U.S. Withholding on Synthetic Trades over U.S. Equities—Further Delay of Full Implementation Until 2019 (Notice 2017-42)

by Akin Gump Strauss Hauer & Feld LLP

Akin Gump Strauss Hauer & Feld LLP

Key Points

  • The broader application of Section 871(m) has been delayed further until January 1, 2019, and, as a result, investment funds with non-U.S. feeders or investors up the chain should generally expect to incur U.S. withholding only if they act as the “long” party on certain synthetic U.S. equity trades with a delta of 1.0 during the transition period.
  • The broader application of the combination rule adopted under the final regulations has also been delayed until January 1, 2019, making the rule easier to administer for withholding agents during the transition period.
  • Since investment funds typically enter into synthetic U.S. equity trades with U.S. or non-U.S. broker/dealers acting in such capacity, they should generally not expect to act as the U.S. withholding agent under Section 871(m) with respect to short positions. However, updated withholding tax forms should be obtained from any non-U.S. broker/dealers to confirm such capacity (generally, IRS Form W-8IMY).

In response to perceived abuses in taxpayers’ use of swaps and other derivative transactions (e.g., options, futures or forwards) to avoid withholding tax on U.S. source dividends, Congress added Section 871(m) to the Internal Revenue Code, which provides that any “dividend equivalent” amount payable on a “specified notional principal contact” (a “Specified Notional Principal Contract”) over U.S. equity is treated as U.S. source dividend income.  Very generally, a dividend equivalent payment is a payment under a derivative that is directly or indirectly contingent on the payment of a dividend by a U.S. corporation.  Therefore, income received or paid by non-U.S. investment funds, or flow-through funds with non-U.S. feeders or investors up the chain, pursuant to certain U.S. equity derivative transactions could potentially be subject to a 30 percent gross-based U.S. withholding tax.

Final U.S. Treasury regulations were adopted in 2015 and 2017 (the “Regulations”) that greatly expanded the scope of a Specified Notional Principal Contract that is covered by Section 871(m).  The Regulations are very complex, but, in essence, treat swaps and other derivative contracts as Specified Notional Principal Contracts if they qualify as (i) “simple” equity swaps or derivatives that have a “delta” of at least 0.8, or (ii) “complex” equity swaps or derivatives that meet a “substantial equivalence” test, which, very generally, is satisfied where the swap or derivative substantially replicates the economic performance of the underlying security.  For this purpose, “delta” is very generally the ratio of a change in the fair market value of the derivative relative to a change in the fair market value of the underlying equity security.  The Regulations also adopted a combination rule that requires that multiple transactions be treated as a Specified Notional Principal Contract if they are entered into in connection with each other and replicate the economics of a single swap or derivative that would have been treated as such.  Special look-through rules were also adopted for swaps and other derivatives over equity indices and exchange-traded funds that include or reference one or more U.S. equities, or over flow-through entities (including, without limitation, master limited partnerships (MLPs)).

Since the Section 871(m) withholding regime under the new Regulations is very complex and requires U.S. withholding agents to develop new systems permitting to identify, report and withhold on such transactions, the Internal Revenue Service (IRS) had provided certain transitional relief for the implementation of Section 871(m) withholding for transactions that do not achieve a delta of 1.0 (“Non-Delta 1 Transactions”) entered into before January 1, 2018 (Notice 2016-76).  Before January 1, 2018, a simplified standard also applies for the combination rule adopted under the Regulations, pursuant to which only long parties are required to combine transactions involving listed securities and over-the-counter transactions that are priced, marketed or sold in connection with each other (i.e., investment funds should not be withheld upon, but may have substantive U.S. tax liability under Section 871(m) when the combination rule applies and a delta of 1.0 is achieved during the transition period).  The IRS has now announced that it is further extending such relief for Non-Delta 1 Transactions, as well as applying the simplified combination rule for transactions entered into before January 1, 2019 (Notice 2017-42).  The IRS will also take into account any good-faith efforts of investment funds to comply with the Regulations during the transition period and in 2019 when Section 871(m) is expected also to apply to Non-Delta 1 Transactions.  Additional guidance is likely forthcoming.

Investment funds should note that the transitional relief described above does not prevent the IRS from applying an anti-abuse rule pursuant to which a payment may be treated as subject to Section 871(m) if the relevant transaction was entered into with a principal purpose of avoiding the Regulations.  Further, investment funds should note that certain swaps and other derivative transactions entered into before January 1, 2017, will continue to be treated as Specified Notional Principal Contracts subject to Section 871(m) if they meet at least one of four factors enumerated in the Section 871(m) statute (i.e., the transitional relief does not apply irrespective of the delta achieved by such transactions): (i) in connection with entering into such transaction, any long party transfers the underlying security to any short party (so-called “crossing in”); (ii) in connection with the termination of such transaction, any short party transfers the underlying security to any long party (so-called “crossing out”); (iii) the underlying security is not readily tradable on an established securities market; or (iv) in connection with entering into such transaction, the underlying security is posted as collateral by any short party with any long party.  Investment funds should also note that swaps and other derivatives that were previously not treated as Specified Notional Principal Contracts may need to be retested if they are significantly modified and treated as reissued under general U.S. federal income tax principles.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Akin Gump Strauss Hauer & Feld LLP | Attorney Advertising

Written by:

Akin Gump Strauss Hauer & Feld LLP

Akin Gump Strauss Hauer & Feld LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.