The IRS and U.S. Treasury Department have issued final regulations 

The Internal Revenue Service (IRS) and U.S. Treasury Department have issued final regulations (T.D. 10037) (Final Regulations) under Section 4501 of the Code (the Excise Tax) that withdraw the previously proposed "funding rule." The broad scope of that rule had been controversial. Under the funding rule, foreign parented groups would have been subjected to the Excise Tax on transactions in which a U.S. affiliate was deemed to have indirectly provided funding for a stock repurchase. Both practitioners and business groups raised concerns that the rule was overly expansive and ambiguous, and it risked pulling in ordinary course cash management transactions that did not resemble stock repurchases and were not within the scope of Section 4501.

Background

When Section 4501 was first enacted, it appeared that the application of the Excise Tax to non-U.S. public corporations that are not subject to the U.S. inversion rules (each, an Applicable Foreign Corporation) might be limited. Pursuant to the statutory language, the Excise Tax applies to an Applicable Foreign Corporation only where a U.S. affiliate (an Applicable Specified Affiliate) acquires stock of the Applicable Foreign Corporation, which is not a common occurrence.

However, as discussed in our prior bulletin, in December 2022, the IRS issued Notice 2023-2, which contemplated a broad funding rule under which a repurchase by an Applicable Foreign Corporation (or its non-U.S. affiliates) could give rise to the Excise Tax if an Applicable Specified Affiliate "funded" the non-U.S. group (via distributions, debt or capital contributions) with the principal purpose of avoiding the tax. The proposal included a per se rule under which the principal purpose prong of this test was deemed satisfied if a repurchase occurred within two years of a funding.

In response to broad pushback on the per se rule, April 2024 proposed regulations would have retained the funding rule but narrowed it by replacing the per se element with a rebuttable presumption limited to the funding (directly or indirectly) of a "downstream" non-U.S. affiliate. Taxpayers seeking to rebut the presumption would have been required to disclose the funding, the repurchase and the facts demonstrating the absence of a principal purpose of avoiding the tax. In addition, the proposed regulations provided that transactions that had a principal purpose of funding a repurchase would also be deemed to have a principal purpose of avoiding the Excise Tax.

Funding Rule and Other Changes in the Final Regulations

The Final Regulations explicitly do not adopt the funding rule in either of its proposed forms, with the IRS noting that it took into account all comments in making this determination and explicitly listing out several of the negative comments received (for instance, the burdensome nature of compliance and the lack of clarity surrounding application of the rule). Instead, the Final Regulations generally limit the application of the Excise Tax, in the case of an Applicable Foreign Corporations, to direct purchases of Applicable Foreign Corporation stock by an Applicable Specified Affiliate.

In addition to removing the funding rule, the Final Regulations (among other things) confirm that certain transactions that fundamentally restructure corporate ownership, including many take-private transactions and various upstream and other acquisitive reorganizations, are not treated as repurchases for excise tax purposes. The Final Regulations also provide transition and de minimis relief for certain foreign partnership structures.

The Final Regulations generally apply to repurchases occurring after December 31, 2022, and to issuances of stock during taxable years ending after that date.

What This Means for Multinationals

The IRS’s decision to withdraw the funding rule marks a significant retreat from the broader reach contemplated by prior regulations and returns the focus of the Excise Tax, in the case of non-U.S. public corporations, to direct acquisitions by their U.S. affiliates. Non-U.S. public corporate groups may now assess repurchase activity without the added layer of analyzing upstream and downstream funding flows with U.S. affiliates for potential Excise Tax exposure.