section 317(b) redemption? 3. Are the factors present? Public Target stock Factor Target/ Acq Public Acquiror Public Target Is made by a corporation that is publicly traded before and after the repurchase YES Is in the context of a single-corporation transaction (i.e., not in an acquisitive or divisive transaction) YES Consists of shares other than regular preferred stock YES Public Target Is not pro rata ? Is made by a corporation that conducts, directly or indirectly, operations that generate material revenues and expenses at the time of the share repurchase YES 4. Does the Purpose Exception apply? 30

Reverse stock split with cash in lieu of fractional shares 1. Does the Aggregate Repurchasing Corporation Rule apply? Public Company SHs 2. Is there a Section 317(b) redemption? 3. Are the factors present? Public Company New Public Company shares + $ shares Factor PubCo Public Company Is made by a corporation that is publicly traded before and after the repurchase YES Is in the context of a single-corporation transaction (i.e., not in an acquisitive or divisive transaction) YES Consists of shares other than regular preferred stock YES Is not pro rata ? Is made by a corporation that conducts, directly or indirectly, operations that generate material revenues and expenses at the time of the share repurchase YES 4. Does the Purpose Exception apply? 31

Consolidated intercompany redemption 1. Does the Aggregate Repurchasing Corporation Rule apply? Public 2 2. Is there a Section 317(b) redemption? 3. Are the factors present? Common Parent Public 1 Factor Member $ Is made by a corporation that is publicly traded before and after the repurchase YES 85% 15% Is in the context of a single-corporation transaction (i.e., not in an acquisitive or divisive transaction) YES < 5% of Member shares Consists of shares other than regular preferred stock YES Member Is not pro rata YES Is made by a corporation that conducts, directly or indirectly, operations that generate material revenues and expenses at the time of the share repurchase YES 4. Does the Purpose Exception apply? 32