Under code section 871(m), and the regulations thereunder, U.S. payors are required to withhold Federal income tax on the gross amount of certain derivative payments to foreign persons which are economically equivalent to dividends paid on U.S. equities (so-called “dividend equivalents”). The regulations prescribe a complex set of mathematical rules for determining if a derivative instrument is subject to section 871(m), and are based primarily on “delta,” or the expected change in the value of the derivative given a change in the value of the underlying equity.
Owing to this complexity, and to give affected industries time to update their systems, the IRS has previously granted a phase-in period, during which only derivatives with a delta of 1.0 (derivatives that track their underlying equities on a one-to-one basis, such as a single stock future) would be subject to withholding. This phase-in was originally effective for the 2017 calendar year, but was previously extended to include the 2018 calendar year (see prior coverage: IRS delays updated dividend equivalent withholding requirements and IRS extends dividend equivalent withholding transition period. Recently issued Notice 2018-72 again extends this period, through calendar year 2020.
Note that, pursuant to President Trump’s executive order directing agencies to review and reduce regulatory burdens, the section 871(m) regulations themselves are currently under review, and may be modified as a result of that review. This extension is, in part, to give Treasury time to complete this review. Also, consistent with the prior section 871(m) phase-in notices, the IRS has indicated that it will consider taxpayers’ good faith efforts to comply with the new regulations, once it begins enforcing the regulations, through 2020 for delta-one transactions, and during 2021 for all transactions subject to section 871(m). Related relief for taxpayers with qualified derivatives dealer status has also been extended.
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