Today, the IRS issued final (T.D. 9648) and new proposed (REG-120282-10) regulations relating to certain dividend equivalents under section 871(m). The final regulations offer guidance to nonresident alien individuals and foreign corporations that hold specified notional principal contracts providing for payments that are contingent upon or determined by reference to U.S. source dividend payments and to withholding agents. The final regulations extend the applicability of the four-factor specified notional principal contract definition, outlined in §1.871-16T(b), to payments made before January 1, 2016.
- The final regulations also adopt a number of other temporary rules without change, including the 2012 temporary regulations’ (T.D. 9572) modification of §1.863-7, providing that the general source rule for notional principal contracts does not apply to a dividend equivalent under section 871(m), and provision that section 871(m) and §1.871-16T apply to dividend equivalents received by foreign corporations.
- The final regulations also modify certain regulations under section 1441 to require a withholding agent to withhold tax owed with respect to a dividend equivalent. In addition, the final regulations restore to §1.1441-7(a)(3) examples relating to the definition of a withholding agent.
- The final regulations are effective December 5, 2013.
The 2013 proposed regulations abandon the 2012 proposed regulations’ seven-factor approach to identifying a specified notional principal contract. Instead, the 2013 proposed regulations are based on the objective measurement of a derivative’s delta to establish whether a contract is subject to tax under section 871(m).
- Under the terms of the 2013 proposed regulations, the delta of a notional principal contract or equity-linked instrument is the ratio of the change in the fair market value of the contract to the change in the fair market value of the property referenced by the contract.
- Treasury and the IRS believe that the 2013 proposed regulations’ delta-based standard is not only easier to administer than the 2012 proposed regulations’ seven-factor test, but will also inhibit taxpayers from avoiding withholding tax by electing derivative exposure to U.S. equities rather than physical ownership.
- The new proposed regulations are generally applicable to payments made on or after the date the final regulations are published. Comments on the proposed regulations are due by March 5, 2014, and discussion topic outlines for the April 11, 2014 public hearing are due February 3, 2014.