IRS Phases in Section 871(m) Dividend Equivalent Withholding
On December 2, the U.S. Internal Revenue Service issued Notice 2016-76, which phases in the application of withholding on dividend equivalent payments under Section 871(m). Under the notice, withholding applies only to delta-one transactions in 2017, and applies to other U.S. equity transactions beginning after 2017. A delta-one transaction tracks the underlying on a dollar-for-dollar basis.
In addition, the notice generally provides that:
When enforcing section 871(m) in 2017 (for delta-one transactions) and 2018 (for non-delta-one transactions), the IRS will take into account the extent to which the taxpayer or withholding agent made a good faith effort to comply with section 871(m).
In 2017, withholding agents will be required to combine transactions for purposes of determining whether the transactions are subject to withholding under section 871(m) only if the transactions are over-the-counter transactions and are priced, marketed, or sold in connection with each other. (This simplified standard applies only to withholding agents, and not to long parties. Thus, a long party may still owe substantive tax with respect to equity-linked derivatives that are entered into in connection with each other and, when combined, have a delta of at least .80, even if the withholding agent does not withhold.)
The IRS intends to revise the proposed QI agreement issued under Notice 2016-42 to (1) impose withholding on actual dividends paid to a QDD, (2) calculate a QDD’s tax liability under section 871(m) by reference to the QDD’s "net delta exposure," and (3) provide additional phase-in rules for QDDs for 2017.
Withholding under section 871(m) will not apply until 2020 to certain existing exchange-traded notes that are specifically identified in the notice.
A copy of Notice 2016-72 can be found here.