The Hiring Incentives to Restore Employment Act (or HIRE Act) has now come into effect in the United States and it will likely be relevant to Canadian participants in the OTC derivatives and securities lending areas.
By way of background, the HIRE Act added a new U.S. withholding tax provision for certain equity-related swaps, sale-repurchase transactions and securities lending transactions. The HIRE Act applies to dividend equivalent payments made on or after September 14, 2010. Dividend equivalent payments include payments that are contingent on, or determined by reference to, U.S.-source dividends in sale-repurchase and securities lending transactions, including certain equity swap transactions where a non-U.S. counterparty buys or sells the underlying U.S. security from or to its counterparty. After March 18, 2012, cross-border dividend equivalent payments made under all equity swap transactions will be treated as U.S.-source dividend income, unless the U.S. Department of the Treasury issues regulations exempting any particular equity–related swap from its application. As a result, any U.S. source dividend equivalent payment received or paid by Canadian parties, for example, generally will be subject to U.S. withholding tax even if there is no U.S. counterparty to the transaction. The withholding tax is imposed on the “gross amount” of any dividend-equivalent payment used in computing any net amount paid to the non-U.S. counterparty in connection with the transaction. The U.S. withholding tax generally will be imposed at a 30% rate, unless the applicable withholding rate is reduced under the terms of an income tax treaty and proper documentary evidence is timely provided to the appropriate counterparty.
As a result of these new rules, ISDA published the 2010 HIRE Act Protocol to enable parties to amend the terms of their existing Covered Master Agreements to reflect the new U.S. withholding requirements enacted under the HIRE Act and the increased tax risk associated with IRS audits of equity swap transactions. Adherence to the Protocol is voluntary.
Because the HIRE Act applies to payments made on certain swaps and other contracts on or after September 14, 2010, regardless of when the contract was entered into, it is important for Canadian market participant to: (1) review existing agreements, (2) consider carefully the impact of the HIRE Act withholding requirements on their transactions and (3) assess the implications of adherence or non-adherence to the 2010 HIRE Act Protocol.