On August 4, 2017, the Treasury Department and the Internal Revenue Service (the “IRS”) issued Notice 2017-42 (the “New Notice”) providing taxpayers with relief from certain aspects of the final and temporary regulations under sections 871(m), 1441, 1461 and 1473 of the Internal Revenue Code (collectively referred to as the “section 871(m) regulations”) and Revenue Procedure 2017-15 (which contains the final 2017 QI withholding agreement) for 2018 and 2019. The New Notice extends the effective date for certain rules in those final regulations and extends the phase-in period provided last December, in Notice 2016-76 (the “2016 Notice”), for certain other provisions of the section 871(m) regulations. Notwithstanding the extensions, the New Notice notes that the anti-abuse rule in Treas. Reg. 1.871-15(o) will continue to apply, potentially resulting in a transaction that otherwise would benefit from the provisions of the New Notice nevertheless being treated as a section 871(m) transaction in certain circumstances. Taxpayers and withholding agents may rely on the provisions of the New Notice prior to the promulgation of the amendments to the section 871(m) regulations and the final 2017 QI Agreement.
Extension of Effective Date for Non-Delta-One Transactions
Prior to the New Notice, section 871(m) would have applied to non-delta-one transactions issued on or after January 1, 2018. In order to grant taxpayers and withholding agents additional time to implement the section 871(m) regulations, the New Notice provides that the effective date of the section 871(m) regulations for non-delta-one transactions will be delayed such that the section 871(m) regulations will not apply to any payment made with respect to any non-delta-one transaction issued prior to January 1, 2019.
Extension of Good Faith Efforts Standard
The 2016 Notice previously provided a one-year good faith efforts standard for complying with the section 871(m) regulations. Specifically, the 2016 Notice provided that the IRS, when enforcing the section 871(m) regulations, would take into account the extent to which a taxpayer or withholding agent made a good faith effort to comply with the section 871(m) regulations with respect to delta-one transactions in 2017 and for non-delta-one transactions in 2018.
The New Notice extends the good faith efforts standard provided in the 2016 Notice for an additional year. Thus, the good faith efforts standard will now apply to delta-one transactions in both 2017 and 2018 and to non-delta-one transactions in 2019. Similarly, the New Notice extends through 2018 the period during which the IRS will take into account the extent to which a qualified derivatives dealer (a “QDD”) makes a good faith effort to comply with section 871(m) regulations and relevant provisions of the final 2017 QI Agreement. In addition, the IRS intends to revise the final 2017 QI Agreement to consider a QDD to satisfy the obligations specifically applying to a QDD under that agreement for 2018 so long as the QDD makes a good faith effort to comply with the relevant provisions of the final 2017 QI Agreement.
Extension of Relief for Withholding Agents with Respect to Combined Transactions
The 2016 Notice had provided a simplified standard for withholding agents to determine whether transactions entered into in 2017 must be combined for purposes of determining whether the transactions are “section 871(m) transactions” subject to withholding under the section 871(m) regulations. The New Notice extends the period, to include 2018, during which this simplified combination rule applies. Thus, a withholding agent is required to combine transactions entered into in 2017 and 2018 only when the transactions are over-the-counter transactions that are priced, marketed or sold in connection with each other. In general, transactions entered into in 2017 and 2018 that are combined under the simplified rule will continue to be treated as combined transactions for future years and transactions entered into in 2017 and 2018 that are not combined (from the perspective of the withholding agent) under the simplified rule will not become combined transactions in future years.
Extension of Relief for QDDs
The New Notice also extends several phase-in dates providing relief to QDDs.
Prior to the issuance of the New Notice, the final regulations and final 2017 QI Agreement provided that both dividends and dividend equivalents received by a QDD in its equity derivatives dealer capacity in 2017 will not be subject to tax, but that actual dividends received after 2017 would be subject to tax (even if the QDD makes offsetting payments with respect to its derivatives positions). The New Notice provides that a QDD will not be subject to withholding or income tax on dividends (including deemed dividends) received in both 2017 and 2018 in its equity derivatives dealer capacity.
With respect to the requirement provided under Rev. Proc. 2017-15 that a QDD will be required to compute its section 871(m) amount using the net delta approach beginning in 2018, the New Notice delays the requirement to calculate net delta until 2019.
Finally, a QDD will not be required to perform a periodic review with respect to its QDD activities for calendar years 2017 and 2018. Prior to the issuance of the New Notice, the final 2017 QI Agreement provided that such limitation on periodic reviews extended only to 2017.
A Ray of Hope for Further Relief
The New Notice states that, consistent with Executive Order 13777 (82 FR 12285), the Treasury Department and the IRS continue to evaluate the section 871(m) regulations and consider possible agency actions that may reduce unnecessary burdens imposed by the regulations.