ISDA Protocol Addresses New Withholding Rules for Dividend Equivalent Payments


On August 23, 2010, the International Swaps and Derivatives Association (ISDA) announced a new Protocol intended to address new U.S. withholding tax rules for certain notional principal contract payments. Under the new U.S. withholding tax rules, which were enacted in March as part of the Hiring Incentives to Restore Employment Act (HIRE Act), a payment made pursuant to a “specified notional principal contract” that is contingent upon, determined by reference to, or made in substitution of a U.S. source dividend payment (a “dividend equivalent payment”) generally will be treated as a dividend from U.S. sources for U.S. tax purposes. U.S. source dividends generally are subject to withholding tax at a 30% rate, except where the rate is reduced by an applicable treaty. As a result, U.S. withholding tax generally will be imposed at a 30% rate on the gross amount of a dividend equivalent payment, unless the applicable withholding rate is reduced under the terms of an income tax treaty.

Specified notional principal contracts that currently are covered by the new provision include notional principal contracts where a party transfers the underlying security to the other party (including as collateral) and contracts with respect to securities that are not readily traded on an established market. After March 18, 2012, this definition is expanded to include all notional principal contracts except those specifically identified by the IRS as not having the potential for tax avoidance. Thus, a significant number of notional principal contracts may be impacted by the new rules.

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