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IRS Issues Final and New Proposed Regulations on Dividend Equivalent Payments
Practical Law Legal Update 3-551-3277 (Approx. 3 pages)
IRS Issues Final and New Proposed Regulations on Dividend Equivalent Payments
by Practical Law Finance
| Published on 06 Dec 2013 • USA (National/Federal) |
The IRS and Treasury Department issued final and reproposed Treasury regulations addressing the tax treatment of dividend equivalent payments.
The IRS and Treasury Department recently issued final and new proposed regulations addressing the treatment of dividend equivalent payments on US equity swaps and certain other instruments linked to US equities. The IRS and Treasury Department previously issued temporary and proposed regulations on dividend equivalent payments in January 2012 (for more information on these earlier regulations, see Legal Update, IRS Issues Regulations on Dividend Equivalent Payments). IRC Section 871(m), enacted in 2010, treats dividend equivalent payments as US-source dividends subject to US withholding tax (unless eliminated by an applicable income tax treaty) (IRC § 871(m)).
Under IRC Section 871(m), a dividend equivalent payment is any of the following:
- A substitute dividend payment made under a securities lending or sale-repurchase transaction if the payment is contingent on or determined by reference to the payment of a dividend from US sources.
- A payment under a "specified notional principal contract" if the payment is contingent on or determined by reference to the payment of a dividend from US sources.
- Any other payment determined by the Secretary of the Treasury to be substantially similar to the two previous categories.
The final regulations extend the statutory definition of specified notional principal contract for two years, to dividend equivalent payments made before January 1, 2016. Under the final regulations, before January 1, 2016 a specified notional principal contract is any notional principal contract if one or more of the following apply:
- In connection with entering into the contract, any long party transfers the underlying security to the short party.
- In connection with the termination of the contract, any short party transfers the underlying security to the long party.
- The underlying security is not readily tradable on an established securities market.
- In connection with entering into the contract, the underlying security is posted as collateral by any short party with any long party.
The new proposed regulations replace the seven-factor test for identifying a specified notional principal contract included in the January 2012 proposed regulations with a single-factor test based on the delta of a notional principal contract. The seven-factor test was originally proposed to be effective for payments contingent on or referencing the payment of a dividend from US sources made under a notional principal contract on or after January 1, 2013 (later extended to payments made on or after January 1, 2014). Under the new proposed regulations, for dividend equivalent payments made on or after January 1, 2016, a specified notional principal contract is any notional principal contract that has a delta of 0.7 or greater at the time the long party acquires the contract (Prop. Treas. Reg. § 1.871-15(d)(2)). Delta is the ratio of the change in the fair market value of a notional principal contract to the change in the fair market value of the property referenced by the contract.
The same delta standard applies under the new proposed regulations to determine whether an equity-linked instrument (ELI) (including futures, forwards, options, structured notes, contingent and convertible instruments, and other instruments referencing US equities) is a "specified ELI." A dividend equivalent payment includes any payment pursuant to a specified ELI that references the payment of a US-source dividend. However, the delta standard for specified ELIs applies to any ELI acquired by a long party on or after March 5, 2014.