On January 14, 2010, the IRS issued an Industry Director Directive on Total Return Swaps Used to Avoid Dividend Withholding Tax (“IDD”). The IDD provides audit guidance to IRS field agents auditing financial institutions and contains six forms of Information Document Requests for IRS field agents to use in order to obtain information from financial institutions that have engaged in equity swap transactions. The purpose of the IDD is to assist IRS field agents in uncovering and developing cases related to total return swap transactions that may have been executed in order to avoid U.S. withholding tax with respect to U.S. source dividend income paid to non-U.S. persons. It seems that the IRS is looking to assert deficiencies against the financial institutions that facilitated the equity swap transactions, in their capacity as a withholding agent, rather than against the non-U.S. persons that have the substantive tax liability. The IDD includes a description of several transactions perceived to be potentially abusive involving equity swaps such as: cross-in and cross-out transactions, cross-in and interdealer broker out transactions, cross-in and foreign affiliate out transactions, and “fully synthetic” transactions. The IRS encourages its field agents to develop cases where it could be concluded that, in substance, the non-U.S. person retained ownership of the U.S. equities referenced by the swap transactions. As such, the non-U.S. person would be treated as having received a payment of a U.S. source dividend, instead of a payment under a swap which would be foreign source, and which would be subject to U.S. withholding tax. The financial institution, as a financial intermediary, would be considered a withholding agent with respect to those payments and would be liable for the withholding tax if it failed to withhold and remit the withholding tax to the IRS. To avoid this liability, the financial institution would be expected to argue that the form of the swap transaction should be respected. It is not possible to predict the extent of the impact of the IDD on the equity swap market or the ultimate outcome of the transactions described in the IDD if litigated. We understand, however, that a number of financial institutions in the U.S. are already under audit on this issue.