Vol. 80 Friday, No. 181 September 18, 2015

Part VI

Department of the Treasury

Internal Revenue Service 26 CFR Part 1 Dividend Equivalents From Sources Within the United States; Final Rule

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DEPARTMENT OF THE TREASURY conduct or sponsor, and a person is not the Treasury Department and the IRS required to respond to, a collection of anticipated limiting the application of Internal Revenue Service information unless it displays a valid the rules with respect to specified ELIs control number. described in the 2013 proposed 26 CFR Part 1 Books or records relating to a regulations to ELIs issued on or after 90 collection of information must be [TD 9734] days after the date of publication of final retained as long as their contents may regulations. RIN 1545–BJ56 become material in the administration The Treasury Department and the IRS of any internal revenue law. Generally, received written comments on the 2013 Dividend Equivalents From Sources tax returns and return information are proposed regulations, which are Within the United States confidential, as required by 26 U.S.C. available at www.regulations.gov. The AGENCY: Internal Revenue Service (IRS), 6103. public hearing scheduled for April 11, 2013, was cancelled because no request Treasury. Background to speak was received. This Treasury ACTION: Final regulations and temporary On January 23, 2012, the Federal decision generally adopts the 2013 regulations. Register published temporary proposed regulations with the changes SUMMARY: This document provides regulations (TD 9572) at 77 FR 3108 discussed in this preamble. This guidance to nonresident alien (2012 temporary regulations), and a Treasury decision also includes individuals and foreign corporations notice of proposed rulemaking by cross- temporary regulations, which provide that hold certain financial products reference to the temporary regulations new rules for determining whether providing for payments that are and notice of public hearing at 77 FR certain complex derivatives are subject contingent upon or determined by 3202 (2012 proposed regulations, and to section 871(m) and for payments to reference to U.S. source dividend together with the 2012 temporary certain dealers in response to comments payments. This document also provides regulations, 2012 section 871(m) on the 2013 proposed regulations. regulations) under section 871(m) of the guidance to withholding agents that are Summary of Comments and responsible for withholding U.S. tax Internal Revenue Code (Code). The 2012 section 871(m) regulations relate to Explanation of Provisions with respect to a dividend equivalent. dividend equivalents from sources I. In General DATES: Effective Date: These regulations within the United States paid to The Treasury Department and the IRS are effective on September 18, 2015. nonresident alien individuals and received numerous comments regarding Applicability Dates: For dates of foreign corporations. Corrections to the the 2013 proposed regulations. Most applicability, see §§ 1.871–14(j)(3), 2012 temporary regulations were 1.871–15(r), 1.871–15T(r)(4), 1.1441– published on February 6, 2012, and comments agreed that the approach 1(f)(4), 1.1441–1T(f)(3), 1.1441–2(f), March 8, 2012, in the Federal Register taken in the 2013 proposed regulations, 1.1441–3(h)(3), 1.1441–7(a)(4), and at 77 FR 5700 and 77 FR 13969, in particular the use of a test based on 1.1473–1(f). respectively. A correcting amendment to delta, was a fair and practical way to FOR FURTHER INFORMATION CONTACT: D. the 2012 temporary regulations was also apply section 871(m) to financial Peter Merkel or Karen Walny at (202) published on August 31, 2012, in the instruments linked to one or more U.S. 317–6938 (not a toll-free number). Federal Register at 77 FR 53141. The equity securities. Commenters, however, SUPPLEMENTARY INFORMATION: Treasury Department and the IRS identified a number of issues with the received written comments on the 2012 2013 proposed regulations. Many of the Paperwork Reduction Act proposed regulations, and a public comments suggested modifications and The collection of information hearing was held on April 27, 2012. clarifications to the 2013 proposed contained in these final regulations has On December 5, 2013, the Federal regulations before they are issued as been reviewed and approved by the Register published final regulations and final regulations. Those comments are Office of Management and Budget in removal of temporary regulations (TD summarized in Part II of this preamble. accordance with the Paperwork 9648) at 78 FR 73079 (2013 final Part II also explains the changes made Reduction Act of 1995 (44 U.S.C. regulations), which finalized a portion to the final regulations in response to 3507(d)) under control numbers 1545– of the 2012 section 871(m) regulations. those comments. 0096 and 1545–1597. The collections of Also on December 5, 2013, the Federal Several of the issues identified by information in this final regulation are Register published a withdrawal of commenters required more significant in § 1.871–15(p), and are an increase in notice of proposed rulemaking, a notice changes or additions to the 2013 the total annual burden in the current of proposed rulemaking, and a notice of proposed regulations. To allow regulations under §§ 1.1441–1 through public hearing at 78 FR 73128 (2013 taxpayers adequate opportunity to 1.1441–9, 1.1461–1, and 1.1474–1. This proposed regulations). In light of consider and comment on these information is required to establish comments on the 2012 proposed changes, the Treasury Department and whether a payment is treated as a U.S. regulations, the 2013 proposed the IRS are issuing portions of the source dividend for purposes of section regulations described a new approach regulations as temporary and proposed 871(m). This information will be used for determining whether a payment regulations. Those provisions, and the for audit and examination purposes. made pursuant to a notional principal relevant comments, are summarized in The IRS intends that these information contract (NPC) or an equity-linked Part III of this preamble. collection requirements will be satisfied instrument (ELI) is a dividend II. Final Regulations by persons complying with revised equivalent based on the delta of the chapter 3 reporting requirements and contract. In response to written A. Source of a Dividend Equivalent the requirements of the applicable QI comments on the 2013 proposed The 2013 proposed regulations revenue procedure to be revised by the regulations, the Treasury Department provide that a dividend equivalent is IRS, or alternative certification and and the IRS released Notice 2014–14, treated as a dividend from sources documentation requirements set out in 2014–13 IRB 881, on March 24, 2014 within the United States for purposes of these regulations. An agency may not (see § 601.601(d)(2)(ii)(b)), stating that sections 871(a), 881, 892, 894, and

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4948(a), and chapters 3 and 4 of subtitle the temporary statutory definition The Treasury Department and the IRS A of the Code. This rule follows section adopted in the 2013 final regulations to received many comments regarding the 871(m)(1) but adds the reference to payments made before January 1, 2017. delta test. Commenters generally agreed section 894 to clarify (as provided in Pursuant to the grant of authority in that the delta test was both a fair and § 1.894–1(c)(2)) that a dividend section 871(m)(2)(C), the 2013 proposed comprehensive way to implement equivalent is treated as a dividend for regulations provide that certain section 871(m), but provided comments purposes of any provision regarding payments made pursuant to a specified on several aspects of the test. The major dividends in an income tax treaty. The ELI are substantially similar to a concerns noted in the comments relate final regulations retain the general dividend equivalent payment. Section to: (1) The use of 0.70 as the delta sourcing provision. See § 1.871–15(b). 1.871–15(c)(1)(iii) of the 2013 proposed threshold; (2) the time for testing delta; (3) the ability of parties to the B. Definition of a Dividend Equivalent regulations defines a dividend equivalent to include any payment that transaction to obtain and track the The 2013 proposed regulations define references the payment of a dividend necessary delta information; and (4) the a dividend equivalent as (1) any from an underlying security on a difficulty of determining an initial delta substitute dividend that references a specified ELI. Section 1.871–15(a)(3) of with respect to certain complex equity U.S. source dividend made pursuant to the 2013 proposed regulations defines derivatives (in contrast with simple a securities lending or sale-repurchase an ELI (whether or not specified) as any contracts, as defined in Part II.C.4 of this transaction, (2) any payment that financial transaction (other than a preamble). references a U.S. source dividend made securities lending or sale-repurchase pursuant to a specified NPC, (3) any 1. Delta Threshold transaction or an NPC) that references payment that references a U.S. source Comments on the 2013 proposed the value of one or more underlying dividend made pursuant to a specified regulations recommended raising the securities. Forward contracts, futures ELI, or (4) any other substantially delta threshold, with suggestions contracts, options, debt instruments similar payment. A payment references ranging from a delta of 0.80 to 0.95. The convertible into underlying securities, a U.S. source dividend if the payment majority of comments preferred a delta and debt instruments that have is directly or indirectly contingent upon threshold of 0.90 or greater. Comments payments linked to underlying a U.S. source dividend or determined by maintained that a higher delta would securities are common examples of an reference to such a dividend. While the more accurately capture transactions ELI. transactions described in (1) and (2) are that are economically equivalent to transactions described in sections C. The Delta Test stock ownership and likely to be used 871(m)(2)(A) and (B), respectively, the for tax-avoidance. One comment noted 2013 proposed regulations extend The 2012 proposed regulations used a that a 0.80 delta standard, although not section 871(m) to the transactions multi-factor test to determine whether prescribed in regulatory guidance, is described in (3) and (4) under the an NPC or ELI is a specified contract used by some practitioners as a regulatory authority granted in section subject to withholding under section yardstick to judge economic equivalence 871(m)(2)(C), which includes as a 871(m). The 2013 proposed regulations in other tax contexts. dividend equivalent ‘‘any other replace the multi-factor test with a The Treasury Department and the IRS payment determined by the Secretary to single-factor test that employs a ‘‘delta’’ agree that the 0.70 delta in the 2013 be substantially similar to a payment threshold to determine whether a proposed regulations could apply to described in subparagraph (A) or (B)’’ of transaction is a section 871(m) contracts with economic characteristics section 871(m)(2). The final regulations transaction. Delta refers to the ratio of a that do not sufficiently resemble the retain this four-part definition of a change in the fair market value of a underlying security to be within the dividend equivalent. See § 1.871– contract to a small change in the fair scope of section 871(m). On the other 15(c)(1). The final regulations also market value of the property referenced hand, a delta threshold that is 0.90 (or provide certain exceptions to the term by the contract. Delta is widely used by higher) would exclude many ‘‘dividend equivalent,’’ which are participants in the derivatives markets instruments that are surrogates for the described in section II.D of this to measure and manage risk. Under the underlying security, such as deep-in- preamble. test in the 2013 proposed regulations, the-money options. The final Section 871(m)(3)(A) provides a any NPC or ELI that had a delta of 0.70 regulations adopt a delta threshold of temporary definition of the term or greater when the long party acquired 0.80, which strikes a balance between ‘‘specified notional principal contract.’’ the transaction would be a section the potential over-inclusiveness of the This definition is effective for payments 871(m) transaction subject to 0.70 delta threshold and the likelihood made on or after September 14, 2010, withholding. that a 0.90 (or higher) threshold would and on or before March 18, 2012. The Treasury Department and the IRS exclude transactions with economic Section 871(m)(3)(B) provides that, for proposed a delta-based standard after returns that closely resemble an payments made after March 18, 2012, a concluding that it would provide a underlying security. specified NPC includes ‘‘any notional comparatively simple, administrable, Several comments noted that a delta principal contract unless the Secretary and objective framework that would ratio is intended to measure the determines that such contract is of a also minimize potential avoidance of sensitivity of the value of a contract to type which does not have the potential U.S. withholding tax. A financial comparatively small changes in the for tax avoidance.’’ The 2013 final instrument that provides an economic market value of the referenced property regulations extend the applicability of return that is substantially similar to the and suggested that the regulations the temporary statutory definition in return on the underlying stock should incorporate this qualification in the section 871(m)(3)(A) (the four-part be taxed in the same manner as the definition of delta. The final regulations definition provided in paragraphs underlying stock for the purpose of accept this suggestion and clarify the (3)(A)(i) through (iv)) to payments made section 871(m). The Treasury definition of delta by specifying that before January 1, 2016. These final Department and the IRS concluded that delta is calculated with respect to a regulations amend the 2013 final the delta test was the best way to small change in the fair market value of regulations to extend the application of identify these instruments. the property referenced by the contract.

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Typically, a small change is a change of Comments suggested adopting an linked derivatives, numerous comments less than 1 percent. alternative test for identifying high-delta explained that the delta test would be options based on their relative intrinsic difficult or impossible to apply to 2. Time for Testing Delta value (amount by which the option is certain more exotic equity derivatives. Many comments stated that the in-the-money) and relative extrinsic For example, contracts that have requirement to test delta each time a value (time value). This test would asymmetrical or binary payouts may contract is acquired would be extremely require the simpler calculation of reference a different number of shares of difficult to administer, especially for determining the applicable strike price an underlying security at different ELIs that trade frequently. Multiple as a percentage of the current fair payout points. Similarly, contracts that testing events create the possibility that market value of the ELI and deeming have path-dependent payouts may identical instruments acquired at ELIs at a certain percentage as passing reference multiple underlying different times would have different tax or failing the delta threshold. securities, with payouts that are characteristics, which withholding Alternatively, comments suggested interdependent on the performance of systems are generally not designed to permitting the long party to rely on each underlying security. In each of handle. To ease compliance, comments commonly available online tools to these cases, comments noted that the suggested that delta be tested only when calculate delta for exchange-traded ELIs, delta is indeterminate because the a contract is issued. For derivatives that provided that the taxpayer uses inputs number of shares of the underlying are listed and cleared through central that are within the range of security that determine the payout of clearinghouses, another comment commercially acceptable variation, uses the derivative cannot be known at the suggested that the delta test would be a consistent methodology, and records time the contract is entered into. more administrable if taxpayers were its calculations contemporaneously. The Treasury Department and the IRS permitted to simplify their calculations. Comments also recommended relying agree that an alternative to the delta test For example, delta could be calculated on an anti-abuse rule for particularly is needed for contracts with using the fair market value of an ELI complex derivatives for which delta indeterminate deltas. To address these determined as of the market close on the information would be unavailable to contracts, the final regulations trading day prior to the date the ELI is any party other than the issuer, distinguish between simple contracts acquired, even though this approach speculating that the increased cost and and complex contracts. would result in a less accurate risk of complex transactions generally Generally, a simple contract is a calculation. Other comments suggested would outweigh any tax savings. contract that references a single, fixed that, in determining the delta of an The Treasury Department and the IRS number of shares of one or more issuers option, only the stock price at the time are concerned that these alternative tests to determine the payout. The number of the option is entered into should be or shorthand methods for determining shares must be known when the considered. delta may result in uncertainty for contract is issued. In addition, the The Treasury Department and the IRS withholding agents and the IRS that contract must have a single maturity or are persuaded that the difficulties of could make it difficult to determine the exercise date on which all amounts testing delta each time an NPC or ELI is status of potential section 871(m) (other than any upfront payment or any acquired outweigh the benefit of the transactions. Moreover, the changes to periodic payments) are required to be increased accuracy of that approach. the final regulations to require that delta calculated with respect to the Accordingly, the final regulations be tested only when a contract is first underlying security. The fact that a provide that the delta of an ELI or NPC issued, accompanied by enhanced contract has more than one expiry, or a is determined only when the instrument reporting rules (described in more detail continuous expiry, does not preclude is issued; it is not re-tested when the later in this preamble), make these the contract from being a simple instrument is purchased or otherwise alternative tests unnecessary. contract. Thus, an American-style acquired in the secondary market. Accordingly, the final regulations do not option is a simple contract even though Consequently, only an NPC or ELI that adopt these recommendations. the option may be exercised by the has a delta of 0.80 or greater at the time However, in order to simplify the holder at any time on or before the it is issued is a specified NPC or delta calculation for contracts that expiration of the option if amounts due specified ELI. reference multiple underlying under the contract are determined by For purposes of § 1.871–15, an securities, the final regulations provide reference to a single, fixed number of instrument is treated as ‘‘issued’’ when that a short party may calculate delta shares on the exercise date. Most NPCs it is entered into, purchased, or using a single exchange-traded security and ELIs are expected to be simple otherwise acquired at its inception or in certain circumstances. More contracts and remain subject to the delta original issuance, which includes an specifically, if a short party issues a test described above. issuance that results from a deemed contract that references a basket of 10 or A complex contract is any contract exchange pursuant to section 1001. The more underlying securities and uses an that is not a simple contract. Contracts requirement to test delta only at the exchange-traded security, such as an with indeterminate deltas are classified time an instrument is issued also exchange-traded fund, that references as complex contracts, which are subject extends to the rules for determining the substantially the same underlying to a new substantial equivalence test. amount of each dividend equivalent (as securities to hedge the contract at the That test is included in the temporary discussed in section E.1 of this time it is issued, the short party may use regulations, described in more detail in preamble). the hedge security to determine the Part III of this preamble. The delta test delta of the security it is issuing rather in the final regulations therefore applies 3. Access to Delta Information than determining the delta of each only to simple contracts. Comments noted practical issues with security referenced in the basket. obtaining delta information, particularly D. Exceptions for Certain Payments and for exchange-traded positions where the 4. Contracts With Indeterminate Deltas Transactions dealer is not involved in determining Although commenters generally Several comments requested that the pricing and the short party may not agreed that the delta test was fair and final regulations exclude certain have the expertise to calculate delta. practical for the majority of equity- payments from the definition of

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‘‘dividend equivalent’’ or exclude dividend equivalent with respect to a dividend date that occurs after the certain transactions from the definition section 871(m) transaction is reduced by record date. This rule is expected to of ‘‘section 871(m) transaction.’’ These any amount treated in accordance with apply in situations in which a securities comments generally noted that the section 305(b) and (c) as a dividend exchange sets an ex-dividend date after payment or transaction at issue either is with respect to the underlying security the record date to accommodate a already taxed under another provision referenced by the section 871(m) special dividend. of the Code or does not provide the long transaction. For example, if a change in 4. Employee Compensation party with an opportunity to avoid gross the conversion ratio of a convertible basis taxation on U.S. source dividends. security that is a section 871(m) The 2013 proposed regulations do not transaction is treated as a section 305 specifically exclude payments of 1. Payment Referencing Distributions dividend made to the holder of the compensation for personal services of a That Are Not Dividends convertible security, a dividend nonresident alien individual from being The 2013 proposed regulations equivalent is reduced by the amount of treated as a dividend equivalent. provide that a payment referencing a the section 305 dividend arising from Comments suggested that compensation distribution on an underlying security is such change. arrangements should be excluded from not a dividend equivalent to the extent Although a transaction (for example, dividend equivalent treatment because that the distribution would not be a change in conversion ratio of a compensation is already subject to an subject to tax pursuant to section 871 or convertible security) may give rise to existing tax withholding framework, section 881 if the long party owned the both a dividend equivalent and a compensatory transactions arise in a underlying security directly. The final section 305 dividend, dividend different context from other derivatives regulations retain this provision. See equivalents and section 305 dividends and do not have the potential to avoid § 1.871–15(c)(2)(i). have different characteristics. These U.S. withholding tax, and compensation should be subject to tax where the 2. Section 305 Coordination final regulations do not alter any of the rules applicable to section 305 services are performed. Under sections 305(b) and (c) and dividends. As noted in Part II.L. of this The Treasury Department and the IRS regulations authorized by section 305(c), preamble, however, the changes made have determined that section 871(m) a change to the conversion ratio or elsewhere in these final regulations should not apply to compensation that conversion price of a convertible debt should make section 871(m) is generally subject to withholding or instrument that is a convertible security inapplicable to most convertible debt has a specific exception therefrom. for purposes of section 305 (a instruments, including those that are Accordingly, the final regulations convertible security) may be treated as convertible securities subject to section provide that a dividend equivalent does a distribution of property to which 305(c). not include the portion of equity-based section 301 applies made to the holder compensation for personal services of a of the convertible security. See § 1.305– 3. Due Bills nonresident alien individual that is 7. To the extent such a distribution is The 2013 proposed regulations wages subject to withholding under treated under section 301(c)(1) as a reserve on the question of whether a due section 3402, excluded from the dividend as defined in section 316 (a bill gives rise to a dividend equivalent definition of wages under section 305 dividend), § 1.1441–2(d)(1) and request comments regarding § 31.3401(a)(6)–1, or exempt from would require withholding on the whether a payment made by a seller of withholding under § 1.1441–4(b). For section 305 dividend without regard to stock to the purchaser pursuant to an example, when a restricted stock unit is the fact that there is no payment at that agreement to deliver a pending U.S. paid as compensation and tax is time. Absent special rules, a section 305 source dividend after the record date collected by the employer at the time of dividend resulting from a change in (for example, a due bill) should be payment through withholding, the conversion ratio or price of a convertible treated as a substantially similar payment will not also be a dividend security that is a section 871(m) payment. equivalent subject to withholding. If the transaction could also be subject to One comment noted that a due bill restricted stock unit results in the withholding as a dividend equivalent. may give rise to payments that appear receipt of stock, however, dividends The 2013 proposed regulations to satisfy the criteria for a dividend subsequently paid on that stock would provide that a payment pursuant to a equivalent. That comment expressed be subject to withholding under section section 871(m) transaction is not a concern regarding the impact this 871. dividend equivalent to the extent that it treatment might have on the capital is treated as a distribution taxable as a markets because of the relative 5. Certain Corporate Acquisitions dividend pursuant to section 305. frequency of due bills, as well as the In response to comments, § 1.871– Comments noted that section 305 administrative complexity of treating 15(j) of the 2013 proposed regulations dividends and dividend equivalents these payments as dividend equivalents. provides an exception to the definition under section 871(m) arise in different Another comment asserted that a due of a section 871(m) transaction when a contexts and are determined differently. bill is not the economic equivalent of a taxpayer enters into a transaction as part Moreover, section 305 dividends will dividend. Both comments requested that of a plan pursuant to which one or more reduce earnings and profits pursuant to the regulations either address due bills persons (including the taxpayer) are section 312. Comments suggested that under the anti-abuse rule or exclude obligated to acquire more than 50 the regulations provide more detail to them from the term dividend percent of the entity issuing the coordinate these two provisions, equivalent. underlying securities. including guidance on how to reconcile The final regulations provide that a Comments requested that the withholding on the delta-based dividend equivalent does not include a acquisition threshold in this exception dividend equivalent in these regulations payment made pursuant to a due bill be lowered from 50 percent to 10 or 20 with withholding otherwise required on that arises from the actions of a percent. Comments noted that corporate section 305 dividends. securities exchange that apply to all acquisitions generally would not After consideration of the comments, transactions in the stock and when the provide an opportunity for avoiding these final regulations clarify that a relevant exchange has set an ex- dividend withholding. Further,

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comments noted that the anti-abuse rule terms of the NPC, such as in the dividend is used to calculate the should be sufficient to address any payments that the long party is required amount of the dividend equivalent abuse that could occur through such to make to the short party or in setting unless the short party identifies a transactions. Comments acknowledged the price of the underlying securities reasonable estimated dividend amount that when a target company pays a pre- referenced in the price return swap. in writing at the inception of the closing dividend and the purchase price Comments objected to the provisions transaction. When a payment based on is reduced for the dividend, this may in the 2013 proposed regulations that estimated dividends is supported by the allow the purchaser to avoid a include estimated and implicit required documentation, the per-share subsequent dividend. However, dividends in the definition of a dividend amount used to compute the comments observed that this event dividend equivalent. These comments amount of a dividend equivalent is the should be viewed as a purchase price noted that an estimated dividend is lesser of the estimated dividend and the adjustment rather than a dividend reflected as a price reduction or as an actual dividend. equivalent. amount that the foreign investor does Comments on the 2013 proposed The final regulations do not change not have to pay rather than an amount regulations noted that recalculating the the 50 percent threshold. Requiring that the foreign investor affirmatively delta of a section 871(m) transaction an acquisition (as part of a plan by one receives for holding the derivative, each time the amount of a dividend or more person) total more than 50 which suggests that there is no equivalent is determined would add percent of a corporation is appropriate ‘‘payment’’ of a dividend equivalent to administrative complexity without because it indicates that the primary the foreign investor. Comments also intent of the acquirer is to obtain a noted that, while estimated dividends necessarily improving accuracy. In the controlling interest rather than just a may be implicitly incorporated into the interest of simplicity, several comments substantial investment in the target pricing of a derivative, the price is recommended using the actual dividend company. In circumstances where a ultimately determined by supply and amount rather than an amount adjusted taxpayer enters into a transaction demand in the market and the expected for delta as the dividend equivalent pursuant to which the taxpayer is dividend is not always explicitly used amount. Other comments suggested obligated to acquire 50 percent or less in computing the amount paid. using the delta at the time the of the entity issuing the underlying The Treasury Department and the IRS transaction is issued or entered into for securities, and the transaction is a have concluded that the economic determining the dividend equivalent section 871(m) transaction, any party to benefit of a dividend is present in amount. For complex transactions for the transaction that is a broker, dealer, transactions that implicitly incorporate which the delta is indeterminate, or intermediary, a short party, or a estimated dividends to virtually the comments suggested that withholding withholding agent, must comply with same extent as transactions that pay or be based on the number of shares any requirements in the final regulation adjust for actual dividends. Thus, the required by the short party to the to make appropriate determinations, final regulations retain the rules in the transaction to hedge its initial position and satisfy reporting and withholding 2013 proposed regulations that include in the transaction. obligations, as applicable. estimated and implicit dividends as The final regulations simplify the D. Payment of a Dividend Equivalent dividend equivalents. See § 1.871– rules for determining the amount of a 15(i)(2). More specifically, the final dividend equivalent in response to these Section 871(m)(5) provides that a regulations provide that any gross comments. For a simple contract, the ‘‘payment’’ includes any gross amount amount that references the payment of final regulations provide that the that references a U.S. source dividend a dividend, whether actual or estimated, amount of the dividend equivalent for and that is used to compute any net explicit or implicit, is treated as a each underlying security equals the amount transferred to or from the dividend equivalent to the extent of the amount of the per-share dividend, taxpayer. The 2013 proposed amount determined under the multiplied by the number of shares regulations provide that a dividend regulations. The final regulations equivalent includes any amount that referenced in the contract, multiplied by references an actual or estimated change the time that withholding is the applicable delta. In a change from payment of a U.S. source dividend, required on a payment of a dividend the 2013 proposed regulations, the final whether the reference is explicit or equivalent, as discussed in Part II.M of regulations provide that this formula implicit. Thus, in addition to amounts this preamble. references the delta of the transaction at the time the simple contract is issued, equal to actual payments of dividends E. Amount of a Dividend Equivalent and estimated dividends, a dividend rather than when the dividend is paid. equivalent includes any other 1. Calculation of Dividend Equivalent For a complex contract, the amount of contractual term of a section 871(m) Amount the dividend equivalent equals the transaction that is calculated based on Under the 2013 proposed regulations, amount of the per-share dividend an actual or estimated dividend. For the amount of a dividend equivalent for multiplied by the number of shares that example, when a long party enters into a specified NPC or specified ELI equals constitute the initial hedge of the an NPC that provides for payments the per-share dividend amount with complex contract (as that term is based on the appreciation in the value respect to the underlying security defined in § 1.871–15(a)(14)(ii) and of an underlying security but that does multiplied by the number of shares of discussed in Part III.A of this preamble). not explicitly entitle the long party to the underlying security referenced in Another simplifying rule applies to receive payments based on regular the contract (subject to adjustment), dividend equivalents paid with respect dividends (a price return swap), the multiplied by the delta of the to baskets of more than 25 securities. If 2013 proposed regulations treat the transaction with respect to the a section 871(m) transaction references price return swap as a transaction that underlying security at the time when a basket of more than 25 underlying provides for the payment of a dividend the amount of the dividend equivalent securities, the short party is allowed to equivalent because the anticipated is determined. If a transaction provides treat all of the dividends on the basket dividend payments are presumed to be for a payment based on an estimated or as paid on the last day of the calendar taken into account in determining other implicit estimated dividend, the actual quarter.

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2. Specified NPCs and Specified ELIs any component underlying security of S&P 500 Index, rebalance using a With a Term of One Year or Less the qualified index other than a short combination of objective and subjective For a specified NPC or specified ELI position with respect to the entire factors. Comments further requested that the with a term of one year or less when qualified index (such as a cap or a permitted dividend yield be increased acquired, the 2013 proposed regulations floor). One comment recommended to 2.5 times the current dividend yield provide that the amount of a dividend eliminating the exception for a qualified of the S&P 500 Index. The comments equivalent is determined when the long index. This comment noted that when a noted that an index may not satisfy the party disposes of the section 871(m) long party holds a total return swap requirement based on 1.5 times the transaction. Therefore, a long party that referencing a basket of underlying current dividend yield of the S&P 500 acquires an option with a term of one securities, that swap is economically Index if the stocks in the index year or less that is a specified ELI would equivalent to multiple total return depreciated significantly relative to the not incur a withholding tax if the option swaps that each reference a single general U.S. stock market. In addition, lapses. underlying security. Similarly, when a other indices would not qualify because One comment noted that the rule long party holds a delta-one derivative some market sectors routinely pay providing that there is no dividend that references an index, that derivative dividends at a rate that is more than 1.5 equivalent for options that have a term is economically equivalent to multiple times the average rate in the U.S. of one year or less and lapse delta-one derivatives each referencing a market. unexercised is inappropriate in the case single component of the index; Other comments suggested additional of written put options because put therefore, that long party is receiving the categories of indices that should be writers realize their maximum profit economic equivalent of all dividends treated as qualified indices. Specifically, when puts lapse. Comments further paid with respect to each stock in the one comment recommended that any noted that the one-year rule could have index. Thus, transactions that reference index that was published by a uneconomic consequences for options U.S. stock indices have no less potential recognized independent index publisher close to expiration and for options that for avoidance of gross basis withholding should be a qualified index if the index are slightly in-the-money or slightly out- tax on dividends than transactions that is offered for license to third parties on of-the-money because the delta could reference single equities or that similar terms and multiple third party fluctuate materially in response to small reference customized baskets of industry participants actually license changes in the price of the underlying equities. the index. The comments proposed stock. Another comment noted that the defining a recognized independent Based on the comments received, the criteria in the 2013 proposed regulations index publisher as an organization that final regulations eliminate the special provide a reasonable method for publishes indices that are created, rule for contracts with terms of one year identifying legitimate indices that have calculated, and compiled by a group of or less. Any benefit from the rule is not been designed to avoid withholding employees that have no duties other outweighed by the complexity of taxes. That comment noted that the than those related to the publication of creating systems to track contracts that rules would exclude most securities that the indices. differ only in term. Eliminating the are linked to an index and traded on The rule in the 2013 proposed special rule for contracts of one year or U.S. stock exchanges from dividend regulations that prevents taxpayers from less means that a dividend equivalent taxation, while preventing customized using short positions to decrease their amount must be determined for any indices from becoming a vehicle long position with respect to one or option, including a short-term option, designed to evade U.S. dividend taxes. more components of an index was also that is a specified ELI. The majority of comments, however, noted by comments as too restrictive. recommended that the scope of the Comments suggested permitting F. Qualified Indices index exception be expanded to include taxpayers to decrease risk with respect The 2013 proposed regulations revise most of the indices that are represented to a small percentage of the value of the rules provided in the 2012 proposed by exchange traded funds. Several stocks in the index without regulations pertaining to an exception comments requested that the definition disqualifying the index. One comment for transactions that reference certain allow an index with fewer than 25 suggested that an index should remain equity indices. Under the 2013 stocks to be a qualified index, noting a qualified index unless the short proposed regulations, a qualified index that many sector indices have fewer position is used to establish a net long is any index that (1) references 25 or than 25 names. Another comment position in a narrow set of underlying more underlying securities, (2) suggested providing an exception to the securities for purposes of evading references only long positions in requirement that an index be referenced withholding. underlying securities, (3) contains no by exchange-traded futures or options The 2013 proposed regulations also underlying security that represents more that would apply to indices that are included a safe harbor for global indices than 10 percent of the index’s sufficiently broad-based (for example, with 10 percent or less U.S. stocks. weighting, (4) rebalances based on indices containing one hundred or more Comments recommended expanding objective rules at set intervals, (5) does component securities). Comments also this safe harbor because U.S. equities in not provide a dividend yield that is suggested eliminating the requirement a global index can comprise more than greater than 1.5 times the dividend yield that the stock of a single company half of the index’s weighting. The of the S&P 500 Index, and (6) is cannot represent more than 10 percent comments proposed increasing the referenced by futures or option contracts of the index’s weighting because some threshold to allow U.S. stocks to that trade on a national securities indices include component securities represent 50 percent or more of the exchange or a domestic board of trade. that grow rapidly. Several comments index. These comments also noted that In addition, the 2013 proposed also noted that many indices would fail global indices do not typically trade on regulations provide that a qualified to satisfy the requirement that a U.S. securities or commodities index would become disqualified if a qualified index rebalance based on exchanges and will not be qualified transaction references a qualified index objective rules at set intervals because indices under the current provisions. and also references a short position in many popular indices, including the Other comments suggested that the

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regulations except from withholding all rebalance based on objective rules, the related person) enters into two or more global indices that are not created to final regulations do not require that an transactions that reference the same avoid withholding tax, with a index be modified or rebalanced at set underlying security and the transactions presumption that widely-used dates or intervals, and provide were entered into in connection with benchmark indices are not designed to flexibility for how the rules governing each other. The 2013 proposed avoid tax. the constitution of an index are applied. regulations apply only to combine The Treasury Department and the IRS Instead, under the final regulations, an transactions in which the taxpayer is the believe that the approach taken in the index that is periodically rebalanced by long party, and typically would not 2013 proposed regulations for a board or committee that is allowed to combine transactions when a taxpayer is identifying qualified indices exercise judgment in interpreting the the long party with respect to an appropriately balances the competing rules governing the composition of the underlying security in one transaction concerns. Accordingly, the final index will not be disqualified if the and the short party with respect to the regulations generally retain the criteria index is otherwise a qualified index. same underlying security in another of the 2013 proposed regulations with The final regulations continue to transaction. The 2013 proposed modifications to clarify the intent and require that an index be referenced by regulations provide that a broker-dealer improve the functionality of the futures or options listed on a national must use ‘‘reasonable diligence’’ to qualified index rule. See § 1.871–15(l) securities exchange or board of trade to determine whether a transaction is a The final regulations add a paragraph be a qualified index, which is consistent section 871(m) transaction. Under the stating that the purpose of the qualified with the intent to provide a safe harbor 2013 proposed regulations, a index rule is to provide a safe harbor for only for non-customized and widely- withholding agent was not required to transactions on passive indices that available indices. The final regulations withhold on a dividend equivalent paid reference a diverse basket of securities do, however, permit an index that trades pursuant to a transaction that is and that are widely used by numerous on certain foreign exchanges to be a combined with one or more other market participants. The index qualified index, provided that the transactions unless the withholding exception is not intended to apply to referenced component underlying agent knew that the long party (or a any index that is customized or reflects securities, in aggregate, comprise less related person) entered into the a trading strategy, is unavailable to other than 50 percent of the weighting of the potential section 871(m) transactions in investors, or targets special dividends. component securities in the index and connection with each other. The final regulations further provide the index otherwise meets the definition The Treasury Department and the IRS that an index will not be treated as a of a qualified index. requested comments regarding whether qualified index if treating the index as Similarly, the Treasury Department and how the rules for combining a qualified index would be contrary to and the IRS have concluded that the separate transactions should apply in this purpose. proposed rule permitting no more than other situations, such as when a To make the rules easier to 1.5 times the current dividend yield of taxpayer holds both long and short administer, the final regulations modify the S&P 500 Index is appropriate and positions with respect to the same the time for determining whether an have retained it in the final regulations. underlying security (for example, a call index satisfies the qualified index To reduce the number of required spread). Comments also were requested criteria. Specifically, the final calculations, however, the final regarding whether and how the regulations provide that the regulations provide that the annual remaining transaction (or transactions) determination of whether an index is a yields of the tested index and of the S&P should be retested when a long party qualified index is made on the first 500 Index are determined based on their terminates one or more, but not all, of business day of each calendar year, and annual yields for the immediately the transactions that make up a that determination applies for all preceding calendar year, rather than combined position. potential section 871(m) transactions requiring comparison of the annual Several comments recommended that issued during that calendar year. yields for the month immediately the regulations not provide a specific In response to comments, a number of preceding the date that the potential combination rule and instead rely on an changes also were made to specific section 871(m) transaction is issued. anti-abuse rule. One comment endorsed aspects of the qualified index definition. The Treasury Department and the IRS the proposed regulations as they applied First, the final regulations delete the agree that de minimis short positions, to combinations of long calls and modifier ‘‘underlying’’ with respect to whether as part of the index or entered written puts (two options that can be ‘‘securities,’’ thereby allowing an index into separately, should not disqualify an used to closely approximate the to qualify with fewer than 25 index. Accordingly, the final regulations economics of stock ownership) but component underlying securities permit a qualified index to reference recommended that transactions not be provided that the index contains a total one or more short positions (in addition combined if the transactions replicate of at least 25 component securities (in to any short positions with respect to the same or similar risks with respect to other words, a component security may the entire qualified index, such as caps additional shares (for example, two include a security that does not give rise or floors, which were already permitted purchased calls on the same underlying to U.S. source dividends). The index, by the 2013 proposed regulations) that securities). however, will not qualify if it references represent five percent or less, in the Many comments observed that five or fewer component underlying aggregate, of the value of the long determining whether transactions were securities that together represent more positions in underlying securities in the entered into ‘‘in connection with’’ each than 40 percent of the weighting of the qualified index. other would be difficult for a component securities in the index. withholding agent and that the Second, the final regulations increase G. Combined Transactions regulations should adopt a different the 10 percent limit for the maximum The 2013 proposed regulations treat standard or clarify the meaning of the weighting of a single underlying multiple transactions as a single phrase. Comments asked that the final security to 15 percent. Third, in transaction for purposes of determining regulations conform the standard for response to concerns regarding the if the transactions are a section 871(m) combined transactions to the narrower requirement that a qualified index transaction when a long party (or a withholding standard that requires

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‘‘actual knowledge.’’ Comments noted connection with each other if the long monitor their compliance with section that the requirement in the 2013 party holds the transactions in separate 871(m). proposed regulations for broker-dealers accounts. Second, a broker may The Treasury Department and the IRS to use ‘‘reasonable diligence’’ to presume that transactions entered into will continue to evaluate the possibility determine whether a transaction is a two or more business days apart are not of expanding the combination rules to section 871(m) transaction could be entered into in connection with each accommodate netting of long and short interpreted to require broker-dealers to other. These presumptions are positions in light of future inquire whether transactions are entered independent of each other. Thus, a developments in transactional reporting into in connection with each other in broker acting as a short party is relieved and recordkeeping. Additional order to determine whether they must of the obligation to withhold if either of comments regarding combined be combined. These comments observed the two presumptions is met. A broker transactions are welcome. that this standard for combined cannot rely on the first presumption if H. Derivatives Referenced to Partnership transactions is impractical because it has actual knowledge that the long Interests broker-dealers are generally not in a party created or used separate accounts position to discern the intent of their to avoid section 871(m), however, and The 2013 proposed regulations treat a counterparties, even using ‘‘reasonable neither presumption applies if the transaction that references an interest in diligence.’’ broker has actual knowledge that an entity that is not a C corporation for Several comments recommended that transactions were entered into in Federal tax purposes as referencing the a combination rule permit netting of connection with each other. allocable portion of any underlying securities and potential section 871(m) long and short positions. Commenters In addition, the final regulations contracts held directly or indirectly by observed that many standard option provide that the Commissioner will that entity. The 2013 proposed strategies involve multiple options presume that transactions that are regulations provide an exception for a positions, often combining positive and properly reflected on separate trading transaction that references an interest in negative delta options. As a result, an books of the taxpayer are not entered approach that does not combine these an entity that is not a C corporation if into in connection with each other. The the underlying securities and potential positions would fail to reflect the Commissioner will also presume that a economics of the transactions. section 871(m) transactions allocable to long party did not enter into two or that interest represent, in the aggregate, Commenters suggested that when a more transactions in connection with taxpayer modifies an existing combined 10 percent or less of the value of the each other if the long party entered into interest in the referenced entity at the position that includes both long and the transactions two or more business short positions, the combined position time the transaction is entered into. days apart. These presumptions are Comments recommended changing the should continue to be tested based on rebuttable. The Commissioner may the net deltas of the component threshold for applying the look-through rebut the first presumption with facts positions rather than test the delta for rule from 10 percent to 50 percent and circumstances showing that each position separately. None of the unless the taxpayer controls the entity. separate trading books were created or comments, however, proposed an Comments also noted that taxpayers used to avoid section 871(m), and may administrable test that could be used to would have difficulty determining the rebut either presumption with facts and reliably combine long and short assets owned by referenced entities. circumstances showing that the positions and net the resulting deltas. The final regulations revise the rules The final regulations retain the transactions in question were entered to provide that section 871(m) applies to general rules from the 2013 proposed into in connection with each other. derivatives that reference a partnership regulations that define when The Commissioner will also apply an interest only when the partnership is transactions are combined. In response affirmative presumption. The either a dealer or trader in securities, to questions about whether the rules Commissioner will presume that has significant investments in securities, were intended to combine transactions transactions that are entered into fewer or holds an interest in a lower-tier that had similar economic exposure, the than two business days apart and partnership that engages in those final regulations add a requirement that reflected on the same trading book are activities. The final regulations define a the potential section 871(m) entered into in connection with each security by cross-reference to section transactions, when combined, replicate other. In this case, the long party can 475(c). When the rule in the final the economics of a transaction that rebut the presumption by presenting regulations applies, a potential section would be a section 871(m) transaction if facts and circumstances showing that 871(m) transaction that references a the transactions had been entered into the transactions were not entered into in partnership interest is treated as as a single transaction. Thus, the connection with each other. In applying referencing the allocable share of purchase of two out-of-the-money call the presumptions that are based on underlying securities and the potential options would typically not be trades being separated by at least two section 871(m) transactions in the combined because each call option business days, the regulations include a partnership directly or indirectly provides the taxpayer with exposure to rule of convenience that generally allocable to that partnership interest. appreciation, but not depreciation, on allows parties to treat all of their Even when a partnership is not covered the referenced stock. transactions as entered into at 4:00 p.m. by this rule, the anti-abuse rule in The Treasury Department and the IRS The presumptions are not available to § 1.871–15(o) may still apply, or the recognize the challenges that short the long party. A long party therefore transaction may be recharacterized parties could face in identifying must treat two or more transactions as under the substance-over-form doctrine transactions to be combined. The final combined transactions if the or other common law doctrine. regulations therefore provide brokers transactions satisfy the requirements to acting as short parties with two be a combined transaction. The long I. Anti-Abuse Rule presumptions they can apply to parties affected by this rule consist The 2013 proposed regulations determine their liability to withhold. primarily of securities traders, who are provide that the Commissioner may First, a broker may presume that in a position to know their securities treat any payment made with respect to transactions are not entered into in positions and trading strategies and to a transaction as a dividend equivalent if

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the taxpayer acquires the transaction on an issuer’s Web site at or prior to the K. Recordkeeping Rules with a principal purpose of avoiding the time that the transaction is issued and The 2013 proposed regulations application of section 871(m). updated regularly. Investors could then generally cross-reference the Comments generally agreed with the rely on such information between recordkeeping rules in § 1.6001–1 for need for such a rule, and the final update intervals. how a taxpayer establishes whether a regulations retain this provision. See In response to these comments, the transaction is a section 871(m) § 1.871–15(o). final regulations make several changes transaction and whether a payment is a In addition, the IRS may challenge the to the reporting obligations in the 2013 dividend equivalent. For clarity and to U.S. tax results claimed in connection proposed regulations. The final ensure that the IRS will have access to with transactions that are designed to sufficient information to audit taxpayers avoid the application of section 871(m) regulations revise the period for providing requested information from and withholding agents that are parties using all available statutory provisions to section 871(m) transactions, the final and judicial doctrines (including the 14 calendar days to 10 business days from the date of the request. In addition, regulations provide more detailed substance-over-form doctrine, the recordkeeping rules. The final economic substance doctrine under the final regulations replace the list of persons entitled to request information regulations provide that any person section 7701(o), the step transaction required to retain records must keep doctrine, and tax ownership principles) in the 2013 proposed regulations with a simpler provision that entitles ‘‘any sufficient information to establish as appropriate. For example, nothing in whether a transaction is a section section 871(m) precludes the IRS from party to the transaction’’ to request information. The final regulations 871(m) transaction and the amount of a asserting that a contract labeled as an dividend equivalent. To satisfy this NPC or other equity derivative is in fact define ‘‘a party to the transaction’’ to include any agent acting on behalf of a requirement, a taxpayer must retain an ownership interest in an underlying documentation and work papers security referenced in the contract. long party or short party to a potential section 871(m) transaction, or any supporting a delta calculation or J. Reporting Obligations person acting as an intermediary with substantial equivalence calculation (including the number of shares of the The 2013 proposed regulations respect to a potential section 871(m) initial hedge) and written estimated provide rules for reporting and transaction. This simplification dividends (if any). The records and withholding. The preamble to the 2013 responds to the requests to expand the documentation must be created proposed regulations explains that most scope of persons entitled to request substantially contemporaneously with equity-linked transactions involve a information. Several other changes that financial institution acting as a broker, the time the potential section 871(m) were requested, however, such as transaction is issued. dealer, or intermediary and that the posting information electronically, were financial institution would be in the already permitted by the 2013 proposed L. Contingent and Convertible Debt best position to report the tax regulations. Like the 2013 proposed Instruments consequences of a potential section regulations, the final regulations permit 1. Contingent Debt Instruments 871(m) transaction. Accordingly, parties to a transaction to obtain § 1.871–15(o) of the 2013 proposed information on potential section 871(m) Section 871(h)(1) generally provides regulations provides that when a broker transactions in a variety of ways, that U.S. source portfolio interest or dealer is a party to a potential section including through electronic received by a nonresident alien 871(m) transaction the broker or dealer publication (such as a Web site). individual is not subject to the 30- is required to determine whether the percent U.S. tax imposed under section transaction is a section 871(m) Comments also noted that a short 871(a)(1). Section 871(h)(4)(A)(i), transaction, and if so, the amounts of party to a listed option will not be able however, excludes certain contingent the dividend equivalents. If no broker or to provide the long party with a written interest payments from the definition of dealer is a party to a transaction or both estimate of dividends at inception portfolio interest. Section parties are brokers or dealers, the short because the short party does not have a 871(h)(4)(A)(ii) grants the Secretary party is required to determine whether contractual relationship with the long authority to impose tax on contingent the transaction is a section 871(m) party. These comments requested that interest other than the payments transaction and the amounts of the the broker be required to provide the described in section 871(h)(4)(A)(i) dividend equivalents. Determinations written estimates. As in the 2013 when necessary or appropriate to made by the broker, dealer, or short proposed regulations, the final prevent the avoidance of federal income party are binding on the parties to the regulations do not require any party to tax. section 871(m) transaction unless a a transaction to provide written Comments on the 2012 proposed party to the transaction knows or has estimates of dividends. The final regulations recommended narrowing the reason to know that the information is regulations have taken these comments definition of a specified notional incorrect. Those determinations, into account, however, by increasing a principal contract to clarify that the however, are not binding on the IRS. taxpayer’s ability to obtain information term does not include contingent or Comments expressed concern that the from other parties to the transaction. convertible debt. These comments delta information necessary for an The final regulations accomplish this by suggested that section 871(m) should investor to determine whether a expanding the definition of a ‘‘party to not override the portfolio interest transaction is subject to section 871(m) the transaction’’ to include a broker and exception. Section 871(h)(4)(A)(ii) may not be available on a timely basis, by clarifying that either a dealer or a expressly provides authority to the and requested that the regulations middleman is a ‘‘broker.’’ Therefore, if Secretary to treat interest as contingent expand the categories of persons written estimates of dividends are interest if necessary or appropriate to permitted to request information about prepared when a transaction is issued, prevent the avoidance of federal income the status and calculations associated the long party should be able to obtain tax. Consistent with this grant of with potential section 871(m) the information from another party to authority, the 2013 proposed regulations transactions. Comments recommended the transaction, whether the short party provide that contingent interest will not requiring the information to be provided or a broker. qualify for the portfolio interest

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exemption to the extent that the debt instrument in making section receives or makes a payment, when contingent interest payment is a 871(m) calculations. there is a final settlement of the section dividend equivalent. The final 871(m) transaction, or when the long M. Amounts Subject to Withholding regulations retain this exception to the party sells or otherwise disposes of the portfolio interest exemption. There is no Section 1.1441–2(d)(5) of the 2013 section 871(m) transaction. For options reason that an equity derivative that proposed regulations provides that a and other contracts that typically otherwise would be a specified NPC or withholding agent is not obligated to require an upfront payment, the final a specified ELI should receive different withhold on a dividend equivalent until regulations do not treat the premium or treatment because it is embedded in a the later of: (1) When the amount of the other upfront payment as a payment for debt instrument. A debt instrument that dividend equivalent is determined and withholding purposes. Thus, provides for a contingent interest (2) when any of the following occurs: (a) withholding on these section 871(m) payment determined by reference to a Money or other property is paid transactions is not required until there U.S. source dividend payment that pursuant to a section 871(m) is a final settlement (including, in the would otherwise be a section 871(m) transaction, (b) the withholding agent case of an option, a lapse) or the long transaction is a transaction that has the has custody or control of money or other party sells or otherwise disposes of the potential for tax avoidance, and it is property, or (c) there is an upfront transaction. Consequently, if an option appropriate for section 871(m) to apply. payment or a prepayment of the that is a section 871(m) transaction The effect of this rule, however, is purchase price. lapses, the short party is nonetheless expected to be minimal because the Comments emphasized the burden of required to withhold on any dividend delta of the embedded derivative in a withholding on dividend equivalents equivalent associated with the option. contingent debt or convertible debt absent actual payments, and noted that, Parties may need to modify contractual instrument is tested only at the time it in the absence of actual payment, arrangements to ensure that there are continuous monitoring and withholding is issued. sufficient funds available to satisfy on each specified ELI over time is withholding obligations. 2. Convertible Debt Instruments impractical. Certain comments Numerous comments requested that suggested that a foreign broker only be III. Temporary and Proposed convertible debt instruments be required to withhold on dividend Regulations equivalents from ELIs when there is a excluded from the definition of an ELI. A. Test for Contracts With final payment or a sale. Comments suggested that certain Indeterminate Deltas characteristics typical of convertible Comments also maintained that debt would discourage foreign investors upfront payments should not be viewed As noted in Part II of this preamble, from using these instruments to avoid as payments subject to withholding many commenters stated that the delta U.S. withholding tax. Comments because such proceeds are received in test was workable for most equity pointed, for example, to high exchange for issuing the instrument, are derivatives but would be difficult or transaction costs and certain used by the issuer to purchase related impossible to apply to more exotic discontinuities between the economic hedging positions, and are not intended equity derivatives. In particular, a performance of the convertible debt and to be reserves for satisfying tax owed by contract that provides for payments that of the underlying stock, such as the the counterparty. based on a number of shares of stock downside protection and creditors’ Some comments expressed concern that varies at different points, or that rights afforded by convertible debt. regarding the practical difficulties in provides for a payment that does not Comments noted that convertible bonds withholding from funds that the broker- vary with the price of the shares (often are important capital markets dealer holds as collateral. Comments called ‘‘digital’’ options), have an instruments used by U.S. corporations noted that the broker-dealer may not be indeterminate delta because the number to raise capital at lower rates. Comments legally entitled to use cash or property of shares of the underlying security that also speculated that treating such bonds in one account to satisfy a withholding determine the payout of the derivative as specified ELIs could adversely impact obligation in another account. In cannot be known at the time the capital markets by decreasing demand, addition, foreign counterparties may contract is entered into. Path-dependent reducing liquidity, and increasing costs. hold different accounts through contracts were also mentioned as The final regulations do not provide different affiliates of a broker-dealer. problematic for the delta computation. an exception from section 871(m) for Comments indicated that it would be Indeterminate delta may, for example, convertible debt. When the stock price impractical to determine the existence occur in contracts commonly known as significantly exceeds the conversion of affiliate accounts and apply set-off structured notes. Structured notes are price, convertible debt becomes a rules on that basis. financial instruments that combine surrogate for the stock into which the After consideration of these aspects of debt with aspects of debt can be converted. Accordingly, a comments, the Treasury Department derivatives, such as equity options. As convertible debt obligation is a specified and the IRS have concluded that the an example, in return for an upfront ELI if the delta of the embedded option withholding agent’s obligations should payment of a set amount, a structured at the time the convertible debt is not arise until an actual payment is note might provide the long party with originally issued is 0.80 or higher. made or there is a final settlement of a leveraged upside return, meaning that Moreover, the fact that convertible debt transaction. Accordingly, the final the long party is entitled to receive a ordinarily has been issued with a delta regulations provide that a withholding fixed percentage (for example, 200 on the embedded option of less than agent is not obligated to withhold on a percent) of any appreciation in the value 0.80 is expected to significantly reduce dividend equivalent until the later of of a referenced stock up to a capped the effect of these regulations on the when a payment is made with respect amount (for example, 125 percent of the convertible debt market. In response to to a section 871(m) transaction or when issue price) in addition to return of the uncertainty expressed by some market the amount of a dividend equivalent is upfront payment, while being exposed participants, the final regulations clarify determined. A payment with respect to to 100 percent of any depreciation in the that the delta of the convertible feature a section 871(m) transaction will value of the referenced stock, with any is tested separately from the delta of the generally occur when the long party such depreciation reducing the amount

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of the upfront payment that is returned the delta test seeks to measure without its application to complex contracts that to the long party. In such a structured needing to know the number of shares reference multiple securities, including note, the holder would have two times that the contract references at the outset. path-dependent instruments. the ‘‘upside’’ up to the cap but only one Like the delta test, a proportionality test B. Withholding Requirements and QDDs times exposure to the ‘‘downside.’’ The is based on the principle that when the issuer of this kind of structured note value of an NPC or ELI closely tracks the 1. Background cannot readily determine a delta for the value of an underlying security, it is Section 871(m)(1) generally treats a note because it references a different appropriate to treat the NPC or ELI as a dividend equivalent as a dividend from number of shares at different payoff surrogate for the underlying security. sources within the United States To test whether a complex contract is amounts. In other words, because delta without regard to the residence of the a section 871(m) transaction, the is the ratio of the change in the fair person paying the dividend equivalent. market value of a contract to a small temporary regulations adopt the As a result, section 871(m) may apply to change in the fair market value of the ‘‘substantial equivalence’’ test. The payments made by a foreign payor to a property referenced by the contract, the substantial equivalence test is a version foreign payee. See Staff of J. Comm. on value of the referenced property must be of a proportionality test that was Taxation, Technical Explanation of the known to calculate delta. In the case of advocated by many commenters, and it Revenue Provisions Contained in Senate the structured note described in this uses information easily accessible to Amendment 3310, the ‘‘Hiring paragraph, the number of shares of stock most issuers of complex contracts. Incentives to Restore Employment Act,’’ (and hence the value of the property) Generally, the substantial equivalence JCX–4–10, at 79 (Feb. 23, 2010) referenced by the contract will be test measures the change in value of a (explaining that section 871(m) may different depending on whether the complex contract when the price of the stock appreciates, and in such case underlying security referenced by that apply to a chain of dividend whether the cap is reached, or whether contract is hypothetically increased by equivalents, including payments made the stock depreciates. one standard deviation or decreased by by a foreign person pursuant to As explained in Part II.C.4 of this one standard deviation (each, a ‘‘testing transactions described in Notice 97–66); preamble, a contract with an price’’) and compares that change to the see also Notice 97–66, 1997–2 C.B. 328, indeterminate delta is not a simple change in value of the shares of the at § 5, Examples 3 and 4 (illustrating contract, and therefore falls into the underlying security that would be held that a foreign person making a substitute residual category as a complex contract. to hedge the complex contract at the dividend payment to another foreign Because the delta test cannot accurately time the contract is issued (the ‘‘initial person must withhold U.S. tax). Because be applied to a complex contract, hedge’’) at each testing price. The Congress was concerned that this rule commenters had various suggestions for smaller the proportionate difference may result in over-withholding in some how to determine whether such a between the change in value of the instances, Congress granted the contract should be a section 871(m) complex contract and the change in Secretary authority in section 871(m)(6) transaction. One comment suggested value of its initial hedge at multiple to reduce tax on a chain of dividend that the delta should be calculated using testing prices, the more equivalence equivalents, but only to the extent that the highest possible number of shares there is between the contract and the the taxpayer can establish that tax has that could be referenced by the referenced underlying security. When been paid with respect to another derivative at maturity. This comment this difference is equal to or less than dividend equivalent in the chain, or is further suggested that the regulations the difference for a simple contract not otherwise due, or as the Secretary include a delta-specific anti-abuse rule benchmark with a delta of 0.80 and its determines is appropriate to address the to prevent issuers from manipulating initial hedge, the complex contract is role of financial intermediaries in such the number of referenced shares to treated as substantially equivalent to the chain. For purposes of section artificially reduce delta. Other underlying security. 871(m)(6), a dividend is treated as a comments suggested that the regulations The Treasury Department and the IRS dividend equivalent. should disaggregate a transaction into a are aware that there may be NPCs or 2. Comments on the 2013 Proposed series of components and then ELIs that even the substantial Regulations separately apply the delta test to each equivalence test may not adequately component. When multiple derivatives address. The temporary regulations The 2013 proposed regulations are embedded in a single instrument, a provide that when the steps of the address the role of financial comment recommended that multiple substantial equivalence test cannot be intermediaries in a chain of dividend pieces be aggregated into separate applied to a particular complex equivalents with a rule that provides components (for example, aggregating contract, a taxpayer must use the that payments made to a ‘‘qualified all embedded calls and separately principles of the substantial equivalence dealer’’ are not treated as dividend aggregating all embedded puts) using an test to reasonably determine whether equivalents if made pursuant to a ordering rule that would maximize the the complex contract is a section 871(m) transaction that is entered into by the likelihood that the delta threshold transaction with respect to each qualified dealer in its capacity as a would be met. underlying security. dealer in securities and the dealer is the A majority of comments requested The Treasury Department and the IRS long party. For purposes of this rule, a that some version of a ‘‘proportionality’’ request comments regarding the qualified dealer is any dealer that is test be applied to complex contracts or substantial equivalence test described in subject to regulatory supervision by a to contracts where the basic delta test is the temporary regulations. In particular, governmental authority in the susceptible of manipulation. A comments are requested on whether the jurisdiction in which it was created or proportionality test measures the two testing points required for most organized and that certifies to the short likelihood that a contract’s performance transactions in the temporary party that it is receiving the payment in will track the performance of the regulations are adequate to ensure that its capacity as a dealer. The 2013 referenced equity. That is, a the substantial equivalence test captures proposed regulations require the proportionality test measures the same the appropriate types of transactions, qualified dealer to certify as to its dealer variability or economic equivalence that and the administrability of the test and status to a short party on a transaction-

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by-transaction basis, and do not apply to QIs that hold stocks and bonds for to hedges of potential section 871(m) dividends paid to a qualified dealer. customers often receive payments transactions that it issues. The latter Comments requested that the subject to withholding on behalf of their category of QDDs is intended to allow qualified dealer exception in the 2013 foreign account holders as custodians banks and bank affiliates that issue proposed regulations be expanded, rather than as beneficial owners. In equity-linked instruments on an noting that it would be impractical for contrast, a broker that enters into occasional basis to still act as QDDs. derivative contracts as a principal dealers to certify that each transaction 4. Notice 2010–46 was entered into in a dealer capacity typically receives dividends and (and not as a proprietary trade) and that dividend equivalents as part of a chain Shortly after section 871(m) was the rule did not accommodate of transactions in which the broker is a enacted, the Treasury Department and transactions entered into as a hedge of counterparty to both long and short the IRS published Notice 2010–46, another transaction. Some comments positions. 2010–24 I.R.B. 757. Notice 2010–46 suggested that the regulations exclude The Treasury Department and the IRS addresses potential overwithholding in the context of securities lending and transactions entered into in the ordinary intend to implement the particular sale repurchase agreements. Notice course of the dealer’s business for requirements of withholding and 2010–46 provides a two-part solution to hedging purposes. Other comments reporting on dividend equivalents the problem of overwithholding on a recommended expanding the exception received and paid by brokers by chain of dividends and dividend to include affiliates of qualified dealers amending the QI agreement to include equivalents. First, it provides an that issue certain potential section new provisions that will permit an exception from withholding for 871(m) transactions. Comments further eligible QI to act as a qualified payments to a qualified securities lender recommended that an affiliate in these derivatives dealer (QDD). A QI that acts (QSL). Second, it provides a proposed circumstances should not be required to as a QDD will not be subject to framework to credit forward prior certify that it is acting in its capacity as withholding on dividends or payments that may be dividend equivalents made withholding on a chain of substitute a dealer. Several comments requested with respect to potential section 871(m) dividends paid pursuant to a chain of that, in addition to expanding the transactions that the QDD receives securities loans or stock repurchase definition of qualified dealer, the final while acting in its capacity as a dealer. agreements. The QSL regime requires a regulations provide rules similar to the In order to act as a QDD, a QI must person that agrees to act as a QSL to proposed regulatory framework meet four requirements. First, the QDD comply with certain withholding and described in Notice 2010–46 (discussed must furnish to withholding agents a QI documentation requirements. Notice in more detail in section III.B.4 of this withholding certificate affirming that 2010–46 and any QI agreement preamble). the recipient is acting as a QDD for imposing QSL requirements will remain 3. Qualified Intermediaries Acting as dividends and dividend equivalent effective until final regulations Qualified Derivatives Dealers payments associated with the implementing the QDD rules are withholding certificate. Second, the published. The comments received on both the QDD must agree to assume primary As stated above, Notice 2010–46 2012 proposed regulations and the 2013 withholding and reporting provided a proposed framework to proposed regulations consistently responsibilities on all payments credit forward prior withholding on a expressed the desire for a associated with the withholding chain of substitute dividends paid comprehensive withholding and certificate that the QDD receives and pursuant to a chain of securities loans documentation regime tailored to makes as a dealer, and to determine or stock repurchase agreements. The derivatives dealers. Rather than create a whether payments it makes are Treasury Department and the IRS will new regime for section 871(m) dividend equivalents. Third, a QDD continue to consider whether a credit transactions, the Treasury Department must agree to remain liable for tax on forward system for prior withholding and the IRS determined that the most any dividends and dividend equivalents would be appropriate in the context of comprehensive and efficient way to it receives unless the QDD is obligated a chain of dividend equivalents on respond to the requests in the comments to make an offsetting dividend NPCs or ELIs. While administrating the is to expand the existing qualified equivalent payment as the short party credit forward system described in intermediary (QI) regime to on the same underlying securities. Notice 2010–46, however, the IRS has accommodate taxpayers acting as Finally, a QDD must comply with any had difficulty verifying that prior financial intermediaries on section compliance review procedures that are withholding in a chain of securities 871(m) transactions. Generally, a QI is applicable to a QI acting as a QDD, as loans had in fact occurred in order to an eligible person that enters into a QI specified in the QI agreement. justify the crediting of prior withholding agreement with the IRS and that acts as The class of persons eligible to act as to a subsequent payment. The a QI under such agreement. See Rev. a QDD is narrower than the class of temporary regulations, therefore, reserve Proc. 2014–39, 2014–29 I.R.B. 150. A QI persons that are eligible to enter into a on the issue of a general credit forward agreement typically requires the QI to QI agreement. A QI will be allowed to system, and the Treasury Department assume certain documentation and act as a QDD if it is either (1) a securities and the IRS request comments on the withholding responsibilities in dealer that is regulated as a dealer in the need for such a system and how it could exchange for simplified information jurisdiction in which it was organized be implemented. reporting for its foreign account holders or operates, or (2) a bank that is and the ability to not disclose regulated as a bank in the jurisdiction in 5. Implementation of the QDD Regime proprietary account holder information which it was organized or operates (or and Phase-out of the QSL Regime to a withholding agent that may be a a wholly-owned foreign affiliate of such All existing QI agreements expire on competitor. A QI may either assume a bank). To act as a QDD, a QI that is December 31, 2016. Prior to January 1, primary withholding responsibilities or not a securities dealer also must issue 2017, the Treasury Department and the may provide withholding information to potential section 871(m) transactions to IRS intend to publish an updated QI a withholding agent from which it customers and receive dividends or agreement and rules addressing the receives a payment. dividend equivalent payments incident requirements for QDD status.

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Procedures for entering into a QI law. Therefore, the temporary because the obligation gives rise to a agreement that permits a QI to act as a regulations provide that there is no dividend equivalent pursuant to section QDD are expected to be set out in this dividend equivalent associated with a 871(m) and the regulations thereunder. agreement. QDD status will be effective payment that a foreign person receives This grandfather rule applies only to no sooner than January 1, 2017. Until pursuant to the terms of an annuity, obligations that are executed on or these temporary regulations are endowment, or life insurance contract before the date that is six months after finalized and appropriate provisions are issued by a domestic insurance the date on which obligations of its type incorporated into a new QI agreement, company (including the foreign or U.S. are first treated as giving rise to the provisions for QSLs and the credit- possession branch of the domestic dividend equivalents. forward rules under Notice 2010–46 insurance company). will continue to apply for dividend The Treasury Department and the IRS Special Analyses equivalents that are substitute dividend are considering how section 871(m) Certain IRS regulations, including this payments made pursuant to a securities should apply to annuity, endowment, one, are exempt from the requirements lending or a sale-repurchase transaction. and life insurance contracts that of Executive Order 12866, as Once fully implemented, the new reference U.S. equities and that are supplemented and reaffirmed by QDD status under the QI regime will issued by foreign life insurance Executive Order 13563. Therefore, a replace and expand the QSL regime companies. Until further guidance is regulatory impact assessment is not described in Notice 2010–46. To issued, the temporary regulations required. It also has been determined continue to be eligible for the exception provide that these contracts do not that section 553(b) of the Administrative from withholding, entities that have include a dividend equivalent when Procedure Act (5 U.S.C. chapter 5) does been treated as QSLs will be required to issued by a foreign corporation that is not apply to these regulations. It is enter into a QI agreement to satisfy and predominately engaged in an insurance hereby certified that these regulations comply with the requirements for QDD business and that would be subject to will not have a significant economic treatment provided in the temporary tax under subchapter L if it were a impact on a substantial number of small regulations and in the updated QI domestic corporation. Similarly, the entities. This certification is based on Agreement. When these temporary temporary regulations do not treat any the fact that few, if any, small entities regulations are finalized, the Treasury portion of a payment received by a will be affected by these regulations. Department and the IRS expect the final foreign life insurance company as a The regulations will primarily affect regulations to supplant the proposed dividend equivalent when the payment multinational financial institutions, regulatory framework described in is made according to the terms of an which tend to be larger businesses, and Notice 2010–46. insurance contract, such as reinsurance, foreign entities. Therefore, a Regulatory by a foreign corporation meeting the C. Certain Insurance Contracts Flexibility Analysis is not required. same requirements. The Treasury The 2013 proposed regulations do not Pursuant to section 7805(f) of the Code, Department and the IRS are also these regulations have been submitted specifically address whether payments evaluating how section 871(m) should made on life insurance or annuity to the Chief Counsel for Advocacy of the apply to reinsurance contracts. Small Business Administration for contracts are dividend equivalents when Taxpayers are encouraged to send the payments are directly or indirectly comment on its impact on small comments on how section 871(m) business. contingent upon or determined by should apply to foreign life insurance reference to the payment of a dividend companies and the contracts they issue. Drafting Information from sources within the United States. Comments noted that treating annuity IV. Effective/Applicability Date The principal authors of these contract payments as dividend The final and temporary regulations regulations are D. Peter Merkel and equivalents could conflict with section are generally effective on September 18, Karen Walny of the Office of Associate 72, which provides that the holder of an 2015. To ensure that brokers have Chief Counsel (International). Other annuity contract is taxed only when an adequate time to develop the systems personnel from the Treasury amount is received from the annuity. needed to implement the regulations, Department and the IRS also Comments further noted that when a however, the final and temporary participated in the development of these foreign person receives payments or regulations generally apply to regulations. withdrawals from an annuity contract transactions issued on or after January 1, List of Subjects in 26 CFR Part 1 issued by a domestic insurance 2017. In addition, with respect to company, the payment is FDAP subject transactions issued on or after January 1, Income taxes, Reporting and to 30% withholding to the extent such 2016, and before January 1, 2017, that recordkeeping requirements. payment or withdrawal constitutes gross are section 871(m) transactions, the Adoption of Amendments to the income as determined in accordance regulations also apply to any payment of Regulations with section 72. Similarly, withdrawals a dividend equivalent made on or after of income from a life insurance contract January 1, 2018. The regulations do not ■ Accordingly, 26 CFR part 1 is issued by a domestic insurance change the applicability date of § 1.871– amended as follows: company are generally U.S. source 15(d)(1)(i) for specified NPCs described FDAP subject to withholding. in that section. PART 1—INCOME TAXES Commenters argued that the existing The chapter 4 regulations provide a ■ Paragraph 1. The authority citation rules that apply to life insurance and coordinating effective date for the for part 1 continues to read in part as annuity contracts obviate the need for treatment of dividend equivalents as follows: withholding under section 871(m). withholdable payments for purposes of The Treasury Department and the IRS chapter 4 withholding. Section 1.1471– Authority: 26 U.S.C. 7805 * * * agree that the taxation of life insurance 2(b)(2)(i)(A)(2) provides that § 1.871–14(h) also issued under 26 U.S.C. and annuity contracts issued by grandfathered obligations under chapter 871(h) and 871(m). * * * domestic insurance companies is 4 include any obligation that gives rise §§ 1.871–15 and 1.871–15T also adequately addressed under current to a withholdable payment solely issued under 26 U.S.C. 871(m). * * *

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Par. 2. Section 1.871–14 is amended § 1.871–15 Treatment of dividend described in paragraph (c) of this by: equivalents. section. ■ 1. Redesignating paragraphs (h) and (i) (a) Definitions. For purposes of this (iii) Party to the transaction. A party as paragraphs (i) and (j), respectively. section, the following terms have the to the transaction is any person that is ■ 2. Adding new paragraphs (h) and meanings described in this paragraph a long party or a short party to a (j)(3). (a). potential section 871(m) transaction, The additions read as follows: (1) Broker. A broker is a broker within any agent acting on behalf of the long the meaning provided in section party or short party, or any person § 1.871–14 Rules relating to repeal of tax 6045(c). acting as an intermediary with respect on interest of nonresident alien individuals (2) Dealer. A dealer is a dealer in to the potential section 871(m) and foreign corporations received from securities within the meaning of section transaction. certain portfolio debt investments. 475(c)(1). (iv) Party to the transaction that is * * * * * (3) Dividend. A dividend is a dividend both a long party and a short party—(A) (h) Portfolio interest not to include as described in section 316. In general. If a potential section 871(m) certain contingent interest—(1) (4) Equity-linked instrument. An transaction references more than one Dividend equivalents. Contingent equity-linked instrument (ELI) is a underlying security, the long party and interest does not qualify as portfolio financial transaction, other than a short party are determined separately interest to the extent that the interest is securities lending or sale-repurchase with respect to each underlying a dividend equivalent within the transaction or an NPC, that references security. A party to a potential section meaning of section 871(m). the value of one or more underlying 871(m) transaction is both a long party (2) Amount of dividend equivalent securities. For example, a futures and a short party when the party is that is not portfolio interest. The contract, forward contract, option, debt entitled to a payment that references a amount that does not qualify as instrument, or other contractual dividend payment on an underlying portfolio interest because it is a arrangement that references the value of security and the same party is obligated dividend equivalent equals the amount one or more underlying securities is an to make a payment that references a of the dividend equivalent determined ELI. dividend payment on another pursuant to § 1.871–15(j). Unless (5) Initial hedge. An initial hedge is underlying security pursuant to the otherwise excluded pursuant to section the number of underlying security potential section 871(m) transaction. 871(h), any other interest paid on an shares that a short party would need to (B) Example. The following example obligation that is not a dividend fully hedge an NPC or ELI (whether the illustrates the definitions in paragraph equivalent may qualify as portfolio NPC or ELI is a complex contract or a (a)(9) of this section: simple contract benchmark (within the interest. Example. (i) Stock X and Stock Y are * * * * * meaning of paragraph (h)(2) of this underlying securities. A and B enter into an (j) * * * section), as appropriate) with respect to NPC that entitles A to receive payments from an underlying security at the time the (3) Effective/applicability date. The B based on any appreciation in the value of NPC or ELI is issued, even if the short Stock X and dividends paid on Stock X rules of paragraph (h) of this section party does not in fact fully hedge the during the term of the contract and obligates apply beginning September 18, 2015. NPC or ELI. A to make payments to B based on any ■ Par. 3. Section 1.871–15 is amended (6) Issue. An NPC or ELI is treated as depreciation in the value of Stock X during by: issued at inception, original issuance, or the term of the contract. In return, the NPC entitles B to receive payments from A based ■ 1. Redesignating paragraphs (d)(1)(i) at the time of an issuance as a result of as (d)(1)(i)(A), (d)(1) introductory text as on any appreciation in the value of Stock Y a deemed exchange pursuant to section and dividends paid on Stock Y during the (d)(1)(i), (d)(1)(ii) as (d)(1)(i)(B), 1001. term of the contract and obligates B to make (d)(1)(iii) as (d)(1)(i)(C), and (d)(1)(iv) as (7) Notional principal contract. A payments to A based on any depreciation in (d)(1)(i)(D). notional principal contract (NPC) is a the value of Stock Y during the term of the ■ 2. Removing ‘‘2016’’ from newly notional principal contract as defined in contract. redesignated paragraph (d)(1)(i) and § 1.446–3(c). (ii) A is the long party with respect to adding ‘‘2017’’ in its place. (8) Option. An option includes an Stock X, and the short party with respect to ■ option embedded in any debt Stock Y. B is the long party with respect to 3. Removing ‘‘Specified NPCs before Stock Y, and the short party with respect to January 1, 2016’’ from newly instrument, forward contract, NPC, or Stock X. redesignated paragraph (d)(1)(i) and other potential section 871(m) adding ‘‘In general’’ in its place. transaction. (10) Payment. A payment has the ■ 4. Adding new paragraphs (d)(1) (9) Parties to the transaction—(i) Long meaning provided in paragraph (i) of introductory text, (d)(1)(ii) and (d)(2). party. A long party is the party to a this section. ■ 5. Redesignating paragraph (o) as potential section 871(m) transaction (11) Reference. To reference means to paragraph (r)(2) and: with respect to an underlying security be contingent upon or determined by that would be entitled to receive a reference to, directly or indirectly, ■ a. Revising the heading for newly payment of a dividend equivalent whether in whole or in part. redesignated paragraph (r)(2), (within the meaning of paragraph (i) of (12) Section 871(m) transaction and ■ b. Removing the language ‘‘This’’ in this section) described in paragraph (c) potential section 871(m) transaction. A paragraph (r)(2) and adding ‘‘Paragraph of this section. section 871(m) transaction is any (d)(1)(i) of this’’ in its place, and (ii) Short party. A short party is the securities lending or sale-repurchase ■ c. Adding new paragraphs (r)(1), (r)(3) party to a potential section 871(m) transaction, specified NPC, or specified and (q). transaction with respect to an ELI. A potential section 871(m) ■ 7. Adding new paragraphs (a) through underlying security that would be transaction is any securities lending or (c), and (e) through (p). obligated to make a payment of a sale-repurchase transaction, NPC, or ELI The additions and revisions read as dividend equivalent (within the that references one or more underlying follows: meaning of paragraph (i) of this section) securities.

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(13) Securities lending or sale- dividend pursuant to § 1.861–3, where (iii) Due bills. A dividend equivalent repurchase transaction. A securities applicable taking into account does not include a payment made lending or sale-repurchase transaction paragraph (m) of this section. Except as pursuant to a due bill arising from the is any securities lending transaction, provided in paragraph (l) of this section, actions of a securities exchange that sale-repurchase transaction, or if a potential section 871(m) transaction apply to all transactions in the stock substantially similar transaction that references an interest in more than one with respect to the dividend. For references an underlying security. entity described in the preceding purposes of this section, a stock will be Securities lending transaction and sale- sentence or different interests in the considered to trade with a due bill only repurchase transaction have the same same entity, each referenced interest is when the relevant securities exchange meaning as provided in § 1.861–3(a)(6). a separate underlying security for has set an ex-dividend date with respect (14) Simple contracts and complex purposes of applying the rules of this to a dividend that occurs after the contracts—(i) Simple contract. A simple section. record date. contract is an NPC or ELI for which, (b) Source of a dividend equivalent. A (iv) Certain payments pursuant to with respect to each underlying dividend equivalent is treated as a annuity, endowment, and life insurance security, dividend from sources within the contracts. [Reserved]. For further (A) All amounts to be paid or received United States for purposes of sections guidance, see § 1.871–15T(c)(2)(iv). on maturity, exercise, or any other 871(a), 881, 892, 894, and 4948(a), and (v) Certain payments pursuant to payment determination date are chapters 3 and 4 of subtitle A of the employee compensation arrangements. calculated by reference to a single, fixed Internal Revenue Code. A dividend equivalent does not include number of shares (as determined in (c) Dividend equivalent—(1) In the portion of equity-based paragraph (j)(3) of this section) of the general. Except as provided in compensation for personal services of a underlying security, provided that the paragraph (2), dividend equivalent nonresident alien individual that is— number of shares can be ascertained means— (A) Wages subject to withholding when the contract is issued, and (B) The (i) Any payment that references the under section 3402 and the regulations contract has a single maturity or payment of a dividend from an under that section; exercise date with respect to which all underlying security pursuant to a (B) Excluded from the definition of amounts (other than any upfront securities lending or sale-repurchase wages under § 31.3401(a)(6)–1; or payment or any periodic payments) are transaction; (C) Exempt from withholding under § 1.1441–4(b). required to be calculated with respect to (ii) Any payment that references the (d) Specified NPCs—(1) Specified the underlying security. A contract has payment of a dividend from an NPCs entered into before January 1, a single exercise date even though it underlying security pursuant to a may be exercised by the holder at any 2017—(i) * * *. specified NPC described in paragraph (ii) Specified NPC status as of January time on or before the stated expiration (d) of this section; of the contract. An NPC or ELI that 1, 2017. An NPC that is treated as a (iii) Any payment that references the specified NPC pursuant to paragraph includes a term that discontinuously payment of a dividend from an increases or decreases the amount paid (d)(1)(i) of this section will remain a underlying security pursuant to a specified NPC on or after January 1, or received (such as a digital option), or specified ELI described in paragraph (e) that accelerates or extends the maturity 2017. of this section; and (2) Specified NPCs on or after January is not a simple contract. A simple (iv) Any other substantially similar contract that is an NPC is a simple NPC. 1, 2017—(i) Simple NPCs. A simple NPC payment as described in paragraph (f) of that has a delta of 0.8 or greater with A simple contract that is an ELI is a this section. simple ELI. respect to an underlying security when (2) Exceptions—(i) Not a dividend. A (ii) Complex contract—(A) In general. the NPC is issued is a specified NPC. payment that references a distribution A complex contract is any NPC or ELI (ii) Complex NPCs. A complex NPC with respect to an underlying security is that is not a simple contract. A complex that meets the substantial equivalence not a dividend equivalent to the extent contract that is an NPC is a complex test described in paragraph (h) of this that the distribution would not be NPC. A complex contract that is an ELI section with respect to an underlying subject to tax pursuant to section 871 or is a complex ELI. security when the NPC is issued is a section 881 if the long party owned the specified NPC. (B) Example. An ELI entitles the long party underlying security. For example, if an (e) Specified ELIs—(1) Simple ELIs. A to a return equal to 200 percent of the NPC references stock in a regulated appreciation on 100 shares of Stock X, and simple ELI that has a delta of 0.8 or obligates the long party to pay an amount investment company that pays a greater with respect to an underlying equal to the actual depreciation on 100 dividend that includes a capital gains security when the ELI is issued is a shares of Stock X. Because the ELI does not dividend described in section specified ELI. provide the long party with an amount that 852(b)(3)(C) that would not be subject to (2) Complex ELIs. A complex ELI that is calculated by reference to a single, fixed tax under section 871 or section 881 if meets the substantial equivalence test number of shares of Stock X on the maturity paid directly to the long party, then an described in paragraph (h) of this date that can be ascertained at issuance, it is NPC payment is not a dividend section with respect to an underlying not a simple ELI. More specifically, upon equivalent to the extent that it is maturity the ELI will either entitle the long security when the ELI is issued is a party to receive a payment that is, in determined by reference to the capital specified ELI. substance, measured by reference to 200 gains dividend. (f) Other substantially similar shares of stock or obligate the long party to (ii) Section 305 coordination. A payments. For purposes of this section, make a payment measured by reference to dividend equivalent with respect to a any payment made in satisfaction of a 100 shares of stock. The ELI is a complex ELI section 871(m) transaction is reduced by tax liability of the long party with because it is not a simple ELI. any amount treated in accordance with respect to a dividend equivalent by a (15) Underlying security. An section 305(b) and (c) as a dividend withholding agent is a dividend underlying security is any interest in an with respect to the underlying security equivalent received by the long party. entity if a payment with respect to that referenced by the section 871(m) The amount of that dividend equivalent interest could give rise to a U.S. source transaction. constitutes additional income to the

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payee to the extent provided in and Stock Y are common stock of actual dividend amount unless the short § 1.1441–3(f)(1). domestic corporations X and Y. LP is party to the section 871(m) transaction (g) Delta—(1) In general. Delta is the the long party to the transaction. identifies a reasonable estimated ratio of the change in the fair market Example 1. Delta calculation for an NPC. dividend amount in writing at the time value of an NPC or ELI to a small change The terms of an NPC require LP to pay the the transaction is issued. For this in the fair market value of the number short party an amount equal to all of the purpose, a reasonable estimated of shares of the underlying security (as depreciation in the value of 100 shares of dividend amount stated in an offering determined under paragraph (j)(3) of Stock X and an interest-rate based return. In document or the documents governing this section) referenced by the NPC or return, the NPC requires the short party to the terms at the time the transaction is ELI. If an NPC or ELI contains more than pay LP an amount equal to all of the issued will establish the estimated one reference to a single underlying appreciation in the value of 100 shares of dividend amount. To qualify as an security, all references to that Stock X and any dividends paid by X on those shares. The value of the NPC will estimated dividend amount, the written underlying security are taken into change by $1 for each $0.01 change in the estimated dividend amount must account in determining the delta with price of a share of Stock X. When LP entered separately state the amount estimated respect to that underlying security. If an into the NPC, Stock X had a fair market value for each anticipated dividend or state a NPC or ELI references more than one of $50 per share. The NPC therefore has a formula that allows each dividend to be underlying security or other property, delta of 1.0 ($1.00/($0.01 × 100)). determined. If an underlying security is the delta with respect to each Example 2. Delta calculation for an option. not expected to pay a dividend, a underlying security must be determined LP purchases a call option that references reasonable estimate of the dividend without taking into account any other 100 shares of Stock Y. At the time LP amount may be zero. underlying security or property. The purchases the call option, the value of the (iv) Additions to estimated payments. delta of an equity derivative that is option is expected to change by $0.30 for a If a section 871(m) transaction provides embedded in a debt instrument or other $0.01 change in the price of a share of Stock for any payment in addition to an derivative is determined without taking Y. When LP purchases the option, Stock Y estimated dividend and that additional has a fair market value of $100 per share. The into account changes in the market × payment is determined by reference to value of the debt instrument or other call option has a delta of 0.3 ($0.30/($0.01 a dividend (for example, a special derivative that are not directly related to 100)). dividend), both the estimated dividend the equity element of the instrument. (h) Substantial Equivalence. and the additional payment are used to Thus, for example, the delta of an [Reserved]. For further guidance, see determine the per-share dividend option embedded in a convertible note § 1.871–15T(h). amount. is determined without regard to the debt (i) Payment of a dividend (3) Dividends for certain baskets—(i) component of the convertible note. For equivalent—(1) Payments determined In general. If a section 871(m) purposes of this section, delta must be on gross basis. For purposes of this transaction references long positions in determined in a commercially section, a payment includes any gross more than 25 underlying securities, the reasonable manner. If a taxpayer amount that references the payment of short party may treat the dividends with calculates delta for non-tax business a dividend and that is used in respect to the referenced underlying purposes, that delta ordinarily is the computing any net amount transferred securities as paid at the end of the delta used for purposes of this section. to or from the long party even if the long applicable calendar quarter to compute (2) Time for determining delta. For party makes a net payment to the short the per-share dividend amount. purposes of applying the rules of this party or no amount is paid because the (ii) Publicly available dividend yield. section, the delta of a potential section net amount is zero. For purposes of paragraph (i)(3)(i) of 871(m) transaction is determined only (2) Actual and estimated dividends— this section, if a section 871(m) when the potential section 871(m) (i) In general. A payment includes any transaction references the same transaction is issued (as defined in amount that references an actual or underlying securities as a security (for paragraph (a)(6) of this section). estimated payment of dividends, example, stock in an exchange-traded (3) Simplified delta calculation for whether the reference is explicit or fund) or index for which there is a certain simple contracts that reference implicit. If a potential section 871(m) publicly available quarterly dividend multiple underlying securities. If an transaction provides for a payment yield, the publicly available dividend NPC or ELI references 10 or more based on an estimated dividend that yield may be used to determine the per- underlying securities and the short adjusts to account for the amount of an share dividend amount for the section party uses an exchange-traded security actual dividend paid, the payment is 871(m) transaction with any adjustment (for example, an exchange-traded fund) treated as referencing the actual for special dividends. that references substantially all of the dividend amount and not an estimated (iii) Dividend yield for a section underlying securities (the hedge dividend amount. 871(m) transaction using the simplified security) to hedge the NPC or ELI at the (ii) Implicit dividends. A payment delta calculation. When the delta of a time it is issued, the delta of the NPC includes an actual or estimated section 871(m) transaction is or ELI may be calculated by determining dividend payment that is implicitly determined under paragraph (g)(3) of the ratio of the change in the fair market taken into account in computing one or this section, the per-share dividend value of the simple contract to a small more of the terms of a potential section amount for that section 871(m) change in the fair market value of the 871(m) transaction, including interest transaction must be determined using hedge security. A delta determined rate, notional amount, purchase price, the dividend yield for the exchange- under this paragraph (g)(3) must be used premium, upfront payment, strike price, traded security that fully hedges the as the delta for each underlying security or any other amount paid or received section 871(m) transaction. for purposes of calculating the amount pursuant to the potential section 871(m) (4) Examples. The following examples of a dividend equivalent as provided in transaction. illustrate the rules of this paragraph (i). paragraph (j)(1)(ii) of this section. (iii) Actual dividend presumption. A For purposes of these examples, Stock X (4) Examples. The following examples short party to a section 871(m) is common stock of Corporation X, a illustrate the rules of this paragraph (g). transaction is treated as paying a per- domestic corporation, that historically For purposes of these examples, Stock X share dividend amount equal to the pays quarterly dividends on Stock X.

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The parties anticipate that Corporation (A) The per-share dividend amount are obligated to acquire underlying X will continue to pay quarterly (as determined under either paragraph securities representing more than 50 dividends. (i)(2) or (i)(3) of this section) with percent of the value of the entity issuing Example 1. Forward contract to purchase respect to the underlying security the underlying securities. domestic stock. (i) When Stock X is trading multiplied by; (l) Rules relating to indices—(1) at $50 per share, Foreign Investor enters into (B) The number of shares of the Purpose. The purpose of this section is a forward contract to purchase 100 shares of underlying security multiplied by; to provide a safe harbor for potential Stock X in one year. Reasonable estimates of (C) The delta of the section 871(m) section 871(m) transactions that the quarterly dividend are specified in the transaction with respect to the reference certain passive indices that are transaction documents. The price in the underlying security. based on a diverse basket of publicly- forward contract is determined by (iii) Complex contracts. For a complex traded securities and that are widely multiplying the number of shares referenced contract that is a section 871(m) used by numerous market participants. in the contract by the current price of the transaction, the amount of the dividend Notwithstanding any other provision in shares and an interest rate, and subtracting equivalent for each underlying security the value of any dividends expected to be this paragraph (l), an index is not a paid during the term of the contract. equals: qualified index if treating the index as Assuming that the forward contract is priced (A) The per-share dividend amount a qualified index would be contrary to using an interest rate of 4 percent and total (as determined under paragraph (i)(2) or the purpose described in this paragraph. estimated dividends with a future value of $1 (i)(3) of this section) with respect to the (2) Qualified index not treated as an per share during the term of the forward underlying security multiplied by; underlying security. For purposes of this contract, the purchase price set in the (B) The initial hedge for the section, a qualified index is treated as a forward contract is $5,100 (100 shares × $50 underlying security. × ¥ × single security that is not an underlying per share 1.04 ($1 100)). (iv) Other substantially similar security. The determination of whether (ii) Subject to paragraph (i)(2)(iv) of this payments. In addition to any amount an index referenced in a potential section, the estimated dividend amount is the determined pursuant to paragraph per-share dividend amount because the section 871(m) transaction is a qualified (j)(1)(i), (ii), or (iii), the amount of a index is made at the time the estimate is reasonable and specified in dividend equivalent includes the accordance with paragraph (i)(2)(iii) of this transaction is issued based on whether section. The estimated per-share dividend amount of any payment described in the index is a qualified index on the amount is a dividend equivalent for purposes paragraph (f) of this section. first business day of the calendar year in (2) Time for determining the amount of this section. which the transaction is issued. of a dividend equivalent. The amount of (3) Qualified index. A qualified index Example 2. Price return only swap a dividend equivalent is determined on contract. (i) Foreign Investor enters into a means an index that— price return swap contract that entitles the earlier of the date that is the record (i) References 25 or more component Foreign Investor to receive payments based date of the dividend and the day prior securities (whether or not the security is on the appreciation in the value of 100 shares to the ex-dividend date with respect to an underlying security); of Stock X and requires Foreign Investor to the dividend. For example, if a specified (ii) Except as provided in paragraph pay an amount based on LIBOR plus any NPC provides for a payment at (l)(6)(ii) of this section, references only depreciation in the value of Stock X. The settlement that takes into account an long positions in component securities; swap contract neither explicitly entitles earlier dividend payment, the amount of (iii) References no component Foreign Investor to payments based on the dividend equivalent is determined underlying security that represents more dividends paid on Stock X during the term on the earlier of the record date or the of the contract nor references an estimated than 15 percent of the weighting of the dividend amount. The LIBOR rate in the day prior to the ex-dividend date for component securities in the index; swap contract, however, is reduced to reflect that dividend. (iv) References no five or fewer expected annual dividends on Stock X. (3) Number of shares. The number of component underlying securities that (ii) Because the LIBOR leg of the swap shares of an underlying security together represent more than 40 percent contract is reduced to reflect estimated generally is the number of shares of the of the weighting of the component dividends and the estimated dividend underlying security stated in the securities in the index; amount is not specified, Foreign Investor is contract. If the transaction modifies that (v) Is modified or rebalanced only treated as receiving the actual dividend number by a factor or fraction or according to publicly stated, predefined amount in accordance with paragraph (i)(2) otherwise alters the amount of any criteria, which may require of this section. The actual per-share dividend payment, the number of shares is amounts are dividend equivalents for interpretation by the index provider or purposes of this section. adjusted to take into account the factor, a board or committee responsible for fraction, or other modification. For maintaining the index; (j) Amount of dividend equivalent— example, in a transaction in which the (vi) Did not provide an annual (1) Calculation of the amount of a long party receives or makes payments dividend yield in the immediately dividend equivalent—(i) Securities based on 200 percent of the appreciation preceding calendar year from lending or sale-repurchase transactions. or depreciation (as applicable) of 100 component underlying securities that is For a securities lending or sale- shares of stock, the number of shares of greater than 1.5 times the annual repurchase transaction, the amount of the underlying security is 200 shares of dividend yield of the S&P 500 Index as the dividend equivalent for each the stock. reported for the immediately preceding underlying security equals the amount (k) Limitation on the treatment of calendar year; and of the actual per-share dividend paid on certain corporate acquisitions as section (vii) Is traded through futures the underlying security multiplied by 871(m) transactions. A potential section contracts or option contracts (regardless the number of shares of the underlying 871(m) transaction is not a section of whether the contracts provide price security. 871(m) transaction with respect to an only or total return exposure to the (ii) Simple contracts. For a simple underlying security if the transaction index or provide for dividend contract that is a section 871(m) obligates the long party to acquire reinvestment in the index) on— transaction, the amount of the dividend ownership of the underlying security as (A) A national securities exchange equivalent for each underlying security part of a plan pursuant to which one or that is registered with the Securities and equals: more persons (including the long party) Exchange Commission or a domestic

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board of trade designated as a contract component securities of a qualified to cross either of the thresholds market by the Commodity Futures index (excluding any short positions described in paragraph (m)(2)(i). The Trading Commission; or with respect to the entire qualified value of a partnership’s assets is equal (B) A foreign exchange or board of index) by five percent or less of the to their fair market value, except that trade that is a qualified board or value of the long positions in the value of any NPC, futures contract, exchange as determined by the component securities in the qualified forward contract, option, and any Secretary pursuant to section index. similar financial instrument held by the 1256(g)(7)(C) or that has a staff no action (7) Transactions that indirectly partnership is deemed to be the value of letter from the CFTC permitting direct reference a qualified index. If a the notional securities referenced by the access from the United States that is potential section 871(m) transaction transaction. effective on the applicable testing date, references a security (for example, stock (n) Combined transactions—(1) In provided that the referenced component in an exchange-traded fund) that tracks general. For purposes of determining underlying securities, in the aggregate, a qualified index, the potential section whether a potential section 871(m) comprise less than 50 percent of the 871(m) transaction will be treated as transaction is a section 871(m) weighting of the component securities referencing a qualified index. transaction, two or more potential in the index. (m) Rules relating to derivatives that section 871(m) transactions are treated (4) Safe harbor for certain indices that reference partnerships—(1) In general. as a single transaction with respect to an reference assets other than underlying When a potential section 871(m) underlying security when— securities. Notwithstanding paragraph transaction references a partnership (i) A person (or a related person (l)(3) of this section, an index is a interest, the assets of the partnership within the meaning of section 267(b) or qualified index if the referenced will be treated as referenced by the section 707(b)) is the long party with component underlying securities in the potential section 871(m) transaction respect to the underlying security for aggregate comprise 10 percent or less of only if the partnership carries on a trade each potential section 871(m) the weighting of the component or business of dealing or trading in transaction; securities in the index. securities, holds significant investments (ii) The potential section 871(m) (5) Weighting of component securities. in securities (either of which is a transactions reference the same For purposes of this paragraph (l), the covered partnership), or directly or underlying security; weighting of a component security of an indirectly holds an interest in a lower- (iii) The potential section 871(m) index is the percentage of the index’s tier partnership that is a covered transactions, when combined, replicate value represented, or accounted for, by partnership. For purposes of this the economics of a transaction that the component security. section, if a covered partnership directly would be a section 871(m) transaction if (6) Transactions that reference a or indirectly holds assets that are the transactions had been entered into qualified index and one or more underlying securities or potential as a single transaction; and component securities or indices—(i) In section 871(m) transactions, any (iv) The potential section 871(m) general. When a potential section potential section 871(m) transaction that transactions are entered into in 871(m) transaction references a references an interest in the covered connection with each other (regardless qualified index and one or more partnership is treated as referencing the of whether the transactions are entered component securities or other indices, shares of the underlying securities, into simultaneously or with the same the qualified index remains a qualified including underlying securities of counterparty). index only if the potential section potential section 871(m) transactions, (2) Section 871(m) transactions. If a 871(m) transaction does not reference a directly or indirectly allocable to that potential section 871(m) transaction is a short position in any referenced partnership interest. For purposes of section 871(m) transaction, either by component security of the qualified this paragraph (m), a security is defined itself or as a result of a combination index, other than a short position with in section 475(c). with one or more other potential section respect to the entire qualified index (for (2) Significant investments in 871(m) transactions, it does not cease to example, a cap or floor) or a de minimis securities—(i) In general. For purposes be a section 871(m) transaction as a short position described in paragraph of this paragraph (m), a partnership result of applying paragraph (n) of this (l)(6)(ii) of this section. If, in connection holds significant investments in section or disposing of one or more of with a potential section 871(m) securities if either— the potential section 871(m) transaction transaction that references a qualified (A) 25 percent or more of the value of with which it is combined. index, a taxpayer (or a related person the partnership’s assets consist of (3) Short party presumptions within the meaning of section 267(b) or underlying securities or potential regarding combined transactions—(i) section 707(b)) enters into one or more section 871(m) transactions; or Transactions in separate accounts. A transactions that reduce exposure to any (B) The value of the underlying short party that is a broker may presume referenced component security of the securities or potential section 871(m) that transactions are not entered into in index, other than transactions that transactions equals or exceeds $25 connection with each other for purposes reduce exposure to the entire index, million. of paragraph (n)(1) of this section if a then the potential section 871(m) (ii) Determining the value of the long party holds or reflects the transaction is not treated as referencing partnership’s assets. For purposes of transactions in separate accounts a qualified index. this paragraph (m)(2), the value of a maintained by the short party, unless (ii) Safe harbor for de minimis short partnership’s assets is determined at the the short party has actual knowledge positions. Notwithstanding paragraphs time the potential 871(m) transaction that the transactions held or reflected in (l)(3)(ii) and (l)(6)(i) of this section, an referencing that partnership interest is separate accounts by the long party were index may be a qualified index if the issued based on the value of the assets entered into in connection with each short position (whether part of the index held by the partnership on the last day other or that separate accounts were or entered into separately by the of the partnership’s prior taxable year created or used to avoid section 871(m). taxpayer or related person within the unless the long party or the short party (ii) Transactions separated by at least meaning of section 267(b) or section has actual knowledge that a subsequent two business days. A short party that is 707(b)) reduces exposure to referenced transaction has caused the partnership a broker may presume that transactions

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entered into two or more business days than two potential section 871(m) components of indices to reflect the apart are not entered into in connection transactions that could be combined substance of the transaction or with each other for purposes of under this paragraph (n), a short party transactions, or otherwise depart from paragraph (n)(1) of this section unless is required to apply paragraph (n)(1) of the rules of this section as necessary to the short party has actual knowledge this section by combining transactions determine whether the transaction that the transactions were entered into in a manner that results in the most includes a dividend equivalent or the in connection with each other. transactions with a delta of 0.8 or higher amount or timing of a dividend (4) Presumptions Commissioner will with respect to the referenced equivalent. A purpose may be a apply to long party—(i) Transactions in underlying security. Thus, for example, principal purpose even though it is separate trading books. The if a taxpayer has sold one at-the-money outweighed by other purposes (taken Commissioner will presume that a long put and purchased two at-the-money together or separately). When a party did not enter into two or more calls, each with respect to 100 shares of withholding agent knows that the transactions in connection with each the same underlying security, the put taxpayer acquired or disposed of a other for purposes of paragraph (n)(1) of and one call are combined. Similarly, a transaction or transactions with a this section if the long party properly purchased call on 100 shares and a sold principal purpose of avoiding the reflected those transactions on separate put on 200 shares of the same application of this section and the trading books. The Commissioner may underlying security can be combined for Commissioner treats a payment made rebut this presumption with facts and 100 shares with 100 shares of the put with respect to any transaction as a circumstances showing that transactions remaining separate. The two calls are dividend equivalent, the withholding reflected on separate trading books were not combined because they do not entered into in connection with each provide the long party with economic agent may be liable for any tax pursuant other or that separate trading books exposure to depreciation in the to section 1461. were created or used to avoid section underlying security. Similarly, if a long (p) Information required to be 871(m). party enters into more than two reported regarding a potential section (ii) Transactions separated by at least potential section 871(m) transactions 871(m) transaction—(1) In general. If a two days. The Commissioner will that could be combined under this broker or dealer is a party to a potential presume that a long party did not enter paragraph (n), but have not been section 871(m) transaction with a into two or more transactions in combined by a short party, the long counterparty or customer that is not a connection with each other for purposes party is required to apply paragraph broker or dealer, the broker or dealer is of paragraph (n)(1) of this section if the (n)(1) of this section by combining required to determine whether the long party entered into the transactions transactions in a manner that results in potential section 871(m) transaction is a two or more business days apart. The the most transactions with a delta of 0.8 section 871(m) transaction. If both Commissioner may rebut this or higher with respect to the referenced parties to a potential section 871(m) presumption with facts and underlying security. transaction are brokers or dealers, or circumstances showing that the (7) More than one underlying security neither party to a potential section transactions entered into two or more referenced. If potential section 871(m) 871(m) transaction is a broker or dealer, business days apart were entered into in transactions reference more than one the short party must determine whether connection with each other. underlying security, paragraph (n)(1) of the potential section 871(m) transaction (iii) Transactions separated by less this section applies separately with is a section 871(m) transaction. The than two days and reflected in the same respect to each underlying security. party to the transaction that is required trading book. The Commissioner will (o) Anti-abuse rule. If a taxpayer to determine whether a transaction is a presume that transactions that are (directly or through the use of a related section 871(m) transaction must also entered into less than two business days person within the meaning of section determine and report to the apart and reflected on the same trading 267(b) or section 707(b)) acquires counterparty or customer the timing and book are entered into in connection (whether by entering into, purchasing, amount of any dividend equivalent (as with each other. A long party can rebut accepting by transfer, by exchange, or by described in paragraphs (i) and (j) of this this presumption with facts and conversion, or otherwise acquiring) or section). Except as otherwise provided circumstances showing that the disposes of (whether by sale, offset, in paragraph (n)(3) of this section, the transactions were not entered into in exercise, termination, expiration, connection with each other. maturity, or other means) a transaction party required to make the (5) Rules of application—(i) Two or transactions with a principal purpose determinations described in this business days rule. For the purpose of of avoiding the application of this paragraph is required to exercise determining the number of business section, the Commissioner may treat any reasonable diligence to determine days between transactions, the short payment (as described in paragraph (i) whether a transaction is a section party may, and the Commissioner will, of this section) made with respect to 871(m) transaction, the amount of any assume that all transactions are entered that transaction or transactions as a dividend equivalents, and any other into at 4:00 p.m. on the date the dividend equivalent to the extent information necessary to apply the rules transaction becomes effective in the necessary to prevent the avoidance of of this section. The information must be jurisdiction of the long party. this section. Therefore, notwithstanding provided in the manner prescribed in (ii) No long party presumptions. any other provision of this section, the paragraphs (p)(2) and (p)(3) of this Notwithstanding the presumptions Commissioner may, for example, adjust section. The determinations required by described in paragraphs (n)(3) and (n)(4) the delta of a transaction, change the paragraph (p) of this section are binding of this section, the long party must treat number of shares, adjust an estimated on the parties to the potential section two or more transactions as combined dividend amount, change the maturity, 871(m) transaction and on any person transactions if the transactions are adjust the timing of payments, treat a who is a withholding agent with respect described in paragraph (n)(1) of section. transaction that references a partnership to the potential section 871(m) (6) Ordering rule for transactions interest as referencing the assets of the transaction unless the person knows or entered into in connection with each partnership, combine, separate, or has reason to know that the information other. If a long party enters into more disregard transactions, indices, or received is incorrect. The

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determinations are not binding on the section that requests information from endowment, or life insurance contract Commissioner. the recipient. issued by a domestic corporation (2) Reporting requirements. For rules (4) Recordkeeping rules—(i) In (including its foreign or U.S. possession regarding the reporting requirements of general. For rules regarding branch) that is a life insurance company withholding agents with respect to recordkeeping requirements sufficient to described in section 816(a) does not dividend equivalents described in this establish whether a transaction is a include a dividend equivalent if the section, see §§ 1.1461–1(b) and (c) and section 871(m) transaction and whether payment is subject to tax under section 1.1474–1(c) and (d). a payment is a dividend equivalent and 871(a) or section 881. (3) Additional information available the amount of gross income treated as a (B) Insurance contracts issued by to a party to a potential section 871(m) dividend equivalent, see § 1.6001–1. foreign insurance companies. A transaction—(i) In general. Upon (ii) Records sufficient to establish payment does not include a dividend request by any person described in whether a transaction is a section equivalent if it is made pursuant to a paragraph (p)(3)(ii) of this section, the 871(m) transaction and any dividend contract that is an annuity, endowment, party required to report information equivalent amount. Any person or life insurance contract issued by a pursuant to paragraph (p)(1) of this required to retain records must keep foreign corporation that is section must provide the requester with sufficient information to establish predominantly engaged in an insurance information regarding the amount of whether a transaction is a section business and that would be subject to each dividend equivalent, the delta of 871(m) transaction and the amount of a tax under subchapter L if it were a the potential section 871(m) transaction, dividend equivalent (if any), including domestic corporation. the amount of any tax withheld and documentation and work papers (C) Insurance contracts held by deposited, the estimated dividend supporting the delta calculation or the foreign insurance companies. A amount if specified in accordance with substantial equivalence test (including payment made pursuant to a policy of paragraph (i)(2)(iii) of this section, the the number of shares of the initial insurance (including a policy of identity of any transactions combined hedge), as applicable, and written reinsurance) does not include a pursuant to paragraph (n) of this estimated dividends (if any). The dividend equivalent if it is made to a section, and any other information records and documentation must be foreign corporation that is necessary to apply the rules of this created substantially predominantly engaged in an insurance section. The information requested must contemporaneously. A record will be business and that would be subject to be provided within a reasonable time, considered to have been created tax under subchapter L if it were a not to exceed 10 business days, and substantially contemporaneously if it domestic corporation. communicated in one or more of the was created within 10 business days of (v) [Reserved]. For further guidance, following ways: the date the potential section 871(m) see § 1.871–15(c)(2)(v). (d) through (g) [Reserved]. For further (A) By telephone, and confirmed in transaction is issued. guidance, see § 1.871–15(d) through (g). writing; (q) Dividend and dividend equivalent (h) Substantial equivalence test—(1) (B) By written statement sent by first payments to a qualified derivatives In general. The substantial equivalence class mail to the address provided by dealer. [Reserved]. For further guidance, the requesting party; test described in this paragraph (h) see § 1.871–15T(q). applies to determine whether a complex (C) By electronic publication available (r) Effective/applicability date—(1) In contract is a section 871(m) transaction. to all persons entitled to request general. This section applies to The substantial equivalence test information; or payments made on or after September (D) By any other method agreed to by assesses whether a complex contract 18, 2015 except as provided in substantially replicates the economic the parties, and confirmed in writing. paragraphs (r)(2) and (3) of this section. (ii) Persons entitled to request performance of the underlying security (2) Effective/applicability date for information. Any party to the by comparing, at various testing prices paragraph (d)(1)(i). *** for the underlying security, the transaction described in paragraph (a)(9) (3) Effective/applicability date for differences between the expected of this section may request the paragraphs (d)(2) and (e). Paragraphs changes in value of that complex information specified in paragraph (p) (d)(2) and (e) apply to any payment contract and its initial hedge with the of this section with respect to a made on or after January 1, 2017, with differences between the expected potential section 871(m) transaction respect to any transaction issued on or changes in value of a simple contract from the party required by paragraph after January 1, 2017, and to any benchmark (as described in paragraph (p)(3)(i) of this section to provide the payment made on or after January 1, (h)(2) of this section) and its initial information. 2018, with respect to any transaction (iii) Reliance on information received. hedge. If the complex contract contains issued on or after January 1, 2016, and A person described in paragraph (p)(1) more than one reference to a single before January 1, 2017. or (p)(3)(ii) of this section that receives underlying security, all references to ■ Par. 4. Section 1.871–15T is added to information described in paragraph that underlying security are taken into read as follows: (p)(1) or (p)(3)(i) of this section may rely account for purposes of applying the on that information to provide § 1.871–15T Treatment of dividend substantial equivalence test with respect information to any other person unless equivalents (temporary). to that underlying security. With respect the recipient knows or has reason to (a) through (b) [Reserved]. For further to an equity derivative that is embedded know that the information received is guidance, see § 1.871–15(a) through (b). in a debt instrument or other derivative, incorrect. When the recipient knows or (c) [Reserved]. For further guidance, the substantial equivalence test is has reason to know that the information see § 1.871–15(c)(1) through (c)(2)(iii). applied to the complex contract without received is incorrect, the recipient must (iv) Payments made pursuant to taking into account changes in the make a reasonable effort to determine annuity, endowment, and life insurance market value of the debt instrument or and provide the information described contracts—(A) Insurance contracts other derivative that are not directly in paragraph (p)(1) or (p)(3)(i) of this issued by domestic insurance related to the equity element of the section to any person described in companies. A payment made pursuant instrument. The complex contract is a paragraph (p)(1) or (p)(3)(ii) of this to a contract that is an annuity, section 871(m) transaction with respect

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to an underlying security if, for that this section and the change in value of complex contract is issued. For underlying security, the expected the initial hedge determined in purposes of paragraphs (h)(4)(i)(D) and change in value of the complex contract paragraph (h)(4)(i)(B) of this section at (E) of this section, the probability of a and its initial hedge is equal to or less each testing price; decrease by one standard deviation is than the expected change in value of the (D) Determining the probability (as the measure of the likelihood that the simple contract benchmark and its described in paragraph (h)(4)(iv) of this price of the underlying security will initial hedge when the substantial section) associated with each testing decrease by any amount from its price equivalence test described in this price; at the time the complex contract is paragraph (h) is calculated at the time (E) Multiplying the absolute value for issued. the complex contract is issued. To the each testing price determined in (5) Benchmark calculation. The extent that the steps of the substantial paragraph (h)(4)(i)(C) of this section by benchmark calculation with respect to equivalence test set out in this the corresponding probability for that each underlying security referenced by testing price determined in paragraph paragraph (h) cannot be applied to a the potential section 871(m) transaction (h)(4)(i)(D) of this section; particular complex contract, a taxpayer is determined by using the computation must use the principles of the (F) Adding the product of each calculation determined in paragraph methodology described in paragraph substantial equivalence test to (h)(4) of this section with respect to a reasonably determine whether the (h)(4)(i)(E) of this section; and (G) Dividing the sum determined in simple contract benchmark for the complex contract is a section 871(m) underlying security. transaction with respect to each paragraph (h)(4)(i)(F) of this section by underlying security. For purposes of the initial hedge for the complex (6) Substantial equivalence this section, the test must be applied contract. calculation for certain complex and the inputs must be determined in a (ii) Determining the change in value. contracts that reference multiple commercially reasonable manner. If a The change in value of a complex underlying securities. If a complex taxpayer calculates any relevant input contract is the difference between the contract references 10 or more for non-tax business purposes, that value of the complex contract with underlying securities and the short input ordinarily is the input used for respect to the underlying security at the party uses an exchange-traded security purposes of this section. time the complex contract is issued and (for example, an exchange-traded fund) (2) Simple contract benchmark. The the value of the complex contract with that references substantially all of the simple contract benchmark is a closely respect to the underlying security if the underlying securities (the hedge comparable simple contract that, at the price of the underlying security were security) to hedge the complex contract time the complex contract is issued, has equal to the testing price at the time the at the time it is issued, the substantial a delta of 0.8, references the applicable complex contract is issued. The change equivalence calculations for the underlying security referenced by the in value of the initial hedge of a complex contract may be calculated by complex contract, and has the same complex contract with respect to the treating the hedge security as the maturity as the complex contract with underlying security is the difference underlying security. When the hedge respect to the applicable underlying between the value of the initial hedge at security is used for the substantial security. Depending on the complex the time the complex contract is issued equivalence calculation pursuant to this contract, the simple contract benchmark and the value of the initial hedge if the paragraph (h)(6), the initial hedge is the might be, for example, a call option, a price of the underlying security were number of shares of the hedge security put option, or a collar. equal to the testing price at the time the for purposes of calculating the amount (3) Substantial equivalence. A complex contract is issued. of a dividend equivalent as provided in complex contract is a section 871(m) (iii) Testing price. The testing prices paragraph (j)(1)(iii) of this section. transaction with respect to an must include the prices of the (7) Example. The following example underlying security if the complex underlying security if the price of the illustrates the rules of paragraph (h) of contract calculation described in underlying security at the time the this section. For purposes of this paragraph (h)(4) of this section results in complex contract is issued were example, Stock X is common stock of an amount that is equal to or less than alternatively increased by one standard domestic corporation X. FI is the the amount of the benchmark deviation and decreased by one financial institution that structures the calculation described in paragraph standard deviation, each of which is a transaction described in the example, (h)(5) of this section. separate testing price. In circumstances and is the short party to the transaction. (4) Complex contract calculation—(i) where using only two testing prices is Investor is a nonresident alien In general. The complex contract reasonably likely to provide an individual. calculation for each underlying security inaccurate measure of substantial Example. Complex contract that is not referenced by a potential section 871(m) equivalence, a taxpayer must use additional testing prices as necessary to substantially equivalent. (i) FI issues an transaction that is a complex contract is investment contract (the Contract) that has a computed by: determine whether a complex contract stated maturity of one year, and Investor (A) Determining the change in value satisfies the substantial equivalence test. purchases the Contract from FI at issuance (as described in paragraph (h)(4)(ii) of If additional testing prices are used for for $10,000. At maturity, the Contract entitles this section) of the complex contract the substantial equivalence test, the Investor to a return of $10,000 (i) plus 200 with respect to the underlying security probabilities as described in paragraph percent of any appreciation in Stock X above at each testing price (as described in (h)(4)(iv) of this section must be $100 per share, capped at $110, on 100 paragraph (h)(4)(iii) of this section); adjusted accordingly. shares or (ii) minus 100 percent of any (B) Determining the change in value (iv) Probability. For purposes of depreciation in Stock X below $90 on 100 paragraphs (h)(4)(i)(D) and (E) of this shares. At the time FI issues the Contract, the of the initial hedge for the complex price of Stock X is $100 per share. Thus, for contract at each testing price; section, the probability of an increase by example, Investor will receive $11,000 if the (C) Determining the absolute value of one standard deviation is the measure of price of Stock X is $105 per share at maturity the difference between the change in the likelihood that the price of the of the Contract, but Investor will receive value of the complex contract underlying security will increase by any $9,000 if the price of Stock X is $80 per share determined in paragraph (h)(4)(i)(A) of amount from its price at the time the when the Contract matures. At issuance, FI

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acquires 64 shares of Stock X to fully hedge (v) FI then performs the same calculation derivatives dealer receives a dividend or the Contract issued to Investor. with respect to the simple contract dividend equivalent payment on or (ii) The Contract references an underlying benchmark, which is a one-year call option determined by reference to an security and is not an NPC, so it is classified that references one share of Stock X, settles underlying security and the offsetting as an ELI under paragraph (a)(4) of this on the same date as the Contract, and has a section. At issuance, the Contract does not delta of 0.8. The one-year call option has a dividend equivalent payment the provide for an amount paid at maturity that strike price of $79 and has a cost (the qualified derivatives dealer is is calculated by reference to a single, fixed purchase premium) of $22. The initial hedge contractually obligated to make on the number of shares of Stock X. When the for the one-year call option is 0.8 shares of same underlying security is less than Contract matures, the amount paid is Stock X. the dividend and dividend equivalent effectively calculated based on either 200 (vi) FI first determines that the change in amount received (including when the shares of Stock X (if the price of Stock X has value of the simple contract benchmark is qualified derivatives dealer is not appreciated up to $110) or 100 shares of $19.05 if the testing price is increased by one contractually obligated to make an Stock X (if the price of Stock X has declined standard deviation ($22.00 at issuance to below $90). Consequently, the Contract is a $41.05 at the testing price) and negative offsetting dividend equivalent complex contract described in paragraph $20.95 if the testing price is decreased by one payment), the qualified derivatives (a)(14) of this section. standard deviation ($22.00 at issuance to dealer is liable for tax under section 871 (iii) Because it is a complex ELI, FI applies $1.05 at the testing price). Second, FI or section 881 for the difference. For the substantial equivalence test described in determines that the change in value of the purposes of this paragraph (q), a paragraph (h) of this section to determine initial hedge is $16.00 at the testing price that dividend or dividend equivalent is not whether the Contract is a specified ELI. FI represents an increase by one standard treated as received by a qualified determines that the price of Stock X would deviation ($80 at issuance to $96 at the derivatives dealer acting in its dealer be $120 if the price of Stock X were increased testing price) and negative $16.80 at the by one standard deviation, and $79 if the testing price that represents a decrease by capacity if the dividend or dividend price of Stock X were decreased by one one standard deviation ($80.00 at issuance to equivalent is received by the qualified standard deviation. Based on these results, FI $63.20 at the testing price). derivatives dealer acting as a proprietary next determines the change in value of the (vii) FI determines the absolute value of the trader. Transactions properly reflected Contract to be $2,000 at the testing price that difference between the change in value of the in a qualified derivatives dealer’s dealer represents an increase by one standard initial hedge and the one-year call option at book are presumed to be held by a deviation ($12,000 testing price minus the testing price that represents an increase dealer in its dealer capacity for purposes $10,000 issue price) and a negative $1,100 at by one standard deviation is $3.05 ($16.00 of this paragraph (q). minus $19.05). FI next determines the the testing price that represents a decrease by (2) Examples. The following examples one standard deviation ($10,000 issue price absolute value of the difference between the minus $8,900 testing price). FI performs the change in value of the initial hedge and the illustrate the rules of this paragraph (q): same calculations for the 64 shares of Stock option at the testing price that represents a Example 1. Forward contract entered into X that constitute the initial hedge, decrease by one standard deviation is $4.15 by a foreign dealer. (i) Facts. FB is a foreign determining that the change in value of the (negative $16.80 minus negative $20.95). FI bank that is a qualified intermediary that acts initial hedge is $1,280 at the testing price that multiplies the absolute value of the as a qualified derivatives dealer. On April 1, represents an increase by one standard difference between the change in value of the Year 1, FB enters into a cash settled forward deviation ($6,400 at issuance compared to initial hedge and the option at the testing contract initiated by a foreign customer $7,680 at the testing price) and negative price that represents an increase by one (Customer) that entitles Customer to receive $1,344 at the testing price that represents a standard deviation by 52%, which equals from FB all of the appreciation and dividends decrease by one standard deviation ($6,400 at $1.586. FI multiplies the absolute value of on 100 shares of Stock X, and obligates issuance compared to $5,056 at the testing the difference between the change in value of Customer to pay FB any depreciation on 100 price). the initial hedge and the option at the testing shares of Stock X, at the end of three years. (iv) FI then determines the absolute value price that represents a decrease by one FB hedges the forward contract by entering of the difference between the change in value standard deviation by 48%, which equals into a total return swap contract with a of the initial hedge and the Contract at the $1.992. FI adds these two numbers and domestic broker (U.S. Broker) and maintains testing price that represents an increase by divides by the number of shares that the swap contract as a hedge for the duration one standard deviation and a decrease by one constitute the initial hedge to determine that of the forward contract. The swap contract standard deviation. Increased by one the benchmark calculation is 4.473 ((1.586 entitles FB to receive an amount equal to all standard deviation, the absolute value of the plus 1.992) divided by .8). of the dividends on 100 shares of Stock X difference is $720 ($2,000 ¥ $1,280); (viii) FI concludes that the Contract is not and obligates FB to pay an amount referenced decreased by one standard deviation, the a section 871(m) transaction because the to a floating interest rate each quarter, and absolute value of the difference is $244 transaction calculation of 7.68 exceeds the also entitles FB to receive from or pay to U.S. (negative $1,100 minus negative $1,344). FI benchmark calculation of 4.473. Broker, as the case may be, the difference determines that there is a 52% chance that (i) through (p) [Reserved]. For further between the value of 100 shares of Stock X the price of Stock X will have increased in guidance, see § 1.871–15(i) through (p). at the inception of the swap and the value value when the Contract matures and a 48% (q) Dividend and dividend equivalent of 100 shares of Stock X at the end of 3 years. chance that the price of Stock X will have payments to a qualified derivatives FB provides valid documentation to U.S. decreased in value at that time. FI multiplies Broker that FB will receive payments under the absolute value of the difference between dealer—(1) In general. Except as the swap contract in its capacity as a the change in value of the initial hedge and otherwise provided in this paragraph qualified derivatives dealer, and FB the Contract at the testing price that (q), a qualified derivatives dealer contemporaneously enters both the swap represents an increase by one standard described in § 1.1441–1(e)(6) that contract with U.S. Broker and the forward deviation by 52%, which equals $374.40. FI receives a dividend or the payment of a contract with Customer on its dealer books. multiplies the absolute value of the dividend equivalent (within the Stock X pays a quarterly dividend of $0.25 difference between the change in value of the meaning of paragraph (i) of this section) per share. initial hedge and the Contract at the testing in its dealer capacity will not be liable (ii) Application of rules. FB is a long party price that represents a decrease by one for tax under section 871 or section 881 on a delta one contract (the total return swap) standard deviation by 48%, which equals and a short party on a delta one contract (the $117.12. FI adds these two numbers and provided that the qualified derivatives forward contract with Customer). U.S. Broker divides by the number of shares that dealer complies with its obligations is not obligated to withhold on the dividend constitute the initial hedge to determine that under the qualified intermediary equivalent payments to FB on the swap the transaction calculation is 7.68 ((374.40 agreement described in §§ 1.1441– contract that are referenced to Stock X plus 117.12) divided by 64). 1(e)(5) and 1.1441–1(e)(6). If a qualified dividends, however, because U.S. Broker has

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received valid documentation that it may rely § 1.1441–2(e)(8). FB is also liable for tax exemption, the qualified derivatives upon to treat the payment as made to FB under section 871 or section 881 on Stock X dealer must furnish to the withholding acting as a qualified derivatives dealer. dividends, if any, that exceed the dividend agent the documentation described in Similarly, FB is not obligated to pay tax on equivalent payment to Customer. paragraph (e)(3)(ii) of this section. A the payments it receives from U.S. Broker referenced to Stock X dividends because at (r)(1) through (3) [Reserved]. For withholding agent that makes a payment the time it received the payments FB was further guidance, see § 1.871–15(r)(1) of a dividend or a divided equivalent to contractually obligated to make fully through (3). a qualified intermediary that is acting as offsetting dividend equivalent payments as (4) Effective/applicability date. This a qualified derivatives dealer is not the short party with respect to 100 shares of section applies to payments made on or required to withhold on the payment if Stock X to Customer. FB is required to after January 1, 2017. the withholding agent can reliably withhold on dividend equivalent payments (s) Expiration date. This section associate the payment with a valid to Customer on the forward contract in expires September 17, 2018. qualified intermediary withholding accordance with § 1.1441–2(e)(8). ■ Par. 5. Section 1.1441–1 is amended certificate as described in paragraph Example 2. At-the-money option contract by: (e)(3)(ii) of this section, including the entered into by a foreign dealer. (i) Facts. The ■ 1. Redesignating paragraph (b)(4)(xxi) certification described in paragraph facts are the same as Example 1, but customer as (b)(4)(xxiv). (e)(3)(ii)(E). purchases from FB an at-the-money call ■ 2. Adding paragraphs (b)(4)(xxi) (xxiii) Amounts paid with respect to option on 100 shares of Stock X with a term through (xxiii). a potential section 871(m) transaction of one year. The call option has a delta of 0.5 ■ and FB hedges the call option by purchasing 3. Adding new paragraphs (e)(3)(ii)(E) that is only a section 871(m) transaction 50 shares of Stock X, which are held in an and (6). as a result of applying § 1.871–15(n) to account with U.S. Broker, who also acts as ■ 4. Adding new paragraph (f)(4). treat certain transactions as combined paying agent. The additions read as follows: transactions, if the withholding agent is (ii) Application of rules. FB is a long party able to rely on one or more of the § 1.1441–1 Requirement for the deduction on 50 shares of Stock X and a short party on and withholding of tax on payments to presumptions provided in § 1.871– an option. Because the option has a delta of foreign persons. 15(n)(3)(i) or (ii) (applying those less than 0.8 on the date it was issued, it is paragraphs whether or not the (b) * * * not a section 871(m) transaction. U.S. Broker withholding agent is a short party by is not obligated to withhold on the Stock X (4) * * * dividends paid to FB because U.S. Broker has (xxi) Amounts paid with respect to a substituting ‘‘withholding agent’’ for received valid documentation that it may rely notional principal contract described in ‘‘short party’’), and the withholding upon to treat the dividends as paid to FB § 1.871–15(a)(7), an equity-linked agent does not otherwise have actual acting as a qualified derivatives dealer. FB is instrument described in § 1.871– knowledge that the long party (or a liable for tax under section 871 or section 881 15(a)(4), or a securities lending or sale- related person within the meaning of on the Stock X dividends it receives from repurchase transaction described in section 267(b) or section 707(b)) entered U.S. Broker, however, because at the time it into the potential section 871(m) received the dividends FB was not § 1.871–15(a)(13) are exempt from withholding under section 1441(a) as transaction in connection with any contractually obligated to make an offsetting other potential section 871(m) dividend equivalent payment to Customer. dividend equivalents under section FB is not required to make an offsetting 871(m) if the transaction is not a section transactions. The ability of one or more dividend equivalent payment to Customer 871(m) transaction within the meaning withholding agents to rely on the because the option has a delta of 0.5; of § 1.871–15(a)(12), if the transaction is presumptions provided in section therefore, it is not a section 871(m) subject to the exception described in 1.871–15(n)(3) does not affect the transaction. § 1.871–15(k), or if the payment is not withholding tax obligations or liability Example 3. In-the-money option contract a dividend equivalent pursuant to of any party to the transaction that entered into by a foreign dealer. (i) Facts. The § 1.871–15(c)(2). However, the amounts cannot rely on the presumptions. facts are the same as Example 2, but may be subject to withholding under Notwithstanding the withholding Customer purchases from FB an in-the- section 1441(a) if they are subject to tax exemption provided to the withholding money call option on 100 shares of Stock X under any section other than section agent in this paragraph (b)(4)(xxii), the with a term of one year. The call option has long party may still be liable for tax on a delta of 0.8 and FB hedges the call option 871(m). For purposes of this withholding exemption, it is not dividend equivalent amounts with by purchasing 80 shares of Stock X, which respect to such combined transactions are held in an account with U.S. Broker, who necessary for the payee to provide also acts as paying agent. The price of Stock documentation establishing that a under section 871(m). (e)(3)(ii)(E) [Reserved]. For further X declines substantially and the option notional principal contract or equity- guidance, see § 1.1441–1T(e)(3)(ii)(E). lapses unexercised. linked instrument has a delta (as (ii) Application of rules. FB is a long party (6) Qualified derivatives dealers. described in § 1.871–15(g)) that is less [Reserved]. For further guidance, see on 80 shares of Stock X and a short party on than 0.80 or does not have substantial an option. Because the option has a delta of § 1.1441–1T(e)(6). 0.8 on the date it was issued, it is a section equivalence (as defined in § 1.871– (f) * * * 871(m) transaction. U.S. Broker is not 15(h)) with the underlying security. For (4) Effective/applicability date. obligated to withhold on the Stock X purposes of the withholding exemption Paragraphs (b)(4)(xxi) through dividends paid to FB because U.S. Broker has regarding corporate acquisitions (b)(4)(xxiii) of this section, and received valid documentation that it may rely described in § 1.871–15(k), the paragraphs (e)(3)(ii)(E) and (e)(6) of this upon to treat the dividends as paid to FB exemption only applies if the long party section apply to payments made on or acting as a qualified derivatives dealer. furnishes, under penalties of perjury, a Similarly, FB is not obligated to pay tax on after September 18, 2015. written statement to the withholding ■ Par. 6. Section 1.1441–1T is amended the Stock X dividends it receives from U.S. agent certifying that it satisfies the Broker to the extent that FB is contractually by: obligated to make offsetting dividend requirements of § 1.871–15(k). ■ 1. Redesignating paragraph (e)(3)(ii)(E) equivalent payments as the short party to (xxii) Certain payments to qualified as paragraph (e)(3)(ii)(F). Customer. FB is required to withhold on derivatives dealers (as described in ■ 2. Adding new paragraphs (e)(3)(ii)(E) dividend equivalent payments to Customer paragraph (e)(6) of this section). For and (e)(6). on the option contract in accordance with purposes of this withholding ■ 3. Revising paragraph (e)(5)(i).

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■ 4. Amending paragraph (f)(3) by addresses, and taxpayer identifying dividend equivalent payment on an removing ‘‘This section’’ and adding in numbers, if known, of those U.S. non- underlying security the qualified its place ‘‘Except for paragraphs exempt recipients for whom the derivatives dealer is contractually (e)(3)(ii)(E) and (e)(6), this section’’ and qualified intermediary receives obligated to make is less than the adding a third sentence. reportable amounts (within the meaning dividend and dividend equivalent ■ 5. Amending paragraph (g) by of paragraph (e)(3)(vi) of this section) to amount the qualified derivatives dealers removing ‘‘The applicability’’ and the extent required in the qualified received on or with respect to the same adding in its place ‘‘Except for intermediary’s agreement with the IRS. underlying security (including when the paragraphs (e)(3)(ii)(E) and (e)(6), the When a qualified intermediary is acting qualified derivatives dealer is not applicability’’ and adding a third as a qualified derivatives dealer, the contractually obligated to make an sentence. withholding certificate entitles a offsetting dividend equivalent withholding agent to make payments of payment); and § 1.1441–1T Requirement for the dividend equivalents and dividends to (D) Comply with the compliance deduction and withholding of tax on the qualified derivatives dealer free of payments to foreign persons (temporary). review procedures applicable to a withholding. Paragraph (e)(6) of this qualified intermediary that acts as a (e) * * * section contains detailed rules qualified derivatives dealer under a (3) * * * prescribing the circumstances in which (ii) * * * qualified intermediary agreement, (E) In the case of dividends or a qualified intermediary can act as a which will specify the time and manner dividend equivalents received by a qualified derivatives dealer. A person in which a qualified derivatives dealer may claim qualified intermediary status qualified intermediary acting as a must: before an agreement is executed with qualified derivatives dealer, a (1) Certify to the IRS that it has the IRS if it has applied for such status certification that the qualified complied with the obligations to act as and the IRS authorizes such status on an intermediary meets the requirements to a qualified derivatives dealer (including interim basis under such procedures as act as a qualified derivatives dealer as its performance of a periodic review the IRS may prescribe. applicable to a qualified derivatives further described in paragraph (e)(6) of (6) Qualified derivatives dealers—(i) this section and that the qualified dealer); In general. To act as a qualified (2) Report to the IRS the dividend derivatives dealer assumes primary derivatives dealer under a qualified equivalent payments that it made and withholding and reporting intermediary agreement, a qualified the dividends and dividend equivalent responsibilities under chapters 3, 4, and intermediary must be an eligible entity amounts received in determining 61, and section 3406 with respect to any as described in paragraph (e)(6)(ii) of offsetting payments (as described in dividend equivalent payments; this section and, in accordance with the (5) Qualified intermediaries—(i) In § 1.871–15(q)(1)); and qualified intermediary agreement, (3) Respond to inquiries from the IRS general. A qualified intermediary, as must— about obligations it has assumed as a defined in paragraph (e)(5)(ii) of this (A) Furnish to a withholding agent a qualified derivatives dealer in a timely section, may furnish a qualified qualified intermediary withholding manner. intermediary withholding certificate to a certificate (described in paragraph (ii) Definition of eligible entity. An withholding agent. The withholding (e)(3)(ii) of this section) that indicates eligible entity is a qualified certificate provides certifications on that the qualified intermediary is a intermediary that is— behalf of other persons for the purpose qualified derivatives dealer with respect (A) A dealer in securities subject to of claiming and verifying reduced rates to the applicable dividends and regulatory supervision as a dealer by a of withholding under section 1441 or dividend equivalent payments; governmental authority in the 1442 and for the purpose of reporting (B) Agree to assume the primary jurisdiction in which it was organized and withholding under other provisions withholding and reporting or operates; or of the Internal Revenue Code, such as responsibilities, including the (B) A bank subject to regulatory the provisions under chapter 61 and documentation provisions under supervision as a bank by a governmental section 3406 (and the regulations under chapters 3, 4, and 61, and section 3406, authority in the jurisdiction in which it those provisions). Furnishing such a the regulations under those provisions, was organized or operates or an entity certificate is in lieu of transmitting to a and other withholding provisions of the that is wholly-owned by a bank subject withholding agent withholding Internal Revenue Code, on all dividends to regulatory supervision as a bank by certificates or other appropriate and dividend equivalents that it a governmental authority in the documentation for the persons for receives and makes in its dealer jurisdiction in which it was organized whom the qualified intermediary capacity. For this purpose, a qualified or operates and that— receives the payment, including interest derivatives dealer is required to obtain (1) Issues potential section 871(m) holders in a qualified intermediary that a withholding certificate or other transactions to customers; and is fiscally transparent under the appropriate documentation from each (2) Receives dividends with respect to regulations under section 894. Although counterparty to whom the qualified stock or dividend equivalent payments the qualified intermediary is required to derivatives dealer pays a dividend pursuant to potential section 871(m) obtain withholding certificates or other equivalent. The qualified derivatives transactions that hedge potential section appropriate documentation from dealer is also required to determine 871(m) transactions that it issued. beneficial owners, payees, or interest whether a payment it makes to a (iii) Crediting prior withholding to a holders pursuant to its agreement with counterparty is, in whole or in part, a subsequent dividend equivalent the IRS, it is generally not required to dividend equivalent; payment. [Reserved]. attach such documentation to the (C) Agree to remain liable for tax (f)(3) * * * Paragraphs (e)(3)(ii)(E) intermediary withholding certificate. under section 871 and section 881 on and (e)(6) apply beginning September Notwithstanding the preceding any dividend or payment of a dividend 18, 2015. sentence, a qualified intermediary must equivalent (within the meaning of (g) * * * Paragraphs (e)(3)(ii)(E) and provide a withholding agent with the § 1.871–15(i)) it receives in its dealer (e)(6) of this section expire September Forms W–9, or disclose the names, capacity to the extent that the offsetting 17, 2018.

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■ Par. 7. Section 1.1441–2 is amended the timing and amount of a dividend ELI (as described in § 1.871–15(e)). CB effects by adding paragraph (e)(8) and adding a equivalent under section 871(m), a the trade for FC on the exchange. The sentence to the end of paragraph (f) to withholding agent may rely on the exchange matches FC’s order with an order read as follows: information received from the party to for a written call option with the same terms. The exchange then sends the matched trade the transaction that is required (as to CO, which clears the trade. CB and the § 1.1441–2 Amounts subject to provided in § 1.871–15(p)) to make withholding. clearing member representing the call option those determinations, unless the seller settle the trade with CO. Upon * * * * * withholding agent knows or has reason receiving the matched trade, the option (e) * * * to know that the information is contracts are novated and CO becomes the (8) Payments of dividend incorrect. When a withholding agent counterparty to CB and the counterparty to equivalents—(i) In general. A payment fails to withhold the required amount the clearing member representing the call of a dividend equivalent is not because the party described in § 1.871– option seller. To the extent that there is a considered to be made until the later of 15(p) fails to reasonably determine or dividend equivalent with respect to the call option, both CO and CB are withholding when— timely provide information regarding (A) The amount of a dividend agents as described in paragraph (a)(1) of this whether a transaction is a section section. equivalent is determined as provided in 871(m) transaction, the timing and § 1.871–15(j)(2), and amount of any dividend equivalent, or (4) * * * Example 7 of paragraph (B) A payment occurs with respect to any other information required to be (a)(3) of this section applies to payments the section 871(m) transaction. provided pursuant to § 1.871–15(p), and made on or after September 18, 2015. (ii) Payment. For purposes of the withholding agent relied, absent * * * * * paragraph (e)(8) of this section, a actual knowledge to the contrary, on ■ Par. 10. Section 1.1461–1 is amended payment occurs with respect to a that party’s determination or did not by: section 871(m) transaction when— timely receive required information, ■ 1. Redesignating paragraphs (A) Money or other property is paid then the failure to withhold is imputed (c)(2)(i)(N) as (c)(2)(i)(O) and (c)(2)(i)(M) to or by the long party; to the party required to make the as (c)(2)(i)(N). (B) In the case of a section 871(m) determinations described in § 1.871– ■ 2. Adding paragraph (c)(2)(i)(M). transaction described in § 1.871– ■ 15(p). In that case, the IRS may collect 3. Redesignating paragraph 15(i)(3), a payment is treated as being any underwithheld amount from the (c)(2)(ii)(K) as (c)(2)(ii)(L) and made at the end of the applicable party to the transaction that was redesignating paragraph (c)(2)(ii)(J) as calendar quarter; or required to make the determinations (c)(2)(ii)(K) (C) The long party sells, exchanges, ■ described in § 1.871–15(p) or timely 4. Adding paragraph (c)(2)(ii)(J). transfers, or otherwise disposes of the provide the information and subject that section 871(m) transaction (including by § 1.1461–1 Payments and returns of tax party to applicable interest and settlement, offset, termination, withheld. penalties as if the party were a expiration, lapse, or maturity). * * * * * withholding agent with respect to the (iii) Premiums and other upfront (c) * * * payment of the dividend equivalent payments. When a long party pays a (2) * * * made pursuant to the section 871(m) premium or other upfront payment to (i) * * * transaction. the short party at the time a section (M) Any dividend or any payment (3) Effective/applicability date. Except 871(m) transaction is issued, the that references the payment of a for the first sentence of paragraph (h)(1), premium or other upfront payment is dividend from an underlying security this paragraph (h) applies to payments not treated as a payment for purposes of pursuant to a securities lending or sale- made on or after September 18, 2015. paragraph (e)(8)(ii)(A) of this section. repurchase transaction paid to a The first sentence of paragraph (h)(1) of * * * * * qualified derivatives dealer even when this section, applies to payments made the withholding agent is not required to (f) * * * Paragraph (e)(8) of this on or after January 23, 2012. section applies to payments made on or withhold on the payment pursuant to * * * * * § 1.1441–1(b)(4)(xxi), (xxii), or (xxiii); after September 18, 2015. ■ ■ Par. 8. Section 1.1441–3 is amended Par. 9. Section 1.1441–7 is amended * * * * * by: (ii) * * * by: ■ ■ 1. Adding a second sentence to 1. Adding Example 7 to paragraph (J) Except as provided in § 1.1461– paragraph (h)(1). (a)(3). 1(c)(2)(i)(M), any payment to a qualified ■ ■ 2. Redesignating paragraph (h)(2) as 2. Adding a second sentence to derivatives dealer when the withholding (h)(3) and revising newly redesignated paragraph (a)(4). agent is not required to withhold on the paragraph (h)(3). The additions read as follows: payment pursuant to § 1.1441– ■ 3. Adding new paragraph (h)(2). § 1.1441–7 General provisions relating to 1(b)(4)(xxi), (xxii), or (xxiii); The additions and revisions read as withholding agents. * * * * * follows: (a) * * * ■ Par. 11. Section 1.1473–1 is amended (3) * * * by: § 1.1441–3 Determination of amounts to be ■ 1. Adding new paragraph (a)(4)(viii). withheld. Example 7. CO is a domestic clearing ■ 2. Adding a sentence to the end of * * * * * organization. CO serves as a central paragraph (f). counterparty clearing and settlement service (h) * * * The additions read as follows: (1) * * * Withholding is required on provider for derivatives exchanges in the the amount of the dividend equivalent United States. CB is a broker organized in § 1.1473–1 Section 1473 definitions. Country X, a foreign country, and a clearing calculated under § 1.871–15(j). member of CO. CB is a nonqualified (a) * * * (2) Reliance by withholding agent on intermediary, as defined in § 1.1441–1(c)(14). (4) * * * reasonable determinations. For FC is a foreign corporation that has an (viii) Certain dividend equivalents. purposes of determining whether a investment account with CB. FC instructs CB Amounts paid with respect to a notional payment is a dividend equivalent and to purchase a call option that is a specified principal contract described in § 1.871–

VerDate Sep<11>2014 21:46 Sep 17, 2015 Jkt 235001 PO 00000 Frm 00026 Fmt 4701 Sfmt 4700 E:\FR\FM\18SER4.SGM 18SER4 mstockstill on DSK4VPTVN1PROD with RULES4 Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations 56891

15(a)(7), an equity-linked instrument of § 1.871–15(a)(12), if the transaction is (f) * * * Paragraph (a)(4)(viii) of this described in § 1.871–15(a)(4), or a subject to the exception described in section applies to payments made on or securities lending or sale-repurchase § 1.871–15(k), or to the extent the after September 18, 2015. transaction described in § 1.871– payment is not a dividend equivalent John Dalrymple, 15(a)(13) that are exempt from pursuant to § 1.871–15(c)(2). Deputy Commissioner for Services and withholding under section 1441(a) as * * * * * Enforcement. dividend equivalents under section Approved: July 20, 2015. 871(m) if the transaction is not a section Mark J. Mazur, 871(m) transaction within the meaning Assistant Secretary of the Treasury (Tax Policy). [FR Doc. 2015–21759 Filed 9–17–15; 8:45 am] BILLING CODE 4830–01–P

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