New “Dividend Equivalent” Withholding Regulations


New temporary and proposed Treasury regulations were issued on January 19, 2012 concerning withholding taxes imposed on certain “dividend equivalent” payments with respect to “specified notional principal contracts” (specified NPCs) and certain other transactions. The temporary regulations generally extend the current rules for dividend equivalent payments through the end of this year. The proposed regulations provide new rules which are currently scheduled to be effective for payments made on or after January 1, 2013. Because the effective date provision references payments, contracts entered into in 2012 would not be grandfathered if they extend into 2013.

Section 871(m)

Section 871(m) of the Internal Revenue Code (the Code) was added in 2010 to treat dividend equivalents as US source dividends for withholding tax purposes. A “dividend equivalent” for this purpose is 1) any substitute dividend made pursuant to a securities lending or a sale-repurchase (repo) transaction or any payment made under a specified NPC, if the substitute dividend or payment is contingent upon, or determined by reference to, the payment of a US source dividend, and 2) any other payment determined by the government to be substantially similar to the payments described in clause 1 above.

Under the statute, a notional principal contract is a “specified NPC” if one or more of four criteria are met: 1) any long party transfers the underlying security to any short party (a cross-in); 2) any short party transfers the underlying security to any long party (a cross-out); 3) the underlying security is not “readily tradable” on an established securities market; or 4) the underlying security is posted as collateral by any short party to a long party “in connection with entering into” the contract. In addition, the IRS is authorized to identify other contracts as specified NPCs.

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