Tax Talks

The Proskauer Tax Blog

IRS and Treasury Provide Guidance on the Excise Tax on Repurchases of Corporate Stock under Section 4501

On December 27, 2022, the Internal Revenue Service (“IRS”) and the U.S. Department of the Treasury (the “Treasury”) released Notice 2023-2 (the “Notice”), which provides guidance regarding the application of the 1% excise tax on corporate stock buybacks under recently enacted section 4501 (the “Tax”).[1]  Taxpayers may rely on the Notice until proposed regulations are published.  The Notice also contains a request for comments on the rules included in the Notice and rules not included in the Notice.

The Treasury and the IRS took a literal interpretation of the statute; thus, the Tax applies broadly to stock repurchases and other transactions that are not traditionally viewed as stock buybacks, including a repurchase of mandatorily redeemable preferred stock (even if such stock was issued before January 1, 2023).  Special purpose acquisition companies (“SPACs”) will need to analyze whether a transaction is subject to the Tax under the general rules as the Notice does not include any special guidance for SPACs.  However, SPACs did receive comfort that redemptions that take place in the same year as a “complete liquidation” under section 331 are not subject to the Tax.

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New Proposed Regulations Would Impact the Determination of Domestically Controlled REIT and Structures for Sovereign Wealth Funds’ US Real Estate Investments

On December 28, 2022, the Internal Revenue Service (the “IRS”) and the Treasury Department released proposed regulations (the “Proposed Regulations”) under sections 892 and 897 of the Internal Revenue Code (the “Code”).[1] If finalized as proposed, the Proposed Regulations would prevent a non-U.S. person from investing through a wholly-owned U.S. corporation in order to cause a real estate investment trust (“REIT”) to be “domestically controlled”.  The ability of a non-U.S. person to invest through a U.S. corporation to cause a REIT to be domestically controlled had been approved in a private letter ruling, and is a structure that is widely used.  The Proposed Regulations would also apply to existing REITs that rely on a non-U.S. owned U.S. corporation for their domestically-controlled status, and suggest that the IRS could attack such a structure under current law (i.e., even if the Proposed Regulations are not finalized).

The Proposed Regulations also clarify that in determining a REIT’s domestically controlled status, a foreign partnership would be looked through and “qualified foreign pension funds” (“QFPFs”) and entities that are wholly owned by one or more QFPFs (“QCEs”) would be treated as foreign persons.  Lastly, the Proposed Regulations also provide a helpful set of rules for sovereign wealth fund investors that indirectly invest in U.S. real estate. Continue Reading

U.S. District Court Finds Mayo Clinic Qualifies as an “Educational Organization”; Awards $11.5M UBTI Refund

Tax-exempt organizations, while not generally subject to tax, are subject to tax on their “unrelated business taxable income” (“UBTI”).  One category of UBTI is debt-financed income; that is, a tax-exempt organization that borrows money directly or through a partnership and uses that money to make an investment is generally subject to tax on a portion of the income or gain from that investment.[1]  However, under section 514(c)(9),[2] “educational organizations” are not subject to tax on their debt-financed income from certain real estate investments.

The Mayo Clinic in Minnesota is one of the country’s leading hospitals.  Between 2003 and 2012, the Mayo Clinic was a partner in a partnership that borrowed money to make real estate investments.[3]

On November 22, 2022, U.S. District Court for the district of Minnesota held that the Mayo Clinic qualified as an educational organization within the meaning of section 514(c)(9) and, therefore, was not subject to tax on the debt-financed income from the partnership.[4]

To read the full post, please visit our Not For Profit/Exempt Organizations Blog.

 

[1] IRC §§ 511(a), 512, 514(a)(1).

[2] All references to section numbers are to the Internal Revenue Code, unless otherwise specified.

[3] Mayo Clinic v. United States, 412 F. Supp. 3d 1038, 1042-43 (D. Minn. 2019).

[4] Mayo Clinic v. United States, 2022 BL 419596 (D. Minn. Nov. 22, 2022).

Massive U-Turn on Mini Budget

As has been widely reported, a number of the Mini Budget proposals (summarised in our recent Tax Blog) have been scrapped.  The new Chancellor of the Exchequer Jeremy Hunt announced these measures claiming that they are estimated to raise £32 billion in taxes every year.  More tax rises and spending cuts are expected to be announced by the Chancellor on 31 October which will be accompanied by Office of Budget Responsibility forecasts.

These include:

  • the proposed removal of the 45% additional rate of UK income tax from 6 April 2023
  • the proposed reduction of the basic rate of UK income tax from 20% to 19% from 6 April 2023
  • the proposed reduction in the UK dividend income tax rate by 1.25% from 6 April 2023
  • the cancelling of the planned increase to UK corporation tax, which will now increase to 25% from 1 April 2023 as had previously been intended
  • the proposed repeal of existing IR35 legislation from 6 April 2023
  • the VAT-free shopping scheme for non-UK visitors.

Some of the previous mini budget proposals that have not been amended include:

  • 0% rate of stamp duty land tax on residential properties applying to the first £250,000
  • the previously planned health and social levy of 1.25% won’t take effect
  • the rate of employee and employer national insurance contributions decreasing by 1.25% from 6 November 2022.

Please contact any member of our UK tax group if you have any queries about how this Budget will affect your business.

UK Mini Budget 2022

UK Mini Budget 2022

The Chancellor today unveiled the UK’s 2022 Growth Plan which has been described as being “the biggest package of tax cuts in generations”.  We have summarised here the tax changes that we think will be of interest to our client base.

  • UK corporation tax: the main corporation tax rate that was due to increase to 25% for companies with annual profits in excess of £250,000 from the start of the 2023/2024 tax year will remain at 19%.
  • Diverted Profit Tax: the planned increase in the rate of diverted profit tax to 31% has been cancelled with the tax due to remain at a rate of 25%.
  • Annual Investment Allowance: the threshold for the annual investment allowance (which allows for a 100% deduction for UK companies on qualifying expenditure on plant and machinery) has been permanently set at £1 million and will not, as had been planned, reduce to £200,000.
  • IR35 (off-payroll working rules): the Government has confirmed that is repealing the current IR35 regime from 6 April 2023. The current IR35 regime requires the fee-paying party to determine whether its relationship with workers providing services via an intermediary resembles an employment or a self-employment arrangement.  The responsibility will now shift back to the service provider to determine their own employment status and ensure that the appropriate amount of tax and national insurance contributions are paid.
  • National Insurance Contributions: the rate of employee and employer national insurance contributions will decrease by 1.25% from 6 November 2022, reversing the increase introduced in April.
  • New Low Tax Investment Zones: the government intends to create new low tax investment zones which would result in reduced taxes for businesses in designated zones for a 10 year period. The proposed tax incentives include (i) a 100% first year enhanced capital allowance relief for plant and machinery used within designated sites, (ii) an accelerated enhanced structures and buildings allowance relief of 20% per year, (iii) no stamp duty land tax on newly occupied commercial premises, and (iv) certain employer NIC concessions.  There are currently 38 sites in England identified as potential investment zones.
  • Company Share Option Plan (CSOP) options: the limit for the amount of company share option plan options which qualifying companies can issue to each employee will double from £30,000 to £60,000.
  • Seed Enterprise Investment Schemes (SEIS): there have been a number of extensions to the SEIS regime which will apply from 6 April 2023 including that (i) companies will be able to raise up to £250,000 in investment (an increase of £100,000), (ii) the gross asset limit will be increased from £200,000 to £250,000, (iii) the trading time limit has been extended from two to three years, and (iv) the individual annual investor limit will double to £200,000.
  • Certain personal tax measures:
    • the basic income tax rate will reduce to 19% from 6 April 2023;
    • the additional income tax rate of 45% will be abolished from 6 April 2023;
    • the planned health and social levy of 1.25% which was due to come into force in April 2023 will no longer take effect; and
    • the dividend tax rate will be reduced by 1.25% from 6 April 2023 representing a reversal of the increase introduced earlier this year.
  • Stamp Duty Land Tax: the 0% residential rate will increase to the first £250,000 (previously £125,000).

Please contact any member of our UK tax group if you have any queries about how this Budget will affect your business.

President Biden Signs Inflation Reduction Act into Law

On August 16, 2022 President Biden signed the Inflation Reduction Act of 2022 (the “IRA”) into law.

The IRA  includes a 15% corporate alternative minimum tax, a 1% excise tax on stock buybacks and a two-year extension of the excess business loss limitation rules. The IRA also contains a number of energy tax provisions.

I. Main Tax Provisions

  1. 15% corporate alternative minimum tax

The IRA imposes a 15% corporate alternative minimum tax based on the financial statement income of corporations or their predecessors with a three-year taxable year average annual adjusted financial statement income in excess of $1 billion.  The corporate alternative minimum tax is effective for tax years beginning after December 31, 2022.

The 15% corporate alternative minimum tax is equal to the difference between a corporation’s “adjusted financial statement income” for the taxable year and the corporation’s “alternative minimum tax foreign tax credit” for the taxable year. A corporation’s tax liability is the greater of its regular tax liability and the 15% alternative minimum tax.

A corporation’s annual adjusted financial statement income is based on its book income, with certain adjustments, such as to account for a corporation’s activities undertaken indirectly through a consolidated group, a partnership, or a disregarded entity. The adjusted financial statement income is also adjusted for certain taxes, such as federal income and excess profits taxes, and accelerated depreciation.

The average annual adjusted financial statement income of a corporation includes any other entities that are treated as a single employer with the corporation under section 52 to determine whether the corporation satisfies the $1 billion threshold.[1] This may cause corporations with less than $1 billion of adjusted financial statement income to be subject to the tax; however, portfolio companies of an investment fund generally will not be aggregated with other portfolio companies for purposes of the $1 billion threshold.

For corporations in existence for less than three years, the three-year income test is applied over the period during which the corporation was in existence. The adjusted financial statement income of a corporation with a taxable year shorter than 12 months is applied on an annualized basis.

Corporations  generally are eligible to claim net operating losses and tax credits against the alternative minimum tax. Adjusted financial statement income is reduced by the lesser of (i) the aggregate amount of financial statement net operating loss carryovers to the taxable year and (ii) 80% of adjusted financial statement income (reflecting the tax rule that net operating losses are permitted to offset only 80% of taxable income). The IRA’s clean energy credits and other business credits would be limited to 75% of a corporation’s alternative minimum tax. In addition, a corporation is eligible to claim a credit for corporate alternative minimum tax paid in prior years against the regular corporate tax if the regular tax liability exceeds 15% of the corporation’s adjusted financial statement income.

The corporate alternative minimum tax applies to a foreign-parented corporation (i.e., a U.S. subsidiary of a foreign parent) if its three-year taxable year average annual adjusted financial statement income exceeds $100 million and that of the foreign-parented multinational group exceeds $1 billion.[2] It is not clear whether the $100 million threshold is tested on a separate basis or on aggregate basis so that, for example, the adjusted financial statement income of two domestic subsidiaries of a common foreign parent (neither of which would separately meet the $100 million threshold) would be aggregated. The Secretary has the authority to issue regulations on the threshold tests.

The corporate alternative minimum tax does not apply to S corporations, regulated investment companies, or real estate investment trusts. In addition, the tax does not apply to corporations that have had a change in ownership or has a specified number of consecutive taxable years that will be determined by the Secretary.

The corporate alternative minimum tax does not conform to the “qualified domestic minimum top-up tax” proposed by the OECD/G20. As a result, if the OECD/G20 rules are adopted in their current form, the foreign subsidiaries of U.S. multinationals located or doing business in OECD countries could be subject to additional taxes by those jurisdictions.

  1. Excise tax on corporate stock buybacks

The IRA imposes a nondeductible 1% excise tax on stock repurchases by publicly traded corporations and certain “surrogate foreign corporations”.[3] The tax applies to repurchases of stock after December 31, 2022.

The tax is imposed on the fair market value of the stock “repurchased” by the corporation during the tax year, reduced by value of stock issued by the corporation during the tax year (including those issued to the employees).  The term “repurchase” is defined as a redemption within the meaning of section 317(b), which is a transaction in which a corporation acquires its stock from a shareholder (and is not a dividend for federal income tax purposes).

The tax is also imposed on a corporation if its “specified affiliate” repurchases the corporation’s stock from another person (including another “specified affiliate”). The term “specified affiliate” is defined as (i) any corporation in which the taxpayer-corporation directly or indirectly owns more than 50% of the stock by vote or value; and (ii) any partnership in which the taxpayer-corporation directly or indirectly holds more than 50% of the capital or profits interests.

In addition, the tax is imposed on a specified affiliate (i.e., a domestic subsidiary) of a non-U.S. publicly traded corporation that purchases the non-U.S. corporation’s stock from another person (excluding another specified affiliate of the non-U.S. corporation).

If a surrogate foreign corporation (or its specified affiliate) repurchases its stock, the tax is imposed on the surrogate foreign corporation’s expatriated entity (i.e., its U.S. subsidiary).

Repurchases that are (i) dividends for  federal income tax purposes, (ii) part of tax-free reorganizations, (iii) made to contribute stock to an employee pension plan or ESOP, (iv) made by a dealer in securities in the ordinary course of business, or (v) made by a RIC or a REIT is not be subject to the excise tax.  Repurchases that are less than $1 million in a year is also excluded.

The IRS has the authority to issue regulations to prevent abuse through the above exclusions and apply the rules to other classes of stock and surrogate foreign corporations. It is not clear how broad that authority is intended to be and whether the Secretary will issue guidance on certain common transactions, such as redemptions of preferred stock or of a non-publicly traded subsidiary’s debt that is exchangeable for its publicly-traded parent’s stock.

  1. Extension of excess business loss limitation rules

Under pre-IRA law, for taxable years that begin before January 1, 2027, non-corporate taxpayers may not deduct excess business loss (generally, net business deductions over business income) if the loss is in excess of $250,000 ($500,000 in the case of a joint return), indexed for inflation.  The excess loss becomes a net operating loss in subsequent years and is available to offset 80% of taxable income each year.

The IRA extends the excess business loss limitation rules to taxable years that begin before January 1, 2029.

The IRA’s amendments apply to taxable years beginning after December 31, 2026.

II.Energy Tax Provisions

  1. Extension and expansion of production tax credit

Section 45 of the Internal Revenue Code provides a tax credit for renewable electricity production. To be eligible for the credit, a taxpayer must (i) produce electricity from renewable energy resources at certain facilities during a ten-year period beginning on the date the facility was placed in service and (ii) sell that renewable electricity to an unrelated person. Under pre-IRA law law, the credit was not available for renewable electricity produced at facilities whose construction began after December 31, 2021.

The IRA extends the credit for renewable electricity produced at facilities whose construction begins before January 1, 2025. The credit for electricity produced by solar power –which expired in 2016—is reinstated, as extended by the IRA.

The IRA also increases the credit from 1.5 to 3 cents per kilowatt hour of electricity produced.

A taxpayer will be entitled to increase its production tax credit by 500% if (i) its facility’s maximum net output is less than 1 megawatt, (ii) it meets the IRA’s prevailing wage and apprenticeship requirements,[4] and (iii) the construction of its facility begins within fifty-nine days after the Secretary publishes guidance on these requirements.

In addition, the IRA adds a 10% bonus credit for a taxpayer (i) that certifies that any steel, iron, or manufactured product that is a component of its facility was produced in the United States (the “domestic content bonus credit”) or (ii) whose facility is in an energy community (the “energy community bonus credit”).[5]

  1. Extension, expansion, and reduction of investment tax credit

Section 48(a) provides an investment tax credit for the installation of renewable energy property. The amount of the credit is equal to a certain percentage (described below) of the property’s tax basis. Under pre-IRA law, the credit was limited to property whose construction began before January 1, 2024.

The IRA extends the credit to property whose construction begins before January 1, 2025. This period is extended to January 1, 2035 for geothermal property projects. The IRA also allows the investment tax credit for energy storage technology, qualified biogas property, and microgrid controllers.

The IRA reduces the base credit from 30% to 6% for qualified fuel cell property; energy property whose construction begins before January 1, 2025; qualified small wind energy property; waste energy recovery property; energy storage technology; qualified biogas property; microgrid controllers; and qualified facilities that a taxpayer elects to treat as energy property. For all other types of energy property, the base credit is reduced from 10% to 2%.

A taxpayer is entitled to increase this base credit by 500% (for a total investment tax credit of 30%) if (i) its facility’s maximum net output is less than 1 megawatt of electrical or thermal energy, (ii) it meets the prevailing wage and apprenticeship requirements, and (iii) its facility begins construction within fifty-nine days after the Secretary publishes guidance on these requirements.

In addition, a taxpayer is entitled to a 10% domestic content bonus credit and 10% energy community bonus credit (subject to the same requirements as for bonus credits under section 45). The IRA also adds a (i) 10% bonus credit for projects undertaken in a facility with a maximum net output of 5 megawatts and is located in low-income communities or on Indian land, and (ii) 20% bonus credit if the facility is part of a qualified low-income building project or qualified low-income benefit project.

  1. Section 45Q (Carbon Oxide Sequestration Credit)

Section 45Q provides a tax credit for each metric ton of qualified carbon oxide (“QCO”) captured using carbon capture equipment and either disposed of in secure geological storage or used as a tertiary injection in certain oil or natural gas recovery projects.  While eligibility for the section 45Q credit under pre-IRA law required that projects begin construction before January 1, 2026, the IRA extends credit eligibility to those carbon sequestration projects that commence construction before January 1, 2033.

The IRA increases the amount of tax credits for projects that meet certain wage and apprenticeship requirements. Specifically, the IRA increases the amount of section 45Q credits for industrial facilities and power plants to $85/metric ton for QCO stored in geologic formations, $60/metric ton for the use of captured carbon emissions, and $60/metric ton for QCO stored in oil and gas fields.  With respect to direct air capture projects, the IRAincreases the credit to $180/metric ton for projects that store captured QCO in secure geologic formations, $130/metric ton for carbon utilization, and $130/metric ton for QCO stored in oil and gas fields.  The changes in the amount of the credit appkies to facilities or equipment placed in service after December 31, 2022.

The IRA also decreases the minimum annual QCO capture requirements for credit eligibility to 1,000 metric tons (from 100,000 metric tons) for direct air capture facilities, 18,750 metric tons (from 500,000 metric tons) of QCO for an electricity generating facility that has a minimum design capture capacity of 75% of “baseline carbon oxide” and 12,500 metric tons (from 100,000 metric tons) for all other facilities.  These changes to the minimum capture requirements apply to facilities or equipment that begin construction after the date of enactment.

  1. Introduction of zero-emission nuclear power production credit

The IRA introduces, as new section 45U, a credit for zero-emission nuclear power production.

The credit for a taxable year is the amount by which 3 cents multiplied by the kilowatt hours of electricity produced by a taxpayer at a qualified nuclear power facility and sold by the taxpayer to an unrelated person during the taxable year exceeds the “reduction amount” for that taxable year.[6]

In addition, a taxpayer is entitled to increase this base credit by 500% if it meets the prevailing wage requirements.

New section 45U applies to taxable years beginning after December 31, 2032.

  1. Biodiesel, Alternative Fuels, and Aviation Fuel Credit

The IRA extends the pre-IRA tax credit for biodiesel and renewable diesel at $1.00/gallon and the pre-IRA tax credit for alternative fuels at $.50/gallon through the end of 2024.  Additionally, the IRA creates a new tax credit for sustainable aviation fuel of between $1.25/gallon and $1.75/gallon.  Eligibility for the aviation fuel credit depends on whether the aviation fuel reduces lifecycle greenhouse gas emissions by at least 50%, which corresponds to a $1.25/gallon credit (with an additional $0.01/gallon for each percentage point above the 50% reduction, resulting in a maximum possible credit of $1.75/gallon). This credit applies to sales or uses of qualified aviation fuel before the end of 2024.

  1. Introduction of clean hydrogen credit

The IRA introduces, as new section 45V, a clean hydrogen production tax credit. To be eligible, a taxpayer must produce the clean hydrogen after December 31, 2022 in facilities whose construction begins before January 1, 2033.

The credit for the taxable year is equal to the kilograms of qualified clean hydrogen produced by the taxpayer during the taxable year at a qualified clean hydrogen production facility during the ten-year period beginning on the date the facility was originally placed in service, multiplied by the “applicable amount” with respect to such hydrogen.[7]

The “applicable amount” is equal to the “applicable percentage” of $0.60. The “applicable percentage” is equal to:

  • 20% for qualified clean hydrogen produced through a process that results in a lifecycle greenhouse gas emissions rate between 2.5 and 4 kilograms of CO₂e per kilogram of hydrogen;
  • 25% for qualified clean hydrogen produced through a process that results in a lifecycle greenhouse gas emissions rate between 1.5 and 2.5 kilograms of CO₂e per kilogram of hydrogen;
  • 4% for qualified clean hydrogen produced through a process that results in a lifecycle greenhouse gas emissions rate between 0.45 and 1.5 kilograms of CO₂e per kilogram of hydrogen; and
  • 100% for qualified clean hydrogen produced through a process that results in a lifecycle greenhouse gas emissions rate of less than 0.45 kilograms of CO₂e per kilogram of hydrogen.

A taxpayer is entitled to increase this base credit by 500% if (i) it meets the prevailing wage and apprenticeship requirements or (ii) it meets the prevailing wage requirements, and its facility begins construction within fifty-nine days after the Secretary publishes guidance on the prevailing wage and apprenticeship requirements.

 _____________

[1] All references to section are to the Internal Revenue Code.

[2] The IRA defines “foreign-parented multinational group” as a group of two or more entities in a taxable year, in which (i) at least one is a domestic corporation and the other is a foreign corporation, (ii) the entities are included in the same applicable financial statement for the taxable year, and (iii) either (a) their common parent is a foreign corporation or (b) if there is no common parent, they are treated as having a common parent that is a foreign corporation under rules to be prescribed by the Secretary.

To determine whether a foreign-parented multinational group exists, the IRA treats a foreign corporation’s trade or business as a separate, wholly-owned domestic corporation.

[3] A surrogate foreign corporation is a foreign corporation (i) that has acquired substantially all of the properties held directly or indirectly by a domestic corporation or substantially all of the properties constituting a trade or business of a domestic partnership; (ii) the acquisition of at least 60% of the stock (by vote or value) of the entity is held, (a) in the case of an acquisition with respect to a domestic corporation, by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation, (b) in the case of an acquisition with respect to a domestic partnership, by former partners of the domestic partnership by reason of holding a capital or profits interest in the domestic partnership or (c) in the case of an acquisition with respect to a domestic partnership, by former partners of the domestic partnership by reason of holding a capital or profits interest in the domestic partnership; and (iii) after the acquisition the “expanded affiliated group” which includes the entity does not have substantial business activities in the foreign country in which, or under the law of which, the entity is created or organized, when compared to the total business activities of such expanded affiliated group.

[4] The IRA requires new prevailing wage and apprenticeship requirements to be satisfied in order for a taxpayer to be eligible for increased credits. To satisfy the prevailing wage requirements, a taxpayer is required to ensure that any laborers and mechanics employed by contractors or subcontractors to construct, alter or repair the taxpayer’s facility are paid at least prevailing local wages with respect to those activities. To satisfy the apprenticeship requirements, “qualified apprentices” are required to construct a certain percentage of the taxpayer’s facilities (10% for facilities whose construction begins before January 1, 2023 and 15% for facilities whose construction begins on January 1, 2024 or after). A “qualified apprentice” is a person employed by a contractor or subcontractor to work on a taxpayer’s facilities and is participating in a registered apprenticeship program.

[5] An “energy community” is a brownfield site; an area which has (or had at any time after December 31, 1999) significant employment related to the extraction, processing, transport, or storage of coal, oil, or natural gas; and a census tract in which a coal mine closed or was retired after December 31, 1999 (or an adjoining census tract).

[6] A “qualified nuclear power facility” is any nuclear facility that is owned by the taxpayer, that uses nuclear energy to produce electricity, that is not an “advanced nuclear power facility” as described in section 45J(d)(1),  and is placed in service before the date that new section 45U is enacted.

“Reduction amount” is, for any taxable year, the amount equal to (x) the lesser of (i) the product of 3 cents multiplied by the kilowatt hours of electricity produced by a taxpayer at a qualified nuclear power facility and sold by the taxpayer to an unrelated person during the taxable year and (ii) the amount equal to 80% of the excess of the gross receipts from any electricity produced by the facility (excluding an advanced nuclear power facility) and sold to an unrelated person during the taxable year; (y) over the amount equal to the product of 2.5 cents multiplied by the kilowatt hours of electricity produced by the taxpayer at a qualified nuclear power facility and sold by the taxpayer to an unrelated person during the taxable year.

[7] “Qualified clean hydrogen” is hydrogen that is produced (i) through a process that results in a lifecycle greenhouse gas emissions rate of no more than 4 kilograms of CO₂e per kilogram of hydrogen, (ii) in the United States, (iii) in the ordinary course of the taxpayer’s trade or business, (iv) for sale or use, and (v) whose production and sale or use is verified by an unrelated party. The IRA does not explain what “verified by an unrelated party” means.

Senate Democrats Reach Agreement to Pass Inflation Reduction Act

On August 7, the Senate passed the Inflation Reduction Act of 2022 (the “IRA”).  The tax provisions in the bill that was passed vary from the bill that was originally released on July 27, 2022 by Senator Joe Manchin (D-W.Va.) and Senate Majority Leader Chuck Schumer (D-NY) in four significant respects:  The carried interest proposal was removed, the 15% corporate alternative minimum tax now allows accelerated depreciation deductions to reduce annual adjusted financial statement income (as explained below), a 1% excise tax on stock buybacks was added, and the excess business loss limitation rules were extended by two years. This blog post summarizes the version of the IRA that was passed by the Senate.

  1. Removal of carried interest proposal

As originally introduced, the IRA would have extended the holding period for long-term capital gain treatment for certain carried interests from three years to five years (or, in certain circumstances, longer).

The carried interest provision has been removed from the IRA.

  1. Modification of corporate alternative minimum tax

The IRA would impose a 15% corporate alternative minimum tax based on the financial statement income of corporations or their predecessors with a three-year taxable year average annual adjusted financial statement income in excess of $1 billion.  The corporate alternative minimum tax would be effective for tax years beginning after December 31, 2022.

The 15% corporate alternative minimum tax would be equal to the difference between a corporation’s “adjusted financial statement income” for the taxable year and the corporation’s “alternative minimum tax foreign tax credit” for the taxable year. A corporation’s tax liability would be the greater of its regular tax liability and the 15% alternative minimum tax.

As originally proposed, the IRA would not have allowed a corporation to reduce its adjusted financial statement income by taking into account accelerated deductions for depreciation. As modified, the IRA would exempt accelerated depreciation deductions from a corporation’s adjusted financial statement income.

A corporation’s annual adjusted financial statement income would be based on its book income, with certain adjustments, such as to account for a corporation’s activities undertaken indirectly through a consolidated group, a partnership, or a disregarded entity. The adjusted financial statement income would also be adjusted for certain taxes, such as federal income and excess profits taxes, and accelerated depreciation.

The average annual adjusted financial statement income of a corporation would include any other entities that are treated as a single employer with the corporation under section 52 to determine whether the corporation satisfies the $1 billion threshold.[1] This may cause corporations with less than $1 billion of adjusted financial statement income to be subject to the proposal.

As originally proposed, the IRA was unclear whether the portfolio companies of an investment fund would be aggregated with the fund’s ultimate parent under section 52 to determine whether each company would satisfy the $1 billion threshold. An interim version of the IRA would have treated an investment fund as engaged in a trade or business, which would have resulted in the aggregation of portfolio companies. A last minute amendment by Senator John Thune (R-SD) removed the modification; accordingly, portfolio companies of an investment fund generally will not be aggregated with other portfolio companies for purposes of the $1 billion threshold.

For corporations in existence for less than three years, the three-year income test would be applied over the period during which the corporation was in existence. The adjusted financial statement income of a corporation with a taxable year shorter than 12 months would be applied on an annualized basis.

Corporations would generally be eligible to claim net operating losses and tax credits against the alternative minimum tax. Adjusted financial statement income would be reduced by the lesser of (i) the aggregate amount of financial statement net operating loss carryovers to the taxable year and (ii) 80% of adjusted financial statement income (reflecting the tax rule that net operating losses are permitted to offset only 80% of taxable income). The proposed clean energy credits and other business credits would be limited to 75% of a corporation’s alternative minimum tax. In addition, a corporation would be eligible to claim a credit for corporate alternative minimum tax paid in prior years against the regular corporate tax if the regular tax liability exceeds 15% of the corporation’s adjusted financial statement income.

The corporate alternative minimum tax would apply to a foreign-parented corporation (i.e., a U.S. subsidiary of a foreign parent) if its three-year taxable year average annual adjusted financial statement income exceeds $100 million and that of the foreign-parented multinational group exceeds $1 billion.[2] It is not clear whether the $100 million threshold is tested on a separate basis or on aggregate basis so that, for example, the adjusted financial statement income of two domestic subsidiaries of a common foreign parent (neither of which would separately meet the $100 million threshold) would be aggregated. The Secretary would have the authority to issue regulations on the threshold tests.

The corporate alternative minimum tax would not apply to S corporations, regulated investment companies, or real estate investment trusts. In addition, the tax would not apply to corporations that have had a change in ownership or has a specified number of consecutive taxable years that will be determined by the Secretary.

The corporate alternative minimum tax does not conform to the “qualified domestic minimum top-up tax” proposed by the OECD/G20. As a result, if the OECD/G20 rules are adopted in their current form, the foreign subsidiaries of U.S. multinationals located or doing business in OECD countries could be subject to additional taxes by those jurisdictions.

  1. Excise tax on corporate stock buybacks

The IRA now includes a nondeductible 1% excise tax on stock repurchases by publicly traded corporations and certain “surrogate foreign corporations”.[3] The proposal would apply to repurchases of stock after December 31, 2022.

The tax would be imposed on the fair market value of the stock “repurchased” by the corporation during the tax year, reduced by value of stock issued by the corporation during the tax year (including those issued to the employees).  The term “repurchase” is defined as a redemption within the meaning of section 317(b), which is a transaction in which a corporation acquires its stock from a shareholder (and is not a dividend for federal income tax purposes).

The tax would also be imposed on a corporation if its “specified affiliate” repurchases the corporation’s stock from another person (including another “specified affiliate”). The term “specified affiliate” is defined as (i) any corporation in which the taxpayer-corporation directly or indirectly owns more than 50% of the stock by vote or value; and (ii) any partnership in which the taxpayer-corporation directly or indirectly holds more than 50% of the capital or profits interests.

In addition, the tax would be imposed on a specified affiliate (i.e., a domestic subsidiary) of a non-U.S. publicly traded corporation that purchases the non-U.S. corporation’s stock from another person (excluding another specified affiliate of the non-U.S. corporation).

If a surrogate foreign corporation (or its specified affiliate) repurchases its stock, the tax would be imposed on the surrogate foreign corporation’s expatriated entity (i.e., its U.S. subsidiary).

Repurchases that are (i) dividends for  federal income tax purposes, (ii) part of tax-free reorganizations, (iii) made to contribute stock to an employee pension plan or ESOP, (iv) made by a dealer in securities in the ordinary course of business, or (v) made by a RIC or a REIT would not be subject to the excise tax.  Repurchases that are less than $1 million in a year would also be excluded.

The Secretary would have the authority to issue regulations to prevent abuse through the above exclusions and apply the rules to other classes of stock and surrogate foreign corporations. It is not clear how broad that authority is intended to be and whether the Secretary will issue guidance on certain common transactions, such as redemptions of preferred stock or of a non-publicly traded subsidiary’s debt that is exchangeable for its publicly-traded parent’s stock.

  1. Extension of excess business loss limitation rules

Under current law, for taxable years that begin before January 1, 2027, non-corporate taxpayers may not deduct excess business loss (generally, net business deductions over business income) if the loss is in excess of $250,000 ($500,000 in the case of a joint return), indexed for inflation.  The excess loss becomes a net operating loss in subsequent years and is available to offset 80% of taxable income each year.

The IRA would extend the excess business loss limitation rules to taxable years that begin before January 1, 2029.

The IRA’s amendments would apply to taxable years beginning after December 31, 2026.

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[1] All references to section are to the Internal Revenue Code.

[2] As modified, the IRA defines “foreign-parented multinational group” as a group of two or more entities in a taxable year, in which (i) at least one is a domestic corporation and the other is a foreign corporation, (ii) the entities are included in the same applicable financial statement for the taxable year, and (iii) either (a) their common parent is a foreign corporation or (b) if there is no common parent, they are treated as having a common parent that is a foreign corporation under rules to be prescribed by the Secretary.

To determine whether a foreign-parented multinational group exists, the IRA treats a foreign corporation’s trade or business as a separate, wholly-owned domestic corporation.

As originally introduced, this provision applied to a foreign-parented “international reporting group” rather than a foreign-parented multi-national group.

[3] A surrogate foreign corporation is a foreign corporation (i) that has acquired substantially all of the properties held directly or indirectly by a domestic corporation or substantially all of the properties constituting a trade or business of a domestic partnership; (ii) the acquisition of at least 60% of the stock (by vote or value) of the entity is held, (a) in the case of an acquisition with respect to a domestic corporation, by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation, (b) in the case of an acquisition with respect to a domestic partnership, by former partners of the domestic partnership by reason of holding a capital or profits interest in the domestic partnership or (c) in the case of an acquisition with respect to a domestic partnership, by former partners of the domestic partnership by reason of holding a capital or profits interest in the domestic partnership; and (iii) after the acquisition the “expanded affiliated group” which includes the entity does not have substantial business activities in the foreign country in which, or under the law of which, the entity is created or organized, when compared to the total business activities of such expanded affiliated group.

A Summary of Inflation Reduction Act’s Main Energy Tax Proposals

On August 7, the Senate passed the Inflation Reduction Act of 2022 (the “IRA”). The IRA contains a significant number of climate and energy tax proposals, many of which were previously proposed in substantially similar form by the House of Representatives in November 2021 (in the “Build Back Better Act”).

Extension and expansion of production tax credit

Section 45 of the Internal Revenue Code provides a tax credit for renewable electricity production. To be eligible for the credit, a taxpayer must (i) produce electricity from renewable energy resources at certain facilities during a ten-year period beginning on the date the facility was placed in service and (ii) sell that renewable electricity to an unrelated person.[1] Under current law, the credit is not available for renewable electricity produced at facilities whose construction began after December 31, 2021.

The IRA would extend the credit for renewable electricity produced at facilities whose construction begins before January 1, 2025. The credit for electricity produced by solar power –which expired in 2016—would be reinstated, as extended by the IRA.

The IRA would also increase the credit from 1.5 to 3 cents per kilowatt hour of electricity produced.

A taxpayer would be entitled to increase its production tax credit by 500% if (i) its facility’s maximum net output is less than 1 megawatt, (ii) it meets the IRA’s prevailing wage and apprenticeship requirements,[2] and (iii) the construction of its facility begins within fifty-nine days after the Secretary publishes guidance on these requirements.

In addition, the IRA would add a 10% bonus credit for a taxpayer (i) that certifies that any steel, iron, or manufactured product that is a component of its facility was produced in the United States (the “domestic content bonus credit”) or (ii) whose facility is in an energy community (the “energy community bonus credit”).[3]

Extension, expansion, and reduction of investment tax credit

Section 48(a) provides an investment tax credit for the installation of renewable energy property. The amount of the credit is equal to a certain percentage (described below) of the property’s tax basis. Under current law, the credit is limited to property whose construction began before January 1, 2024.

The IRA would extend the credit to property whose construction begins before January 1, 2025. This period would be extended to January 1, 2035 for geothermal property projects. The IRA would also allow the investment tax credit for energy storage technology, qualified biogas property, and microgrid controllers.

The IRA would reduce the base credit from 30% to 6% for qualified fuel cell property; energy property whose construction begins before January 1, 2025; qualified small wind energy property; waste energy recovery property; energy storage technology; qualified biogas property; microgrid controllers; and qualified facilities that a taxpayer elects to treat as energy property. For all other types of energy property, the base credit would be reduced from 10% to 2%.

A taxpayer would be entitled to increase this base credit by 500% (for a total investment tax credit of 30%) if (i) its facility’s maximum net output is less than 1 megawatt of electrical or thermal energy, (ii) it meets the prevailing wage and apprenticeship requirements, and (iii) its facility begins construction within fifty-nine days after the Secretary publishes guidance on these requirements.

In addition, a taxpayer would be entitled to a 10% domestic content bonus credit and 10% energy community bonus credit (subject to the same requirements as for bonus credits under section 45). The IRA would also add a (i) 10% bonus credit for projects undertaken in a facility with a maximum net output of 5 megawatts and is located in low-income communities or on Indian land, and (ii) 20% bonus credit if the facility is part of a qualified low-income building project or qualified low-income benefit project.

Section 45Q (Carbon Oxide Sequestration Credit)

Section 45Q provides a tax credit for each metric ton of qualified carbon oxide (“QCO”) captured using carbon capture equipment and either disposed of in secure geological storage or used as a tertiary injection in certain oil or natural gas recovery projects.  While eligibility for the section 45Q credit under current law requires that projects begin construction before January 1, 2026, the IRA would extend credit eligibility to those carbon sequestration projects that commence construction before January 1, 2033.

The IRA would increase the amount of tax credits for projects that meet certain wage and apprenticeship requirements. Specifically, the IRA would increase the amount of section 45Q credits for industrial facilities and power plants to $85/metric ton for QCO stored in geologic formations, $60/metric ton for the use of captured carbon emissions, and $60/metric ton for QCO stored in oil and gas fields.  With respect to direct air capture projects, the IRA would increase the credit to $180/metric ton for projects that store captured QCO in secure geologic formations, $130/metric ton for carbon utilization, and $130/metric ton for QCO stored in oil and gas fields.  The proposed changes in the amount of the credit would apply to facilities or equipment placed in service after December 31, 2022.

The IRA also would decrease the minimum annual QCO capture requirements for credit eligibility to 1,000 metric tons (from 100,000 metric tons) for direct air capture facilities, 18,750 metric tons (from 500,000 metric tons) of QCO for an electricity generating facility that has a minimum design capture capacity of 75% of “baseline carbon oxide” and 12,500 metric tons (from 100,000 metric tons) for all other facilities.  These changes to the minimum capture requirements would apply to facilities or equipment that begin construction after the date of enactment.

Introduction of zero-emission nuclear power production credit

The IRA would introduce, as new section 45U, a credit for zero-emission nuclear power production.

The credit for a taxable year would be the amount by which 3 cents multiplied by the kilowatt hours of electricity produced by a taxpayer at a qualified nuclear power facility and sold by the taxpayer to an unrelated person during the taxable year exceeds the “reduction amount” for that taxable year.[4]

In addition, a taxpayer would be entitled to increase this base credit by 500% if it meets the prevailing wage requirements.

New section 45U would not apply to taxable years beginning after December 31, 2032.

Biodiesel, Alternative Fuels, and Aviation Fuel Credit

The IRA would extend the existing tax credit for biodiesel and renewable diesel at $1.00/gallon and the existing tax credit for alternative fuels at $.50/gallon through the end of 2024.  Additionally, the IRA would create a new tax credit for sustainable aviation fuel of between $1.25/gallon and $1.75/gallon.  Eligibility for the aviation fuel credit would depend on whether the aviation fuel reduces lifecycle greenhouse gas emissions by at least 50%, which corresponds to a $1.25/gallon credit (with an additional $0.01/gallon for each percentage point above the 50% reduction, resulting in a maximum possible credit of $1.75/gallon). This credit would apply to sales or uses of qualified aviation fuel before the end of 2024.

Introduction of clean hydrogen credit

The IRA would introduce, as new section 45V, a clean hydrogen production tax credit. To be eligible, a taxpayer must produce the clean hydrogen after December 31, 2022 in facilities whose construction begins before January 1, 2033.

The credit for the taxable year would be equal to the kilograms of qualified clean hydrogen produced by the taxpayer during the taxable year at a qualified clean hydrogen production facility during the ten-year period beginning on the date the facility was originally placed in service, multiplied by the “applicable amount” with respect to such hydrogen.[5]

The “applicable amount” is equal to the “applicable percentage” of $0.60. The “applicable percentage” is equal to:

  • 20% for qualified clean hydrogen produced through a process that results in a lifecycle greenhouse gas emissions rate between 2.5 and 4 kilograms of CO₂e per kilogram of hydrogen;
  • 25% for qualified clean hydrogen produced through a process that results in a lifecycle greenhouse gas emissions rate between 1.5 and 2.5 kilograms of CO₂e per kilogram of hydrogen;
  • 4% for qualified clean hydrogen produced through a process that results in a lifecycle greenhouse gas emissions rate between 0.45 and 1.5 kilograms of CO₂e per kilogram of hydrogen; and
  • 100% for qualified clean hydrogen produced through a process that results in a lifecycle greenhouse gas emissions rate of less than 0.45 kilograms of CO₂e per kilogram of hydrogen.

A taxpayer would be entitled to increase this base credit by 500% if (i) it meets the prevailing wage and apprenticeship requirements or (ii) it meets the prevailing wage requirements, and its facility begins construction within fifty-nine days after the Secretary publishes guidance on the prevailing wage and apprenticeship requirements.

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[1] All references to section are to the Internal Revenue Code.

[2] The IRA would require new prevailing wage and apprenticeship requirements to be satisfied in order for a taxpayer to be eligible for increased credits. To satisfy the prevailing wage requirements, a taxpayer would be required to ensure that any laborers and mechanics employed by contractors or subcontractors to construct, alter or repair the taxpayer’s facility are paid at least prevailing local wages with respect to those activities. To satisfy the apprenticeship requirements, “qualified apprentices” would be required to construct a certain percentage of the taxpayer’s facilities (10% for facilities whose construction begins before January 1, 2023 and 15% for facilities whose construction begins on January 1, 2024 or after). A “qualified apprentice” is a person employed by a contractor or subcontractor to work on a taxpayer’s facilities and is participating in a registered apprenticeship program.

[3] An “energy community” is a brownfield site; an area which has (or had at any time after December 31, 1999) significant employment related to the extraction, processing, transport, or storage of coal, oil, or natural gas; and a census tract in which a coal mine closed or was retired after December 31, 1999 (or an adjoining census tract).

[4] A “qualified nuclear power facility” is any nuclear facility that is owned by the taxpayer, that uses nuclear energy to produce electricity, that is not an “advanced nuclear power facility” as described in section 45J(d)(1),  and is placed in service before the date that new section 45U is enacted.

“Reduction amount” is, for any taxable year, the amount equal to (x) the lesser of (i) the product of 3 cents multiplied by the kilowatt hours of electricity produced by a taxpayer at a qualified nuclear power facility and sold by the taxpayer to an unrelated person during the taxable year and (ii) the amount equal to 80% of the excess of the gross receipts from any electricity produced by the facility (excluding an advanced nuclear power facility) and sold to an unrelated person during the taxable year; (y) over the amount equal to the product of 2.5 cents multiplied by the kilowatt hours of electricity produced by the taxpayer at a qualified nuclear power facility and sold by the taxpayer to an unrelated person during the taxable year.

[5] “Qualified clean hydrogen” is hydrogen that is produced (i) through a process that results in a lifecycle greenhouse gas emissions rate of no more than 4 kilograms of CO₂e per kilogram of hydrogen, (ii) in the United States, (iii) in the ordinary course of the taxpayer’s trade or business, (iv) for sale or use, and (v) whose production and sale or use is verified by an unrelated party. The IRA does not explain what “verified by an unrelated party” means.

A Summary of Inflation Reduction Act’s Main Tax Proposals

On July 27, 2022, Senator Joe Manchin (D-W.Va.) and Senate Majority Leader Chuck Schumer (D-N.Y.) released the Inflation Reduction Act of 2022 (the “IRA”). The IRA contains only two non-climate and non-energy tax proposals – a 15% corporate alternative minimum tax and a provision significantly narrowing the applicability of preferential long-term capital gain rates to carried interests. Each of these proposals had previously been proposed in substantially similar form.

1. 15% corporate alternative minimum tax

The IRA would impose a 15% corporate minimum tax based on the financial statement income of corporations or their predecessors with a three-year taxable year average annual adjusted financial statement income in excess of $1 billion. The corporate minimum tax would be effective for tax years beginning after December 31, 2022.

The proposal is substantially the same as the proposals introduced in the House of Representatives in November 2021 and by the Senate Finance Committee in December 2021 (in the “Build Back Better Act”). In May 2021, the Biden Administration had also proposed a 15% corporate alternative minimum tax for corporations with worldwide book income in excess of $2 billion, rather than $1 billion.

The 15% corporate alternative minimum tax would be equal to the difference between a corporation’s “adjusted financial statement income” for the taxable year and the corporation’s “alternative minimum tax foreign tax credit” for the taxable year. A corporation’s tax liability would be the greater of its regular tax liability and the 15% alternative minimum tax.

A corporation’s annual adjusted financial statement income would be based on its book income, with certain adjustments, such as to account for a corporation’s activities undertaken indirectly through a consolidated group, a partnership, or a disregarded entity. The adjusted financial statement income would also be adjusted for certain taxes, such as federal income and excess profits taxes.

The average annual adjusted financial statement income of a corporation would include any other entities that are treated as a single employer with the corporation under section 52 to determine whether the corporation satisfies the $1 billion threshold.[1] This may cause corporations with less than $1 billion of adjusted financial statement income – including possibly portfolio companies of an investment fund – to be subject to the proposal. For corporations in existence for less than three years, the three-year income test would be applied over the period during which the corporation was in existence. The adjusted financial statement income of a corporation with a taxable year shorter than 12 months would be applied on an annualized basis.

Corporations would generally be eligible to claim net operating losses and tax credits against the alternative minimum tax. Adjusted financial statement income would be reduced by the lesser of (i) the aggregate amount of financial statement net operating loss carryovers to the taxable year and (ii) 80% of adjusted financial statement income (reflecting the tax rule that net operating losses are permitted to offset only 80% of taxable income). The proposed clean energy credits and other business credits would be limited to 75% of a corporation’s alternative minimum tax. In addition, a corporation would be eligible to claim a credit for corporate alternative minimum tax paid in prior years against the regular corporate tax if the regular tax liability exceeds 15% of the corporation’s adjusted financial statement income.

The corporate alternative minimum tax would apply to a foreign-parented corporation if its three-year taxable year average annual adjusted financial statement income exceeds $100 million and the international financial reporting group’s exceeds $1 billion.

The corporate alternative minimum tax would not apply to S corporations, regulated investment companies, or real estate investment trusts. In addition, the tax would not apply to corporations that have had a change in ownership or has a specified number of consecutive taxable years that will be determined by the Secretary.

The corporate alternative minimum tax does not conform to the “qualified domestic minimum top-up tax” proposed by the OECD/G20. As a result, if the OECD/G20 rules are adopted in their current form, the foreign subsidiaries of U.S. multinationals located or doing business in OECD countries could be subject to additional taxes by those jurisdictions.

2. Taxation of carried interest

Under current law, a “carried” or “profits” interest in a partnership received in exchange for services is generally not taxable when received and the recipient is taxed on their share of partnership income based on the character of the income at the partnership level. Section 1061 requires certain carried interest holders to satisfy a three-year holding period – rather than the normal one-year holding period – to be eligible for the long-term capital gain rate.

The IRA would amend section 1061 to extend the holding period for long-term capital gain treatment on all income (including dividends) from three years to five years (or longer) (the “holding period exception”). The amendments would apply to taxable years beginning after December 31, 2022.

The House Ways & Means Committee’s draft of the Build Back Better Act from September 2021 contained substantially the same carried interest proposal.

Under the IRA, the holding period exception for long-term capital gain treatment would apply to amounts realized after the date that is five years after the latest of (i) the date on which the taxpayer acquired substantially all of the carried interest with respect to which the amount is realized; (ii) the date on which the partnership in which the carried interest is held acquired substantially all of its assets; or (iii) if the partnership owns, directly or indirectly, interests in one or more other partnerships, the dates determined by applying rules similar to the rules in (i) and (ii) in the case of each other partnership.

The IRA does not define the term “substantially all” and it is unclear how these rules would apply. Many private investment funds, for example, acquire their investments over a number of years (some of which are held in partnerships which themselves may make further investments). Consequently, the five year holding period could easily be much longer in practice.

Taxpayers (other than trusts and estates) with adjusted gross income of less than $400,000 per taxable year or with income from a real property trade or business would be subject to the current holding period of three years (except determined under the rules of the IRA).

If a profits interest holder transfers its interest, the IRA would require gain recognition (even if nonrecognition would otherwise be available).

The IRA would apply only to income or gain attributable to an asset held for portfolio investment on behalf of third-party investors. The Secretary would have broad authority to issue guidance on these provisions, including to apply them to other arrangements and assets.

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[1] All references to section are to the Internal Revenue Code.

HMRC Announces Welcome Changes to the QAHC Regime

On 20 July 2022, the UK government published draft legislation for the Finance Bill 2022-2023.

Of particular interest are amendments to be made to the qualifying asset holding company (QAHC) regime that was introduced from 1 April this year.

The regime is part of the UK government’s attempt to increase the attractiveness of the UK as a jurisdiction for asset management and introduces a simplified tax regime applicable to QAHCs that should, broadly, tax investors as if they had invested directly in the underlying assets. Please see our submission to the 2021 PIF Annual Review and Outlook here for the circumstances in which the regime is available and its benefits.

The QAHC regime was introduced reasonably quickly and contained some limitations on how an asset holding company owned by a private fund could qualify as a QAHC. In particular, one of the main conditions to qualify as a QAHC is that the asset holding company is owned as to at least 70% by what are described as Category A investors. In the context of private funds, the most useful Category A investor is a “qualifying fund”. That is a collective investment scheme (as defined for UK purposes) which meets a “genuine diversity of ownership” test. The “genuine diversity of ownership” is based, broadly, on the fund being widely marketed.

This requirement raised questions about whether asset holding companies that were owned by either a number of parallel fund vehicles (as will often be the case to cater for different classes of investor) or by a master fund itself owned by feeder funds into which the investors invest.

The recent amendments to the regime have been introduced to ensure the conditions to be a QAHC better align with the initial intended scope of the regime by extending the “genuine diversity of ownership” tests to parallel funds and master funds where, looked at in aggregate with the other parallel funds or the feeder funds, the test would be satisfied.

As HMRC notes, in a parallel fund structure, the interests in one fund may be widely marketed and made available, but certain investors will then invest via a different fund based on their particular characteristics. That parallel fund might not, itself, be widely marketed. Similarly for master/feeder structures, with the overall fund being marketed but the master fund itself, which will be the investor in the asset holding company, not being directly marketed. This meant that it is not clear under the existing rules whether the diversity of ownership condition would be satisfied by these common fund structures.

To rectify this unintended issue, the amendment to the QAHC rules relevant to parallel fund structures provides that a fund will be treated as meeting the diversity of ownership condition where it is closely associated with another investment fund that satisfies the condition because it is widely marketed and made available. The vehicles must also satisfy conditions requiring investments in substantially the same assets, holding investments using the same companies on substantially the same terms and in the same ratios, and the management of the funds to be substantially coordinated such that they act together in relation to their investments as if they were a single fund. HMRC notes that this means funds will be prevented from being treated as parallel if they each own shares in the same potential QAHC of different classes and those shares carry materially different rights (i.e. not substantially the same asset). Additionally, the updated legislation will not apply to a parallel fund if the main purpose, or one of the main purposes, of the arrangements that result in it being a parallel fund is so that the diversity of ownership condition is satisfied.

To deal with the master/feeder fund structure, the master fund (referred to as the “aggregator fund” in the rules) can be treated as meeting the diversity of ownership condition provided that the feeder funds into it meet that condition (or are treated as doing so by reason of the change to the rules referred to above).

The changes for parallel funds and master/feeder funds will apply from a date to be confirmed.

In addition to this, the amendments have dealt with another, unconnected issue with the existing rules. To be a “qualifying fund” (and so a Category A investor in a QAHC), the fund vehicle has to be a collective investment scheme (CIS) for UK law purposes. Certain types of non-UK vehicle that would be a collective investment scheme in general terms might not be if they are constituted as a body corporate under their law of establishment. The QAHC rules are amended to state that fund entities that would be a CIS if they were not a body corporate are treated as if they were a CIS and so can be qualifying funds provided that they meet the other conditions for them to so qualify. This change is retrospective and applies from 1 April 2022.

Finally, in relation to calculating the ownership of a QAHC, there is an anti-fragmentation rule that aggregates the different interests of a direct investor in a company with their indirect interests. This rule is now extended so that it applies in circumstances where interests are held indirectly through one or more QAHCs. This change limits the QAHC qualification by excluding from the regime investment structures involving more than one QAHC in which the combined percentage owned by non-Category A investors is greater than 30% and came into force on 20 July 2022.

These changes are very welcome and prompt changes to the regime and remove significant barriers to a wide uptake of UK-based QAHCs in fund structures and add to the equally welcome clarification of the application of the QAHC regime to UK lending companies established by credit funds that we discussed in our previous Tax Talks blog.

For further information on the QAHC regime, please contact a member of the Proskauer London Tax team.

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