Issuers of catastrophe bonds or “cat bonds” often hold the proceeds from the issuance of cat bonds in U.S. money market funds. U.S. money market fund dividends have in recent years been excepted from U.S. federal withholding tax pursuant to Section 871(k) of the Internal Revenue Code. However, the exception to withholding under Section 871(k) does not apply with respect to taxable years of money market funds beginning after December 31, 2013. The taxable year of money market funds often begins during a later month in the year. For example, the taxable year of many money market funds begins on September 1. Thus, even if a cat bond issuer has previously been receiving dividends from a U.S. money market fund free of withholding, that may change as a new taxable year begins for the money market fund.
It is not clear whether Congress will enact legislation to extend the applicability of Section 871(k) or whether any such legislation, if enacted, will be on a retroactive basis. Thus, cat bond issuers may be subject to a 30% U.S. federal withholding tax on dividends from U.S. money market funds beginning at some point in 2014.