On 16 December 2019, the IRS published Notice 2020-02 extending the transitional relief with respect to certain requirements under the Sec. 871(m) regime for another two years. This is good news for all financial institutions involved in the issuance, or trade, of financial instruments referencing US stock.
In addition, certain temporary provisions in the Sec. 871(m) regulations were finalised and published in the Federal Register on 17 December 2019. Similarly, final QI and FATCA regulations were published in the Federal Register on 2 January 2020. Overall, the regulations formalized pre-announced updates and there were no surprises.
Notice 2020-02 defers the full application of Sec. 871(m) as follows:
- The application of Sec. 871(m) to transactions that have a delta of 0.8 or greater but are non-delta-one transactions is delayed until 1 January 2023. Thus, transactions entered into between 1 January 2017 and 31 December 2022 are only subject to US withholding and reporting if they qualify as delta-one transactions.
- The good faith effort standard is further extended and now applies to any delta-one transaction in 2017 through 2022, and any non-delta-one transaction in 2023.
- The period during which a withholding agent is allowed to rely on the simplified standard for combined transactions (as described in Notice 2017-42) is extended to include 2021 and 2022.
- The exception from withholding on dividends and dividend equivalents received by a Qualified Derivatives Dealer (QDD) in its equity derivatives dealer capacity (i.e. for hedging purposes) is extended until 31 December 2022.
- The requirement for a QDD to compute its Sec. 871(m) amount using the net delta approach will only apply as of 2023. Until then, a QDD must only consider for its QDD tax liability dividend equivalents received in a non-equity derivatives dealer capacity (i.e. as part of its proprietary trading) and other US source fixed or determinable annual or periodic (FDAP) payments for which the full US tax liability was not satisfied by withholding (irrespective of whether or not they were received in an equity derivatives dealer capacity).
- The exception from reviewing QDD activities during the QI periodic review is extended to all review years until and including 2022 and the IRS will take into account the extent to which a QDD made a good faith effort to comply with its obligations through 2022.
- For its first certification period ending after 2022, a QDD must choose 2023 or a later year for the periodic review. For example, a QDD whose Qualified Intermediary (QI) Agreement entered into force on 1 July 2014 must select 2023 for its periodic review for its third certification period ending on 31 December 2023.
- The Qualified Securities Lender (QSL) regime is extended by two more years until 31 December 2022.
Final Sec. 871(m) regulations
Compared to Notice 2020-02, the final Sec. 871(m) regulations do not include any ground-breaking news, but were a rather formal act to confirm previously proposed definitions and concepts.
Final QI and FATCA regulations
Generally, the final QI and FATCA regulations incorporate temporary rules from January 2017 and December 2018 as well as Notice 2017-46 and 2018-20. Key areas include:
- Limited 3-year validity period for treaty statements,
- Validation of treaty claims with respect to limitation on benefits (LOB) provision and existence of a treaty,
- Possibility to use simplified withholding statements for accounts of non-qualified intermediaries and flow-through entities,
- Reliance on permanent residence addresses subject to hold mail instruction,
- Requirement to collect a non-US taxpayer identification number (TIN) and date of birth for an account maintained in the US, and
- Reliance on electronically signed forms and forms furnished through a third party repository.
Obviously, the additional delay provided in Notice 2020-02 is good news for the financial industry. Nevertheless, postponed is not abandoned, which means that there are two more years of regulatory uncertainty. Hope continues that the IRS will use those two years wisely and timely publish necessary guidance around open points (e.g. with respect to the combined transaction rules and the net delta approach) providing financial institutions with sufficient time for implementation in anticipation of the new milestone that is 1 January 2023. Finally, withholding agents should keep in mind that the good faith effort standard does not apply to dividend equivalents they receive in their intermediary capacity (e.g. as a QI). Thus, in anticipation of the next round of QI reviews, QIs should carefully consider whether their QI compliance program sufficiently addresses the handling of Sec. 871(m) transactions, e.g. where they hold in custody for their clients structured products or exchange-traded derivatives referencing US stocks.
On the other side, the final regulations did not include any welcome surprises but instead only formalized pre-announced updates. Most unfortunately for non-US financial institutions, the IRS did not listen to the respective industry comments and actually confirmed the limited 3-year validity period for treaty statements, which will increase the QI documentation efforts going forward.
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