On December 27, 2022, Treasury released Notices 2023-7 and 2023-2 (the "Notices"). The Notices provide initial guidance on the 15% corporate minimum tax on the book income of large corporations (the "CAMT") and the non-deductible 1% excise tax on certain corporate stock buybacks by publicly traded companies (the "Buyback Tax") that were included in the Inflation Reduction Act (the "IRA").1 The CAMT and the Buyback Tax both are effective January 1, 2023. The CAMT Notice provides immediate guidance on time-sensitive areas of uncertainty, such as tax-free transactions that may give rise to financial statement income, and requests comments on over 30 specific interpretative issues. The Buyback Tax Notice provides helpful guidance in several areas but subjects a wider range of transactions to the tax than many had hoped.
The Notices are intended to provide interim guidance until proposed Treasury Regulations are promulgated. Until such time, Taxpayers can rely on the Notices.
CAMT Notice
Key Takeaways
The CAMT Notice addresses the following items which are outlined in greater detail below.
- Future Mark-to-Market Guidance. While the
Notice does not provide guidance regarding the book/tax difference
that can be created when assets are marked to market for financial
accounting purposes but not tax purposes (leading to the potential
for CAMT on unrealized gains), Treasury and IRS indicated that
subsequent interim guidance will be issued to address this issue
and helpfully noted that the upcoming guidance would be intended to
help avoid "substantial unintended adverse consequences to the
insurance industry and certain other industries." The Notice
specifically asks for comments on what type of guidance should be
issued to address this issue.
- Relief for Tax-Free and Certain Other
Transactions. The Notice provides relief in a number of
situations where book/tax disparities could arise. In these
situations, pursuant to the Notice, book income would essentially
be adjusted to match (or more closely match) taxable income for
purposes of the CAMT. These adjustments generally would apply to
book income generated by (i) fully tax-free or tax-deferred
transactions, (ii) certain cancellation of indebtedness
transactions where income is exempt from regular tax and (iii)
emergence from bankruptcy. The relief, among other things, would
remove obstacles to effecting tax-free/tax-deferred transactions,
such as tax-free split-offs. In addition, adjustments generally
would be made to match book depreciation to the more accelerated
tax depreciation with respect to tangible property.
- Clarification in Determination of Applicable
Corporation Status. The Notice provides additional
clarifications and rules relevant to the determination of
applicable corporation status, including rules relevant to a
corporation that is (i) a member of a tax consolidated group, (ii)
a partner of a partnership or (iii) a member of a group that
acquires new members (or a new group) or has members leave the
group.
- Safe Harbor for Small Corporations. The Notice provides a safe harbor for smaller corporations to test whether they are applicable corporations using a simplified method of determining AFSI.
Mark-to-Market Financial Statement Items
- Items that are marked to market for financial statement
purposes (but not tax purposes) may produce temporary book-to-tax
income differences that are subject to CAMT. The application of
CAMT to unrealized mark-to-market income would amount to a tax on
unrealized gains.
- The CAMT Notice does not provide guidance on financial
statement mark-to-market issues, but it includes a helpful
statement that Treasury expects to issue additional interim
guidance on these issues, intended to help avoid "substantial
unintended adverse consequences to the insurance industry and
certain other industries."
- Topics to be covered by future mark-to-market guidance include
the treatment of certain items reflected in Other Comprehensive
Income on an applicable financial statement, and the treatment of
embedded derivatives under reinsurance contracts. Relief in these
areas, all of which have the potential to cause significant
timing-based volatility in the minimum tax calculation, will be
helpful to insurance groups and other taxpayers that mark assets to
market on their balance sheets but do not do so (and may not be
permitted to do so) for tax purposes.
Comment: The IRS jumping ahead on this important issue should provide meaningful comfort to taxpayers with significant mark-to-market gains on their financials that future interim and final guidance will mitigate unintended CAMT friction in relation to such financial gains.
Relief for Tax-Free Transactions
- The CAMT Notice provides immediate relief for taxpayers that
engage in tax-free transactions, called "Covered
Nonrecognition Transactions," that result in financial
accounting gain. Applicable financial statement ("AFS")
gain or loss resulting from these transactions is not taken into
account for purposes of calculating a taxpayer's applicable
financial statement income ("AFSI"). In addition, any
resulting increase or decrease in the financial accounting basis
will be disregarded when calculating AFSI gain or loss from a
future disposition of such property.
- Covered Nonrecognition Transactions are defined broadly to
include transactions that qualify for nonrecognition treatment for
U.S. federal income tax purposes under the corporate spin-off,
split-off, reorganization, formation and liquidation rules, as well
as in relation to contributions and distributions to partnerships
and LLCs.
- Importantly, a Covered Nonrecognition Transaction must not
result in any amount of recognized gain or loss with regard to the
relevant corporation or partnership. Accordingly, until additional
guidance is issued, a transaction that is taxable in part to the
relevant corporation or partnership because of the receipt of cash
or other property would not be protected by these rules. The
Treasury and IRS have requested further comments on this
issue.
Comment: The guidance aligns the CAMT rules with U.S. federal income tax principles by preventing a tax-free transaction that results in a book income or loss event from affecting the calculation of AFSI. Some asymmetry remains between the book minimum tax rules and nonrecognition under the Code, however, as the relief does not extend to partially tax-free transactions, for which any financial accounting gain or loss or basis increase or decrease will still impact AFSI despite the lack of corresponding tax gain or loss. In requesting comments on this issue, the Treasury and IRS seem amenable to achieving consistency across nonrecognition transactions.
- Protection for spin-offs and split-offs that include
deleveraging transactions. In an example dealing with a
split-off that includes a deleveraging transaction involving a
transfer of spinco cash and securities to the distributing
corporation's creditors which is tax free to distributing under
Sections 361(b) and 361(c)(3), the transactions qualify as a
Covered Nonrecognition Transaction. This is so even if the
creditors take into account income, as the Covered Nonrecognition
Transaction rules only look to tax treatment of the relevant
corporation (or partnership).
- Series of transactions with some taxable
components. Each component transaction that is part of a
series of transactions is tested separately to qualify for Covered
Nonrecognition Transaction status based on all relevant provisions
of the Code and general principles of tax law, such as the step
transaction doctrine. For example, in a spin-off that is preceded
by a tax-free contribution of assets and liabilities to the spinco,
a tax on the distributing corporation attributable to a failed
tax-free transfer of spinco securities to the distributing
corporation's creditors will not cause the other steps to fail
to qualify as a Covered Nonrecognition Transaction.
On the other hand, the Notice provides an example where a partner contributes property to a partnership and the partnership distributes cash to the partner that is recast for tax purposes as a part disguised sale and part tax-free contribution. The Notice concludes that the component parts (contribution and distribution) are stepped together as one transaction resulting in a single transaction that is in part a taxable transaction and therefore the whole transaction fails to qualify as a Covered Nonrecognition Transaction.
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Footnote
1. For more information on the Inflation Reduction Act of 2022, please see our client update at: https://www.debevoise.com/insights/publications/2022/08/senate-passes-15-corporate-minimum-tax.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
