On August 16, 2022, House Resolution 5376, the Inflation Reduction Act (IRA), was signed into law. An August 11 Cooley client alert explains some of the tax provisions contained in the IRA, including the 1% excise tax on certain stock buybacks, which may impact special purpose acquisition companies (SPACs) at key points in their life cycle. This blog post highlights the potential application of the excise tax to SPACs.
Overview of the excise tax
The excise tax may apply if a publicly traded US corporation “repurchases” any of its own stock from its shareholders after December 31, 2022. For this purpose, a “repurchase” includes any transaction that is a “redemption” for US federal income tax purposes, and any transaction that the Treasury Department determines is economically similar to such a transaction. This definition would generally include, but is not limited to, corporate buybacks and other transactions in which the corporation acquires its stock from a shareholder in exchange for cash or property.
The excise tax generally is assessed on the difference between the fair market value of any stock of the corporation that is repurchased and the fair market value of any stock of the corporation that is issued in the same taxable year. In other words, for purposes of determining the amount to which the excise tax applies, stock issuances in a taxable year are “netted” against stock repurchases in the same taxable year and, therefore, mitigate the impact of the excise tax under what’s known as the “netting rule.” Thus, the excise tax would not apply in any taxable year in which the fair market value of stock issuances exceeds the fair market value of stock repurchases.
Examples of same-year issuances that could mitigate the excise tax under the netting rule include the following:
- Public offerings of stock, including a SPAC’s initial public offering.
- Private investment in public equity offerings.
- Stock issued to acquire other companies in acquisitive transactions.
- Stock issued as compensation, including upon option exercises.
- Stock issued upon warrant exercises or convertible debt conversions.
The excise tax rules contain certain exceptions, none of which by their terms are likely to apply to the types of SPAC stock repurchases that typically occur prior to, or concurrent with, a SPAC business combination – also known as a “deSPAC transaction” – or a liquidation of a SPAC.
Application of the excise tax to SPACs
A SPAC issues publicly traded stock to raise capital with which to undertake a deSPAC transaction. Public shareholders of the SPAC typically have the right to have their stock redeemed if they do not approve of the deSPAC transaction, or to have their money returned if a deSPAC transaction is not completed within a prescribed time period. These rights potentially can trigger the excise tax, even when the SPAC shares that carry such rights were issued before enactment of the IRA.
The excise tax may be applicable to a US SPAC, including a non-US SPAC that domesticates to the US in connection with a deSPAC transaction, to the extent holders of publicly traded SPAC stock exercise their rights to be redeemed after December 31, 2022 (and the netting rule does not fully eliminate the excise tax). Non-US SPACs that do not domesticate to the US generally should not be subject to the excise tax.
Note: Pending further guidance, it appears that redemptions by a non-US SPAC of its stock prior to a domestication would not cause the SPAC to be subject to the excise tax, but redemptions after a domestication could subject the SPAC to the excise tax.
If a deSPAC transaction is structured such that the SPAC does not issue a significant amount of stock in the transaction, the deSPAC transaction may not produce significant offsetting stock issuances to mitigate the excise tax under the netting rule. For example, a deSPAC transaction that is structured as an “UP-C” or a “double dummy,” or in which the operating company is in form the acquirer of the SPAC, may not result in significant stock issuances that could be netted against redemptions. In addition, as mentioned above, if stock issuances do not occur in the same taxable year as the relevant stock repurchases, such issuances would not reduce the associated excise tax under the netting rule.
Pending further guidance, the excise tax might apply to the liquidation of a US SPAC that does not consummate a deSPAC transaction. In such event, the excise tax would deplete funds available for return to investors pursuant to the liquidation.
Note:A SPAC that intends to liquidate should consider liquidating on or prior to December 31, 2022, before the excise tax goes into effect. For liquidations after 2022, it may be possible to structure payments to public shareholders as liquidating distributions that are not considered repurchases if and to the extent provided in any forthcoming guidance.
A US SPAC, including a non-US SPAC that domesticates to the US, could be subject to the excise tax if the SPAC repurchases its stock after December 31, 2022, including actual and deemed repurchases in connection with a deSPAC transaction and upon a liquidation of the SPAC. The ability to “net” issuances of SPAC stock that are made in the same taxable year of the repurchases, however, may reduce or eliminate the excise tax.
To the extent that the enactment of the excise tax was motivated by concerns that companies can manipulate their stock price and earnings per share through buybacks (including to the benefit of executives with share-based compensation), some commentators have argued that the excise tax should not apply to the return of capital to public shareholders pursuant to the terms of their SPAC shares in connection with the completion (or failure to complete) a deSPAC transaction. SPAC shares do not present the same possibilities for manipulation because they are subject to redemption rights from the outset, the redemption rights are exercised at the option of the public shareholders (not the SPAC) and, when exercised, the SPAC merely returns capital to public shareholders – as contrasted with distributing profits that could otherwise be paid as dividends. The SPAC generally is not permitted to deploy capital raised in its initial public offering in any manner other than completing a deSPAC transaction, returning capital to its public shareholders, or both. Nevertheless, it is not clear whether the US government will provide any relief for SPACs.
In the meantime, SPACs and their sponsors should consider steps to address the potential application of the excise tax, including the timing and structuring of deSPAC transactions and SPAC liquidations, the inclusion of risk factors in public disclosures, and contractual terms to allow payment of the tax.
 In addition, the excise tax may be imposed on certain US affiliates of publicly traded non-US corporations and non-US “inverted” corporations in connection with repurchases of such non-US corporations’ stock.