Effective Date of Dividend Equivalent Withholding Regulations Postponed
May 14, 2015
By Richard Shapiro
At an American Bar Association Tax Section meeting in Washington on May 8, a senior counsel at the Treasury Office of Tax Legislative Counsel announced that the effective date of the rather controversial proposed dividend equivalent withholding regulations would be delayed by a year. The regulations, when finalized, will now be effective for contracts and payments on or after January 1, 2017.
Under IRC Section 871(m), a “dividend equivalent” is treated as a dividend from sources within the United States for purposes of taxing and withholding at source on nonresident aliens, foreign corporations and foreign organizations. A dividend equivalent is any payment or substitute dividend that (directly or indirectly) is contingent upon, or determined by reference to, the payment of a U.S. source dividend, but only if that payment or substitute payment is made pursuant to a securities lending transaction, a sale-repurchase transaction, or a “specified notional principal contract” (“specified NPC”). A dividend equivalent is also any other payment that is determined to be substantially similar to these payments.
A specified NPC is any NPC with respect to which:
- In connection with entering into an NPC, a long party transfers the underlying security to a short party;
- In connection with terminating an NPC, a short party transfers the underlying security to a long party;
- The underlying security is not readily tradable on an established securities market; or
- In connection with entering into an NPC, the underlying security is posted as collateral by the short party.
In December 2013, the IRS issued proposed regulations pursuant to IRC Section 871(m). Of particular significance was the introduction of a “delta” based approach to certain dividend equivalent payments (for example, payments on certain equity swaps or other derivatives referencing U.S. equity securities) made on or after January 1, 2016. Specifically, in determining whether an equity swap or an equity linked instrument was subject to the Section 871(m) withholding rules, the proposed regulations applied to instruments with a delta of greater than or equal to 0.70 at the time of acquisition by the long party. Delta is the ratio of the change in the fair market of the instrument to the change in the fair market value of the property referenced in the instrument.
Prior to the recent announcement, many financial institutions had expressed concern with the impending effective date, the actual application of the delta standard and its potential use by the IRS beyond dividend equivalent withholding under Section 871(m). Hopefully the additional time will provide the IRS and Treasury with further opportunity to fully consider and take into account the various concerns that have been raised.