IRS Provides Phase-In Relief for Dividend Equivalent Payments | Practical Law

IRS Provides Phase-In Relief for Dividend Equivalent Payments | Practical Law

The IRS recently issued guidance providing phase-in relief under IRC Section 871(m) Treasury regulations addressing dividend equivalent payments.

IRS Provides Phase-In Relief for Dividend Equivalent Payments

Practical Law Legal Update w-004-8486 (Approx. 3 pages)

IRS Provides Phase-In Relief for Dividend Equivalent Payments

by Practical Law Finance
Published on 06 Dec 2016 • USA (National/Federal)
The IRS recently issued guidance providing phase-in relief under IRC Section 871(m) Treasury regulations addressing dividend equivalent payments.
The IRS recently issued Notice 2016-76 providing phase-in relief for dividend equivalent payments on US equity swaps and certain other US-linked instruments held by foreign persons. IRC Section 871(m) treats dividend equivalent payments as US source dividends. Dividend equivalent payments made to a foreign person are therefore subject to a 30% withholding tax unless an exception or lower rate of withholding applies (for example, under an applicable income tax treaty).
Under the Section 871(m) regulations, a dividend equivalent is any of the following:
  • Any substitute dividend that references a US source dividend made pursuant to a securities lending or sale-repurchase transaction.
  • Any payment that references a US source dividend pursuant to a "specified notional principal contract" (NPC).
  • Any payment that references a US source dividend made pursuant to a "specified equity-linked instrument" (ELI). ELIs include futures and forward contracts, options, debt instruments, and other instruments that reference the value of one or more underlying securities.
  • Any substantially similar payment.
NPCs or ELIs are generally covered by the Section 871(m) rules if the NPC or ELI has a delta of 0.80 or greater with respect to the underlying security. Prior to the Notice, the Section 871(m) regulations generally applied to transactions entered into on or after January 1, 2017.
The Notice provides phase-in relief under the Section 871(m) rules:
  • In 2017, the Section 871(m) regulations will only apply to NPCs and ELIs issued on or after January 1, 2017 with a delta of one (meaning that a change in the value of the underlying security results in a change of the same proportion to the value of the NPC or ELI).
  • The Section 871(m) regulations will apply to NPCs and ELIs with a delta of less than one (but 0.80 or greater) issued on or after January 1, 2018.
  • Withholding agents will be required to combine transactions entered into in 2017 (to determine if the transactions generate dividend equivalent payments) only if they are over-the-counter positions that are priced, marketed, or sold in connection with each other.
  • Audits of withholding agents for 2017 (for delta one transactions) and 2018 (for non-delta one transactions) will take into account the withholding agent's good faith efforts to comply with the Section 871(m) regulations.
For more information on the Section 871(m) regulations, see Legal Update, IRS Issues Regulations on Dividend Equivalent Payments.