On August 4, 2017, the Internal Revenue Service released Notice 2017-42 (the "Notice"),7 which further extends the phase-in of regulations under Section 871(m) of the Internal Revenue Code (the "Regulations"). Section 871(m) is the U.S. federal tax code provision that treats "dividend equivalents" paid under certain contracts as dividends from sources within the United States, and, therefore, subject to U.S. withholding tax if paid to a non-U.S. person.8
The Notice extends the effective dates found in certain provisions of:
- IRS Notice 2016-76;
- amendments to the Regulations under Notice 2016-76; and
- the final Qualified Intermediary Agreement.
The extensions are as follows:
- Phased-in Application for Delta-One and Non-Delta-One Transactions.
The Notice provides an extension to the phased-in application of the Regulations to potential Section 871(m) transactions9 that do not have a delta of one (as determined under the Regulations). Now, the Regulations will not generally apply to non-delta-one transactions entered into before January 1, 2019. The Regulations will continue to apply to any potential Section 871(m) transaction that has a delta of one entered into on or after January 1, 2017, including combined transactions; however, the Notice states that now both 2017 and 2018 will be phase-in years10 for these transactions.
- Phase-in Year for Qualified Derivatives Dealers.
The Notice extends three portions of the QDD rules.
o First, previous guidance provided that a QDD will not be subject to tax on dividends and dividend equivalents received in the QDD's equity derivatives dealer capacity until January 1, 2018, which the Notice extends to January 1, 2019.
o Second, previous guidance provided that a QDD will be required to compute its Section 871(m) tax liability using a "net delta" approach beginning in 2018; the Notice extends this effective date for the net delta approach to begin in 2019.
o Finally, the final QI Agreement provides that a QDD must perform certain periodic reviews with respect to its QDD activities, but only beginning on January 1, 2018. The Notice extends this date to January 1, 2019.
Simplified Standard for Determining Whether Transactions Are Combined Transactions.
Notice 2016-76 and the subsequent final regulations provide for a simplified standard for withholding agents to apply when two or more transactions should be combined in order to determine whether the transactions are subject to Section 871(m); however, the simplified method only applied for transactions entered into in 2017.11 The Notice extends the period during which this simplified standard applies to 2018.
On February 24, 2017, President Trump issued Executive Order 13777, which directed U.S. agencies to reduce the regulatory burdens created by these agencies. The Notice states that, under this executive order, the Treasury Department and IRS will continue to evaluate the Regulations and consider possible agency actions that may reduce unnecessary burdens imposed by the Regulations. On October 2, 2017, the U.S. Department of the Treasury delivered a report to President Trump that proposes substantial revisions to eight sets of U.S. federal income tax regulations. While the Section 871(m) regulations were not one of the eight, the report states that the Treasury is considering possible reforms to the Regulations.12 Additionally, on October 26, 2017, the IRS published corrections to the Regulations; these corrections were generally non-substantive in nature.13 Finally, Dana Trier, Department of Treasury deputy assistant secretary for tax policy, suggested at a District of Columbia Bar Taxation Community luncheon that Section 871(m) could potentially be limited to delta-one transactions only.14
The Notice states that taxpayers are permitted to rely on it until the Regulations and the final QI Agreement are amended to reflect the extensions provided for in the Notice.