Notice 2017-42 Delays Effective/Applicability Dates in Dividend Equivalent Rules
Notice 2017-42 (the “Notice”) provides taxpayers with additional guidance for complying with final and temporary regulations under Sections 871(m), 1441, 1461, and 1473 of the Internal Revenue Code (collectively referred to as the “Section 871(m) regulations”) in calendar year 2018 and 2019. The Department of the Treasury and the Internal Revenue Service (collectively, “Treasury”) announced in the Notice their intention to amend the Section 871(m) regulations to delay the effective/applicability date of certain rules in those final regulations and also extend the phase-in period provided in Notice 2016-76 for certain provisions of the Section 871(m) regulations.
The anti-abuse rule provided in Treas. Reg. §1.871-15(o) will continue to apply during the phase-in years described in the Notice. As a result, a transaction that would not otherwise be treated as a Section 871(m) transaction (including as a result of the Notice) may be a Section 871(m) transaction under Treas. Reg. §1.871-15(o).
Consistent with Executive Order 13777 (82 FR 12285), the Notice states that Treasury continues to evaluate the Section 871(m) regulations and consider possible agency actions that may reduce unnecessary burdens imposed on regulations.
Section 871(m) treats dividend equivalents as U.S.-source dividends generally subject to withholding for Chapter 3 and 4 purposes. Over the past several years, Treasury issued final and temporary Treasury Regulations (TD 9734 and TD 9815), a Notice (Notice 2016-76), and a Revenue Procedure (Rev. Proc. 2017-15) providing guidance for taxpayers and withholding agents to comply with Section 871(m).
The Notice delays the applicability date for certain rules in the Section 871(m) regulations and also extends the phase-in period provided in Notice 2016-76 for certain provisions of the Section 871(m) regulations.
In particular, the Notice states that:
- Treasury intends to revise the effective/applicability date for Treas. Reg. §1.871-15(d)(2) and (e) to provide that these rules will not apply to any payment made with respect to any non-delta-one transaction issued before January 1, 2019;
- The IRS will take into account the extent to which the taxpayer or withholding agent made a good faith effort to comply with the Section 871(m) regulations in enforcing the Section 871(m) regulations for (1) any delta-one transaction in calendar year 2017 and 2018, and (2) any non-delta-one transaction that is a Section 871(m) transaction pursuant to Treas. Reg. §1.871-15(d)(2) or (e) in calendar year 2019;
- For purposes of the IRS’s enforcement and administration of the qualified derivatives dealer (“QDD”) rules in the Section 871(m) regulations and the relevant provisions of the final qualified intermediary withholding agreement (the “2017 QI Agreement”), the Notice extends through calendar year 2018 the period during which the IRS will take into account the extent to which the QDD made a good faith effort to comply with Section 871(m) regulations and the relevant provisions of the 2017 QI Agreement;
- The IRS intends to revise the 2017 QI Agreement to provide that a QDD will be considered to satisfy the obligations that apply specifically to a QDD under that agreement for calendar year 2018 provided that the QDD makes a good faith effort to comply with the relevant provisions of the 2017 QI Agreement;
- The period during which the simplified standard for combined transactions provided in Notice 2016-76 for withholding agents to determine whether transactions entered into are combined transactions is extended to include calendar year 2018. Transactions that are entered into in calendar year 2017 and 2018 that are combined under this simplified standard will continue to be treated as combined transactions for future years and will not cease to be combined transactions as a result of applying Treas. Reg. §1.871-15(n) or disposing of less than all of the potential Section 871(m) transactions that are combined under this rule. Transactions that are entered into in calendar year 2017 and 2018 that are not combined under this simplified standard will not become combined transactions as a result of applying Treas. Reg. §1.871-15(n) to these transactions in future years, unless a reissuance or other event causes the transactions to be retested to determine whether they are Section 871(m) transactions.This simplified standard applies only to withholding agents, and does not apply to taxpayers that are long parties to potential Section 871(m) transactions;
- Treasury intends to amend Treas. Reg. §§ 1.871-15(q)(1) and (r)(3), and 1.1441-1(b)(4)(xxii)(C) to provide that a QDD will not be subject to tax on dividends and dividend equivalents received in calendar year 2017 and 2018 in its equity derivatives dealer capacity or withholding on dividends (including deemed dividends);
- A QDD will be required to compute its Section 871(m) amount using the net delta approach provided in Section 4.01(1) of Rev. Proc. 2017-15 beginning in calendar year 2019. A QDD will remain liable for tax under Section 881(a)(1) on dividends and dividend equivalents that it receives in any capacity other than as an equity derivatives dealer, and on any other U.S.-source FDAP payments that it receives (whether or not in its equity derivatives dealer capacity). In addition, a QDD is responsible for withholding on dividend equivalents it pays to a foreign person on a Section 871(m) transaction, whether acting in its capacity as an equity derivative dealer or otherwise; and
- A QDD is not required to perform a periodic review with respect to its QDD activities for calendar year 2017 and 2018. Note that a QDD must use the same year for the periodic review of its QI activities and its QDD activities. A QI that is a QDD must choose 2019 or a later year within its periodic review period in which to perform its periodic review unless its applicable periodic review period ends in 2018 or an earlier year.
Before the promulgation of the amendments to the Section 871(m) regulations and the 2017 QI Agreement, taxpayers may rely on the provisions of the Notice regarding the proposed amendments discussed above. Withholding agents may rely on the simplified standard for determining whether transactions are combined transactions as described above.
The delay in the applicability/effective date for certain rules in the Section 871(m) regulations and extension of the phase-in period should provide valuable time to dealers, issuers and other withholding agents to test and further develop their withholding and reporting systems needed to comply with the Section 871(m) regulations.
After the issuance of the Notice, it should be noted that the U.S. Chamber of Commerce requested that the regulations under Section 871(m), along with certain other controversial regulations, be included for review under President Trump’s Executive Order 13789, a directive designed to reduce tax regulatory burdens. If these regulations are identified for review, they could be modified or, as recommended by the U.S. Chamber of Commerce, withdrawn back to the in-scope definition adopted by the September 2015 final regulations in TD 9734.
 See, Treas. Reg. §1.871-15(g)(2) (providing that the delta of a potential Section 871(m) transaction generally is determined on the earlier of when the transaction is (1) priced or (2) reissued); see, also Treas. Reg. §1.871-15(a)(6) (defining the term “issue” to include “an issuance as a result of a deemed exchange pursuant to Section 1001”).