IRS extends dividend equivalent withholding transition period
TAX ALERT |
The Internal Revenue Service has announced its intent to amend regulations under Internal Revenue Code section 871(m) by postponing the effective date of certain provisions of the regulations by another year and has indicated that taxpayers can rely on this guidance before amendments to the regulations and the Qualified Intermediary agreement are made. See Notice 2017-42 for more information.
Notice 2017-42 extends the phase-in period previously provided by Notice 2016-76 for certain provisions of the section 871(m) regulations, extends through 2018 the period taken into account when considering whether a good faith effort was made to comply with the regulations, and extends to include 2018 the period during which the simplified standard for determining whether transactions entered into in 2017 are combined transactions. The notice builds on and extends guidance previously published over the past two years. In 2015, the IRS issued final regulations under code section 871(m), requiring tax withholding on certain derivative payments to non-US persons that are linked to payments of dividends from US corporations (so-called “dividend equivalents”). These regulations were to become effective January 1, 2017. In late 2016, the IRS issued Notice 2016-76, which delayed the implementation of a portion of the 871(m) regulations by one year.
The most significant aspect of the transition relief granted by the notices involves the standard by which derivative contracts become potentially subject to 871(m). The final regulations indicate that any derivative contract with a US corporate equity instrument as its underlying security may be subject to 871(m) if its “delta” (a measure of how closely the value of the derivative tracks the value of the underlying equity) is greater than 0.8. Notice 2016-76 provided that, for 2017, only instruments with a delta of 1.0 would be subject to potential dividend equivalent withholding. Notice 2017-42 extends the duration of this relief through the entirety of the 2018 calendar year.
Notice 2016-76 also provided that the IRS, when examining withholding agent compliance (in 2017 for delta-one transactions, and in 2018 for all other 871(m) transactions) will take into account the extent to which taxpayers made a good faith effort to comply with the 871(m) regulations. Notice 2017-42 extends this relief to 2018 for delta-one transactions and to 2019 for non-delta-one transactions. Similarly, the IRS will take good faith compliance efforts into account for taxpayers that have agreed to act as, “qualified derivatives dealers,” through 2018.
Finally, Notice 2017-42 extends relief provided by Notice 2016-76 with respect to certain technical requirements for combined transactions (by which certain derivatives are required to be combined for 871(m) purposes) and qualified derivative dealers.
For more information on section 871(m) and its potential impact on your operations, please refer to our article, “Final and temporary regulations tweak dividend equivalent tax regime,” or contact your tax advisor if any of these provisions are applicable to you.