On November 2, the International Swaps and Derivatives Association, Inc. (ISDA) published the ISDA 2015 Section 871(m) Protocol (the Protocol) that provides an efficient method to amend existing ISDA Master Agreements to address recently issued final regulations. Under Section 871(m), certain payments with respect to equity derivative transactions that are documented under an ISDA Master Agreement may be subject to U.S. withholding tax. The Protocol applies to existing and subsequent ISDA Master Agreements that are between parties that adhere to the Protocol, and allocates the withholding tax risk arising under Section 871(m) between the parties. The Protocol addresses final and temporary regulations recently published by the Treasury Department (Treasury) and the Internal Revenue Service (IRS) under Sections 871(m), 1441, 1461 and 1473 (T.D. 9734).

  • Under the Protocol, Section 871(m) withholding tax risk generally is allocated to the long party.
  • Taxpayers that engage in equity derivative transactions should consider adhering to the Protocol in order to address the implications of the new Section 871(m) final and temporary regulations.
  • Even in cases where adherence to the Protocol may not be warranted, it can be used as a model for negotiation of new, and amendment of existing, ISDA Master Agreements.


Payments of dividends by U.S. corporations to non-U.S. shareholders are subject to withholding at a rate of 30%. Prior to the enactment of Section 871(m), payments of dividend equivalents on contracts that referenced U.S. corporate equities to non-U.S. persons were not subject to such withholding. Section 871(m) is intended to prevent non-U.S. persons from avoiding the 30% tax applicable to U.S.-source dividends by requiring withholding with respect to such dividend equivalents.

The statute defines dividend equivalent payments to include payments made on a “specified notional principal contract” that are contingent upon or determined by reference to the payment of U.S.-source dividends and certain other financial instruments. The statute as enacted identified four situations in which a notional principal contract is treated as a specified notional principal contract because of its perceived potential for abuse.

Notional principal contracts, including total return swaps, are typically documented on an ISDA Master Agreement. Under the ISDA Master Agreement, the payor of a swap payment generally must gross up the payee with respect to any “Indemnifiable Tax.” Absent an amendment, a Section 871(m) withholding tax generally would be an “Indemnifiable Tax” requiring the payor to gross up its payments for such taxes.  

The Protocol

The final and temporary regulations generally rely on a single factor test—the Delta Test—to determine whether a substitute dividend payment with respect to an equity derivative transaction is subject to Section 871(m) withholding. The application of the Delta Test is technical and its application depends on the particular transaction. Taking into account the new Delta Test, the Protocol amends previously executed and subsequent ISDA Master Agreements to allocate the risk of Section 871(m) withholding to the long party, i.e., the party receiving the dividend equivalent payment in transactions between parties that adhere to the Protocol.

In drafting the Protocol, ISDA was cognizant that in its prior protocols addressing Section 871(m), whether Section 871(m) withholding taxes were “Indemnifiable Taxes” for which a gross up would be required depended on representations that were difficult for some users to make and that will not be applicable under the final and temporary regulations. This, combined with the fact that final rules were yet to be issued, resulted in limited use of the prior ISDA Section 871(m) protocols. The Protocol takes a more neutral approach by allocating the withholding tax risk to the long party and takes into account the recently issued final regulations. Accordingly, the expectation is that this Protocol will be better received by the market.

Equity derivatives market participants should consider how to address Section 871(m) withholding tax risk in their existing and future transactions. The Protocol provides a model for doing so and, in some cases, market participants may want to adhere to the Protocol. In the case of ISDA Master Agreements, the Protocol may provide an efficient mechanism to allocate burden of Section 871(m) withholding taxes. The decision of whether or not to adhere to the Protocol depends on your specific circumstances.

Effective Date

The final and temporary Section 871(m) regulations are generally effective for transactions entered into on or after January 1, 2017, and, with respect any transaction issued on or after January 1, 2016, and before January 1, 2017, to any payment made on or after January 1, 2018.

Written comments on the new proposed regulations are due to the IRS byDecember 17, 2015, and a public hearing on the new proposed regulations has been scheduled for January 15, 2016.

The Protocol, the full text of which is available on the ISDA website, is now open for adherence.