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Section 871(m) dividend equivalent rules phase-in period further extended
June 2024
In brief
What happened?
Treasury and the IRS on May 22 issued Notice 2024-44, providing a further extension of the transition relief phase-in period of the regulations under Section 871(m) for select transactions through 2026. The notice also extends the phase-in period previously provided for certain Section 871(m) regulations provisions and permits withholding agents to apply the transition rules from Notice 2010-46 in 2025 and 2026.
Notice 2024-44 also provides that the anti-abuse rule in Reg. 1.871-15(o) will continue to apply to the phased-in application of the Section 871(m) regulations and that, as a result, a transaction that otherwise would not be treated as a Section 871(m) transaction may be treated as such.
Why is it relevant?
Without the extension provided in Notice 2024-44, Section 871(m) transition relief would have terminated at the end of 2024. The relief provided under Notice 2024-44 mirrors the relief provided in prior Section 871(m) delay notices.
Action to consider
No new actions are required at this time; however, withholding agents should continue to monitor for future guidance regarding the development of the Section 871(m) regulations and should ensure that they remain compliant with the requirements under the transitional relief.
In detail
Background – 2017 regulations
Treasury in January 2017 published final, temporary, and proposed regulations under Section 871(m). The 2017 regulations generally impose a withholding tax on ‘dividend equivalent amounts’ paid or deemed paid to non-US taxpayers on derivatives over US equities.
The 2017 regulations:
- Provided that Section 871(m) will apply to delta-one transactions for 2017 (consistent with Notice 2016-76, which provided that the IRS will consider the extent to which the taxpayer or withholding agent made a good-faith effort to comply with the Section 871(m) regulations);
- Provided for changes to the treatment of payments made to qualified derivatives dealers (QDDs) and calculation of their tax liability; and
- Addressed numerous comments made with respect to previous Section 871(m) regulations, including providing clarification with respect to the timing of the determination of delta, the ability for withholding agents to choose to withhold on the underlying dividend payment date, and the treatment of parties to Section 871(m) transactions.
Prior notices
Treasury and the IRS separately issued several notices that provide transition rules, provide a phase-in period for certain provisions of the Section 871(m) regulations, and defer the effective date for portions of the regulations under Section 871(m) (see Notices 2010-46, 2016-76, 2017-42, 2018-5, 2018-72, 2020-2, and 2022-37). The various notices provide the following:
- Transactions in-scope based on their delta are limited to ‘delta one’ transactions; as a result, transactions with a delta less than 1 but greater than 0.8 (delta .80 transactions) generally will not be in scope until a specified date;
- The simplified combination rule will continue to apply for withholding agents until a specified date;
- Withholding on actual and deemed dividends paid to QDDs is deferred until a specified date;
- The good-faith periods for the implementation of Section 871(m) are extended; and
- Withholding agents are permitted to apply the transition rules from Notice 2010-46.
Extension of the phase-in years for delta-one and non-delta-one transactions
Notice 2024-44 provides that the Section 871(m) regulations will (1) continue to apply only to any delta-one transaction entered into through the end of 2026 (this limitation was due to expire at the end of 2024), and (2) begin to apply to any non-delta-one transaction that is a Section 871(m) transaction pursuant to Reg. 1.871- 15(d)(2) or (e) in 2027 (i.e., any derivative with a delta of 0.8 or greater or that fails the “substantial equivalent test”). A delta-one transaction is a transaction in which the value of the derivative moves in tandem with the underlying asset on which the derivative is based and the change in value is one-to-one.
Notice 2024-44 provides that the anti-abuse rule in Reg. 1.871-15(o) will continue to apply to the phased-in application of the Section 871(m) regulations, including for the purpose of determining whether a transaction is a delta-one transaction. Due to the anti-abuse rule, a transaction that otherwise would not be treated as a Section 871(m) transaction may be treated as one.
For purposes of IRS enforcement and administration of the QDD rules in the Section 871(m) regulations and the relevant provisions of the 2023 QI Agreement, Notice 2024-44 extends through 2026 the period during which the IRS will take into account the extent to which the QDD made a good-faith effort to comply with the Section 871(m) regulations and the relevant provisions of the 2023 QI Agreement.
Extension of the simplified standard for determining whether transactions are combined transactions
Notice 2024-44 provides that a withholding agent must combine transactions entered in 2017 through 2026 for purposes of determining whether the transactions are Section 871(m) transactions only when the transactions are over-the-counter transactions that are priced, marketed, or sold in connection with each other (the “simplified standard”). Withholding agents are not required to combine any listed security transactions entered in 2017 through 2026.
Transactions that are entered into in 2017 through 2026 that are combined will continue to be treated as combined transactions for future years and will not cease to be combined transactions because of applying Reg. 1.871-15(n) or disposing of less than all the potential Section 871(m) transactions that are combined under this rule.
Transactions that are entered into in 2017 through 2026 that are not combined will not become combined transactions because of applying 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. The anti-abuse rule continues to apply to the phased-in application of the Section 871(m) regulations, including to determine whether multiple transactions should be combined.
Extension of phase-in relief for QDDs
Under the Section 871(m) regulations, a QDD may rely on the net delta exposure test to determine its residual exposure to underlying securities. That is, if it has a net delta of zero (i.e., no net economic exposure) in respect of an underlying security at the relevant time, then it generally would not have a Section 871(m) liability in respect of that position on that date.
However, to address the concern that the exemption from withholding on dividends paid to a QDD, when combined with the net delta exposure method, could result in US source dividends escaping US tax completely in certain circumstances, a QDD remains liable for tax under Section 881(a)(1) and subject to withholding under chapters 3 and 4 on dividends. To allow taxpayers time to implement the net delta exposure method, dividends and deemed dividends received by a QDD in its equity derivatives dealer capacity in 2017 through 2026 are not subject to tax under Section 881(a)(1) or subject to withholding under chapters 3 and 4.
Notice 2024-44 provides that a QDD will be required to compute its Section 871(m) amount using the net delta exposure method beginning in 2027. 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 US-source fixed, determinable, annual, or periodical income 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 derivatives dealer or otherwise.
Extension of transition rules for payments to a qualified securities lender
Notice 2024-44 extends the qualified securities lending transition rules described in Notice 2010-46 to include payments made in 2025 and 2026. The qualified securities lender (QSL) regime requires a person that agrees to act as a QSL to comply with certain withholding and documentation requirements. Notice 2010-46 addresses potential overwithholding in the context of securities lending and sale-repurchase agreements. It provides an exception from withholding for payments to a QSL. Treasury and the IRS permit withholding agents to rely on transition rules described in Notice 2010-46 until guidance is developed that would include documentation and substantiation of withholding.
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