Cadwalader attorneys reviewed an IRS proposal to revise the qualified intermediary ("QI") agreement. The proposal addresses cascading U.S. withholding tax on dividends and "dividend equivalents" that are received and paid by qualified derivatives dealers ("QDDs") with respect to U.S. equity securities. Section 871(m) of the Internal Revenue Code imposes withholding on "dividend equivalents" that are paid on derivatives that reference U.S. equity securities. (For further discussion on Section 871(m), see also: Cadwalader Clients & Friends Memo). The attorneys explained that Section 871(m) regulations can result in multiple withholdings on the same stream of dividends. For example, when a non-U.S. bank holds U.S. stock, and issues derivatives with respect to the stock to non-U.S. investors, the non-U.S. bank may be subject to withholding on dividends paid on the stock, and also may be required to withhold on the dividend equivalents that it pays on the derivatives.

The attorneys emphasized that the newly proposed rules under Notice 2016-42 would mitigate cascading withholding by expanding the QI regime to include QDDs. Under the proposed rules, a QDD is a QI that is either:

  • a securities dealer regulated as a dealer in the jurisdiction in which it was organized or operates; or
  • a bank, regulated as a bank in the jurisdiction in which it was organized or operates (or a wholly owned affiliate of such a bank), that issues U.S. equity derivatives to customers and receives dividends or dividend equivalent payments on its hedges of these derivatives.

A QDD would not be subject to withholding on dividends or dividend equivalents that it received as a principal if:

  • it assumed primary withholding and reporting responsibilities with respect to the payments;
  • it agreed to remain liable for any tax on dividends and dividend equivalents received to the extent that it did not make offsetting payments as a short party on another transaction that referenced the same stock; and
  • it followed certain compliance procedures.

The new QI agreement becomes effective on January 1, 2017 for QIs that signed or renewed the agreement before March 31, 2017.

Click here to view the Cadwalader memorandum authored by Mark Howe, Jason Schwartz, Brian Foster, Ray Shirazi and Steve Lofchie.

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