CAMT, Excise Tax and Green Credits: U.S. Tax Lingo to Spice up Your Next Cocktail Conversation
January 17, 2023
In the United States, the Inflation Reduction Act of 2022 (IRA) was passed in August.
The IRA will be of relevance to many U.S. taxpayers, with three particular areas of focus for large corporations: the new corporate alternative minimum tax (CAMT), a new 1% excise tax imposed on certain net stock redemptions and repurchases, and tax credit provisions relating to renewable energy.
The CAMT is a 15% alternative minimum tax imposed on certain large corporations and corporate groups (whether public or private), measured on a base of “adjusted financial statement income” (AFSI) – which is basically the income reported on the corporation’s financial statements, with adjustments to certain specified items. Most of the adjustments are to follow the normal tax treatment of a specific item instead of the normal financial accounting treatment (e.g., tax depreciation instead of book depreciation, no deduction for certain income taxes, and the tax-free treatment of certain reorganizations). The CAMT is in effect as of January 1, 2023.
The CAMT is expected to have a particular impact on corporations that have significant deductions under the tax rules that are not matched by accounting deductions (e.g., the tax deductions arising from employee stock options, operating loss carryforwards). Which corporations are most hurt by the CAMT remains to be seen and may depend in large part upon how the new statute is interpreted and applied in forthcoming Treasury regulatory guidance.
Once a corporation meets the earnings thresholds to subject it to the CAMT it remains subject to the CAMT, although the IRS is authorized to provide rules under which corporations may be given a fresh-start (e.g., if earnings have dropped below the threshold or there is a change of control).
Key Considerations for Companies Regarding CAMT
The government has promised additional CAMT guidance early in 2023 and for interested stakeholders it cannot come too soon. The use of accounting statement income as a tax base is new to U.S. tax law (the last and only time accounting income was used as part of the U.S. tax base was in 1987-1989 under a temporary law referred to as the “BURP,” which stood for “business untaxed reported profits”). We expect it will take many years for the CAMT rules to be worked out and we look forward to assisting our clients as the rules are developed.
1% Excise Tax
The IRA also introduced a 1% excise tax on net stock redemptions and repurchases, starting in 2023. The tax is levied on the value of the stock redeemed or repurchased in the tax year, netted against the value of stock issued for cash, property or to employees for services in that year, and is subject to certain exceptions (e.g., it does not apply to tax-free reorganizations to the extent gain or loss is not recognized). The tax applies only to stock issued by publicly traded corporations (and in the case of public corporations, it applies regardless of whether the stock redeemed is publicly traded). In general it applies to U.S. publicly traded companies, excepting REITs, BDCs and other mutual funds, but it can also apply to “inverted” public non-U.S. corporations, and to domestic “specified affiliates” (i.e., more than 50% owned subsidiaries) that acquire (or are deemed to acquire) stock of their non-U.S. publicly traded parent corporations.
The application of this 1% excise tax is still subject to uncertainty, although in late December 2022 the IRS and Treasury issued a notice of proposed regulations (the December Notice) that has, as an interim matter, provided guidance on which taxpayers can rely until proposed regulations are issued.
Key Considerations for Companies Regarding the Excise Tax
- The IRS and Treasury have asked for comments about the application of these rules to redeemable preferred stock and other special classes of stock or debt, including convertible debt.
- While in certain circumstances the application of the 1% excise tax will be relatively simple and understandable (e.g., a domestic public corporation simply redeeming outstanding stock), in others the results may appear to be arbitrary. For example, in M&A transactions the 1% excise tax may or may not apply depending on the source of cash for the acquisition or what entity is primarily liable for the financing. This will become another tax consideration to take into account in structuring M&A transactions and related financing.
- In the context of non-U.S. publicly traded corporations, the December Notice has proposed a “funding” rule that may have a broad and unexpected application. It imposes the 1% excise tax on a domestic subsidiary that “funds” a non-U.S. public company (by any means including through dividends, debt or capital contributions) with the “principal purpose” of avoiding the 1% excise tax. Any funding other than by distribution which occurs within two years of the redemption or repurchase is deemed to have such a principal purpose. The 1% excise tax imposed in respect of a public non-U.S. company is not netted against stock issuances by that non-U.S. corporation. The application of this “funding” rule is currently unclear, although it has the potential to impose the 1% excise tax on intercompany cash flows that otherwise would be tax-neutral.
“Green” Tax Credits
The IRA provides far-reaching tax incentives for investments in renewable energy projects and activities related to reducing greenhouse gases. The IRA significantly expands the scope of available tax incentives and allows for new techniques to monetize tax credits, with the aim of decreasing carbon emissions and boosting U.S. jobs. These tax credits will be of significant interest to taxpayers engaged in renewable energy projects and businesses, and potentially to potential purchasers of the tax credits.
The IRA restores and expands existing tax credits for wind, solar, biomass, geothermal, hydropower, and hydrokinetic energy projects, and adds new tax credits for, among other things: domestic manufacturing of components of renewable energy property (such as electric vehicle batteries, solar panels, or wind turbines), clean hydrogen, nuclear power, stand-alone energy storage, biogas, microgrid controllers, dynamic glass, and any technology used to generate electricity without greenhouse gas emissions. In order to obtain the full benefits of the available credits, projects must meet minimum wage and apprenticeship requirements, minimum thresholds of domestically produced content, and location requirements.
The IRA also allows two important new monetization techniques.
- Taxpayers who own eligible property may sell the tax credits they generate to any unrelated party, provided the credits are sold only once and are exchanged for cash.
- Alternatively, taxpayers who are eligible for clean hydrogen, carbon capture, or domestic manufacturing credits may elect to receive cash refunds for these credits from the government. (Tax-exempt and governmental entities generally are eligible to receive cash refunds for most other available tax credits.)
In addition to the credits described above, the IRA also expands deductions for energy efficient buildings and includes a number of credits for individuals and homeowners, such as credits for buying electric vehicles and making energy efficient home improvements.
Changes to Tax Creditability of Foreign Taxes
In December, 2021 the IRS and Treasury released regulations changing the criteria for determining what foreign taxes may be credited against a taxpayer’s U.S. tax liability. Although the regulations represent a response to the imposition of so-called “digital taxes” on U.S. tech companies outside of the United States, their potential reach is much wider. The regulations effectively require that, in order to be creditable against U.S. tax liability, a foreign tax must be an “income tax,” which effectively is now defined as a tax imposed under rules that are consistent with U.S. income tax principles. Thus, a determination of whether a foreign income tax (including a withholding tax) is creditable appears to require both: (i) a detailed understanding of the relevant foreign tax regime and (ii) the ability to make a determination whether that regime is sufficiently consistent with U.S. tax principles to warrant creditability.
U.S. taxpayers in certain circumstances are entitled to rely upon specific provisions in tax treaties ensuring that a foreign tax will qualify as an “income tax,” although this safe harbor may not always be applicable (e.g., it does not appear to apply to non-U.S. corporate subsidiaries of multinationals, because such subsidiaries are not themselves U.S. taxpayers). Because the regulations are already effective (they apply for taxable years beginning after December 28, 2021 and so are not prospective), they have created uncertainty among taxpayers as to which foreign taxes were creditable for the 2022 tax year and beyond. The IRS has refused to release an “angel list” of creditable foreign taxes, but in response to political pressure on this point, proposed regulations were released in November of 2022 (and on which taxpayer are entitled to rely currently) that allow for certain specified deviations from U.S. tax principles in an apparent effort to expand the universe of taxes that are creditable. The ultimate impact of the regulations on creditability of foreign taxes remains unclear. Taxes that cannot be credited under the new regulations may still be treated as deductible expenses.
The result of these new regulations are that non-U.S. taxes that previously were considered creditable may not be, with the result that taxpayers with non-U.S. operations may be subject to an unexpectedly high rate of marginal income on their non-U.S. income. The adverse effect will vary corporation by corporation, depending on the sources of a corporation’s income and its international structuring.