Tax

Excise Tax

The Inflation Reduction Act of 2022 (the “IRA”) imposes a 1% excise tax on the repurchase of corporate stock (the “Excise Tax”) by a publicly traded U.S. corporation following December 31, 2022. For purposes of the Excise Tax, a “repurchase”[1] will generally include redemptions, corporate buybacks and other transactions in which the corporation acquires its stock from a shareholder in exchange for cash or property, subject to exceptions for de minimis transactions and certain reorganizations.

As a result, subject to the “netting rule” described below, the Excise Tax will apply to any redemption by a U.S.-domiciled special purpose acquisition company (“SPAC”) (and certain foreign domiciled SPACs[2]) taking place after December 31, 2022, including redemptions (i) by shareholders in connection with the SPAC’s initial business combination or a proxy vote to extend the lifespan of the SPAC, (ii) by SPACs if the SPAC does not complete a de-SPAC transaction within the required time set forth in its constituent documents, or (iii) in connection with the wind-up and liquidation of the SPAC.

Netting Rule

In general, under the issuance offset rule of the IRA or “netting rule,” issuances of SPAC stock, including to target company shareholders in a de-SPAC, should be able to offset any SPAC stock repurchases subject to the Excise Tax occurring within the same taxable year. Stock issuances occurring in other taxable years will not qualify for the netting rule.

Some other examples of issuances of SPAC stock that should be able to be offset against the repurchased amounts occurring in the same taxable year, include (i) public offerings of stock, including a SPAC’s initial public offering, (ii) private investment in public equity offerings (PIPEs), (iii) stock issued to acquire other companies, (iv) stock issued as compensation, including upon option exercises, and (v) stock issued upon warrant exercises or convertible debt conversions.

Note, to qualify for the netting rule, the issuer of the stock generally must be the same legal entity as the entity redeeming the stock. As a result certain common de-SPAC structures, such as “UP-Cs” or “double dummy” structures or situations where the target operating company is the acquirer of the SPAC, likely will not qualify for the netting rule, because in those structures the SPAC is not the entity issuing shares in the de-SPAC. Furthermore, given the high redemption rates and the challenges in attracting new-money investors in recent de-SPAC transactions, it may not be possible for a SPAC to issue enough stock to fully offset its redemptions.

Funds Held in Trust Account

Although attention must be paid to each SPAC’s individual agreements, many SPAC formation documents and trust agreements will allow the trust funds (and any interest earned thereon) to be used to pay all or a portion of the Excise Tax to the extent the SPAC’s working capital is not otherwise sufficient to pay the Excise Tax, although it remains to be seen if sponsors will avail themselves of this option.

SPAC Disclosures

Over the last two months, many SPACs have issued proxy statements and other SEC filings containing a disclosure about the risks associated with the Excise Tax. The risk statement is fairly uniform across many of the filings, stating that the Excise Tax may decrease the value of the SPAC securities following the initial business combination, hinder the SPAC’s ability to consummate an initial business combination, and decrease the amount of funds available for distribution in connection with a liquidation. Many filings also warn investors that application of the Excise Tax in a liquidation is uncertain but could reduce the funds in the trust account and thus reduce the per-share amounts they receive in a liquidation.

[1] For purposes of this note, “repurchases” and “redemptions” are used interchangeably to describe any transaction that is a “redemption” for U.S. federal income tax purposes and any transaction that the Treasury Department determines is economically similar to such a transaction. 

[2] In addition, the Excise Tax will apply to repurchases by a non-U.S. SPAC that domesticates to the United States or a “foreign” SPAC if it is considered a “surrogate foreign corporation” under the Internal Revenue Code (a surrogate foreign corporation is a corporation, which, after its acquisition of a domestic corporation, at least 60% of its stock – by vote or value – is held by former shareholders of the domestic corporation by reason of their holding stock in the domestic corporation).