The government filed on Jan. 19 a notice of proposed rulemaking (REG-120282-10) and temporary regulations (TD 9572) under section 871(m). The section treats any notional principal contract as a "specified notional principal contract" subject to these rules after September 14, 2012, unless the Secretary determines that the contract doesn't have the potential for tax avoidance. The temporary rules provide guidance that the statutory definition of the term "specified notional principal contract" shall apply for March through December 2012. The proposed regulations would apply in January 2013 and set out seven factors for determining whether an equity swap is subject to withholding--a swap that satisfies any one of the factors will be. Examples include short-term swaps (90 days), swaps where the short party posts the underlying security as collateral, and equity swaps on stocks that are not regularly traded on an exchange. The idea was to provide bright-line rules that would give participants certainty regarding the applicability of withholding.
Section 871(m) was enacted as part of the HIRE act, and provided that dividend-equivalent payments to foreign persons would be treated as a dividend from sources within the U.S and subject to withholding. (Dividend equivalent payments are a substitute for dividends made pursuant to a securities lending transaction or sale-repuchase transaction or determined by reference to a payment of a dividend on an underlying security in a notional principal contract or swap.) The provision allows the Treasury Secretary to treat payments on other derivatives in the same manner, such as those on forward contracts on US stocks, if it is determined that those payments are substantially similar to dividend-equivalent payments. The preamble notes that Treasury will monitor equity-linked transactions closely to see if other types of derivatives should be encompassed in these rules.
The archetypal notional principal contract is an interest rate swap, such as a fixed for float swap. Corporations, for example, may swap a floating rate on debt issued in the public markets for a fixed rate, thereby hedging the risk of rate increases over the term of the swap. But equity swaps, in which one party receives dividend-equivalent payments on referenced equity issues have surged in use since their development. A typical swap may provide that a foreign corporation receives a payment equal to the appreciation on the referenced security as well as dividend-equivalent payments in respect of dividends issued during the term of the contract. The bank that enters into the swap as a counterparty would receive payments based on depreciation and a payment based on LIBOR or another interest rate index.
Recent Comments