Inflation Reduction Act – Impact on Small to Medium-Sized Foreign Businesses

Rödl & Partner Tax Matters Volume 2022-5, published October 4, 2022

On August 16, 2022, President Biden signed into law the Inflation Reduction Act ("IRA"). Although the bill is focused on climate related investments, it also includes changes to corporate tax to pay for the programs. However, we expect that the impact on our clients with activities in the U.S. will be limited. Below is an overview of the tax-related changes.

Book Minimum Tax

The IRA introduces a 15% alternative minimum tax (book minimum tax, BMT) based on financial statement net profits for tax years beginning after December 31, 2022. The net profits will typically be calculated using U.S. GAAP or IFRS, depending on the financial statement of the tested corporation, with some adjustments.

The BMT only applies to corporations who have an adjusted financial statement net income (AFSI) of more than $1 billion on average over a 3-year period.

Once a corporation exceeds the $1 billion threshold, it generally remains subject to BMT even if its AFSI falls below $1 billion.

U.S.-parented multinational groups generally include worldwide income for the $1 billion test.

Foreign-owned multinational group application: If there are U.S. domestic corporate taxpayers that are included in the AFS of a foreign-parented multinational group, the U.S. taxpayers may be liable for the BMT if:

The AFSI of the entire worldwide group exceeds $1 billion, and
The AFSI of the U.S. members of the group, including U.S. branch activities of foreign members, exceeds $100 million.

If a foreign corporation is directly engaged in a trade or business within the United States without using a U.S. subsidiary (i.e. branch activities reported on Form 1120-F), the U.S. activity is treated as a separate domestic corporation that is wholly owned by the foreign corporation.

Examples of adjustments to book income:

If the corporation is a partner in a partnership, the corporation includes the distributive share of AFSI from the partnership.
If the corporation owns CFCs, the corporation includes its share of CFC income, although losses are disallowed and carried forward.
AFSI does not allow a deduction for U.S. federal income taxes.
AFSI generally replaces book depreciation with tax depreciation.
AFSI allows for a reduction based on financial statement net operating loss (NOL) carryovers.

1% Excise Tax on Repurchase of Corporate Stock

There is a perceived tax avoidance when earnings, which could be distributed as taxable dividends, are instead used to repurchase shares and increase individual stock value. The increased stock value might benefit certain shareholders while still allowing for a deferral of tax. To address this issue, the IRA introduced a new 1% tax on the FMV of repurchased shares.

The tax will apply only to "Covered Corporations". A Covered Corporation is any domestic corporation whose stock is traded on an established securities market. The definition of established market is very broad and includes both U.S. national and local exchanges as well as foreign national exchanges.

The 1% tax is applied when there is a repurchase of stock. The broad definition of a repurchase may include the following:

Standard stock redemptions with cash from the corporation paid to repurchase shares.
Certain reorganizations where stock is exchanged for property, although exceptions may apply. Asset-type reorganizations in particular should be reviewed.

Exceptions to the 1% Excise Tax:

Tax-free reorganizations under Sec. 368.

However, it is unclear how the rule applies to partially exempt transactions, for example a generally tax-free transaction also subject to "boot" taxation.

Repurchased stock contributed to certain retirement or employee stock ownership plans.
When the total value of repurchases during the year is below $1 million.
If the repurchase is treated as a dividend under the income tax rules.

Increase in IRS funding

The IRA assigns about $80 billion to the Internal Revenue Service which will be used to hire new auditors, improve customer service and modernize technology. Approximately $46 billion will be used for additional enforcement and an increase in audits of U.S. taxpayers is expected. It is not yet known if the IRS will increase audits in particular fields or on a broad range.

If you have any questions, please contact your local Rödl & Partner representative.

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