80_FR_57046 80 FR 56865 - Dividend Equivalents From Sources Within the United States

80 FR 56865 - Dividend Equivalents From Sources Within the United States

DEPARTMENT OF THE TREASURY
Internal Revenue Service

Federal Register Volume 80, Issue 181 (September 18, 2015)

Page Range56865-56891
FR Document2015-21759

This document provides guidance to nonresident alien individuals and foreign corporations that hold certain financial products providing for payments that are contingent upon or determined by reference to U.S. source dividend payments. This document also provides guidance to withholding agents that are responsible for withholding U.S. tax with respect to a dividend equivalent.

Federal Register, Volume 80 Issue 181 (Friday, September 18, 2015)
[Federal Register Volume 80, Number 181 (Friday, September 18, 2015)]
[Rules and Regulations]
[Pages 56865-56891]
From the Federal Register Online  [www.thefederalregister.org]
[FR Doc No: 2015-21759]



[[Page 56865]]

Vol. 80

Friday,

No. 181

September 18, 2015

Part VI





Department of the Treasury





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Internal Revenue Service





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26 CFR Part 1





Dividend Equivalents From Sources Within the United States; Final Rule

Federal Register / Vol. 80 , No. 181 / Friday, September 18, 2015 / 
Rules and Regulations

[[Page 56866]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9734]
RIN 1545-BJ56


Dividend Equivalents From Sources Within the United States

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and temporary regulations.

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SUMMARY: This document provides guidance to nonresident alien 
individuals and foreign corporations that hold certain financial 
products providing for payments that are contingent upon or determined 
by reference to U.S. source dividend payments. This document also 
provides guidance to withholding agents that are responsible for 
withholding U.S. tax with respect to a dividend equivalent.

DATES: Effective Date: These regulations are effective on September 18, 
2015.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.871-14(j)(3), 1.871-15(r), 1.871-15T(r)(4), 1.1441-1(f)(4), 1.1441-
1T(f)(3), 1.1441-2(f), 1.1441-3(h)(3), 1.1441-7(a)(4), and 1.1473-1(f).

FOR FURTHER INFORMATION CONTACT: D. Peter Merkel or Karen Walny at 
(202) 317-6938 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under control numbers 1545-0096 and 1545-1597. The collections 
of information in this final regulation are in Sec.  1.871-15(p), and 
are an increase in the total annual burden in the current regulations 
under Sec. Sec.  1.1441-1 through 1.1441-9, 1.1461-1, and 1.1474-1. 
This information is required to establish whether a payment is treated 
as a U.S. source dividend for purposes of section 871(m). This 
information will be used for audit and examination purposes. The IRS 
intends that these information collection requirements will be 
satisfied by persons complying with revised chapter 3 reporting 
requirements and the requirements of the applicable QI revenue 
procedure to be revised by the IRS, or alternative certification and 
documentation requirements set out in these regulations. An agency may 
not conduct or sponsor, and a person is not required to respond to, a 
collection of information unless it displays a valid control number.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
return information are confidential, as required by 26 U.S.C. 6103.

Background

    On January 23, 2012, the Federal Register published temporary 
regulations (TD 9572) at 77 FR 3108 (2012 temporary regulations), and a 
notice of proposed rulemaking by cross-reference to the temporary 
regulations and notice of public hearing at 77 FR 3202 (2012 proposed 
regulations, and together with the 2012 temporary regulations, 2012 
section 871(m) regulations) under section 871(m) of the Internal 
Revenue Code (Code). The 2012 section 871(m) regulations relate to 
dividend equivalents from sources within the United States paid to 
nonresident alien individuals and foreign corporations. Corrections to 
the 2012 temporary regulations were published on February 6, 2012, and 
March 8, 2012, in the Federal Register at 77 FR 5700 and 77 FR 13969, 
respectively. A correcting amendment to the 2012 temporary regulations 
was also published on August 31, 2012, in the Federal Register at 77 FR 
53141. The Treasury Department and the IRS received written comments on 
the 2012 proposed regulations, and a public hearing was held on April 
27, 2012.
    On December 5, 2013, the Federal Register published final 
regulations and removal of temporary regulations (TD 9648) at 78 FR 
73079 (2013 final regulations), which finalized a portion of the 2012 
section 871(m) regulations. Also on December 5, 2013, the Federal 
Register published a withdrawal of notice of proposed rulemaking, a 
notice of proposed rulemaking, and a notice of public hearing at 78 FR 
73128 (2013 proposed regulations). In light of comments on the 2012 
proposed regulations, the 2013 proposed regulations described a new 
approach for determining whether a payment made pursuant to a notional 
principal contract (NPC) or an equity-linked instrument (ELI) is a 
dividend equivalent based on the delta of the contract. In response to 
written comments on the 2013 proposed regulations, the Treasury 
Department and the IRS released Notice 2014-14, 2014-13 IRB 881, on 
March 24, 2014 (see Sec.  601.601(d)(2)(ii)(b)), stating that the 
Treasury Department and the IRS anticipated limiting the application of 
the rules with respect to specified ELIs described in the 2013 proposed 
regulations to ELIs issued on or after 90 days after the date of 
publication of final regulations.
    The Treasury Department and the IRS received written comments on 
the 2013 proposed regulations, which are available at 
www.regulations.gov. The public hearing scheduled for April 11, 2013, 
was cancelled because no request to speak was received. This Treasury 
decision generally adopts the 2013 proposed regulations with the 
changes discussed in this preamble. This Treasury decision also 
includes temporary regulations, which provide new rules for determining 
whether certain complex derivatives are subject to section 871(m) and 
for payments to certain dealers in response to comments on the 2013 
proposed regulations.

Summary of Comments and Explanation of Provisions

I. In General

    The Treasury Department and the IRS received numerous comments 
regarding the 2013 proposed regulations. Most comments agreed that the 
approach taken in the 2013 proposed regulations, in particular the use 
of a test based on delta, was a fair and practical way to apply section 
871(m) to financial instruments linked to one or more U.S. equity 
securities. Commenters, however, identified a number of issues with the 
2013 proposed regulations. Many of the comments suggested modifications 
and clarifications to the 2013 proposed regulations before they are 
issued as final regulations. Those comments are summarized in Part II 
of this preamble. Part II also explains the changes made to the final 
regulations in response to those comments.
    Several of the issues identified by commenters required more 
significant changes or additions to the 2013 proposed regulations. To 
allow taxpayers adequate opportunity to consider and comment on these 
changes, the Treasury Department and the IRS are issuing portions of 
the regulations as temporary and proposed regulations. Those 
provisions, and the relevant comments, are summarized in Part III of 
this preamble.

II. Final Regulations

A. Source of a Dividend Equivalent

    The 2013 proposed regulations provide that a dividend equivalent is 
treated as a dividend from sources within the United States for 
purposes of sections 871(a), 881, 892, 894, and

[[Page 56867]]

4948(a), and chapters 3 and 4 of subtitle A of the Code. This rule 
follows section 871(m)(1) but adds the reference to section 894 to 
clarify (as provided in Sec.  1.894-1(c)(2)) that a dividend equivalent 
is treated as a dividend for purposes of any provision regarding 
dividends in an income tax treaty. The final regulations retain the 
general sourcing provision. See Sec.  1.871-15(b).

B. Definition of a Dividend Equivalent

    The 2013 proposed regulations define a dividend equivalent as (1) 
any substitute dividend that references a U.S. source dividend made 
pursuant to a securities lending or sale-repurchase transaction, (2) 
any payment that references a U.S. source dividend made pursuant to a 
specified NPC, (3) any payment that references a U.S. source dividend 
made pursuant to a specified ELI, or (4) any other substantially 
similar payment. A payment references a U.S. source dividend if the 
payment is directly or indirectly contingent upon a U.S. source 
dividend or determined by reference to such a dividend. While the 
transactions described in (1) and (2) are transactions described in 
sections 871(m)(2)(A) and (B), respectively, the 2013 proposed 
regulations extend section 871(m) to the transactions described in (3) 
and (4) under the regulatory authority granted in section 871(m)(2)(C), 
which includes as a dividend equivalent ``any other payment determined 
by the Secretary to be substantially similar to a payment described in 
subparagraph (A) or (B)'' of section 871(m)(2). The final regulations 
retain this four-part definition of a dividend equivalent. See Sec.  
1.871-15(c)(1). The final regulations also provide certain exceptions 
to the term ``dividend equivalent,'' which are described in section 
II.D of this preamble.
    Section 871(m)(3)(A) provides a temporary definition of the term 
``specified notional principal contract.'' This definition is effective 
for payments made on or after September 14, 2010, and on or before 
March 18, 2012. Section 871(m)(3)(B) provides that, for payments made 
after March 18, 2012, a specified NPC includes ``any notional principal 
contract unless the Secretary determines that such contract is of a 
type which does not have the potential for tax avoidance.'' The 2013 
final regulations extend the applicability of the temporary statutory 
definition in section 871(m)(3)(A) (the four-part definition provided 
in paragraphs (3)(A)(i) through (iv)) to payments made before January 
1, 2016. These final regulations amend the 2013 final regulations to 
extend the application of the temporary statutory definition adopted in 
the 2013 final regulations to payments made before January 1, 2017.
    Pursuant to the grant of authority in section 871(m)(2)(C), the 
2013 proposed regulations provide that certain payments made pursuant 
to a specified ELI are substantially similar to a dividend equivalent 
payment. Section 1.871-15(c)(1)(iii) of the 2013 proposed regulations 
defines a dividend equivalent to include any payment that references 
the payment of a dividend from an underlying security on a specified 
ELI. Section 1.871-15(a)(3) of the 2013 proposed regulations defines an 
ELI (whether or not specified) as any financial transaction (other than 
a securities lending or sale-repurchase transaction or an NPC) that 
references the value of one or more underlying securities. Forward 
contracts, futures contracts, options, debt instruments convertible 
into underlying securities, and debt instruments that have payments 
linked to underlying securities are common examples of an ELI.

C. The Delta Test

    The 2012 proposed regulations used a multi-factor test to determine 
whether an NPC or ELI is a specified contract subject to withholding 
under section 871(m). The 2013 proposed regulations replace the multi-
factor test with a single-factor test that employs a ``delta'' 
threshold to determine whether a transaction is a section 871(m) 
transaction. Delta refers to the ratio of a change in the fair market 
value of a contract to a small change in the fair market value of the 
property referenced by the contract. Delta is widely used by 
participants in the derivatives markets to measure and manage risk. 
Under the test in the 2013 proposed regulations, any NPC or ELI that 
had a delta of 0.70 or greater when the long party acquired the 
transaction would be a section 871(m) transaction subject to 
withholding.
    The Treasury Department and the IRS proposed a delta-based standard 
after concluding that it would provide a comparatively simple, 
administrable, and objective framework that would also minimize 
potential avoidance of U.S. withholding tax. A financial instrument 
that provides an economic return that is substantially similar to the 
return on the underlying stock should be taxed in the same manner as 
the underlying stock for the purpose of section 871(m). The Treasury 
Department and the IRS concluded that the delta test was the best way 
to identify these instruments.
    The Treasury Department and the IRS received many comments 
regarding the delta test. Commenters generally agreed that the delta 
test was both a fair and comprehensive way to implement section 871(m), 
but provided comments on several aspects of the test. The major 
concerns noted in the comments relate to: (1) The use of 0.70 as the 
delta threshold; (2) the time for testing delta; (3) the ability of 
parties to the transaction to obtain and track the necessary delta 
information; and (4) the difficulty of determining an initial delta 
with respect to certain complex equity derivatives (in contrast with 
simple contracts, as defined in Part II.C.4 of this preamble).
1. Delta Threshold
    Comments on the 2013 proposed regulations recommended raising the 
delta threshold, with suggestions ranging from a delta of 0.80 to 0.95. 
The majority of comments preferred a delta threshold of 0.90 or 
greater. Comments maintained that a higher delta would more accurately 
capture transactions that are economically equivalent to stock 
ownership and likely to be used for tax-avoidance. One comment noted 
that a 0.80 delta standard, although not prescribed in regulatory 
guidance, is used by some practitioners as a yardstick to judge 
economic equivalence in other tax contexts.
    The Treasury Department and the IRS agree that the 0.70 delta in 
the 2013 proposed regulations could apply to contracts with economic 
characteristics that do not sufficiently resemble the underlying 
security to be within the scope of section 871(m). On the other hand, a 
delta threshold that is 0.90 (or higher) would exclude many instruments 
that are surrogates for the underlying security, such as deep-in-the-
money options. The final regulations adopt a delta threshold of 0.80, 
which strikes a balance between the potential over-inclusiveness of the 
0.70 delta threshold and the likelihood that a 0.90 (or higher) 
threshold would exclude transactions with economic returns that closely 
resemble an underlying security.
    Several comments noted that a delta ratio is intended to measure 
the sensitivity of the value of a contract to comparatively small 
changes in the market value of the referenced property and suggested 
that the regulations incorporate this qualification in the definition 
of delta. The final regulations accept this suggestion and clarify the 
definition of delta by specifying that delta is calculated with respect 
to a small change in the fair market value of the property referenced 
by the contract.

[[Page 56868]]

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

D. Exceptions for Certain Payments and Transactions

    Several comments requested that the final regulations exclude 
certain payments from the definition of

[[Page 56869]]

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

[[Page 56870]]

comments noted that the anti-abuse rule should be sufficient to address 
any abuse that could occur through such transactions. Comments 
acknowledged that when a target company pays a pre-closing dividend and 
the purchase price is reduced for the dividend, this may allow the 
purchaser to avoid a subsequent dividend. However, comments observed 
that this event should be viewed as a purchase price adjustment rather 
than a dividend equivalent.
    The final regulations do not change the 50 percent threshold. 
Requiring that an acquisition (as part of a plan by one or more person) 
total more than 50 percent of a corporation is appropriate because it 
indicates that the primary intent of the acquirer is to obtain a 
controlling interest rather than just a substantial investment in the 
target company. In circumstances where a taxpayer enters into a 
transaction pursuant to which the taxpayer is obligated to acquire 50 
percent or less of the entity issuing the underlying securities, and 
the transaction is a section 871(m) transaction, any party to the 
transaction that is a broker, dealer, or intermediary, a short party, 
or a withholding agent, must comply with any requirements in the final 
regulation to make appropriate determinations, and satisfy reporting 
and withholding obligations, as applicable.

D. Payment of a Dividend Equivalent

    Section 871(m)(5) provides that a ``payment'' includes any gross 
amount that references a U.S. source dividend and that is used to 
compute any net amount transferred to or from the taxpayer. The 2013 
proposed regulations provide that a dividend equivalent includes any 
amount that references an actual or estimated payment of a U.S. source 
dividend, whether the reference is explicit or implicit. Thus, in 
addition to amounts equal to actual payments of dividends and estimated 
dividends, a dividend equivalent includes any other contractual term of 
a section 871(m) transaction that is calculated based on an actual or 
estimated dividend. For example, when a long party enters into an NPC 
that provides for payments based on the appreciation in the value of an 
underlying security but that does not explicitly entitle the long party 
to receive payments based on regular dividends (a price return swap), 
the 2013 proposed regulations treat the price return swap as a 
transaction that provides for the payment of a dividend equivalent 
because the anticipated dividend payments are presumed to be taken into 
account in determining other terms of the NPC, such as in the payments 
that the long party is required to make to the short party or in 
setting the price of the underlying securities referenced in the price 
return swap.
    Comments objected to the provisions in the 2013 proposed 
regulations that include estimated and implicit dividends in the 
definition of a dividend equivalent. These comments noted that an 
estimated dividend is reflected as a price reduction or as an amount 
that the foreign investor does not have to pay rather than an amount 
the foreign investor affirmatively receives for holding the derivative, 
which suggests that there is no ``payment'' of a dividend equivalent to 
the foreign investor. Comments also noted that, while estimated 
dividends may be implicitly incorporated into the pricing of a 
derivative, the price is ultimately determined by supply and demand in 
the market and the expected dividend is not always explicitly used in 
computing the amount paid.
    The Treasury Department and the IRS have concluded that the 
economic benefit of a dividend is present in transactions that 
implicitly incorporate estimated dividends to virtually the same extent 
as transactions that pay or adjust for actual dividends. Thus, the 
final regulations retain the rules in the 2013 proposed regulations 
that include estimated and implicit dividends as dividend equivalents. 
See Sec.  1.871-15(i)(2). More specifically, the final regulations 
provide that any gross amount that references the payment of a 
dividend, whether actual or estimated, explicit or implicit, is treated 
as a dividend equivalent to the extent of the amount determined under 
the regulations. The final regulations change the time that withholding 
is required on a payment of a dividend equivalent, as discussed in Part 
II.M of this preamble.

E. Amount of a Dividend Equivalent

1. Calculation of Dividend Equivalent Amount
    Under the 2013 proposed regulations, the amount of a dividend 
equivalent for a specified NPC or specified ELI equals the per-share 
dividend amount with respect to the underlying security multiplied by 
the number of shares of the underlying security referenced in the 
contract (subject to adjustment), multiplied by the delta of the 
transaction with respect to the underlying security at the time when 
the amount of the dividend equivalent is determined. If a transaction 
provides for a payment based on an estimated or implicit estimated 
dividend, the actual dividend is used to calculate the amount of the 
dividend equivalent unless the short party identifies a reasonable 
estimated dividend amount in writing at the inception of the 
transaction. When a payment based on estimated dividends is supported 
by the required documentation, the per-share dividend amount used to 
compute the amount of a dividend equivalent is the lesser of the 
estimated dividend and the actual dividend.
    Comments on the 2013 proposed regulations noted that recalculating 
the delta of a section 871(m) transaction each time the amount of a 
dividend equivalent is determined would add administrative complexity 
without necessarily improving accuracy. In the interest of simplicity, 
several comments recommended using the actual dividend amount rather 
than an amount adjusted for delta as the dividend equivalent amount. 
Other comments suggested using the delta at the time the transaction is 
issued or entered into for determining the dividend equivalent amount. 
For complex transactions for which the delta is indeterminate, comments 
suggested that withholding be based on the number of shares required by 
the short party to the transaction to hedge its initial position in the 
transaction.
    The final regulations simplify the rules for determining the amount 
of a dividend equivalent in response to these comments. For a simple 
contract, the final regulations provide that the amount of the dividend 
equivalent for each underlying security equals the amount of the per-
share dividend, multiplied by the number of shares referenced in the 
contract, multiplied by the applicable delta. In a change from the 2013 
proposed regulations, the final regulations provide that this formula 
references the delta of the transaction at the time the simple contract 
is issued, rather than when the dividend is paid. For a complex 
contract, the amount of the dividend equivalent equals the amount of 
the per-share dividend multiplied by the number of shares that 
constitute the initial hedge of the complex contract (as that term is 
defined in Sec.  1.871-15(a)(14)(ii) and discussed in Part III.A of 
this preamble).
    Another simplifying rule applies to dividend equivalents paid with 
respect to baskets of more than 25 securities. If a section 871(m) 
transaction references a basket of more than 25 underlying securities, 
the short party is allowed to treat all of the dividends on the basket 
as paid on the last day of the calendar quarter.

[[Page 56871]]

2. Specified NPCs and Specified ELIs With a Term of One Year or Less
    For a specified NPC or specified ELI with a term of one year or 
less when acquired, the 2013 proposed regulations provide that the 
amount of a dividend equivalent is determined when the long party 
disposes of the section 871(m) transaction. Therefore, a long party 
that acquires an option with a term of one year or less that is a 
specified ELI would not incur a withholding tax if the option lapses.
    One comment noted that the rule providing that there is no dividend 
equivalent for options that have a term of one year or less and lapse 
unexercised is inappropriate in the case of written put options because 
put writers realize their maximum profit when puts lapse. Comments 
further noted that the one-year rule could have uneconomic consequences 
for options close to expiration and for options that are slightly in-
the-money or slightly out-of-the-money because the delta could 
fluctuate materially in response to small changes in the price of the 
underlying stock.
    Based on the comments received, the final regulations eliminate the 
special rule for contracts with terms of one year or less. Any benefit 
from the rule is outweighed by the complexity of creating systems to 
track contracts that differ only in term. Eliminating the special rule 
for contracts of one year or less means that a dividend equivalent 
amount must be determined for any option, including a short-term 
option, that is a specified ELI.

F. Qualified Indices

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

[[Page 56872]]

regulations except from withholding all global indices that are not 
created to avoid withholding tax, with a presumption that widely-used 
benchmark indices are not designed to avoid tax.
    The Treasury Department and the IRS believe that the approach taken 
in the 2013 proposed regulations for identifying qualified indices 
appropriately balances the competing concerns. Accordingly, the final 
regulations generally retain the criteria of the 2013 proposed 
regulations with modifications to clarify the intent and improve the 
functionality of the qualified index rule. See Sec.  1.871-15(l)
    The final regulations add a paragraph stating that the purpose of 
the qualified index rule is to provide a safe harbor for transactions 
on passive indices that reference a diverse basket of securities and 
that are widely used by numerous market participants. The index 
exception is not intended to apply to any index that is customized or 
reflects a trading strategy, is unavailable to other investors, or 
targets special dividends. The final regulations further provide that 
an index will not be treated as a qualified index if treating the index 
as a qualified index would be contrary to this purpose.
    To make the rules easier to administer, the final regulations 
modify the time for determining whether an index satisfies the 
qualified index criteria. Specifically, the final regulations provide 
that the determination of whether an index is a qualified index is made 
on the first business day of each calendar year, and that determination 
applies for all potential section 871(m) transactions issued during 
that calendar year.
    In response to comments, a number of changes also were made to 
specific aspects of the qualified index definition. First, the final 
regulations delete the modifier ``underlying'' with respect to 
``securities,'' thereby allowing an index to qualify with fewer than 25 
component underlying securities provided that the index contains a 
total of at least 25 component securities (in other words, a component 
security may include a security that does not give rise to U.S. source 
dividends). The index, however, will not qualify if it references five 
or fewer component underlying securities that together represent more 
than 40 percent of the weighting of the component securities in the 
index. Second, the final regulations increase the 10 percent limit for 
the maximum weighting of a single underlying security to 15 percent. 
Third, in response to concerns regarding the requirement that a 
qualified index rebalance based on objective rules, the final 
regulations do not require that an index be modified or rebalanced at 
set dates or intervals, and provide flexibility for how the rules 
governing the constitution of an index are applied. Instead, under the 
final regulations, an index that is periodically rebalanced by a board 
or committee that is allowed to exercise judgment in interpreting the 
rules governing the composition of the index will not be disqualified 
if the index is otherwise a qualified index.
    The final regulations continue to require that an index be 
referenced by futures or options listed on a national securities 
exchange or board of trade to be a qualified index, which is consistent 
with the intent to provide a safe harbor only for non-customized and 
widely-available indices. The final regulations do, however, permit an 
index that trades on certain foreign exchanges to be a qualified index, 
provided that the referenced component underlying securities, in 
aggregate, comprise less than 50 percent of the weighting of the 
component securities in the index and the index otherwise meets the 
definition of a qualified index.
    Similarly, the Treasury Department and the IRS have concluded that 
the proposed rule permitting no more than 1.5 times the current 
dividend yield of the S&P 500 Index is appropriate and have retained it 
in the final regulations. To reduce the number of required 
calculations, however, the final regulations provide that the annual 
yields of the tested index and of the S&P 500 Index are determined 
based on their annual yields for the immediately preceding calendar 
year, rather than requiring comparison of the annual yields for the 
month immediately preceding the date that the potential section 871(m) 
transaction is issued.
    The Treasury Department and the IRS agree that de minimis short 
positions, whether as part of the index or entered into separately, 
should not disqualify an index. Accordingly, the final regulations 
permit a qualified index to reference one or more short positions (in 
addition to any short positions with respect to the entire qualified 
index, such as caps or floors, which were already permitted by the 2013 
proposed regulations) that represent five percent or less, in the 
aggregate, of the value of the long positions in underlying securities 
in the qualified index.

G. Combined Transactions

    The 2013 proposed regulations treat multiple transactions as a 
single transaction for purposes of determining if the transactions are 
a section 871(m) transaction when a long party (or a related person) 
enters into two or more transactions that reference the same underlying 
security and the transactions were entered into in connection with each 
other. The 2013 proposed regulations apply only to combine transactions 
in which the taxpayer is the long party, and typically would not 
combine transactions when a taxpayer is the long party with respect to 
an underlying security in one transaction and the short party with 
respect to the same underlying security in another transaction. The 
2013 proposed regulations provide that a broker-dealer must use 
``reasonable diligence'' to determine whether a transaction is a 
section 871(m) transaction. Under the 2013 proposed regulations, a 
withholding agent was not required to withhold on a dividend equivalent 
paid pursuant to a transaction that is combined with one or more other 
transactions unless the withholding agent knew that the long party (or 
a related person) entered into the potential section 871(m) 
transactions in connection with each other.
    The Treasury Department and the IRS requested comments regarding 
whether and how the rules for combining separate transactions should 
apply in other situations, such as when a taxpayer holds both long and 
short positions with respect to the same underlying security (for 
example, a call spread). Comments also were requested regarding whether 
and how the remaining transaction (or transactions) should be retested 
when a long party terminates one or more, but not all, of the 
transactions that make up a combined position.
    Several comments recommended that the regulations not provide a 
specific combination rule and instead rely on an anti-abuse rule. One 
comment endorsed the proposed regulations as they applied to 
combinations of long calls and written puts (two options that can be 
used to closely approximate the economics of stock ownership) but 
recommended that transactions not be combined if the transactions 
replicate the same or similar risks with respect to additional shares 
(for example, two purchased calls on the same underlying securities).
    Many comments observed that determining whether transactions were 
entered into ``in connection with'' each other would be difficult for a 
withholding agent and that the regulations should adopt a different 
standard or clarify the meaning of the phrase. Comments asked that the 
final regulations conform the standard for combined transactions to the 
narrower withholding standard that requires

[[Page 56873]]

``actual knowledge.'' Comments noted that the requirement in the 2013 
proposed regulations for broker-dealers to use ``reasonable diligence'' 
to determine whether a transaction is a section 871(m) transaction 
could be interpreted to require broker-dealers to inquire whether 
transactions are entered into in connection with each other in order to 
determine whether they must be combined. These comments observed that 
this standard for combined transactions is impractical because broker-
dealers are generally not in a position to discern the intent of their 
counterparties, even using ``reasonable diligence.''
    Several comments recommended that a combination rule permit netting 
of long and short positions. Commenters observed that many standard 
option strategies involve multiple options positions, often combining 
positive and negative delta options. As a result, an approach that does 
not combine these positions would fail to reflect the economics of the 
transactions. Commenters suggested that when a taxpayer modifies an 
existing combined position that includes both long and short positions, 
the combined position should continue to be tested based on the net 
deltas of the component positions rather than test the delta for each 
position separately. None of the comments, however, proposed an 
administrable test that could be used to reliably combine long and 
short positions and net the resulting deltas.
    The final regulations retain the general rules from the 2013 
proposed regulations that define when transactions are combined. In 
response to questions about whether the rules were intended to combine 
transactions that had similar economic exposure, the final regulations 
add a requirement that the potential section 871(m) transactions, when 
combined, replicate the economics of a transaction that would be a 
section 871(m) transaction if the transactions had been entered into as 
a single transaction. Thus, the purchase of two out-of-the-money call 
options would typically not be combined because each call option 
provides the taxpayer with exposure to appreciation, but not 
depreciation, on the referenced stock.
    The Treasury Department and the IRS recognize the challenges that 
short parties could face in identifying transactions to be combined. 
The final regulations therefore provide brokers acting as short parties 
with two presumptions they can apply to determine their liability to 
withhold. First, a broker may presume that transactions are not entered 
into in connection with each other if the long party holds the 
transactions in separate accounts. Second, a broker may presume that 
transactions entered into two or more business days apart are not 
entered into in connection with each other. These presumptions are 
independent of each other. Thus, a broker acting as a short party is 
relieved of the obligation to withhold if either of the two 
presumptions is met. A broker cannot rely on the first presumption if 
it has actual knowledge that the long party created or used separate 
accounts to avoid section 871(m), however, and neither presumption 
applies if the broker has actual knowledge that transactions were 
entered into in connection with each other.
    In addition, the final regulations provide that the Commissioner 
will presume that transactions that are properly reflected on separate 
trading books of the taxpayer are not entered into in connection with 
each other. The Commissioner will also presume that a long party did 
not enter into two or more transactions in connection with each other 
if the long party entered into the transactions two or more business 
days apart. These presumptions are rebuttable. The Commissioner may 
rebut the first presumption with facts and circumstances showing that 
separate trading books were created or used to avoid section 871(m), 
and may rebut either presumption with facts and circumstances showing 
that the transactions in question were entered into in connection with 
each other.
    The Commissioner will also apply an affirmative presumption. The 
Commissioner will presume that transactions that are entered into fewer 
than two business days apart and reflected on the same trading book are 
entered into in connection with each other. In this case, the long 
party can rebut the presumption by presenting facts and circumstances 
showing that the transactions were not entered into in connection with 
each other. In applying the presumptions that are based on trades being 
separated by at least two business days, the regulations include a rule 
of convenience that generally allows parties to treat all of their 
transactions as entered into at 4:00 p.m.
    The presumptions are not available to the long party. A long party 
therefore must treat two or more transactions as combined transactions 
if the transactions satisfy the requirements to be a combined 
transaction. The long parties affected by this rule consist primarily 
of securities traders, who are in a position to know their securities 
positions and trading strategies and to monitor their compliance with 
section 871(m).
    The Treasury Department and the IRS will continue to evaluate the 
possibility of expanding the combination rules to accommodate netting 
of long and short positions in light of future developments in 
transactional reporting and recordkeeping. Additional comments 
regarding combined transactions are welcome.

H. Derivatives Referenced to Partnership Interests

    The 2013 proposed regulations treat a transaction that references 
an interest in an entity that is not a C corporation for Federal tax 
purposes as referencing the allocable portion of any underlying 
securities and potential section 871(m) contracts held directly or 
indirectly by that entity. The 2013 proposed regulations provide an 
exception for a transaction that references an interest in an entity 
that is not a C corporation if the underlying securities and potential 
section 871(m) transactions allocable to that interest represent, in 
the aggregate, 10 percent or less of the value of the interest in the 
referenced entity at the time the transaction is entered into. Comments 
recommended changing the threshold for applying the look-through rule 
from 10 percent to 50 percent unless the taxpayer controls the entity. 
Comments also noted that taxpayers would have difficulty determining 
the assets owned by referenced entities.
    The final regulations revise the rules to provide that section 
871(m) applies to derivatives that reference a partnership interest 
only when the partnership is either a dealer or trader in securities, 
has significant investments in securities, or holds an interest in a 
lower-tier partnership that engages in those activities. The final 
regulations define a security by cross-reference to section 475(c). 
When the rule in the final regulations applies, a potential section 
871(m) transaction that references a partnership interest is treated as 
referencing the allocable share of underlying securities and the 
potential section 871(m) transactions in the partnership directly or 
indirectly allocable to that partnership interest. Even when a 
partnership is not covered by this rule, the anti-abuse rule in Sec.  
1.871-15(o) may still apply, or the transaction may be recharacterized 
under the substance-over-form doctrine or other common law doctrine.

I. Anti-Abuse Rule

    The 2013 proposed regulations provide that the Commissioner may 
treat any payment made with respect to a transaction as a dividend 
equivalent if

[[Page 56874]]

the taxpayer acquires the transaction with a principal purpose of 
avoiding the application of section 871(m). Comments generally agreed 
with the need for such a rule, and the final regulations retain this 
provision. See Sec.  1.871-15(o).
    In addition, the IRS may challenge the U.S. tax results claimed in 
connection with transactions that are designed to avoid the application 
of section 871(m) using all available statutory provisions and judicial 
doctrines (including the substance-over-form doctrine, the economic 
substance doctrine under section 7701(o), the step transaction 
doctrine, and tax ownership principles) as appropriate. For example, 
nothing in section 871(m) precludes the IRS from asserting that a 
contract labeled as an NPC or other equity derivative is in fact an 
ownership interest in an underlying security referenced in the 
contract.

J. Reporting Obligations

    The 2013 proposed regulations provide rules for reporting and 
withholding. The preamble to the 2013 proposed regulations explains 
that most equity-linked transactions involve a financial institution 
acting as a broker, dealer, or intermediary and that the financial 
institution would be in the best position to report the tax 
consequences of a potential section 871(m) transaction. Accordingly, 
Sec.  1.871-15(o) of the 2013 proposed regulations provides that when a 
broker or dealer is a party to a potential section 871(m) transaction 
the broker or dealer is required to determine whether the transaction 
is a section 871(m) transaction, and if so, the amounts of the dividend 
equivalents. If no broker or dealer is a party to a transaction or both 
parties are brokers or dealers, the short party is required to 
determine whether the transaction is a section 871(m) transaction and 
the amounts of the dividend equivalents. Determinations made by the 
broker, dealer, or short party are binding on the parties to the 
section 871(m) transaction unless a party to the transaction knows or 
has reason to know that the information is incorrect. Those 
determinations, however, are not binding on the IRS.
    Comments expressed concern that the delta information necessary for 
an investor to determine whether a transaction is subject to section 
871(m) may not be available on a timely basis, and requested that the 
regulations expand the categories of persons permitted to request 
information about the status and calculations associated with potential 
section 871(m) transactions. Comments recommended requiring the 
information to be provided on an issuer's Web site at or prior to the 
time that the transaction is issued and updated regularly. Investors 
could then rely on such information between update intervals.
    In response to these comments, the final regulations make several 
changes to the reporting obligations in the 2013 proposed regulations. 
The final regulations revise the period for providing requested 
information from 14 calendar days to 10 business days from the date of 
the request. In addition, the final regulations replace the list of 
persons entitled to request information in the 2013 proposed 
regulations with a simpler provision that entitles ``any party to the 
transaction'' to request information. The final regulations define ``a 
party to the transaction'' to include any agent acting on behalf of a 
long party or short party to a potential section 871(m) transaction, or 
any person acting as an intermediary with respect to a potential 
section 871(m) transaction. This simplification responds to the 
requests to expand the scope of persons entitled to request 
information. Several other changes that were requested, however, such 
as posting information electronically, were already permitted by the 
2013 proposed regulations. Like the 2013 proposed regulations, the 
final regulations permit parties to a transaction to obtain information 
on potential section 871(m) transactions in a variety of ways, 
including through electronic publication (such as a Web site).
    Comments also noted that a short party to a listed option will not 
be able to provide the long party with a written estimate of dividends 
at inception because the short party does not have a contractual 
relationship with the long party. These comments requested that the 
broker be required to provide the written estimates. As in the 2013 
proposed regulations, the final regulations do not require any party to 
a transaction to provide written estimates of dividends. The final 
regulations have taken these comments into account, however, by 
increasing a taxpayer's ability to obtain information from other 
parties to the transaction. The final regulations accomplish this by 
expanding the definition of a ``party to the transaction'' to include a 
broker and by clarifying that either a dealer or a middleman is a 
``broker.'' Therefore, if written estimates of dividends are prepared 
when a transaction is issued, the long party should be able to obtain 
the information from another party to the transaction, whether the 
short party or a broker.

K. Recordkeeping Rules

    The 2013 proposed regulations generally cross-reference the 
recordkeeping rules in Sec.  1.6001-1 for how a taxpayer establishes 
whether a transaction is a section 871(m) transaction and whether a 
payment is a dividend equivalent. For clarity and to ensure that the 
IRS will have access to sufficient information to audit taxpayers and 
withholding agents that are parties to section 871(m) transactions, the 
final regulations provide more detailed recordkeeping rules. The final 
regulations provide that any person required to retain records must 
keep sufficient information to establish whether a transaction is a 
section 871(m) transaction and the amount of a dividend equivalent. To 
satisfy this requirement, a taxpayer must retain documentation and work 
papers supporting a delta calculation or substantial equivalence 
calculation (including the number of shares of the initial hedge) and 
written estimated dividends (if any). The records and documentation 
must be created substantially contemporaneously with the time the 
potential section 871(m) transaction is issued.

L. Contingent and Convertible Debt Instruments

1. Contingent Debt Instruments
    Section 871(h)(1) generally provides that U.S. source portfolio 
interest received by a nonresident alien individual is not subject to 
the 30-percent U.S. tax imposed under section 871(a)(1). Section 
871(h)(4)(A)(i), however, excludes certain contingent interest payments 
from the definition of portfolio interest. Section 871(h)(4)(A)(ii) 
grants the Secretary authority to impose tax on contingent interest 
other than the payments described in section 871(h)(4)(A)(i) when 
necessary or appropriate to prevent the avoidance of federal income 
tax.
    Comments on the 2012 proposed regulations recommended narrowing the 
definition of a specified notional principal contract to clarify that 
the term does not include contingent or convertible debt. These 
comments suggested that section 871(m) should not override the 
portfolio interest exception. Section 871(h)(4)(A)(ii) expressly 
provides authority to the Secretary to treat interest as contingent 
interest if necessary or appropriate to prevent the avoidance of 
federal income tax. Consistent with this grant of authority, the 2013 
proposed regulations provide that contingent interest will not qualify 
for the portfolio interest

[[Page 56875]]

exemption to the extent that the contingent interest payment is a 
dividend equivalent. The final regulations retain this exception to the 
portfolio interest exemption. There is no reason that an equity 
derivative that otherwise would be a specified NPC or a specified ELI 
should receive different treatment because it is embedded in a debt 
instrument. A debt instrument that provides for a contingent interest 
payment determined by reference to a U.S. source dividend payment that 
would otherwise be a section 871(m) transaction is a transaction that 
has the potential for tax avoidance, and it is appropriate for section 
871(m) to apply. The effect of this rule, however, is expected to be 
minimal because the delta of the embedded derivative in a contingent 
debt or convertible debt instrument is tested only at the time it is 
issued.
2. Convertible Debt Instruments
    Numerous comments requested that convertible debt instruments be 
excluded from the definition of an ELI. Comments suggested that certain 
characteristics typical of convertible debt would discourage foreign 
investors from using these instruments to avoid U.S. withholding tax. 
Comments pointed, for example, to high transaction costs and certain 
discontinuities between the economic performance of the convertible 
debt and that of the underlying stock, such as the downside protection 
and creditors' rights afforded by convertible debt. Comments noted that 
convertible bonds are important capital markets instruments used by 
U.S. corporations to raise capital at lower rates. Comments also 
speculated that treating such bonds as specified ELIs could adversely 
impact capital markets by decreasing demand, reducing liquidity, and 
increasing costs.
    The final regulations do not provide an exception from section 
871(m) for convertible debt. When the stock price significantly exceeds 
the conversion price, convertible debt becomes a surrogate for the 
stock into which the debt can be converted. Accordingly, a convertible 
debt obligation is a specified ELI if the delta of the embedded option 
at the time the convertible debt is originally issued is 0.80 or 
higher. Moreover, the fact that convertible debt ordinarily has been 
issued with a delta on the embedded option of less than 0.80 is 
expected to significantly reduce the effect of these regulations on the 
convertible debt market. In response to uncertainty expressed by some 
market participants, the final regulations clarify that the delta of 
the convertible feature is tested separately from the delta of the debt 
instrument in making section 871(m) calculations.

M. Amounts Subject to Withholding

    Section 1.1441-2(d)(5) of the 2013 proposed regulations provides 
that a withholding agent is not obligated to withhold on a dividend 
equivalent until the later of: (1) When the amount of the dividend 
equivalent is determined and (2) when any of the following occurs: (a) 
Money or other property is paid pursuant to a section 871(m) 
transaction, (b) the withholding agent has custody or control of money 
or other property, or (c) there is an upfront payment or a prepayment 
of the purchase price.
    Comments emphasized the burden of withholding on dividend 
equivalents absent actual payments, and noted that, in the absence of 
actual payment, continuous monitoring and withholding on each specified 
ELI over time is impractical. Certain comments suggested that a foreign 
broker only be required to withhold on dividend equivalents from ELIs 
when there is a final payment or a sale.
    Comments also maintained that upfront payments should not be viewed 
as payments subject to withholding because such proceeds are received 
in exchange for issuing the instrument, are used by the issuer to 
purchase related hedging positions, and are not intended to be reserves 
for satisfying tax owed by the counterparty.
    Some comments expressed concern regarding the practical 
difficulties in withholding from funds that the broker-dealer holds as 
collateral. Comments noted that the broker-dealer may not be legally 
entitled to use cash or property in one account to satisfy a 
withholding obligation in another account. In addition, foreign 
counterparties may hold different accounts through different affiliates 
of a broker-dealer. Comments indicated that it would be impractical to 
determine the existence of affiliate accounts and apply set-off rules 
on that basis.
    After consideration of these comments, the Treasury Department and 
the IRS have concluded that the withholding agent's obligations should 
not arise until an actual payment is made or there is a final 
settlement of a transaction. Accordingly, the final regulations provide 
that a withholding agent is not obligated to withhold on a dividend 
equivalent until the later of when a payment is made with respect to a 
section 871(m) transaction or when the amount of a dividend equivalent 
is determined. A payment with respect to a section 871(m) transaction 
will generally occur when the long party receives or makes a payment, 
when there is a final settlement of the section 871(m) transaction, or 
when the long party sells or otherwise disposes of the section 871(m) 
transaction. For options and other contracts that typically require an 
upfront payment, the final regulations do not treat the premium or 
other upfront payment as a payment for withholding purposes. Thus, 
withholding on these section 871(m) transactions is not required until 
there is a final settlement (including, in the case of an option, a 
lapse) or the long party sells or otherwise disposes of the 
transaction. Consequently, if an option that is a section 871(m) 
transaction lapses, the short party is nonetheless required to withhold 
on any dividend equivalent associated with the option. Parties may need 
to modify contractual arrangements to ensure that there are sufficient 
funds available to satisfy withholding obligations.

III. Temporary and Proposed Regulations

A. Test for Contracts With Indeterminate Deltas

    As noted in Part II of this preamble, many commenters stated that 
the delta test was workable for most equity derivatives but would be 
difficult or impossible to apply to more exotic equity derivatives. In 
particular, a contract that provides for payments based on a number of 
shares of stock that varies at different points, or that provides for a 
payment that does not vary with the price of the shares (often called 
``digital'' options), have an indeterminate delta because the number of 
shares of the underlying security that determine the payout of the 
derivative cannot be known at the time the contract is entered into. 
Path-dependent contracts were also mentioned as problematic for the 
delta computation.
    Indeterminate delta may, for example, occur in contracts commonly 
known as structured notes. Structured notes are financial instruments 
that combine aspects of debt with aspects of derivatives, such as 
equity options. As an example, in return for an upfront payment of a 
set amount, a structured note might provide the long party with 
leveraged upside return, meaning that the long party is entitled to 
receive a fixed percentage (for example, 200 percent) of any 
appreciation in the value of a referenced stock up to a capped amount 
(for example, 125 percent of the issue price) in addition to return of 
the upfront payment, while being exposed to 100 percent of any 
depreciation in the value of the referenced stock, with any such 
depreciation reducing the amount

[[Page 56876]]

of the upfront payment that is returned to the long party. In such a 
structured note, the holder would have two times the ``upside'' up to 
the cap but only one times exposure to the ``downside.'' The issuer of 
this kind of structured note cannot readily determine a delta for the 
note because it references a different number of shares at different 
payoff amounts. In other words, because delta is the ratio of the 
change in the fair market value of a contract to a small change in the 
fair market value of the property referenced by the contract, the value 
of the referenced property must be known to calculate delta. In the 
case of the structured note described in this paragraph, the number of 
shares of stock (and hence the value of the property) referenced by the 
contract will be different depending on whether the stock appreciates, 
and in such case whether the cap is reached, or whether the stock 
depreciates.
    As explained in Part II.C.4 of this preamble, a contract with an 
indeterminate delta is not a simple contract, and therefore falls into 
the residual category as a complex contract. Because the delta test 
cannot accurately be applied to a complex contract, commenters had 
various suggestions for how to determine whether such a contract should 
be a section 871(m) transaction. One comment suggested that the delta 
should be calculated using the highest possible number of shares that 
could be referenced by the derivative at maturity. This comment further 
suggested that the regulations include a delta-specific anti-abuse rule 
to prevent issuers from manipulating the number of referenced shares to 
artificially reduce delta. Other comments suggested that the 
regulations should disaggregate a transaction into a series of 
components and then separately apply the delta test to each component. 
When multiple derivatives are embedded in a single instrument, a 
comment recommended that multiple pieces be aggregated into separate 
components (for example, aggregating all embedded calls and separately 
aggregating all embedded puts) using an ordering rule that would 
maximize the likelihood that the delta threshold would be met.
    A majority of comments requested that some version of a 
``proportionality'' test be applied to complex contracts or to 
contracts where the basic delta test is susceptible of manipulation. A 
proportionality test measures the likelihood that a contract's 
performance will track the performance of the referenced equity. That 
is, a proportionality test measures the same variability or economic 
equivalence that the delta test seeks to measure without needing to 
know the number of shares that the contract references at the outset. 
Like the delta test, a proportionality test is based on the principle 
that when the value of an NPC or ELI closely tracks the value of an 
underlying security, it is appropriate to treat the NPC or ELI as a 
surrogate for the underlying security.
    To test whether a complex contract is a section 871(m) transaction, 
the temporary regulations adopt the ``substantial equivalence'' test. 
The substantial equivalence test is a version of a proportionality test 
that was advocated by many commenters, and it uses information easily 
accessible to most issuers of complex contracts. Generally, the 
substantial equivalence test measures the change in value of a complex 
contract when the price of the underlying security referenced by that 
contract is hypothetically increased by one standard deviation or 
decreased by one standard deviation (each, a ``testing price'') and 
compares that change to the change in value of the shares of the 
underlying security that would be held to hedge the complex contract at 
the time the contract is issued (the ``initial hedge'') at each testing 
price. The smaller the proportionate difference between the change in 
value of the complex contract and the change in value of its initial 
hedge at multiple testing prices, the more equivalence there is between 
the contract and the referenced underlying security. When this 
difference is equal to or less than the difference for a simple 
contract benchmark with a delta of 0.80 and its initial hedge, the 
complex contract is treated as substantially equivalent to the 
underlying security.
    The Treasury Department and the IRS are aware that there may be 
NPCs or ELIs that even the substantial equivalence test may not 
adequately address. The temporary regulations provide that when the 
steps of the substantial equivalence test cannot be applied to a 
particular complex contract, a taxpayer must use the principles of the 
substantial equivalence test to reasonably determine whether the 
complex contract is a section 871(m) transaction with respect to each 
underlying security.
    The Treasury Department and the IRS request comments regarding the 
substantial equivalence test described in the temporary regulations. In 
particular, comments are requested on whether the two testing points 
required for most transactions in the temporary regulations are 
adequate to ensure that the substantial equivalence test captures the 
appropriate types of transactions, and the administrability of the test 
and its application to complex contracts that reference multiple 
securities, including path-dependent instruments.

B. Withholding Requirements and QDDs

1. Background
    Section 871(m)(1) generally treats a dividend equivalent as a 
dividend from sources within the United States without regard to the 
residence of the person paying the dividend equivalent. As a result, 
section 871(m) may apply to payments made by a foreign payor to a 
foreign payee. See Staff of J. Comm. on Taxation, Technical Explanation 
of the Revenue Provisions Contained in Senate Amendment 3310, the 
``Hiring Incentives to Restore Employment Act,'' JCX-4-10, at 79 (Feb. 
23, 2010) (explaining that section 871(m) may apply to a chain of 
dividend equivalents, including payments made by a foreign person 
pursuant to transactions described in Notice 97-66); see also Notice 
97-66, 1997-2 C.B. 328, at Sec.  5, Examples 3 and 4 (illustrating that 
a foreign person making a substitute dividend payment to another 
foreign person must withhold U.S. tax). Because Congress was concerned 
that this rule may result in over-withholding in some instances, 
Congress granted the Secretary authority in section 871(m)(6) to reduce 
tax on a chain of dividend equivalents, but only to the extent that the 
taxpayer can establish that tax has been paid with respect to another 
dividend equivalent in the chain, or is not otherwise due, or as the 
Secretary determines is appropriate to address the role of financial 
intermediaries in such chain. For purposes of section 871(m)(6), a 
dividend is treated as a dividend equivalent.
2. Comments on the 2013 Proposed Regulations
    The 2013 proposed regulations address the role of financial 
intermediaries in a chain of dividend equivalents with a rule that 
provides that payments made to a ``qualified dealer'' are not treated 
as dividend equivalents if made pursuant to a transaction that is 
entered into by the qualified dealer in its capacity as a dealer in 
securities and the dealer is the long party. For purposes of this rule, 
a qualified dealer is any dealer that is subject to regulatory 
supervision by a governmental authority in the jurisdiction in which it 
was created or organized and that certifies to the short party that it 
is receiving the payment in its capacity as a dealer. The 2013 proposed 
regulations require the qualified dealer to certify as to its dealer 
status to a short party on a transaction-

[[Page 56877]]

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

[[Page 56878]]

Procedures for entering into a QI agreement that permits a QI to act as 
a QDD are expected to be set out in this agreement. QDD status will be 
effective no sooner than January 1, 2017. Until these temporary 
regulations are finalized and appropriate provisions are incorporated 
into a new QI agreement, the provisions for QSLs and the credit-forward 
rules under Notice 2010-46 will continue to apply for dividend 
equivalents that are substitute dividend payments made pursuant to a 
securities lending or a sale-repurchase transaction.
    Once fully implemented, the new QDD status under the QI regime will 
replace and expand the QSL regime described in Notice 2010-46. To 
continue to be eligible for the exception from withholding, entities 
that have been treated as QSLs will be required to enter into a QI 
agreement to satisfy and comply with the requirements for QDD treatment 
provided in the temporary regulations and in the updated QI Agreement. 
When these temporary regulations are finalized, the Treasury Department 
and the IRS expect the final regulations to supplant the proposed 
regulatory framework described in Notice 2010-46.

 C. Certain Insurance Contracts

    The 2013 proposed regulations do not specifically address whether 
payments made on life insurance or annuity contracts are dividend 
equivalents when the payments are directly or indirectly contingent 
upon or determined by reference to the payment of a dividend from 
sources within the United States. Comments noted that treating annuity 
contract payments as dividend equivalents could conflict with section 
72, which provides that the holder of an annuity contract is taxed only 
when an amount is received from the annuity. Comments further noted 
that when a foreign person receives payments or withdrawals from an 
annuity contract issued by a domestic insurance company, the payment is 
FDAP subject to 30% withholding to the extent such payment or 
withdrawal constitutes gross income as determined in accordance with 
section 72. Similarly, withdrawals of income from a life insurance 
contract issued by a domestic insurance company are generally U.S. 
source FDAP subject to withholding. Commenters argued that the existing 
rules that apply to life insurance and annuity contracts obviate the 
need for withholding under section 871(m).
    The Treasury Department and the IRS agree that the taxation of life 
insurance and annuity contracts issued by domestic insurance companies 
is adequately addressed under current law. Therefore, the temporary 
regulations provide that there is no dividend equivalent associated 
with a payment that a foreign person receives pursuant to the terms of 
an annuity, endowment, or life insurance contract issued by a domestic 
insurance company (including the foreign or U.S. possession branch of 
the domestic insurance company).
    The Treasury Department and the IRS are considering how section 
871(m) should apply to annuity, endowment, and life insurance contracts 
that reference U.S. equities and that are issued by foreign life 
insurance companies. Until further guidance is issued, the temporary 
regulations provide that these contracts do not include a dividend 
equivalent when issued by a foreign corporation that is predominately 
engaged in an insurance business and that would be subject to tax under 
subchapter L if it were a domestic corporation. Similarly, the 
temporary regulations do not treat any portion of a payment received by 
a foreign life insurance company as a dividend equivalent when the 
payment is made according to the terms of an insurance contract, such 
as reinsurance, by a foreign corporation meeting the same requirements. 
The Treasury Department and the IRS are also evaluating how section 
871(m) should apply to reinsurance contracts. Taxpayers are encouraged 
to send comments on how section 871(m) should apply to foreign life 
insurance companies and the contracts they issue.

IV. Effective/Applicability Date

    The final and temporary regulations are generally effective on 
September 18, 2015. To ensure that brokers have adequate time to 
develop the systems needed to implement the regulations, however, the 
final and temporary regulations generally apply to transactions issued 
on or after January 1, 2017. In addition, with respect to transactions 
issued on or after January 1, 2016, and before January 1, 2017, that 
are section 871(m) transactions, the regulations also apply to any 
payment of a dividend equivalent made on or after January 1, 2018. The 
regulations do not change the applicability date of Sec.  1.871-
15(d)(1)(i) for specified NPCs described in that section.
    The chapter 4 regulations provide a coordinating effective date for 
the treatment of dividend equivalents as withholdable payments for 
purposes of chapter 4 withholding. Section 1.1471-2(b)(2)(i)(A)(2) 
provides that grandfathered obligations under chapter 4 include any 
obligation that gives rise to a withholdable payment solely because the 
obligation gives rise to a dividend equivalent pursuant to section 
871(m) and the regulations thereunder. This grandfather rule applies 
only to obligations that are executed on or before the date that is six 
months after the date on which obligations of its type are first 
treated as giving rise to dividend equivalents.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It also has been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations. It is hereby certified that these regulations will 
not have a significant economic impact on a substantial number of small 
entities. This certification is based on the fact that few, if any, 
small entities will be affected by these regulations. The regulations 
will primarily affect multinational financial institutions, which tend 
to be larger businesses, and foreign entities. Therefore, a Regulatory 
Flexibility Analysis is not required. Pursuant to section 7805(f) of 
the Code, these regulations have been submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

Drafting Information

    The principal authors of these regulations are D. Peter Merkel and 
Karen Walny of the Office of Associate Chief Counsel (International). 
Other personnel from the Treasury Department and the IRS also 
participated in the development of these regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Sec.  1.871-14(h) also issued under 26 U.S.C. 871(h) and 871(m). 
* * *
    Sec. Sec.  1.871-15 and 1.871-15T also issued under 26 U.S.C. 
871(m). * * *

[[Page 56879]]

    Par. 2. Section 1.871-14 is amended by:

0
1. Redesignating paragraphs (h) and (i) as paragraphs (i) and (j), 
respectively.
0
2. Adding new paragraphs (h) and (j)(3).
    The additions read as follows:


Sec.  1.871-14  Rules relating to repeal of tax on interest of 
nonresident alien individuals and foreign corporations received from 
certain portfolio debt investments.

* * * * *
    (h) Portfolio interest not to include certain contingent interest--
(1) Dividend equivalents. Contingent interest does not qualify as 
portfolio interest to the extent that the interest is a dividend 
equivalent within the meaning of section 871(m).
    (2) Amount of dividend equivalent that is not portfolio interest. 
The amount that does not qualify as portfolio interest because it is a 
dividend equivalent equals the amount of the dividend equivalent 
determined pursuant to Sec.  1.871-15(j). Unless otherwise excluded 
pursuant to section 871(h), any other interest paid on an obligation 
that is not a dividend equivalent may qualify as portfolio interest.
* * * * *
    (j) * * *
    (3) Effective/applicability date. The rules of paragraph (h) of 
this section apply beginning September 18, 2015.

0
Par. 3. Section 1.871-15 is amended by:
0
1. Redesignating paragraphs (d)(1)(i) as (d)(1)(i)(A), (d)(1) 
introductory text as (d)(1)(i), (d)(1)(ii) as (d)(1)(i)(B), (d)(1)(iii) 
as (d)(1)(i)(C), and (d)(1)(iv) as (d)(1)(i)(D).
0
2. Removing ``2016'' from newly redesignated paragraph (d)(1)(i) and 
adding ``2017'' in its place.
0
3. Removing ``Specified NPCs before January 1, 2016'' from newly 
redesignated paragraph (d)(1)(i) and adding ``In general'' in its 
place.
0
4. Adding new paragraphs (d)(1) introductory text, (d)(1)(ii) and 
(d)(2).
0
5. Redesignating paragraph (o) as paragraph (r)(2) and:
0
a. Revising the heading for newly redesignated paragraph (r)(2),
0
b. Removing the language ``This'' in paragraph (r)(2) and adding 
``Paragraph (d)(1)(i) of this'' in its place, and
0
c. Adding new paragraphs (r)(1), (r)(3) and (q).
0
7. Adding new paragraphs (a) through (c), and (e) through (p).
    The additions and revisions read as follows:


Sec.  1.871-15  Treatment of dividend equivalents.

    (a) Definitions. For purposes of this section, the following terms 
have the meanings described in this paragraph (a).
    (1) Broker. A broker is a broker within the meaning provided in 
section 6045(c).
    (2) Dealer. A dealer is a dealer in securities within the meaning 
of section 475(c)(1).
    (3) Dividend. A dividend is a dividend as described in section 316.
    (4) Equity-linked instrument. An equity-linked instrument (ELI) is 
a financial transaction, other than a securities lending or sale-
repurchase transaction or an NPC, that references the value of one or 
more underlying securities. For example, a futures contract, forward 
contract, option, debt instrument, or other contractual arrangement 
that references the value of one or more underlying securities is an 
ELI.
    (5) Initial hedge. An initial hedge is the number of underlying 
security shares that a short party would need to fully hedge an NPC or 
ELI (whether the NPC or ELI is a complex contract or a simple contract 
benchmark (within the meaning of paragraph (h)(2) of this section), as 
appropriate) with respect to an underlying security at the time the NPC 
or ELI is issued, even if the short party does not in fact fully hedge 
the NPC or ELI.
    (6) Issue. An NPC or ELI is treated as issued at inception, 
original issuance, or at the time of an issuance as a result of a 
deemed exchange pursuant to section 1001.
    (7) Notional principal contract. A notional principal contract 
(NPC) is a notional principal contract as defined in Sec.  1.446-3(c).
    (8) Option. An option includes an option embedded in any debt 
instrument, forward contract, NPC, or other potential section 871(m) 
transaction.
    (9) Parties to the transaction--(i) Long party. A long party is the 
party to a potential section 871(m) transaction with respect to an 
underlying security that would be entitled to receive a payment of a 
dividend equivalent (within the meaning of paragraph (i) of this 
section) described in paragraph (c) of this section.
    (ii) Short party. A short party is the party to a potential section 
871(m) transaction with respect to an underlying security that would be 
obligated to make a payment of a dividend equivalent (within the 
meaning of paragraph (i) of this section) described in paragraph (c) of 
this section.
    (iii) Party to the transaction. A party to the transaction is any 
person that is a long party or a short party to a potential section 
871(m) transaction, any agent acting on behalf of the long party or 
short party, or any person acting as an intermediary with respect to 
the potential section 871(m) transaction.
    (iv) Party to the transaction that is both a long party and a short 
party--(A) In general. If a potential section 871(m) transaction 
references more than one underlying security, the long party and short 
party are determined separately with respect to each underlying 
security. A party to a potential section 871(m) transaction is both a 
long party and a short party when the party is entitled to a payment 
that references a dividend payment on an underlying security and the 
same party is obligated to make a payment that references a dividend 
payment on another underlying security pursuant to the potential 
section 871(m) transaction.
    (B) Example. The following example illustrates the definitions in 
paragraph (a)(9) of this section:

    Example.  (i) Stock X and Stock Y are underlying securities. A 
and B enter into an NPC that entitles A to receive payments from B 
based on any appreciation in the value of Stock X and dividends paid 
on Stock X during the term of the contract and obligates A to make 
payments to B based on any depreciation in the value of Stock X 
during the term of the contract. In return, the NPC entitles B to 
receive payments from A based on any appreciation in the value of 
Stock Y and dividends paid on Stock Y during the term of the 
contract and obligates B to make payments to A based on any 
depreciation in the value of Stock Y during the term of the 
contract.
    (ii) A is the long party with respect to Stock X, and the short 
party with respect to Stock Y. B is the long party with respect to 
Stock Y, and the short party with respect to Stock X.

    (10) Payment. A payment has the meaning provided in paragraph (i) 
of this section.
    (11) Reference. To reference means to be contingent upon or 
determined by reference to, directly or indirectly, whether in whole or 
in part.
    (12) Section 871(m) transaction and potential section 871(m) 
transaction. A section 871(m) transaction is any securities lending or 
sale-repurchase transaction, specified NPC, or specified ELI. A 
potential section 871(m) transaction is any securities lending or sale-
repurchase transaction, NPC, or ELI that references one or more 
underlying securities.

[[Page 56880]]

    (13) Securities lending or sale-repurchase transaction. A 
securities lending or sale-repurchase transaction is any securities 
lending transaction, sale-repurchase transaction, or substantially 
similar transaction that references an underlying security. Securities 
lending transaction and sale-repurchase transaction have the same 
meaning as provided in Sec.  1.861-3(a)(6).
    (14) Simple contracts and complex contracts--(i) Simple contract. A 
simple contract is an NPC or ELI for which, with respect to each 
underlying security,
    (A) All amounts to be paid or received on maturity, exercise, or 
any other payment determination date are calculated by reference to a 
single, fixed number of shares (as determined in paragraph (j)(3) of 
this section) of the underlying security, provided that the number of 
shares can be ascertained when the contract is issued, and (B) The 
contract has a single maturity or exercise date with respect to which 
all amounts (other than any upfront payment or any periodic payments) 
are required to be calculated with respect to the underlying security. 
A contract has a single exercise date even though it may be exercised 
by the holder at any time on or before the stated expiration of the 
contract. An NPC or ELI that includes a term that discontinuously 
increases or decreases the amount paid or received (such as a digital 
option), or that accelerates or extends the maturity is not a simple 
contract. A simple contract that is an NPC is a simple NPC. A simple 
contract that is an ELI is a simple ELI.
    (ii) Complex contract--(A) In general. A complex contract is any 
NPC or ELI that is not a simple contract. A complex contract that is an 
NPC is a complex NPC. A complex contract that is an ELI is a complex 
ELI.

    (B) Example.  An ELI entitles the long party to a return equal 
to 200 percent of the appreciation on 100 shares of Stock X, and 
obligates the long party to pay an amount equal to the actual 
depreciation on 100 shares of Stock X. Because the ELI does not 
provide the long party with an amount that is calculated by 
reference to a single, fixed number of shares of Stock X on the 
maturity date that can be ascertained at issuance, it is not a 
simple ELI. More specifically, upon maturity the ELI will either 
entitle the long party to receive a payment that is, in substance, 
measured by reference to 200 shares of stock or obligate the long 
party to make a payment measured by reference to 100 shares of 
stock. The ELI is a complex ELI because it is not a simple ELI.

    (15) Underlying security. An underlying security is any interest in 
an entity if a payment with respect to that interest could give rise to 
a U.S. source dividend pursuant to Sec.  1.861-3, where applicable 
taking into account paragraph (m) of this section. Except as provided 
in paragraph (l) of this section, if a potential section 871(m) 
transaction references an interest in more than one entity described in 
the preceding sentence or different interests in the same entity, each 
referenced interest is a separate underlying security for purposes of 
applying the rules of this section.
    (b) Source of a dividend equivalent. A dividend equivalent is 
treated as a dividend from sources within the United States for 
purposes of sections 871(a), 881, 892, 894, and 4948(a), and chapters 3 
and 4 of subtitle A of the Internal Revenue Code.
    (c) Dividend equivalent--(1) In general. Except as provided in 
paragraph (2), dividend equivalent means--
    (i) Any payment that references the payment of a dividend from an 
underlying security pursuant to a securities lending or sale-repurchase 
transaction;
    (ii) Any payment that references the payment of a dividend from an 
underlying security pursuant to a specified NPC described in paragraph 
(d) of this section;
    (iii) Any payment that references the payment of a dividend from an 
underlying security pursuant to a specified ELI described in paragraph 
(e) of this section; and
    (iv) Any other substantially similar payment as described in 
paragraph (f) of this section.
    (2) Exceptions--(i) Not a dividend. A payment that references a 
distribution with respect to an underlying security is not a dividend 
equivalent to the extent that the distribution would not be subject to 
tax pursuant to section 871 or section 881 if the long party owned the 
underlying security. For example, if an NPC references stock in a 
regulated investment company that pays a dividend that includes a 
capital gains dividend described in section 852(b)(3)(C) that would not 
be subject to tax under section 871 or section 881 if paid directly to 
the long party, then an NPC payment is not a dividend equivalent to the 
extent that it is determined by reference to the capital gains 
dividend.
    (ii) Section 305 coordination. A dividend equivalent with respect 
to a section 871(m) transaction is reduced by any amount treated in 
accordance with section 305(b) and (c) as a dividend with respect to 
the underlying security referenced by the section 871(m) transaction.
    (iii) Due bills. A dividend equivalent does not include a payment 
made pursuant to a due bill arising from the actions of a securities 
exchange that apply to all transactions in the stock with respect to 
the dividend. For purposes of this section, a stock will be considered 
to trade with a due bill only when the relevant securities exchange has 
set an ex-dividend date with respect to a dividend that occurs after 
the record date.
    (iv) Certain payments pursuant to annuity, endowment, and life 
insurance contracts. [Reserved]. For further guidance, see Sec.  1.871-
15T(c)(2)(iv).
    (v) Certain payments pursuant to employee compensation 
arrangements. A dividend equivalent does not include the portion of 
equity-based compensation for personal services of a nonresident alien 
individual that is--
    (A) Wages subject to withholding under section 3402 and the 
regulations under that section;
    (B) Excluded from the definition of wages under Sec.  
31.3401(a)(6)-1; or
    (C) Exempt from withholding under Sec.  1.1441-4(b).
    (d) Specified NPCs--(1) Specified NPCs entered into before January 
1, 2017--(i) * * *.
    (ii) Specified NPC status as of January 1, 2017. An NPC that is 
treated as a specified NPC pursuant to paragraph (d)(1)(i) of this 
section will remain a specified NPC on or after January 1, 2017.
    (2) Specified NPCs on or after January 1, 2017--(i) Simple NPCs. A 
simple NPC that has a delta of 0.8 or greater with respect to an 
underlying security when the NPC is issued is a specified NPC.
    (ii) Complex NPCs. A complex NPC that meets the substantial 
equivalence test described in paragraph (h) of this section with 
respect to an underlying security when the NPC is issued is a specified 
NPC.
    (e) Specified ELIs--(1) Simple ELIs. A simple ELI that has a delta 
of 0.8 or greater with respect to an underlying security when the ELI 
is issued is a specified ELI.
    (2) Complex ELIs. A complex ELI that meets the substantial 
equivalence test described in paragraph (h) of this section with 
respect to an underlying security when the ELI is issued is a specified 
ELI.
    (f) Other substantially similar payments. For purposes of this 
section, any payment made in satisfaction of a tax liability of the 
long party with respect to a dividend equivalent by a withholding agent 
is a dividend equivalent received by the long party. The amount of that 
dividend equivalent constitutes additional income to the

[[Page 56881]]

payee to the extent provided in Sec.  1.1441-3(f)(1).
    (g) Delta--(1) In general. Delta is the ratio of the change in the 
fair market value of an NPC or ELI to a small change in the fair market 
value of the number of shares of the underlying security (as determined 
under paragraph (j)(3) of this section) referenced by the NPC or ELI. 
If an NPC or ELI contains more than one reference to a single 
underlying security, all references to that underlying security are 
taken into account in determining the delta with respect to that 
underlying security. If an NPC or ELI references more than one 
underlying security or other property, the delta with respect to each 
underlying security must be determined without taking into account any 
other underlying security or property. The delta of an equity 
derivative that is embedded in a debt instrument or other derivative is 
determined without taking into account changes in the market value of 
the debt instrument or other derivative that are not directly related 
to the equity element of the instrument. Thus, for example, the delta 
of an option embedded in a convertible note is determined without 
regard to the debt component of the convertible note. For purposes of 
this section, delta must be determined in a commercially reasonable 
manner. If a taxpayer calculates delta for non-tax business purposes, 
that delta ordinarily is the delta used for purposes of this section.
    (2) Time for determining delta. For purposes of applying the rules 
of this section, the delta of a potential section 871(m) transaction is 
determined only when the potential section 871(m) transaction is issued 
(as defined in paragraph (a)(6) of this section).
    (3) Simplified delta calculation for certain simple contracts that 
reference multiple underlying securities. If an NPC or ELI references 
10 or more underlying securities and the short party uses an exchange-
traded security (for example, an exchange-traded fund) that references 
substantially all of the underlying securities (the hedge security) to 
hedge the NPC or ELI at the time it is issued, the delta of the NPC or 
ELI may be calculated by determining the ratio of the change in the 
fair market value of the simple contract to a small change in the fair 
market value of the hedge security. A delta determined under this 
paragraph (g)(3) must be used as the delta for each underlying security 
for purposes of calculating the amount of a dividend equivalent as 
provided in paragraph (j)(1)(ii) of this section.
    (4) Examples. The following examples illustrate the rules of this 
paragraph (g). For purposes of these examples, Stock X and Stock Y are 
common stock of domestic corporations X and Y. LP is the long party to 
the transaction.

    Example 1. Delta calculation for an NPC. The terms of an NPC 
require LP to pay the short party an amount equal to all of the 
depreciation in the value of 100 shares of Stock X and an interest-
rate based return. In return, the NPC requires the short party to 
pay LP an amount equal to all of the appreciation in the value of 
100 shares of Stock X and any dividends paid by X on those shares. 
The value of the NPC will change by $1 for each $0.01 change in the 
price of a share of Stock X. When LP entered into the NPC, Stock X 
had a fair market value of $50 per share. The NPC therefore has a 
delta of 1.0 ($1.00/($0.01 x 100)).

    Example 2. Delta calculation for an option. LP purchases a call 
option that references 100 shares of Stock Y. At the time LP 
purchases the call option, the value of the option is expected to 
change by $0.30 for a $0.01 change in the price of a share of Stock 
Y. When LP purchases the option, Stock Y has a fair market value of 
$100 per share. The call option has a delta of 0.3 ($0.30/($0.01 x 
100)).

    (h) Substantial Equivalence. [Reserved]. For further guidance, see 
Sec.  1.871-15T(h).
    (i) Payment of a dividend equivalent--(1) Payments determined on 
gross basis. For purposes of this section, a payment includes any gross 
amount that references the payment of a dividend and that is used in 
computing any net amount transferred to or from the long party even if 
the long party makes a net payment to the short party or no amount is 
paid because the net amount is zero.
    (2) Actual and estimated dividends--(i) In general. A payment 
includes any amount that references an actual or estimated payment of 
dividends, whether the reference is explicit or implicit. If a 
potential section 871(m) transaction provides for a payment based on an 
estimated dividend that adjusts to account for the amount of an actual 
dividend paid, the payment is treated as referencing the actual 
dividend amount and not an estimated dividend amount.
    (ii) Implicit dividends. A payment includes an actual or estimated 
dividend payment that is implicitly taken into account in computing one 
or more of the terms of a potential section 871(m) transaction, 
including interest rate, notional amount, purchase price, premium, 
upfront payment, strike price, or any other amount paid or received 
pursuant to the potential section 871(m) transaction.
    (iii) Actual dividend presumption. A short party to a section 
871(m) transaction is treated as paying a per-share dividend amount 
equal to the actual dividend amount unless the short party to the 
section 871(m) transaction identifies a reasonable estimated dividend 
amount in writing at the time the transaction is issued. For this 
purpose, a reasonable estimated dividend amount stated in an offering 
document or the documents governing the terms at the time the 
transaction is issued will establish the estimated dividend amount. To 
qualify as an estimated dividend amount, the written estimated dividend 
amount must separately state the amount estimated for each anticipated 
dividend or state a formula that allows each dividend to be determined. 
If an underlying security is not expected to pay a dividend, a 
reasonable estimate of the dividend amount may be zero.
    (iv) Additions to estimated payments. If a section 871(m) 
transaction provides for any payment in addition to an estimated 
dividend and that additional payment is determined by reference to a 
dividend (for example, a special dividend), both the estimated dividend 
and the additional payment are used to determine the per-share dividend 
amount.
    (3) Dividends for certain baskets--(i) In general. If a section 
871(m) transaction references long positions in more than 25 underlying 
securities, the short party may treat the dividends with respect to the 
referenced underlying securities as paid at the end of the applicable 
calendar quarter to compute the per-share dividend amount.
    (ii) Publicly available dividend yield. For purposes of paragraph 
(i)(3)(i) of this section, if a section 871(m) transaction references 
the same underlying securities as a security (for example, stock in an 
exchange-traded fund) or index for which there is a publicly available 
quarterly dividend yield, the publicly available dividend yield may be 
used to determine the per-share dividend amount for the section 871(m) 
transaction with any adjustment for special dividends.
    (iii) Dividend yield for a section 871(m) transaction using the 
simplified delta calculation. When the delta of a section 871(m) 
transaction is determined under paragraph (g)(3) of this section, the 
per-share dividend amount for that section 871(m) transaction must be 
determined using the dividend yield for the exchange-traded security 
that fully hedges the section 871(m) transaction.
    (4) Examples. The following examples illustrate the rules of this 
paragraph (i). For purposes of these examples, Stock X is common stock 
of Corporation X, a domestic corporation, that historically pays 
quarterly dividends on Stock X.

[[Page 56882]]

The parties anticipate that Corporation X will continue to pay 
quarterly dividends.

    Example 1. Forward contract to purchase domestic stock. (i) When 
Stock X is trading at $50 per share, Foreign Investor enters into a 
forward contract to purchase 100 shares of Stock X in one year. 
Reasonable estimates of the quarterly dividend are specified in the 
transaction documents. The price in the forward contract is 
determined by multiplying the number of shares referenced in the 
contract by the current price of the shares and an interest rate, 
and subtracting the value of any dividends expected to be paid 
during the term of the contract. Assuming that the forward contract 
is priced using an interest rate of 4 percent and total estimated 
dividends with a future value of $1 per share during the term of the 
forward contract, the purchase price set in the forward contract is 
$5,100 (100 shares x $50 per share x 1.04 - ($1 x 100)).
    (ii) Subject to paragraph (i)(2)(iv) of this section, the 
estimated dividend amount is the per-share dividend amount because 
the estimate is reasonable and specified in accordance with 
paragraph (i)(2)(iii) of this section. The estimated per-share 
dividend amount is a dividend equivalent for purposes of this 
section.

    Example 2. Price return only swap contract. (i) Foreign Investor 
enters into a price return swap contract that entitles Foreign 
Investor to receive payments based on the appreciation in the value 
of 100 shares of Stock X and requires Foreign Investor to pay an 
amount based on LIBOR plus any depreciation in the value of Stock X. 
The swap contract neither explicitly entitles Foreign Investor to 
payments based on dividends paid on Stock X during the term of the 
contract nor references an estimated dividend amount. The LIBOR rate 
in the swap contract, however, is reduced to reflect expected annual 
dividends on Stock X.
    (ii) Because the LIBOR leg of the swap contract is reduced to 
reflect estimated dividends and the estimated dividend amount is not 
specified, Foreign Investor is treated as receiving the actual 
dividend amount in accordance with paragraph (i)(2) of this section. 
The actual per-share dividend amounts are dividend equivalents for 
purposes of this section.

    (j) Amount of dividend equivalent--(1) Calculation of the amount of 
a dividend equivalent--(i) Securities lending or sale-repurchase 
transactions. For a securities lending or sale-repurchase transaction, 
the amount of the dividend equivalent for each underlying security 
equals the amount of the actual per-share dividend paid on the 
underlying security multiplied by the number of shares of the 
underlying security.
    (ii) Simple contracts. For a simple contract that is a section 
871(m) transaction, the amount of the dividend equivalent for each 
underlying security equals:
    (A) The per-share dividend amount (as determined under either 
paragraph (i)(2) or (i)(3) of this section) with respect to the 
underlying security multiplied by;
    (B) The number of shares of the underlying security multiplied by;
    (C) The delta of the section 871(m) transaction with respect to the 
underlying security.
    (iii) Complex contracts. For a complex contract that is a section 
871(m) transaction, the amount of the dividend equivalent for each 
underlying security equals:
    (A) The per-share dividend amount (as determined under paragraph 
(i)(2) or (i)(3) of this section) with respect to the underlying 
security multiplied by;
    (B) The initial hedge for the underlying security.
    (iv) Other substantially similar payments. In addition to any 
amount determined pursuant to paragraph (j)(1)(i), (ii), or (iii), the 
amount of a dividend equivalent includes the amount of any payment 
described in paragraph (f) of this section.
    (2) Time for determining the amount of a dividend equivalent. The 
amount of a dividend equivalent is determined on the earlier of the 
date that is the record date of the dividend and the day prior to the 
ex-dividend date with respect to the dividend. For example, if a 
specified NPC provides for a payment at settlement that takes into 
account an earlier dividend payment, the amount of the dividend 
equivalent is determined on the earlier of the record date or the day 
prior to the ex-dividend date for that dividend.
    (3) Number of shares. The number of shares of an underlying 
security generally is the number of shares of the underlying security 
stated in the contract. If the transaction modifies that number by a 
factor or fraction or otherwise alters the amount of any payment, the 
number of shares is adjusted to take into account the factor, fraction, 
or other modification. For example, in a transaction in which the long 
party receives or makes payments based on 200 percent of the 
appreciation or depreciation (as applicable) of 100 shares of stock, 
the number of shares of the underlying security is 200 shares of the 
stock.
    (k) Limitation on the treatment of certain corporate acquisitions 
as section 871(m) transactions. A potential section 871(m) transaction 
is not a section 871(m) transaction with respect to an underlying 
security if the transaction obligates the long party to acquire 
ownership of the underlying security as part of a plan pursuant to 
which one or more persons (including the long party) are obligated to 
acquire underlying securities representing more than 50 percent of the 
value of the entity issuing the underlying securities.
    (l) Rules relating to indices--(1) Purpose. The purpose of this 
section is to provide a safe harbor for potential section 871(m) 
transactions that reference certain passive indices that are based on a 
diverse basket of publicly-traded securities and that are widely used 
by numerous market participants. Notwithstanding any other provision in 
this paragraph (l), an index is not a qualified index if treating the 
index as a qualified index would be contrary to the purpose described 
in this paragraph.
    (2) Qualified index not treated as an underlying security. For 
purposes of this section, a qualified index is treated as a single 
security that is not an underlying security. The determination of 
whether an index referenced in a potential section 871(m) transaction 
is a qualified index is made at the time the transaction is issued 
based on whether the index is a qualified index on the first business 
day of the calendar year in which the transaction is issued.
    (3) Qualified index. A qualified index means an index that--
    (i) References 25 or more component securities (whether or not the 
security is an underlying security);
    (ii) Except as provided in paragraph (l)(6)(ii) of this section, 
references only long positions in component securities;
    (iii) References no component underlying security that represents 
more than 15 percent of the weighting of the component securities in 
the index;
    (iv) References no five or fewer component underlying securities 
that together represent more than 40 percent of the weighting of the 
component securities in the index;
    (v) Is modified or rebalanced only according to publicly stated, 
predefined criteria, which may require interpretation by the index 
provider or a board or committee responsible for maintaining the index;
    (vi) Did not provide an annual dividend yield in the immediately 
preceding calendar year from component underlying securities that is 
greater than 1.5 times the annual dividend yield of the S&P 500 Index 
as reported for the immediately preceding calendar year; and
    (vii) Is traded through futures contracts or option contracts 
(regardless of whether the contracts provide price only or total return 
exposure to the index or provide for dividend reinvestment in the 
index) on--
    (A) A national securities exchange that is registered with the 
Securities and Exchange Commission or a domestic

[[Page 56883]]

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

[[Page 56884]]

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

[[Page 56885]]

determinations are not binding on the Commissioner.
    (2) Reporting requirements. For rules regarding the reporting 
requirements of withholding agents with respect to dividend equivalents 
described in this section, see Sec. Sec.  1.1461-1(b) and (c) and 
1.1474-1(c) and (d).
    (3) Additional information available to a party to a potential 
section 871(m) transaction--(i) In general. Upon request by any person 
described in paragraph (p)(3)(ii) of this section, the party required 
to report information pursuant to paragraph (p)(1) of this section must 
provide the requester with information regarding the amount of each 
dividend equivalent, the delta of the potential section 871(m) 
transaction, the amount of any tax withheld and deposited, the 
estimated dividend amount if specified in accordance with paragraph 
(i)(2)(iii) of this section, the identity of any transactions combined 
pursuant to paragraph (n) of this section, and any other information 
necessary to apply the rules of this section. The information requested 
must be provided within a reasonable time, not to exceed 10 business 
days, and communicated in one or more of the following ways:
    (A) By telephone, and confirmed in writing;
    (B) By written statement sent by first class mail to the address 
provided by the requesting party;
    (C) By electronic publication available to all persons entitled to 
request information; or
    (D) By any other method agreed to by the parties, and confirmed in 
writing.
    (ii) Persons entitled to request information. Any party to the 
transaction described in paragraph (a)(9) of this section may request 
the information specified in paragraph (p) of this section with respect 
to a potential section 871(m) transaction from the party required by 
paragraph (p)(3)(i) of this section to provide the information.
    (iii) Reliance on information received. A person described in 
paragraph (p)(1) or (p)(3)(ii) of this section that receives 
information described in paragraph (p)(1) or (p)(3)(i) of this section 
may rely on that information to provide information to any other person 
unless the recipient knows or has reason to know that the information 
received is incorrect. When the recipient knows or has reason to know 
that the information received is incorrect, the recipient must make a 
reasonable effort to determine and provide the information described in 
paragraph (p)(1) or (p)(3)(i) of this section to any person described 
in paragraph (p)(1) or (p)(3)(ii) of this section that requests 
information from the recipient.
    (4) Recordkeeping rules--(i) In general. For rules regarding 
recordkeeping requirements sufficient to establish whether a 
transaction is a section 871(m) transaction and whether a payment is a 
dividend equivalent and the amount of gross income treated as a 
dividend equivalent, see Sec.  1.6001-1.
    (ii) Records sufficient to establish whether a transaction is a 
section 871(m) transaction and any dividend equivalent amount. Any 
person required to retain records must keep sufficient information to 
establish whether a transaction is a section 871(m) transaction and the 
amount of a dividend equivalent (if any), including documentation and 
work papers supporting the delta calculation or the substantial 
equivalence test (including the number of shares of the initial hedge), 
as applicable, and written estimated dividends (if any). The records 
and documentation must be created substantially contemporaneously. A 
record will be considered to have been created substantially 
contemporaneously if it was created within 10 business days of the date 
the potential section 871(m) transaction is issued.
    (q) Dividend and dividend equivalent payments to a qualified 
derivatives dealer. [Reserved]. For further guidance, see Sec.  1.871-
15T(q).
    (r) Effective/applicability date--(1) In general. This section 
applies to payments made on or after September 18, 2015 except as 
provided in paragraphs (r)(2) and (3) of this section.
    (2) Effective/applicability date for paragraph (d)(1)(i). * * *
    (3) Effective/applicability date for paragraphs (d)(2) and (e). 
Paragraphs (d)(2) and (e) apply to any payment made on or after January 
1, 2017, with respect to any transaction issued on or after January 1, 
2017, and to any payment made on or after January 1, 2018, with respect 
to any transaction issued on or after January 1, 2016, and before 
January 1, 2017.

0
Par. 4. Section 1.871-15T is added to read as follows:


Sec.  1.871-15T  Treatment of dividend equivalents (temporary).

    (a) through (b) [Reserved]. For further guidance, see Sec.  1.871-
15(a) through (b).
    (c) [Reserved]. For further guidance, see Sec.  1.871-15(c)(1) 
through (c)(2)(iii).
    (iv) Payments made pursuant to annuity, endowment, and life 
insurance contracts--(A) Insurance contracts issued by domestic 
insurance companies. A payment made pursuant to a contract that is an 
annuity, endowment, or life insurance contract issued by a domestic 
corporation (including its foreign or U.S. possession branch) that is a 
life insurance company described in section 816(a) does not include a 
dividend equivalent if the payment is subject to tax under section 
871(a) or section 881.
    (B) Insurance contracts issued by foreign insurance companies. A 
payment does not include a dividend equivalent if it is made pursuant 
to a contract that is an annuity, endowment, or life insurance contract 
issued by a foreign corporation that is predominantly engaged in an 
insurance business and that would be subject to tax under subchapter L 
if it were a domestic corporation.
    (C) Insurance contracts held by foreign insurance companies. A 
payment made pursuant to a policy of insurance (including a policy of 
reinsurance) does not include a dividend equivalent if it is made to a 
foreign corporation that is predominantly engaged in an insurance 
business and that would be subject to tax under subchapter L if it were 
a domestic corporation.
    (v) [Reserved]. For further guidance, see Sec.  1.871-15(c)(2)(v).
    (d) through (g) [Reserved]. For further guidance, see Sec.  1.871-
15(d) through (g).
    (h) Substantial equivalence test--(1) In general. The substantial 
equivalence test described in this paragraph (h) applies to determine 
whether a complex contract is a section 871(m) transaction. The 
substantial equivalence test assesses whether a complex contract 
substantially replicates the economic performance of the underlying 
security by comparing, at various testing prices for the underlying 
security, the differences between the expected changes in value of that 
complex contract and its initial hedge with the differences between the 
expected changes in value of a simple contract benchmark (as described 
in paragraph (h)(2) of this section) and its initial hedge. If the 
complex contract contains more than one reference to a single 
underlying security, all references to that underlying security are 
taken into account for purposes of applying the substantial equivalence 
test with respect to that underlying security. With respect to an 
equity derivative that is embedded in a debt instrument or other 
derivative, the substantial equivalence test is applied to the complex 
contract without taking into account changes in the market value of the 
debt instrument or other derivative that are not directly related to 
the equity element of the instrument. The complex contract is a section 
871(m) transaction with respect

[[Page 56886]]

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

    Example. Complex contract that is not substantially equivalent. 
(i) FI issues an investment contract (the Contract) that has a 
stated maturity of one year, and Investor purchases the Contract 
from FI at issuance for $10,000. At maturity, the Contract entitles 
Investor to a return of $10,000 (i) plus 200 percent of any 
appreciation in Stock X above $100 per share, capped at $110, on 100 
shares or (ii) minus 100 percent of any depreciation in Stock X 
below $90 on 100 shares. At the time FI issues the Contract, the 
price of Stock X is $100 per share. Thus, for example, Investor will 
receive $11,000 if the price of Stock X is $105 per share at 
maturity of the Contract, but Investor will receive $9,000 if the 
price of Stock X is $80 per share when the Contract matures. At 
issuance, FI

[[Page 56887]]

acquires 64 shares of Stock X to fully hedge the Contract issued to 
Investor.
    (ii) The Contract references an underlying security and is not 
an NPC, so it is classified as an ELI under paragraph (a)(4) of this 
section. At issuance, the Contract does not provide for an amount 
paid at maturity that is calculated by reference to a single, fixed 
number of shares of Stock X. When the Contract matures, the amount 
paid is effectively calculated based on either 200 shares of Stock X 
(if the price of Stock X has appreciated up to $110) or 100 shares 
of Stock X (if the price of Stock X has declined below $90). 
Consequently, the Contract is a complex contract described in 
paragraph (a)(14) of this section.
    (iii) Because it is a complex ELI, FI applies the substantial 
equivalence test described in paragraph (h) of this section to 
determine whether the Contract is a specified ELI. FI determines 
that the price of Stock X would be $120 if the price of Stock X were 
increased by one standard deviation, and $79 if the price of Stock X 
were decreased by one standard deviation. Based on these results, FI 
next determines the change in value of the Contract to be $2,000 at 
the testing price that represents an increase by one standard 
deviation ($12,000 testing price minus $10,000 issue price) and a 
negative $1,100 at the testing price that represents a decrease by 
one standard deviation ($10,000 issue price minus $8,900 testing 
price). FI performs the same calculations for the 64 shares of Stock 
X that constitute the initial hedge, determining that the change in 
value of the initial hedge is $1,280 at the testing price that 
represents an increase by one standard deviation ($6,400 at issuance 
compared to $7,680 at the testing price) and negative $1,344 at the 
testing price that represents a decrease by one standard deviation 
($6,400 at issuance compared to $5,056 at the testing price).
    (iv) FI then determines the absolute value of the difference 
between the change in value of the initial hedge and the Contract at 
the testing price that represents an increase by one standard 
deviation and a decrease by one standard deviation. Increased by one 
standard deviation, the absolute value of the difference is $720 
($2,000 - $1,280); decreased by one standard deviation, the absolute 
value of the difference is $244 (negative $1,100 minus negative 
$1,344). FI determines that there is a 52% chance that the price of 
Stock X will have increased in value when the Contract matures and a 
48% chance that the price of Stock X will have decreased in value at 
that time. FI multiplies the absolute value of the difference 
between the change in value of the initial hedge and the Contract at 
the testing price that represents an increase by one standard 
deviation by 52%, which equals $374.40. FI multiplies the absolute 
value of the difference between the change in value of the initial 
hedge and the Contract at the testing price that represents a 
decrease by one standard deviation by 48%, which equals $117.12. FI 
adds these two numbers and divides by the number of shares that 
constitute the initial hedge to determine that the transaction 
calculation is 7.68 ((374.40 plus 117.12) divided by 64).
    (v) FI then performs the same calculation with respect to the 
simple contract benchmark, which is a one-year call option that 
references one share of Stock X, settles on the same date as the 
Contract, and has a delta of 0.8. The one-year call option has a 
strike price of $79 and has a cost (the purchase premium) of $22. 
The initial hedge for the one-year call option is 0.8 shares of 
Stock X.
    (vi) FI first determines that the change in value of the simple 
contract benchmark is $19.05 if the testing price is increased by 
one standard deviation ($22.00 at issuance to $41.05 at the testing 
price) and negative $20.95 if the testing price is decreased by one 
standard deviation ($22.00 at issuance to $1.05 at the testing 
price). Second, FI determines that the change in value of the 
initial hedge is $16.00 at the testing price that represents an 
increase by one standard deviation ($80 at issuance to $96 at the 
testing price) and negative $16.80 at the testing price that 
represents a decrease by one standard deviation ($80.00 at issuance 
to $63.20 at the testing price).
    (vii) FI determines the absolute value of the difference between 
the change in value of the initial hedge and the one-year call 
option at the testing price that represents an increase by one 
standard deviation is $3.05 ($16.00 minus $19.05). FI next 
determines the absolute value of the difference between the change 
in value of the initial hedge and the option at the testing price 
that represents a decrease by one standard deviation is $4.15 
(negative $16.80 minus negative $20.95). FI multiplies the absolute 
value of the difference between the change in value of the initial 
hedge and the option at the testing price that represents an 
increase by one standard deviation by 52%, which equals $1.586. FI 
multiplies the absolute value of the difference between the change 
in value of the initial hedge and the option at the testing price 
that represents a decrease by one standard deviation by 48%, which 
equals $1.992. FI adds these two numbers and divides by the number 
of shares that constitute the initial hedge to determine that the 
benchmark calculation is 4.473 ((1.586 plus 1.992) divided by .8).
    (viii) FI concludes that the Contract is not a section 871(m) 
transaction because the transaction calculation of 7.68 exceeds the 
benchmark calculation of 4.473.

    (i) through (p) [Reserved]. For further guidance, see Sec.  1.871-
15(i) through (p).
    (q) Dividend and dividend equivalent payments to a qualified 
derivatives dealer--(1) In general. Except as otherwise provided in 
this paragraph (q), a qualified derivatives dealer described in Sec.  
1.1441-1(e)(6) that receives a dividend or the payment of a dividend 
equivalent (within the meaning of paragraph (i) of this section) in its 
dealer capacity will not be liable for tax under section 871 or section 
881 provided that the qualified derivatives dealer complies with its 
obligations under the qualified intermediary agreement described in 
Sec. Sec.  1.1441-1(e)(5) and 1.1441-1(e)(6). If a qualified 
derivatives dealer receives a dividend or dividend equivalent payment 
on or determined by reference to an underlying security and the 
offsetting dividend equivalent payment the qualified derivatives dealer 
is contractually obligated to make on the same underlying security is 
less than the dividend and dividend equivalent amount received 
(including when the qualified derivatives dealer is not contractually 
obligated to make an offsetting dividend equivalent payment), the 
qualified derivatives dealer is liable for tax under section 871 or 
section 881 for the difference. For purposes of this paragraph (q), a 
dividend or dividend equivalent is not treated as received by a 
qualified derivatives dealer acting in its dealer capacity if the 
dividend or dividend equivalent is received by the qualified 
derivatives dealer acting as a proprietary trader. Transactions 
properly reflected in a qualified derivatives dealer's dealer book are 
presumed to be held by a dealer in its dealer capacity for purposes of 
this paragraph (q).
    (2) Examples. The following examples illustrate the rules of this 
paragraph (q):

    Example 1. Forward contract entered into by a foreign dealer. 
(i) Facts. FB is a foreign bank that is a qualified intermediary 
that acts as a qualified derivatives dealer. On April 1, Year 1, FB 
enters into a cash settled forward contract initiated by a foreign 
customer (Customer) that entitles Customer to receive from FB all of 
the appreciation and dividends on 100 shares of Stock X, and 
obligates Customer to pay FB any depreciation on 100 shares of Stock 
X, at the end of three years. FB hedges the forward contract by 
entering into a total return swap contract with a domestic broker 
(U.S. Broker) and maintains the swap contract as a hedge for the 
duration of the forward contract. The swap contract entitles FB to 
receive an amount equal to all of the dividends on 100 shares of 
Stock X and obligates FB to pay an amount referenced to a floating 
interest rate each quarter, and also entitles FB to receive from or 
pay to U.S. Broker, as the case may be, the difference between the 
value of 100 shares of Stock X at the inception of the swap and the 
value of 100 shares of Stock X at the end of 3 years. FB provides 
valid documentation to U.S. Broker that FB will receive payments 
under the swap contract in its capacity as a qualified derivatives 
dealer, and FB contemporaneously enters both the swap contract with 
U.S. Broker and the forward contract with Customer on its dealer 
books. Stock X pays a quarterly dividend of $0.25 per share.
    (ii) Application of rules. FB is a long party on a delta one 
contract (the total return swap) and a short party on a delta one 
contract (the forward contract with Customer). U.S. Broker is not 
obligated to withhold on the dividend equivalent payments to FB on 
the swap contract that are referenced to Stock X dividends, however, 
because U.S. Broker has

[[Page 56888]]

received valid documentation that it may rely upon to treat the 
payment as made to FB acting as a qualified derivatives dealer. 
Similarly, FB is not obligated to pay tax on the payments it 
receives from U.S. Broker referenced to Stock X dividends because at 
the time it received the payments FB was contractually obligated to 
make fully offsetting dividend equivalent payments as the short 
party with respect to 100 shares of Stock X to Customer. FB is 
required to withhold on dividend equivalent payments to Customer on 
the forward contract in accordance with Sec.  1.1441-2(e)(8).

    Example 2. At-the-money option contract entered into by a 
foreign dealer. (i) Facts. The facts are the same as Example 1, but 
customer purchases from FB an at-the-money call option on 100 shares 
of Stock X with a term of one year. The call option has a delta of 
0.5 and FB hedges the call option by purchasing 50 shares of Stock 
X, which are held in an account with U.S. Broker, who also acts as 
paying agent.
    (ii) Application of rules. FB is a long party on 50 shares of 
Stock X and a short party on an option. Because the option has a 
delta of less than 0.8 on the date it was issued, it is not a 
section 871(m) transaction. U.S. Broker is not obligated to withhold 
on the Stock X dividends paid to FB because U.S. Broker has received 
valid documentation that it may rely upon to treat the dividends as 
paid to FB acting as a qualified derivatives dealer. FB is liable 
for tax under section 871 or section 881 on the Stock X dividends it 
receives from U.S. Broker, however, because at the time it received 
the dividends FB was not contractually obligated to make an 
offsetting dividend equivalent payment to Customer. FB is not 
required to make an offsetting dividend equivalent payment to 
Customer because the option has a delta of 0.5; therefore, it is not 
a section 871(m) transaction.

    Example 3. In-the-money option contract entered into by a 
foreign dealer. (i) Facts. The facts are the same as Example 2, but 
Customer purchases from FB an in-the-money call option on 100 shares 
of Stock X with a term of one year. The call option has a delta of 
0.8 and FB hedges the call option by purchasing 80 shares of Stock 
X, which are held in an account with U.S. Broker, who also acts as 
paying agent. The price of Stock X declines substantially and the 
option lapses unexercised.
    (ii) Application of rules. FB is a long party on 80 shares of 
Stock X and a short party on an option. Because the option has a 
delta of 0.8 on the date it was issued, it is a section 871(m) 
transaction. U.S. Broker is not obligated to withhold on the Stock X 
dividends paid to FB because U.S. Broker has received valid 
documentation that it may rely upon to treat the dividends as paid 
to FB acting as a qualified derivatives dealer. Similarly, FB is not 
obligated to pay tax on the Stock X dividends it receives from U.S. 
Broker to the extent that FB is contractually obligated to make 
offsetting dividend equivalent payments as the short party to 
Customer. FB is required to withhold on dividend equivalent payments 
to Customer on the option contract in accordance with Sec.  1.1441-
2(e)(8). FB is also liable for tax under section 871 or section 881 
on Stock X dividends, if any, that exceed the dividend equivalent 
payment to Customer.

    (r)(1) through (3) [Reserved]. For further guidance, see Sec.  
1.871-15(r)(1) through (3).
    (4) Effective/applicability date. This section applies to payments 
made on or after January 1, 2017.
    (s) Expiration date. This section expires September 17, 2018.

0
Par. 5. Section 1.1441-1 is amended by:
0
1. Redesignating paragraph (b)(4)(xxi) as (b)(4)(xxiv).
0
2. Adding paragraphs (b)(4)(xxi) through (xxiii).
0
3. Adding new paragraphs (e)(3)(ii)(E) and (6).
0
4. Adding new paragraph (f)(4).
    The additions read as follows:


Sec.  1.1441-1  Requirement for the deduction and withholding of tax on 
payments to foreign persons.

    (b) * * *
    (4) * * *
    (xxi) Amounts paid with respect to a notional principal contract 
described in Sec.  1.871-15(a)(7), an equity-linked instrument 
described in Sec.  1.871-15(a)(4), or a securities lending or sale-
repurchase transaction described in Sec.  1.871-15(a)(13) are exempt 
from withholding under section 1441(a) as dividend equivalents under 
section 871(m) if the transaction is not a section 871(m) transaction 
within the meaning of Sec.  1.871-15(a)(12), if the transaction is 
subject to the exception described in Sec.  1.871-15(k), or if the 
payment is not a dividend equivalent pursuant to Sec.  1.871-15(c)(2). 
However, the amounts may be subject to withholding under section 
1441(a) if they are subject to tax under any section other than section 
871(m). For purposes of this withholding exemption, it is not necessary 
for the payee to provide documentation establishing that a notional 
principal contract or equity-linked instrument has a delta (as 
described in Sec.  1.871-15(g)) that is less than 0.80 or does not have 
substantial equivalence (as defined in Sec.  1.871-15(h)) with the 
underlying security. For purposes of the withholding exemption 
regarding corporate acquisitions described in Sec.  1.871-15(k), the 
exemption only applies if the long party furnishes, under penalties of 
perjury, a written statement to the withholding agent certifying that 
it satisfies the requirements of Sec.  1.871-15(k).
    (xxii) Certain payments to qualified derivatives dealers (as 
described in paragraph (e)(6) of this section). For purposes of this 
withholding exemption, the qualified derivatives dealer must furnish to 
the withholding agent the documentation described in paragraph 
(e)(3)(ii) of this section. A withholding agent that makes a payment of 
a dividend or a divided equivalent to a qualified intermediary that is 
acting as a qualified derivatives dealer is not required to withhold on 
the payment if the withholding agent can reliably associate the payment 
with a valid qualified intermediary withholding certificate as 
described in paragraph (e)(3)(ii) of this section, including the 
certification described in paragraph (e)(3)(ii)(E).
    (xxiii) Amounts paid with respect to a potential section 871(m) 
transaction that is only a section 871(m) transaction as a result of 
applying Sec.  1.871-15(n) to treat certain transactions as combined 
transactions, if the withholding agent is able to rely on one or more 
of the presumptions provided in Sec.  1.871-15(n)(3)(i) or (ii) 
(applying those paragraphs whether or not the withholding agent is a 
short party by substituting ``withholding agent'' for ``short party''), 
and the withholding agent does not otherwise have actual knowledge that 
the long party (or a related person within the meaning of section 
267(b) or section 707(b)) entered into the potential section 871(m) 
transaction in connection with any other potential section 871(m) 
transactions. The ability of one or more withholding agents to rely on 
the presumptions provided in section 1.871-15(n)(3) does not affect the 
withholding tax obligations or liability of any party to the 
transaction that cannot rely on the presumptions. Notwithstanding the 
withholding exemption provided to the withholding agent in this 
paragraph (b)(4)(xxii), the long party may still be liable for tax on 
dividend equivalent amounts with respect to such combined transactions 
under section 871(m).
    (e)(3)(ii)(E) [Reserved]. For further guidance, see Sec.  1.1441-
1T(e)(3)(ii)(E).
    (6) Qualified derivatives dealers. [Reserved]. For further 
guidance, see Sec.  1.1441-1T(e)(6).
    (f) * * *
    (4) Effective/applicability date. Paragraphs (b)(4)(xxi) through 
(b)(4)(xxiii) of this section, and paragraphs (e)(3)(ii)(E) and (e)(6) 
of this section apply to payments made on or after September 18, 2015.

0
Par. 6. Section 1.1441-1T is amended by:
0
1. Redesignating paragraph (e)(3)(ii)(E) as paragraph (e)(3)(ii)(F).
0
2. Adding new paragraphs (e)(3)(ii)(E) and (e)(6).
0
3. Revising paragraph (e)(5)(i).

[[Page 56889]]

0
4. Amending paragraph (f)(3) by removing ``This section'' and adding in 
its place ``Except for paragraphs (e)(3)(ii)(E) and (e)(6), this 
section'' and adding a third sentence.
0
5. Amending paragraph (g) by removing ``The applicability'' and adding 
in its place ``Except for paragraphs (e)(3)(ii)(E) and (e)(6), the 
applicability'' and adding a third sentence.


Sec.  1.1441-1T  Requirement for the deduction and withholding of tax 
on payments to foreign persons (temporary).

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

[[Page 56890]]

0
Par. 7. Section 1.1441-2 is amended by adding paragraph (e)(8) and 
adding a sentence to the end of paragraph (f) to read as follows:


Sec.  1.1441-2  Amounts subject to withholding.

* * * * *
    (e) * * *
    (8) Payments of dividend equivalents--(i) In general. A payment of 
a dividend equivalent is not considered to be made until the later of 
when--
    (A) The amount of a dividend equivalent is determined as provided 
in Sec.  1.871-15(j)(2), and
    (B) A payment occurs with respect to the section 871(m) 
transaction.
    (ii) Payment. For purposes of paragraph (e)(8) of this section, a 
payment occurs with respect to a section 871(m) transaction when--
    (A) Money or other property is paid to or by the long party;
    (B) In the case of a section 871(m) transaction described in Sec.  
1.871-15(i)(3), a payment is treated as being made at the end of the 
applicable calendar quarter; or
    (C) The long party sells, exchanges, transfers, or otherwise 
disposes of the section 871(m) transaction (including by settlement, 
offset, termination, expiration, lapse, or maturity).
    (iii) Premiums and other upfront payments. When a long party pays a 
premium or other upfront payment to the short party at the time a 
section 871(m) transaction is issued, the premium or other upfront 
payment is not treated as a payment for purposes of paragraph 
(e)(8)(ii)(A) of this section.
* * * * *
    (f) * * * Paragraph (e)(8) of this section applies to payments made 
on or after September 18, 2015.

0
Par. 8. Section 1.1441-3 is amended by:
0
1. Adding a second sentence to paragraph (h)(1).
0
2. Redesignating paragraph (h)(2) as (h)(3) and revising newly 
redesignated paragraph (h)(3).
0
3. Adding new paragraph (h)(2).
    The additions and revisions read as follows:


Sec.  1.1441-3  Determination of amounts to be withheld.

* * * * *
    (h) * * *
    (1) * * * Withholding is required on the amount of the dividend 
equivalent calculated under Sec.  1.871-15(j).
    (2) Reliance by withholding agent on reasonable determinations. For 
purposes of determining whether a payment is a dividend equivalent and 
the timing and amount of a dividend equivalent under section 871(m), a 
withholding agent may rely on the information received from the party 
to the transaction that is required (as provided in Sec.  1.871-15(p)) 
to make those determinations, unless the withholding agent knows or has 
reason to know that the information is incorrect. When a withholding 
agent fails to withhold the required amount because the party described 
in Sec.  1.871-15(p) fails to reasonably determine or timely provide 
information regarding whether a transaction is a section 871(m) 
transaction, the timing and amount of any dividend equivalent, or any 
other information required to be provided pursuant to Sec.  1.871-
15(p), and the withholding agent relied, absent actual knowledge to the 
contrary, on that party's determination or did not timely receive 
required information, then the failure to withhold is imputed to the 
party required to make the determinations described in Sec.  1.871-
15(p). In that case, the IRS may collect any underwithheld amount from 
the party to the transaction that was required to make the 
determinations described in Sec.  1.871-15(p) or timely provide the 
information and subject that party to applicable interest and penalties 
as if the party were a withholding agent with respect to the payment of 
the dividend equivalent made pursuant to the section 871(m) 
transaction.
    (3) Effective/applicability date. Except for the first sentence of 
paragraph (h)(1), this paragraph (h) applies to payments made on or 
after September 18, 2015. The first sentence of paragraph (h)(1) of 
this section, applies to payments made on or after January 23, 2012.
* * * * *

0
Par. 9. Section 1.1441-7 is amended by:
0
1. Adding Example 7 to paragraph (a)(3).
0
2. Adding a second sentence to paragraph (a)(4).
    The additions read as follows:


Sec.  1.1441-7  General provisions relating to withholding agents.

    (a) * * *
    (3) * * *

    Example 7.  CO is a domestic clearing organization. CO serves as 
a central counterparty clearing and settlement service provider for 
derivatives exchanges in the United States. CB is a broker organized 
in Country X, a foreign country, and a clearing member of CO. CB is 
a nonqualified intermediary, as defined in Sec.  1.1441-1(c)(14). FC 
is a foreign corporation that has an investment account with CB. FC 
instructs CB to purchase a call option that is a specified ELI (as 
described in Sec.  1.871-15(e)). CB effects the trade for FC on the 
exchange. The exchange matches FC's order with an order for a 
written call option with the same terms. The exchange then sends the 
matched trade to CO, which clears the trade. CB and the clearing 
member representing the call option seller settle the trade with CO. 
Upon receiving the matched trade, the option contracts are novated 
and CO becomes the counterparty to CB and the counterparty to the 
clearing member representing the call option seller. To the extent 
that there is a dividend equivalent with respect to the call option, 
both CO and CB are withholding agents as described in paragraph 
(a)(1) of this section.

    (4) * * * Example 7 of paragraph (a)(3) of this section applies to 
payments made on or after September 18, 2015.
* * * * *

0
Par. 10. Section 1.1461-1 is amended by:
0
1. Redesignating paragraphs (c)(2)(i)(N) as (c)(2)(i)(O) and 
(c)(2)(i)(M) as (c)(2)(i)(N).
0
2. Adding paragraph (c)(2)(i)(M).
0
3. Redesignating paragraph (c)(2)(ii)(K) as (c)(2)(ii)(L) and 
redesignating paragraph (c)(2)(ii)(J) as (c)(2)(ii)(K)
0
4. Adding paragraph (c)(2)(ii)(J).


Sec.  1.1461-1  Payments and returns of tax withheld.

* * * * *
    (c) * * *
    (2) * * *
    (i) * * *
    (M) Any dividend or any payment that references the payment of a 
dividend from an underlying security pursuant to a securities lending 
or sale-repurchase transaction paid to a qualified derivatives dealer 
even when the withholding agent is not required to withhold on the 
payment pursuant to Sec.  1.1441-1(b)(4)(xxi), (xxii), or (xxiii);
* * * * *
    (ii) * * *
    (J) Except as provided in Sec.  1.1461-1(c)(2)(i)(M), any payment 
to a qualified derivatives dealer when the withholding agent is not 
required to withhold on the payment pursuant to Sec.  1.1441-
1(b)(4)(xxi), (xxii), or (xxiii);
* * * * *

0
Par. 11. Section 1.1473-1 is amended by:
0
1. Adding new paragraph (a)(4)(viii).
0
2. Adding a sentence to the end of paragraph (f).
    The additions read as follows:


Sec.  1.1473-1  Section 1473 definitions.

    (a) * * *
    (4) * * *
    (viii) Certain dividend equivalents. Amounts paid with respect to a 
notional principal contract described in Sec.  1.871-

[[Page 56891]]

15(a)(7), an equity-linked instrument described in Sec.  1.871-
15(a)(4), or a securities lending or sale-repurchase transaction 
described in Sec.  1.871-15(a)(13) that are exempt from withholding 
under section 1441(a) as dividend equivalents under section 871(m) if 
the transaction is not a section 871(m) transaction within the meaning 
of Sec.  1.871-15(a)(12), if the transaction is subject to the 
exception described in Sec.  1.871-15(k), or to the extent the payment 
is not a dividend equivalent pursuant to Sec.  1.871-15(c)(2).
* * * * *
    (f) * * * Paragraph (a)(4)(viii) of this section applies to 
payments made on or after September 18, 2015.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: July 20, 2015.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2015-21759 Filed 9-17-15; 8:45 am]
 BILLING CODE 4830-01-P



                                                                                                      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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                                                 56866            Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations

                                                 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                     days after the date of publication of final
                                                 [TD 9734]
                                                                                                         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,
                                                 Treasury.                                                                                                     2013, was cancelled because no request
                                                                                                         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.
                                                 guidance to withholding agents that are                 regulations) under section 871(m) of the
                                                                                                         Internal Revenue Code (Code). The 2012                Summary of Comments and
                                                 responsible for withholding U.S. tax                                                                          Explanation of Provisions
                                                                                                         section 871(m) regulations relate to
                                                 with respect to a dividend equivalent.
                                                                                                         dividend equivalents from sources                     I. In General
                                                 DATES: Effective Date: These regulations
                                                                                                         within the United States paid to
                                                 are effective on September 18, 2015.                                                                             The Treasury Department and the IRS
                                                                                                         nonresident alien individuals and
                                                   Applicability Dates: For dates of                                                                           received numerous comments regarding
                                                                                                         foreign corporations. Corrections to the
                                                 applicability, see §§ 1.871–14(j)(3),                                                                         the 2013 proposed regulations. Most
                                                                                                         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                                                                                       comments suggested modifications and
                                                                                                         proposed regulations, and a public
                                                   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
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                                                 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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                                                                  Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations                                         56867

                                                 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;
                                                                                                         regulations defines a dividend                        (3) the ability of parties to the
                                                 B. Definition of a Dividend Equivalent
                                                                                                         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.                                                  that are economically equivalent to
                                                 transactions described in (1) and (2) are
                                                 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
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                                                 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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                                                 56868            Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations

                                                 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
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                                                 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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                                                                  Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations                                       56869

                                                 ‘‘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                                                                          compensation for personal services of a
                                                                                                         dividend made to the holder of the
                                                 That Are Not Dividends                                                                                        nonresident alien individual from being
                                                                                                         convertible security, a dividend
                                                    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
                                                                                                         final regulations do not alter any of the             should be subject to tax where the
                                                 2. Section 305 Coordination
                                                                                                         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.
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                                                 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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                                                 56870            Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations

                                                 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
                                                    The final regulations do not change                                                                           Comments on the 2013 proposed
                                                                                                         not have to pay rather than an amount
                                                 the 50 percent threshold. Requiring that                                                                      regulations noted that recalculating the
                                                                                                         the foreign investor affirmatively
                                                 an acquisition (as part of a plan by one                                                                      delta of a section 871(m) transaction
                                                                                                         receives for holding the derivative,
                                                 or more person) total more than 50                                                                            each time the amount of a dividend
                                                                                                         which suggests that there is no
                                                 percent of a corporation is appropriate                                                                       equivalent is determined would add
                                                                                                         ‘‘payment’’ of a dividend equivalent to
                                                 because it indicates that the primary                                                                         administrative complexity without
                                                                                                         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                    referenced in the contract, multiplied by
                                                 equivalent includes any amount that
                                                 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
                                                 equal to actual payments of dividends                                                                         the time the simple contract is issued,
                                                                                                         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
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                                                 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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                                                                  Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations                                        56871

                                                 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.
                                                                                                         qualified index (such as a cap or a                      Comments further requested that the
                                                 with a term of one year or less when
                                                                                                         floor).                                               permitted dividend yield be increased
                                                 acquired, the 2013 proposed regulations
                                                                                                            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
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                                                 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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                                                 56872            Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations

                                                 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
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                                                 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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                                                                  Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations                                       56873

                                                 ‘‘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
                                                 long and short positions. Commenters                                                                          securities and potential section 871(m)
                                                                                                            In addition, the final regulations
                                                 observed that many standard option                                                                            contracts held directly or indirectly by
                                                                                                         provide that the Commissioner will
                                                 strategies involve multiple options                                                                           that entity. The 2013 proposed
                                                                                                         presume that transactions that are
                                                 positions, often combining positive and                                                                       regulations provide an exception for a
                                                                                                         properly reflected on separate trading
                                                 negative delta options. As a result, an                                                                       transaction that references an interest in
                                                                                                         books of the taxpayer are not entered                 an entity that is not a C corporation if
                                                 approach that does not combine these                    into in connection with each other. The
                                                 positions would fail to reflect the                                                                           the underlying securities and potential
                                                                                                         Commissioner will also presume that a                 section 871(m) transactions allocable to
                                                 economics of the transactions.                          long party did not enter into two or
                                                 Commenters suggested that when a                                                                              that interest represent, in the aggregate,
                                                                                                         more transactions in connection with                  10 percent or less of the value of the
                                                 taxpayer modifies an existing combined                  each other if the long party entered into
                                                 position that includes both long and                                                                          interest in the referenced entity at the
                                                                                                         the transactions two or more business                 time the transaction is entered into.
                                                 short positions, the combined position                  days apart. These presumptions are
                                                 should continue to be tested based on                                                                         Comments recommended changing the
                                                                                                         rebuttable. The Commissioner may                      threshold for applying the look-through
                                                 the net deltas of the component
                                                                                                         rebut the first presumption with facts                rule from 10 percent to 50 percent
                                                 positions rather than test the delta for
                                                                                                         and circumstances showing that                        unless the taxpayer controls the entity.
                                                 each position separately. None of the
                                                                                                         separate trading books were created or                Comments also noted that taxpayers
                                                 comments, however, proposed an
                                                                                                         used to avoid section 871(m), and may                 would have difficulty determining the
                                                 administrable test that could be used to
                                                                                                         rebut either presumption with facts and               assets owned by referenced entities.
                                                 reliably combine long and short
                                                                                                         circumstances showing that the                           The final regulations revise the rules
                                                 positions and net the resulting deltas.
                                                    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
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                                                 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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                                                 56874            Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations

                                                 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                                                                      dividend equivalent. For clarity and to
                                                                                                         to the reporting obligations in the 2013
                                                 U.S. tax results claimed in connection                                                                        ensure that the IRS will have access to
                                                                                                         proposed regulations. The final
                                                 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
                                                    The 2013 proposed regulations                                                                              (including the number of shares of the
                                                                                                         respect to a potential section 871(m)
                                                 provide rules for reporting and                                                                               initial hedge) and written estimated
                                                                                                         transaction. This simplification
                                                 withholding. The preamble to the 2013                                                                         dividends (if any). The records and
                                                                                                         responds to the requests to expand the
                                                 proposed regulations explains that most                                                                       documentation must be created
                                                                                                         scope of persons entitled to request
                                                 equity-linked transactions involve a                                                                          substantially contemporaneously with
                                                                                                         information. Several other changes that               the time the potential section 871(m)
                                                 financial institution acting as a broker,               were requested, however, such as
                                                 dealer, or intermediary and that the                                                                          transaction is issued.
                                                                                                         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
                                                 871(m) transaction. Accordingly,                                                                              1. Contingent Debt Instruments
                                                                                                         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
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                                                 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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                                                                  Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations                                        56875

                                                 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
                                                 is issued.                                              continuous monitoring and withholding
                                                                                                                                                               sufficient funds available to satisfy
                                                                                                         on each specified ELI over time is
                                                 2. Convertible Debt Instruments                                                                               withholding obligations.
                                                                                                         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
                                                 excluded from the definition of an ELI.                 equivalents from ELIs when there is a
                                                                                                                                                               A. Test for Contracts With
                                                 Comments suggested that certain                         final payment or a sale.
                                                                                                            Comments also maintained that                      Indeterminate Deltas
                                                 characteristics typical of convertible
                                                 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
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                                                 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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                                                 56876            Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations

                                                 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
                                                 amounts. In other words, because delta                     To test whether a complex contract is
                                                                                                                                                               without regard to the residence of the
                                                 is the ratio of the change in the fair                  a section 871(m) transaction, the
                                                                                                                                                               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
                                                                                                         of a proportionality test that was                    foreign payee. See Staff of J. Comm. on
                                                 value of the referenced property must be
                                                                                                         advocated by many commenters, and it                  Taxation, Technical Explanation of the
                                                 known to calculate delta. In the case of
                                                                                                         uses information easily accessible to                 Revenue Provisions Contained in Senate
                                                 the structured note described in this
                                                                                                         most issuers of complex contracts.                    Amendment 3310, the ‘‘Hiring
                                                 paragraph, the number of shares of stock
                                                                                                         Generally, the substantial equivalence                Incentives to Restore Employment Act,’’
                                                 (and hence the value of the property)
                                                                                                         test measures the change in value of a                JCX–4–10, at 79 (Feb. 23, 2010)
                                                 referenced by the contract will be
                                                                                                         complex contract when the price of the                (explaining that section 871(m) may
                                                 different depending on whether 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
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                                                 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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                                                                  Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations                                       56877

                                                 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.
                                                 dealers to certify that each transaction                derivative contracts as a principal
                                                                                                                                                               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
                                                                                                         intend to implement the particular                    the context of securities lending and
                                                 transactions entered into in the ordinary
                                                                                                         requirements of withholding and                       sale repurchase agreements. Notice
                                                 course of the dealer’s business for
                                                                                                         reporting on dividend equivalents                     2010–46 provides a two-part solution to
                                                 hedging purposes. Other comments
                                                                                                         received and paid by brokers by                       the problem of overwithholding on a
                                                 recommended expanding the exception
                                                                                                         amending the QI agreement to include                  chain of dividends and dividend
                                                 to include affiliates of qualified dealers
                                                                                                         new provisions that will permit an                    equivalents. First, it provides an
                                                 that issue certain potential section
                                                                                                         eligible QI to act as a qualified                     exception from withholding for
                                                 871(m) transactions. Comments further
                                                                                                         derivatives dealer (QDD). A QI that acts              payments to a qualified securities lender
                                                 recommended that an affiliate in these
                                                                                                         as a QDD will not be subject to                       (QSL). Second, it provides a proposed
                                                 circumstances should not be required to
                                                                                                         withholding on dividends or payments                  framework to credit forward prior
                                                 certify that it is acting in its capacity as                                                                  withholding on a chain of substitute
                                                                                                         that may be dividend equivalents made
                                                 a dealer. Several comments requested                                                                          dividends paid pursuant to a chain of
                                                                                                         with respect to potential section 871(m)
                                                 that, in addition to expanding the                                                                            securities loans or stock repurchase
                                                                                                         transactions that the QDD receives
                                                 definition of qualified dealer, the final                                                                     agreements. The QSL regime requires a
                                                                                                         while acting in its capacity as a dealer.
                                                 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
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                                                 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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                                                 56878            Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations

                                                 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                  Flexibility Analysis is not required.
                                                 C. Certain Insurance Contracts
                                                                                                         same requirements. The Treasury                       Pursuant to section 7805(f) of the Code,
                                                    The 2013 proposed regulations do not                 Department and the IRS are also
                                                 specifically address whether payments                                                                         these regulations have been submitted
                                                                                                         evaluating how section 871(m) should                  to the Chief Counsel for Advocacy of the
                                                 made on life insurance or annuity                       apply to reinsurance contracts.
                                                 contracts are dividend equivalents when                                                                       Small Business Administration for
                                                                                                         Taxpayers are encouraged to send                      comment on its impact on small
                                                 the payments are directly or indirectly                 comments on how section 871(m)
                                                 contingent upon or determined by                                                                              business.
                                                                                                         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
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                                                                                                                                                               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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                                                                  Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations                                          56879

                                                    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:
                                                 interest.                                               simple contract benchmark (within the                   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                B based on any appreciation in the value of
                                                    (3) Effective/applicability date. The                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
                                                 ■ 1. Redesignating paragraphs (d)(1)(i)                                                                       entitles B to receive payments from A based
                                                                                                         at the time of an issuance as a result of             on any appreciation in the value of Stock Y
                                                 as (d)(1)(i)(A), (d)(1) introductory text as            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
                                                                                                                                                               Stock Y. B is the long party with respect to
                                                 ■ 3. Removing ‘‘Specified NPCs before                   option embedded in any debt
                                                                                                                                                               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
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                                                 (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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                                                 56880            Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations

                                                    (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
                                                 required to be calculated with respect to                                                                     § 1.1441–4(b).
                                                                                                            (ii) Any payment that references the
                                                 the underlying security. A contract has                                                                          (d) Specified NPCs—(1) Specified
                                                                                                         payment of a dividend from an
                                                 a single exercise date even though it                                                                         NPCs entered into before January 1,
                                                                                                         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               the NPC is issued is a specified NPC.
                                                    (ii) Complex contract—(A) In general.
                                                                                                         payment that references a distribution                   (ii) Complex NPCs. A complex NPC
                                                 A complex contract is any NPC or ELI
                                                                                                         with respect to an underlying security is             that meets the substantial equivalence
                                                 that is not a simple contract. A complex
                                                                                                         not a dividend equivalent to the extent               test described in paragraph (h) of this
                                                 contract that is an NPC is a complex
                                                                                                         that the distribution would not be                    section with respect to an underlying
                                                 NPC. A complex contract that is an ELI
                                                                                                         subject to tax pursuant to section 871 or             security when the NPC is issued is a
                                                 is a complex ELI.
                                                                                                         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
                                                 maturity the ELI will either entitle the long
                                                                                                         equivalent to the extent that it is                   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,
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                                                 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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                                                                  Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations                                        56881

                                                 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
                                                                                                         Stock X and any dividends paid by X on
                                                 security, all references to that                                                                              estimated dividend amount, the written
                                                                                                         those shares. The value of the NPC will
                                                 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
                                                 into account changes in the market                      has a fair market value of $100 per share. The        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
                                                                                                         100)).
                                                 derivative that are not directly related to                                                                   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
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                                                 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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                                                 56882            Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations

                                                 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
                                                 shares and an interest rate, and subtracting                                                                  Notwithstanding any other provision in
                                                                                                         equivalent for each underlying security               this paragraph (l), an index is not a
                                                 the value of any dividends expected to be
                                                 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
                                                 section, the estimated dividend amount is the                                                                 an index referenced in a potential
                                                                                                         determined pursuant to paragraph                      section 871(m) transaction is a qualified
                                                 per-share dividend amount because the                   (j)(1)(i), (ii), or (iii), the amount of a
                                                 estimate is reasonable and specified in                                                                       index is made at the time the
                                                                                                         dividend equivalent includes the                      transaction is issued based on whether
                                                 accordance with paragraph (i)(2)(iii) of this
                                                 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
                                                 of this section.                                           (2) Time for determining the amount
                                                                                                                                                               which the transaction is issued.
                                                                                                         of a dividend equivalent. The amount of                  (3) Qualified index. A qualified index
                                                    Example 2. Price return only swap
                                                 contract. (i) Foreign Investor enters into a
                                                                                                         a dividend equivalent is determined on                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
                                                 dividends paid on Stock X during the term                                                                     underlying security that represents more
                                                 of the contract nor references an estimated
                                                                                                         on the earlier of the record date or the              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
                                                 of this section. The actual per-share dividend
                                                                                                                                                               criteria, which may require
                                                 amounts are dividend equivalents for
                                                                                                         payment, the number of shares is                      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
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                                                 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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                                                                  Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations                                       56883

                                                 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
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                                                 (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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                                                 56884            Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations

                                                 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
                                                 circumstances showing that transactions                                                                       with respect to any transaction as a
                                                                                                         remaining separate. The two calls are
                                                 reflected on separate trading books were                                                                      dividend equivalent, the withholding
                                                                                                         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
                                                                                                         conversion, or otherwise acquiring) or                described in paragraphs (i) and (j) of this
                                                 this presumption with facts and
                                                                                                         disposes of (whether by sale, offset,                 section). Except as otherwise provided
                                                 circumstances showing that the
                                                                                                         exercise, termination, expiration,                    in paragraph (n)(3) of this section, the
                                                 transactions were not entered into in
                                                 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
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                                                 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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                                                                  Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations                                       56885

                                                 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).
                                                    (A) By telephone, and confirmed in                                                                            (d) through (g) [Reserved]. For further
                                                                                                         transaction is issued.
                                                 writing;                                                                                                      guidance, see § 1.871–15(d) through (g).
                                                                                                            (q) Dividend and dividend equivalent
                                                    (B) By written statement sent by first                                                                        (h) Substantial equivalence test—(1)
                                                                                                         payments to a qualified derivatives
                                                 class mail to the address provided by                                                                         In general. The substantial equivalence
                                                                                                         dealer. [Reserved]. For further guidance,             test described in this paragraph (h)
                                                 the requesting party;                                   see § 1.871–15T(q).
                                                    (C) By electronic publication available                                                                    applies to determine whether a complex
                                                                                                            (r) Effective/applicability date—(1) In
                                                 to all persons entitled to request                                                                            contract is a section 871(m) transaction.
                                                                                                         general. This section applies to
                                                 information; or                                                                                               The substantial equivalence test
                                                                                                         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). * * *
                                                 transaction described in paragraph (a)(9)                                                                     for the underlying security, the
                                                                                                            (3) Effective/applicability date for
                                                 of this section may request the                                                                               differences between the expected
                                                                                                         paragraphs (d)(2) and (e). Paragraphs
                                                 information specified in paragraph (p)                                                                        changes in value of that complex
                                                                                                         (d)(2) and (e) apply to any payment
                                                 of this section with respect to a                                                                             contract and its initial hedge with the
                                                                                                         made on or after January 1, 2017, with
                                                 potential section 871(m) transaction                                                                          differences between the expected
                                                                                                         respect to any transaction issued on or
                                                 from the party required by paragraph                                                                          changes in value of a simple contract
                                                                                                         after January 1, 2017, and to any
                                                 (p)(3)(i) of this section to provide the                                                                      benchmark (as described in paragraph
                                                                                                         payment made on or after January 1,
                                                 information.                                                                                                  (h)(2) of this section) and its initial
                                                                                                         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
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                                                 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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                                                 56886            Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations

                                                 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
                                                 paragraph (h) cannot be applied to a                    testing price determined in paragraph
                                                                                                                                                               the potential section 871(m) transaction
                                                 particular complex contract, a taxpayer                 (h)(4)(i)(D) of this section;
                                                                                                                                                               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
                                                                                                         equivalence, a taxpayer must use                        Example. Complex contract that is not
                                                 referenced by a potential section 871(m)                                                                      substantially equivalent. (i) FI issues an
                                                 transaction that is a complex contract is               additional testing prices as necessary to             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
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                                                    (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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                                                                  Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations                                            56887

                                                 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).
                                                 the testing price that represents a decrease by         minus $19.05). FI next determines the
                                                                                                         absolute value of the difference between the             (2) Examples. The following examples
                                                 one standard deviation ($10,000 issue price
                                                 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                                                                    FB provides valid documentation to U.S.
                                                                                                         payments to a qualified derivatives
                                                 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.
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                                                 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                                                                       on a delta one contract (the total return swap)
                                                                                                         for tax under section 871 or section 881
                                                 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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                                                 56888            Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations

                                                 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
                                                                                                         ■ 3. Adding new paragraphs (e)(3)(ii)(E)              that is only a section 871(m) transaction
                                                 and FB hedges the call option by purchasing
                                                 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
                                                 on 50 shares of Stock X and a short party on            § 1.1441–1 Requirement for the deduction
                                                                                                         and withholding of tax on payments to                 presumptions provided in § 1.871–
                                                 an option. Because the option has a delta of                                                                  15(n)(3)(i) or (ii) (applying those
                                                 less than 0.8 on the date it was issued, it is          foreign persons.
                                                                                                                                                               paragraphs whether or not the
                                                 not a section 871(m) transaction. U.S. Broker              (b) * * *
                                                                                                            (4) * * *                                          withholding agent is a short party by
                                                 is not obligated to withhold on the Stock X
                                                 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                                                                     section 267(b) or section 707(b)) entered
                                                 U.S. Broker, however, because at the time it            repurchase transaction described in
                                                                                                         § 1.871–15(a)(13) are exempt from                     into the potential section 871(m)
                                                 received the dividends FB was not                                                                             transaction in connection with any
                                                 contractually obligated to make an offsetting           withholding under section 1441(a) as
                                                                                                         dividend equivalents under section                    other potential section 871(m)
                                                 dividend equivalent payment to Customer.
                                                 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                                                                    agent in this paragraph (b)(4)(xxii), the
                                                 with a term of one year. The call option has            under any section other than section
                                                                                                         871(m). For purposes of this                          long party may still be liable for tax on
                                                 a delta of 0.8 and FB hedges the call option                                                                  dividend equivalent amounts with
                                                 by purchasing 80 shares of Stock X, which               withholding exemption, it is not
                                                                                                         necessary for the payee to provide                    respect to such combined transactions
                                                 are held in an account with U.S. Broker, who
                                                 also acts as paying agent. The price of Stock           documentation establishing that a                     under section 871(m).
                                                 X declines substantially and the option                                                                          (e)(3)(ii)(E) [Reserved]. For further
                                                                                                         notional principal contract or equity-
                                                 lapses unexercised.                                                                                           guidance, see § 1.1441–1T(e)(3)(ii)(E).
                                                                                                         linked instrument has a delta (as                        (6) Qualified derivatives dealers.
                                                   (ii) Application of rules. FB is a long party         described in § 1.871–15(g)) that is less
                                                 on 80 shares of Stock X and a short party on                                                                  [Reserved]. For further guidance, see
                                                                                                         than 0.80 or does not have substantial                § 1.1441–1T(e)(6).
                                                 an option. Because the option has a delta of
                                                 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
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                                                 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                by:
                                                 Broker to the extent that FB is contractually
                                                 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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                                                                  Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations                                      56889

                                                 ■  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              review procedures applicable to a
                                                 payments to foreign persons (temporary).
                                                                                                         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               must:
                                                 qualified intermediary acting as a
                                                                                                         before an agreement is executed with                     (1) Certify to the IRS that it has
                                                 qualified derivatives dealer, a
                                                                                                         the IRS if it has applied for such status             complied with the obligations to act as
                                                 certification that the qualified
                                                                                                         and the IRS authorizes such status on an              a qualified derivatives dealer (including
                                                 intermediary meets the requirements to
                                                                                                         interim basis under such procedures as                its performance of a periodic review
                                                 act as a qualified derivatives dealer as
                                                                                                         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
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                                                 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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                                                 56890             Federal Register / Vol. 80, No. 181 / Friday, September 18, 2015 / Rules and Regulations

                                                 ■ 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
                                                 when—                                                                                                           option, both CO and CB are withholding
                                                                                                           timely provide information regarding                  agents as described in paragraph (a)(1) of this
                                                    (A) The amount of a dividend                           whether a transaction is a section
                                                 equivalent is determined as provided in                                                                         section.
                                                                                                           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                                                                          (c)(2)(i)(N) as (c)(2)(i)(O) and (c)(2)(i)(M)
                                                                                                           then the failure to withhold is imputed
                                                 to or by the long party;                                                                                        as (c)(2)(i)(N).
                                                                                                           to the party required to make the
                                                    (B) In the case of a section 871(m)                                                                          ■ 2. Adding paragraph (c)(2)(i)(M).
                                                                                                           determinations described in § 1.871–
                                                 transaction described in § 1.871–                                                                               ■ 3. Redesignating paragraph
                                                                                                           15(p). In that case, the IRS may collect
                                                 15(i)(3), a payment is treated as being                                                                         (c)(2)(ii)(K) as (c)(2)(ii)(L) and
                                                                                                           any underwithheld amount from the
                                                 made at the end of the applicable                                                                               redesignating paragraph (c)(2)(ii)(J) as
                                                                                                           party to the transaction that was
                                                 calendar quarter; or                                                                                            (c)(2)(ii)(K)
                                                                                                           required to make the determinations
                                                    (C) The long party sells, exchanges,                                                                         ■ 4. Adding paragraph (c)(2)(ii)(J).
                                                                                                           described in § 1.871–15(p) or timely
                                                 transfers, or otherwise disposes of the
                                                                                                           provide the information and subject that              § 1.1461–1   Payments and returns of tax
                                                 section 871(m) transaction (including by
                                                                                                           party to applicable interest and                      withheld.
                                                 settlement, offset, termination,
                                                                                                           penalties as if the party were a                      *      *    *      *      *
                                                 expiration, lapse, or maturity).
                                                                                                           withholding agent with respect to the                   (c) * * *
                                                    (iii) Premiums and other upfront
                                                                                                           payment of the dividend equivalent                      (2) * * *
                                                 payments. When a long party pays a
                                                                                                           made pursuant to the section 871(m)                     (i) * * *
                                                 premium or other upfront payment to
                                                                                                           transaction.                                            (M) Any dividend or any payment
                                                 the short party at the time a section
                                                                                                              (3) Effective/applicability date. Except           that references the payment of a
                                                 871(m) transaction is issued, the
                                                                                                           for the first sentence of paragraph (h)(1),           dividend from an underlying security
                                                 premium or other upfront payment is
                                                                                                           this paragraph (h) applies to payments                pursuant to a securities lending or sale-
                                                 not treated as a payment for purposes of
                                                                                                           made on or after September 18, 2015.                  repurchase transaction paid to a
                                                 paragraph (e)(8)(ii)(A) of this section.
                                                                                                           The first sentence of paragraph (h)(1) of             qualified derivatives dealer even when
                                                 *       *    *    *      *                                this section, applies to payments made
                                                    (f) * * * Paragraph (e)(8) of this                                                                           the withholding agent is not required to
                                                                                                           on or after January 23, 2012.                         withhold on the payment pursuant to
                                                 section applies to payments made on or
                                                                                                           *      *     *     *    *                             § 1.1441–1(b)(4)(xxi), (xxii), or (xxiii);
                                                 after September 18, 2015.
                                                                                                           ■ Par. 9. Section 1.1441–7 is amended                 *      *    *      *      *
                                                 ■ Par. 8. Section 1.1441–3 is amended
                                                 by:                                                       by:                                                     (ii) * * *
                                                                                                           ■ 1. Adding Example 7 to paragraph                      (J) Except as provided in § 1.1461–
                                                 ■ 1. Adding a second sentence to
                                                 paragraph (h)(1).                                         (a)(3).                                               1(c)(2)(i)(M), any payment to a qualified
                                                                                                           ■ 2. Adding a second sentence to                      derivatives dealer when the withholding
                                                 ■ 2. Redesignating paragraph (h)(2) as
                                                 (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).
                                                   (h) * * *                                               counterparty clearing and settlement service
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                                                                                                           provider for derivatives exchanges in the
                                                                                                                                                                   The additions read as follows:
                                                   (1) * * * Withholding is required on
                                                                                                           United States. CB is a broker organized in            § 1.1473–1   Section 1473 definitions.
                                                 the amount of the dividend equivalent
                                                                                                           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–


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                                                                  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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Document Created: 2015-12-15 09:27:26
Document Modified: 2015-12-15 09:27:26
CategoryRegulatory Information
CollectionFederal Register
sudoc ClassAE 2.7:
GS 4.107:
AE 2.106:
PublisherOffice of the Federal Register, National Archives and Records Administration
SectionRules and Regulations
ActionFinal regulations and temporary regulations.
ContactD. Peter Merkel or Karen Walny at (202) 317-6938 (not a toll-free number).
FR Citation80 FR 56865 
RIN Number1545-BJ56
CFR AssociatedIncome Taxes and Reporting and Recordkeeping Requirements

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