Prop. Regs. Apply ‘Delta’ Approach For Dividend-Equivalent Payments To Foreign Persons

Section 871(m) was enacted in 2010 to curb the perceived abuse of foreign persons using derivatives — primarily notional principal contracts (NPCs) or swaps — to replicate the ownership of an underlying U.S. equity without such person being subject to U.S. withholding tax on the underlying dividend. Under Section 871(m), a "dividend equivalent payment" is treated as a dividend from U.S. sources and therefore (unless exempt under an applicable income tax treaty) subject to a 30% U.S. withholding tax.

Treasury and the IRS issued Proposed Regulations in 2012 that applied a seven-factor approach to determine whether the use of an NPC by a foreign person was a tax avoidance transaction that would trigger the application of Section 871(m).1 Recently, however, Treasury and the IRS withdrew the 2012 Proposed Regulations and issued new Proposed Regulations (REG-120282-10, 12/4/13) under Section 871(m) that apply a more objective standard.

Originally Published in Journal Of Taxation - January 22, 2014.

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