Stroock Special Bulletin
"IRS Releases 871(m) Final Regulations – New Tests for Dividend Equivalents"
On September 17, 2015, the Internal Revenue Service released final regulations governing “dividend equivalent” payments under Code Section 871(m). These regulations, which build on proposed regulations from 2013, provide guidance for both non-U.S. holders of certain financial products with payments determined by reference to U.S.-source dividend payments, and for potential withholding agents. As the regulations outline, certain such payments are treated as dividend equivalent payments and thus, like dividends, are subject to withholding under Code Section 871 (either at a 30% default rate, or at the rate specified for dividends in an applicable foreign-U.S. treaty, often 15%).
This Stroock Special Bulletin provides a brief overview of several salient aspects of these regulations – which, in particular, provide an outline of a “delta test” for determining when certain notional principal contracts (“NPCs”) and equity-linked instruments (“ELIs”) are specified contracts that would result in dividend equivalent payments. The delta test applies to “simple” contracts. A simple contract is defined as an NPC or an ELI for which, with respect to each underlying security, 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, provided that the number can be ascertained when the contract is issued, and for which there is a single maturity or exercise date with respect to which all amounts (other than an upfront payment and periodic payments) are required to be calculated with respect to the underlying security.
In the preamble to the final regulations, the Service notes that “most NPCs and ELIs are expected to be simple contracts and remain subject to the delta test.” Underlying securities do not include stocks or other financial instruments that would not generate U.S. source dividend payments if a payment was made on them.