[Federal Register Volume 82, Number 14 (Tuesday, January 24, 2017)]
[Rules and Regulations]
[Pages 8144-8165]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-01163]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9815]
RIN 1545-BM33


Dividend Equivalents From Sources Within the United States

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and temporary regulations.

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SUMMARY: This document provides guidance to nonresident alien 
individuals and foreign corporations that hold certain financial 
products providing for payments that are contingent upon or determined 
by reference to U.S. source dividend payments. This document also 
provides guidance to withholding agents that are responsible for 
withholding U.S. tax with respect to a dividend equivalent, as well as 
certain other parties to section 871(m) transactions and their agents.

DATES: Effective Date: These regulations are effective on January 19, 
2017.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.871-15(r); 1.871-15T(r)(4); 1.1441-1(f)(5); 1.1441-2(f); 1.1441-
7(a)(4); 1.1461-1(i).

FOR FURTHER INFORMATION CONTACT: D. Peter Merkel or Karen Walny at 
(202) 317-6938 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collection of information contained in these final regulations 
has been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under control numbers 1545-0096 and 1545-1597. The collections 
of information in these regulations are in Sec.  1.871-15T(p) and are 
an increase in the total annual burden in the current regulations under 
Sec. Sec.  1.1441-1 through 1.1441-9. This information is required to 
establish whether a payment is treated as a U.S. source dividend for 
purposes of section 871(m) of the Internal Revenue Code (Code). This 
information will be used for audit and examination purposes. The IRS 
intends that these information collection requirements will be 
satisfied by persons complying with chapter 3 reporting requirements 
and the requirements of the applicable qualified intermediary (QI) 
revenue procedure, or alternative certification and documentation 
requirements set out in these regulations. An agency may not conduct or 
sponsor, and a person is not required to respond to, a collection of 
information unless it displays a valid control number.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
return information are confidential, as required by 26 U.S.C. 6103.

Background

    On January 23, 2012, the Federal Register published temporary 
regulations (TD 9572) at 77 FR 3108 (2012 temporary regulations), and a 
notice of proposed rulemaking by cross-reference to the temporary 
regulations and notice of public hearing at 77 FR 3202 (2012 proposed 
regulations, and together with the 2012 temporary regulations, 2012 
section 871(m) regulations) under section 871(m) of the Code. The 2012 
section 871(m) regulations relate to dividend equivalents from sources 
within the United States paid to nonresident alien individuals and 
foreign corporations. Corrections to the 2012 temporary regulations 
were published on February 6, 2012, and March 8, 2012, in the Federal 
Register at 77 FR 5700 and 77 FR 13969, respectively. A correcting 
amendment to the 2012 temporary regulations was also published on 
August 31, 2012, in the Federal Register at 77 FR 53141. The Department 
of the Treasury (Treasury Department) and the IRS received written 
comments on the 2012 proposed regulations, and a public hearing was 
held on April 27, 2012.
    On December 5, 2013, the Federal Register published final 
regulations and removal of temporary regulations (TD 9648) at 78 FR 
73079 (2013 final regulations), which finalized a portion of the 2012 
section 871(m) regulations. On the same date, the Federal Register 
published a withdrawal of notice of proposed rulemaking, a notice of 
proposed rulemaking, and a notice of public hearing at 78 FR 73128 
(2013 proposed regulations). In light of comments on the 2012 proposed 
regulations, the 2013 proposed regulations described a new approach for 
determining whether a payment made pursuant to a notional principal 
contract (NPC) or an equity-linked instrument (ELI) is a dividend 
equivalent based on the delta of the contract. In response to written 
comments on the 2013 proposed regulations, the Treasury Department and 
the IRS released Notice 2014-14, 2014-13 IRB 881, on March 24, 2014 
(see Sec.  601.601(d)(2)(ii)(b)), stating that the Treasury Department 
and the IRS anticipated limiting the application of the rules with 
respect to specified ELIs described in the 2013 proposed regulations to 
ELIs issued on or after 90 days after the date of publication of final 
regulations.
    On September 18, 2015, the Federal Register published final 
regulations and temporary regulations (TD 9734), at 80 FR 56866, which 
finalized a portion of the 2013 proposed regulations and

[[Page 8145]]

introduced new temporary regulations based on comments received with 
respect to the 2013 proposed regulations (2015 final regulations and 
2015 temporary regulations, respectively, and together, the 2015 
regulations). On the same date, the Federal Register published a notice 
of proposed rulemaking by cross-reference to temporary regulations and 
a notice of public hearing at 80 FR 56415 (2015 proposed regulations, 
and together with the 2015 final regulations, 2015 section 871(m) 
regulations). A correcting amendment to the 2015 final regulations and 
the 2015 proposed regulations was published on December 7, 2015, in the 
Federal Register at 80 FR 75946 and 80 FR 75956, respectively.
    The Treasury Department and the IRS received written comments on 
the 2015 proposed regulations, which are available at 
www.regulations.gov. The public hearing scheduled for January 15, 2016, 
was cancelled because no request to speak was received.
    On July 1, 2016, the Treasury Department and the IRS released 
Notice 2016-42, 2016-29 IRB 67 (see Sec.  601.601(d)(2)(ii)(b)) (QI 
Notice), containing a proposed amended qualified intermediary 
agreement. The QI Notice included the requirements and obligations 
applicable to a QI that acts as a qualified derivatives dealer (QDD). 
The Treasury Department and the IRS received written comments on Notice 
2016-42, which to the extent related to section 871(m) and QDDs are 
discussed in the ``Qualified Derivatives Dealer'' section of this 
preamble. On December 30, 2016, the Treasury Department and the IRS 
released Revenue Procedure 2017-15, 2017-3 IRB 437 (2017 QI Agreement), 
which contains the final QI withholding agreement and the requirements 
and obligations applicable to QDDs.
    On December 2, 2016, the Treasury Department and the IRS released 
Notice 2016-76, 2016-51 IRB 834, providing guidance for complying with 
the final and temporary regulations under sections 871(m) and 1441, 
1461, and 1473 in 2017 and 2018 and explaining how the IRS intends to 
administer those regulations in 2017 and 2018.
    On March 6, 2014, temporary regulations (TD 9658) revising certain 
provisions of the final chapters 3 and 61 regulations were published in 
the Federal Register (79 FR 12726), and corrections to those temporary 
regulations were published in the Federal Register (79 FR 37181) on 
July 1, 2014. Those regulations were issued to coordinate with certain 
provisions of the 2013 final chapter 4 regulations, as well as 
temporary regulations (TD 9657) under chapter 4 published in the 
Federal Register (79 FR 12812). A notice of proposed rulemaking cross-
referencing the 2014 temporary coordination regulations was published 
in the Federal Register on March 6, 2014 (79 FR 12880). On January 6, 
2017, the Treasury Department and IRS published in the Federal Register 
(82 FR 2046) final chapters 3 and 61 regulations, as well as temporary 
regulations (TD 9808).
    This Treasury decision generally adopts the 2015 proposed 
regulations with the changes discussed in this preamble. This Treasury 
decision also includes several technical amendments to the 2015 final 
regulations in response to comments on those regulations, which are 
discussed in this preamble. Finally, this Treasury decision provides 
new temporary regulations based on comments received with respect to 
the 2015 proposed regulations.

Summary of Comments and Explanation of Provisions

I. Technical Corrections to Certain Definitions

A. Broker

    Section 1.871-15(p) generally provides that a broker or dealer is 
responsible for determining whether a potential section 871(m) 
transaction is a section 871(m) transaction and for reporting to the 
customer the timing and amount of any dividend equivalent. Section 
1.871-15(a)(1) defines the term broker as ``a broker within the meaning 
provided in section 6045(c).'' Comments explained that many regulated 
investment companies satisfy the definition of a broker under section 
6045(c) and the regulations thereunder because the term broker includes 
a corporation that regularly redeems its own shares. The comments noted 
that these regulated investment companies may enter into transactions 
as a short party with a foreign financial institution who is the long 
party. In these transactions, the comments asserted, the foreign 
financial institution (not the regulated investment company) is more 
capable of determining delta and making other calculations.
    The Treasury Department and the IRS agree that an entity should not 
be treated as a broker for purposes of section 871(m) solely because it 
redeems its own shares. The rules are intended to assign responsibility 
for making the determinations related to potential section 871(m) 
transactions to the party that regularly enters into equity derivatives 
with customers or holds equity derivatives on behalf of customers. When 
a regulated investment company is the short party in a transaction with 
a financial institution, the Treasury Department and the IRS agree that 
the financial institution is in the better position to determine delta 
and make other determinations required by section 871(m). Accordingly, 
the definition of the term broker has been revised in the temporary 
regulations so that it will not apply to a corporation that would be 
treated as a broker pursuant to section 6045(c) solely because it 
regularly redeems its own shares.

B. Dividend Equivalents

    Section 1.871-15(c) provides that, subject to certain exceptions, a 
dividend equivalent includes any payment that references the payment of 
a dividend from an underlying security pursuant to a securities lending 
or sale-repurchase transaction, specified NPC, or specified ELI. A 
dividend is defined in Sec.  1.871-15(a)(3) as ``a dividend as 
described in section 316.'' Section 1.871-15(c)(2)(ii) reduces a 
dividend equivalent by any amount treated in accordance with sections 
305(b) and (c) as a dividend (a ``section 305(c) dividend'') with 
respect to the underlying security referenced by the section 871(m) 
transaction.
    A comment suggested that the regulations clarify how this rule 
applies when a derivative references an underlying security that has a 
section 305(c) dividend. Another comment noted that Sec.  1.871-
15(c)(2)(ii) reduces the dividend equivalent amount by section 305(c) 
dividends, and that this reduction arguably applies both to the person 
who holds the underlying security giving rise to the section 305(c) 
dividend and to a holder of a section 871(m) transaction that 
references the underlying security that gives rise to the section 
305(c) dividend.
    To address these comments, these final regulations revise the 
definition of a dividend to explicitly provide that it applies without 
regard to whether there is an actual distribution of cash or property. 
A conforming change is also made to Sec.  1.871-15(c)(2)(ii), which is 
revised to clarify that only a long party that is treated as receiving 
a section 305(c) dividend is entitled to reduce its dividend equivalent 
amount and that a section 305(c) dividend gives rise to a dividend 
equivalent.
    Thus, for example, a long party that owns a convertible note that 
is a section 871(m) transaction and has a section 305(c) dividend can 
reduce its dividend equivalent by the section 305(c) dividend. In 
contrast, a long party that owns a specified NPC that references the 
same convertible note would receive a dividend equivalent that includes 
the

[[Page 8146]]

section 305(c) dividend and would not be entitled to reduce its 
dividend equivalent by the section 305(c) dividend on the convertible 
note because the long party does not own the note, and therefore, is 
not treated as receiving a section 305(c) dividend for federal income 
tax purposes.

C. Simple Contract

    To be a simple contract as defined in Sec.  1.871-15(a)(14)(i), the 
number of shares required to calculate the amounts paid or received on 
any payment determination date must be ascertainable at the time the 
delta for the transaction is calculated. Several comments noted that 
transactions may provide for anti-dilution adjustments to the number of 
shares as a result of certain corporate actions, and that these 
adjustments could cause contracts that otherwise would be simple 
contracts subject to the delta test to become complex contracts subject 
to the more complicated substantial equivalence test. Adjustments that 
are intended to maintain the status quo of shareholders generally 
should not preclude a transaction from being treated as a simple 
contract. Accordingly, a sentence is added to Sec.  1.871-15(a)(14)(i) 
to provide that an adjustment to the number of shares of the underlying 
security for a merger, stock split, cash dividend, or similar corporate 
action that impacts all the holders of the underlying security will not 
prevent the transaction from being a simple contract.

II. Certain Insurance Contracts

    The exceptions for payments made pursuant to annuity, endowment, 
and life insurance contracts were issued as a temporary rule in Sec.  
1.871-15T(c)(2)(iv) of the 2015 temporary regulations. Comments 
generally agreed with the result in Sec.  1.871-15T(c)(2)(iv)(A) with 
respect to insurance contracts issued by domestic insurance companies. 
Several comments requested that Sec.  1.871-15T(c)(2)(iv)(A) be issued 
as a final regulation without any change. These comments noted that any 
U.S. source dividend that a foreign insurer receives on U.S. stock it 
owns with respect to an annuity, endowment, or life insurance contract 
is already subject to withholding tax.
    Another comment recommended changes to make the exception for 
insurance issued by a foreign company more administrable. That comment 
suggested that the regulations be extended to any foreign insurance 
company, without regard to whether the company is predominantly engaged 
in the business of insurance and would be subject to tax under 
subchapter L. This comment also recommended that the regulations define 
the terms ``annuity contract,'' ``insurance contract,'' ``life 
insurance contract,'' ``endowment contract,'' and ``foreign insurance 
company'' based on regulations under section 1471. Finally, the comment 
noted that the requirement that a company be ``predominantly engaged in 
an insurance business'' is unnecessary in light of the requirement that 
a corporation ``would be subject to tax under subchapter L if it were a 
domestic corporation'' because a corporation that would be ``subject to 
tax under subchapter L if it were a domestic corporation'' necessarily 
would be ``predominantly engaged in an insurance business.''
    Comments also recommended that the temporary rule relating to 
reinsurance should be finalized. Another comment noted that reinsurance 
subject to the U.S. federal excise tax under section 4371 is not 
subject to withholding and expressed concern about the interaction of 
the excise tax and the application of section 871(m) if the reinsurance 
exception in the temporary regulations was allowed to expire.
    These regulations finalize Sec.  1.871-15T(c)(2)(iv) with one 
change. The Treasury Department and the IRS agree that a company that 
is taxable under subchapter L as an insurance company is necessarily 
predominantly engaged in an insurance business. Accordingly, in 
finalizing Sec.  1.871-15T(c)(2)(iv)(B), the redundant phrase 
``predominantly engaged in an insurance business '' is removed. 
Although comments suggested other modifications to certain terms and 
the addition of certain defined terms, these final regulations do not 
make these additional changes. The Treasury Department and the IRS have 
determined that the scope of entities and contracts described in the 
temporary regulations as eligible for the exception is appropriate for 
section 871(m), and that it is beyond the scope of these regulations to 
define terms relating to insurance.

III. Determining Delta and the Initial Hedge

    Section 1.871-15(g)(2) provides that the delta of a potential 
section 871(m) transaction is determined only when the contract is 
issued. For this purpose, an NPC or ELI is issued at the time of the 
contract's inception, original issuance, or issuance as a result of a 
deemed exchange pursuant to section 1001. See Sec.  1.871-15(a)(6). The 
same standard is used to determine when a contract is issued for 
purposes of the substantial equivalence test for complex contracts.
    For simple contracts, comments generally suggested changing the 
time for calculating delta to the earlier of the trade date or the date 
on which the parties agreed to the material terms or final pricing for 
the contract. One comment recommended that the date and time when the 
material terms are finalized is the appropriate date for determining 
delta because that is the time when the economic terms of the potential 
section 871(m) transactions are established. Finally, the parties to 
the contract are generally bound by the terms on the pricing date, not 
the settlement date. A comment suggested using the trade date if the 
pricing date is more than 14 days before the issue date because 
providing too long a period between the pricing and issue date may 
present an opportunity for abuse.
    For listed options, comments suggested a different method for 
determining the delta of the contract. These comments recommend that 
the delta for listed options should be based on the closing price from 
the prior trading day. The comments acknowledged that this approach 
would be less accurate than the requirement in the final regulations; 
however, these comments asserted that using the delta calculation from 
the prior day for listed options would substantially reduce the burden 
on taxpayers and make the rules more administrable. Comments also noted 
that the Options Clearing Corporation currently calculates the end-of-
day delta for options listed on U.S. options exchanges.
    For complex contracts, comments recommended that the substantial 
equivalence test should be conducted on the date when the short party's 
hedge is established. According to the comments, the issuer of a 
complex contract enters into a hedge on the pricing date, not the 
settlement date. The pricing date therefore reflects the economics of a 
complex contract more accurately than the settlement date, as long as 
the two dates are not separated by too much time.
    The Treasury Department and the IRS agree with the comments that 
the date for determining delta and for performing the substantial 
equivalence test should be revised to be more administrable and to 
reflect more accurately the economics of the transactions. Accordingly, 
these regulations provide that the delta of a simple contract is 
determined on the earlier of the date that the potential section 871(m) 
transaction is priced and the date when the potential section 871(m) 
transaction is issued; however, the issue date must be used to 
determine the delta if the potential section 871(m) transaction is 
priced

[[Page 8147]]

more than 14 calendar days before it is issued. A similar rule also 
applies to the substantial equivalence test.
    In addition, the regulations provide a new rule for determining the 
delta of an option listed on a regulated exchange. For these options, 
the delta is determined based on the delta of the option at the close 
of business on the business day before the date of issuance. For this 
purpose, the regulations define a regulated exchange. A regulated 
exchange is any exchange defined in Sec.  1.871-15(l)(3)(vii) or a 
foreign exchange that (A) is regulated by a government agency in the 
jurisdiction in which the exchange is located, (B) maintains certain 
requirements designed to protect investors and to prevent fraud and 
manipulation, (C) maintains rules to promote active trading of listed 
options, and (D) had trades for which the notional value exceeded $10 
billion per day during the prior calendar year.
    The 2015 final regulations provided a simplified delta calculation 
for certain simple contracts that reference 10 or more underlying 
securities, provided that the short party uses an exchange-traded 
security that references substantially all the underlying securities to 
hedge the NPC or ELI at the time it is issued (the ``hedge security''). 
The simplified delta calculation allows the short party to calculate 
the delta of the NPC or ELI by reference to changes in the value of the 
hedge security. Comments suggested that this rule be extended to cases 
in which the short party could fully hedge its position by acquiring 
the exchange-traded security even if it does not in fact hedge in this 
manner. Because the exchange-traded security must provide a full hedge 
of the NPC or ELI for this rule to apply, the Treasury Department and 
the IRS agree that the exchange-traded security will provide an 
acceptable delta calculation whether or not the short party actually 
uses that security as its hedge. Accordingly, the regulations are 
amended to permit the delta with respect to those NPCs and ELIs to be 
calculated by determining the ratio of the change in the fair market 
value of the simple contract to a small change in the fair market value 
of an exchanged-traded security when the exchange-traded security would 
fully hedge the NPC or ELI.
    Some comments noted that third-party data, including delta 
calculations, may be available for certain potential section 871(m) 
transactions. These comments requested that the final regulations be 
amended to explicitly permit withholding agents to rely on this data. 
Although the final regulations are not amended, the Treasury Department 
and the IRS note that nothing in the regulations prohibits a taxpayer 
from obtaining information from a third party. While taxpayers and 
withholding agents can use third party data to determine whether a 
potential section 871(m) transaction is a section 871(m) transaction, 
taxpayers and withholding agents that rely on third-party data remain 
responsible for the accuracy of that information.
    One comment noted that the issuer of a structured note (or an 
affiliate of the issuer) may act as a market maker for the structured 
note, and thus may purchase the note in its dealer capacity and then 
sell the note to the market. According to the comment, if the purchase 
is treated as a redemption by the issuer of the instrument for tax 
purposes, the subsequent sale to the market would be treated as a new 
issue for section 871(m) purposes, in which case the delta for the 
instrument (or substantial equivalence test) would need to be 
recomputed at such time. The comment suggested that rules similar to 
those in section 108 with respect to the purchase of debt instruments 
by an issuer acting in a dealer capacity could apply to equity 
derivative structured notes. The Treasury Department and the IRS 
acknowledge the concern raised by the comment. However, the Treasury 
Department and the IRS are concerned that an overly broad exception for 
dealer activity may facilitate transactions that are inconsistent with 
section 871(m) by allowing dealers to offer instruments that would be 
subject to section 871(m) so long as the instruments were originally 
issued with a delta below 0.80. While a dealer that issued such an 
instrument holds the instrument in inventory, the dealer does not need 
to hedge the position with an unrelated party. For this reason, market 
making activity by the issuer of an instrument (or an affiliate of the 
issuer) presents different policy concerns from market making by an 
unrelated dealer. The Treasury Department and the IRS invite further 
comments on the appropriate treatment of structured notes and similar 
instruments that are acquired by the issuer or an affiliate in its 
dealer capacity.

IV. Substantial Equivalence Test

    Comments to the 2013 proposed regulations generally agreed that the 
delta test was fair and practical for the majority of equity-linked 
derivatives. However, comments explained that the delta test would be 
impractical or impossible to apply to more exotic equity derivatives, 
such as structured notes in which the long party's return was 
determined based on an initially indeterminate number of shares of the 
underlying security. The 2015 section 871(m) regulations address this 
concern by providing an alternative test--the ``substantial equivalence 
test''--for contracts with indeterminate deltas. For purposes of 
applying this test, the regulations distinguish between simple and 
complex contracts. Generally, a simple contract is a contract that 
references a single, fixed number of shares and has a single maturity 
or exercise date. A complex contract is any contract that is not a 
simple contract. Contracts with indeterminate deltas are classified as 
complex contracts and are subject to the substantial equivalence test.
    Generally, the substantial equivalence test measures the change in 
value of a complex contract when the price of the underlying security 
referenced by that contract is hypothetically increased by one standard 
deviation or decreased by one standard deviation (each, a ``testing 
price'') and compares that change to the change in value of the shares 
of the underlying security that would be held to hedge the complex 
contract when the contract is issued (the ``initial hedge'') at each 
testing price. The smaller the proportionate difference between the 
change in value of the complex contract and the change in value of its 
initial hedge at multiple testing prices, the more equivalence there is 
between the contract and the referenced underlying security. When this 
difference is equal to or less than the difference for a simple 
contract benchmark with a delta of 0.80 and its initial hedge, the 
complex contract is treated as substantially equivalent to the 
underlying security. When the steps of the substantial equivalence test 
cannot be applied to a particular complex contract, a taxpayer must use 
the principles of the substantial equivalence test to reasonably 
determine whether the complex contract is a section 871(m) transaction 
with respect to each underlying security.
    The Treasury Department and the IRS requested comments regarding 
the substantial equivalence test. In particular, comments were 
requested on whether two testing points were adequate to ensure that 
the test would capture appropriate transactions and on the 
administrability of the test. Comments also were requested on the 
application of the test to complex contracts that reference multiple 
securities, including path-dependent instruments (that is, an 
instrument for which the final value depends, in whole or in part, on 
the price sequence (or

[[Page 8148]]

path) of the underlying security before the maturity of the 
instrument). Comments generally did not recommend material changes to 
the test. As a result, these final regulations adopt the substantial 
equivalence test as proposed in the 2015 proposed regulations with 
minor changes as described in this section.
    One comment noted that the substantial equivalence test might be 
unduly burdensome in certain cases, such as when it is obvious that a 
particular instrument would satisfy the test and application of the 
test would have no effect on the amount of withholding. This comment 
suggested that an issuer of a complex contract be allowed to use an 
alternative test to determine the withholding tax imposed with respect 
to a dividend equivalent as long as the alternative test resulted in 
the same amount of withholding tax as would have been the case if the 
issuer had used the substantial equivalence test. These final 
regulations do not adopt this comment. Even in those cases where the 
result for a potential section 871(m) transaction is intuitive, 
administration of such an alternative approach would generally require 
applying the substantial equivalence test to demonstrate that the 
alternative test results in the same amount of withholding tax as the 
substantial equivalence test. As issuers of complex contracts become 
proficient with the substantial equivalence test it is expected that it 
will be relatively straightforward to determine whether a particular 
instrument is subject to withholding under section 871(m).
    Another comment suggested that the Treasury Department and the IRS 
consider whether the substantial equivalence test could be manipulated 
to allow taxpayers to understate the similarity of a complex contract 
to the underlying security. This comment suggested that more guidance 
should be offered about the criteria for determining whether a simple 
contract is ``closely comparable'' to a complex contract for purposes 
of choosing a simple contract benchmark. The same comment recommended 
that the regulations specify that the benchmark contract could be a 
hypothetical instrument, and that the material terms, including the 
treatment of dividends, should be consistent with the terms of the 
complex contract (aside from the terms that make the contract complex 
and that make the delta of the closely comparable benchmark 0.8).
    In response to this comment, the final regulations provide that the 
simple contract benchmark may be an actual or hypothetical simple 
contract that, at the time the substantial equivalence test is applied 
to the complex contract, has a delta of 0.8, references the applicable 
underlying security referenced by the complex contract, and has terms 
that are consistent with all the material terms of the complex 
contract, including the maturity date. In addition, to further ensure 
comparability between the simple contract benchmark and the complex 
contract, the final regulations provide that the simple contract 
benchmark must consistently apply reasonable inputs, including a 
reasonable time period for the contract. For example, the reasonable 
time period for the contract must be consistently applied in 
determining the standard deviation and probability, as well as the 
maturity date and any other terms dependent on that time period.

V. Amount and Timing of a Taxpayer's Liability

    Section 1.871-15(j) contains rules for determining the amount of 
the dividend equivalent. In addition, Sec.  1.871-15(j) requires that 
the amount of a dividend equivalent be determined on the earlier of the 
record date of the dividend and the day before the ex-dividend date 
with respect to the dividend. In many cases, the amount of a dividend 
equivalent will be determined before a withholding agent will be 
required to withhold any tax pursuant to newly redesignated Sec.  
1.1441-2(e)(7) (formerly Sec.  1.1441-2(e)(8)). Comments requested that 
a foreign holder's tax liability be deferred until withholding is 
required, in order to avoid the need for the foreign holder to file a 
return and pay tax. The comments noted that this approach would be 
consistent with the general withholding regime under chapter 3 of the 
Code. With respect to a section 871(m) transaction acquired by a 
foreign investor after its initial issuance, a comment requested 
clarification that the foreign investor is only liable for dividends 
determined on the underlying security during the period that the 
foreign investor is the beneficial owner of the section 871(m) 
transaction.
    These regulations include several new provisions in response to 
these comments. First, Sec.  1.871-15(j)(4) is added to provide that a 
long party generally is liable for tax on a dividend equivalent in the 
year the dividend equivalent payment is subject to withholding pursuant 
to Sec.  1.1441-2(e)(7), or in the case of a QDD, when the payment of 
the applicable dividend on the underlying security is subject to 
withholding.
    Second, the regulations are amended to clarify that the amount of a 
dividend equivalent subject to tax will not change because the tax is 
withheld at a later date. Section 1.871-15(j)(2) establishes the time 
for determining the amount of a dividend equivalent; the amount of the 
long party's tax liability should not change because the withholding 
agent does not withhold at the time the tax liability arises. 
Therefore, changes in facts (such as the tax rate or whether the 
recipient is a qualified resident of a country with which the U.S. has 
an income tax treaty) between the time that the amount of a dividend 
equivalent is determined and the time that withholding occurs, do not 
affect tax liability. For example, if at the time for determining the 
dividend equivalent amount, the long party qualifies for a treaty, but 
in the year the amount is withheld the long party does not, the 
dividend equivalent would qualify for treaty benefits.
    Finally, Sec.  1.871-15(j)(1) expressly provides that the long 
party is only liable for tax on dividend equivalents that arise while 
the long party is a party to the transaction. For example, if long 
party A, a foreign person, enters into a section 871(m) transaction on 
an underlying stock that pays quarterly dividends, and sells the 
transaction to B, a foreign person, after four dividends on the 
underlying stock have been paid, A will be subject to tax on those four 
dividend equivalents and B will be subject to tax on subsequent 
dividend equivalents as long as B holds the section 871(m) transaction. 
Alternatively, if A is a U.S. person, B would still only be subject to 
tax on the dividend equivalents after it acquires the transaction.

VI. Qualified Index

    Section 1.871-15(l) provides a safe harbor for derivatives based on 
certain qualified indices. Section 1.871-15(l)(1) provides that the 
purpose of the exception for qualified indices is to provide a safe 
harbor for potential section 871(m) transactions that reference certain 
passive indices, and that an index is not a qualified index if treating 
the index as a qualified index would be contrary to this purpose. 
Section 1.871-15(l)(4) provides a specific safe harbor for derivatives 
based on an index in which the U.S. stock components comprise, in the 
aggregate, 10 percent or less of the weighting of all the component 
securities in the index. A comment regarding the 10 percent safe harbor 
indicated that some taxpayers, notwithstanding the purpose test for 
indices in Sec.  1.871-15(l)(1), may seek to use a customized index to 
make tax-advantaged investments in specific U.S. stocks. Although the 
index described by the comment may not be

[[Page 8149]]

a qualified index as a result of the purpose rule in Sec.  1.871-
15(l)(1), the final regulations are revised to clarify that, in order 
to meet this 10 percent safe harbor, an index must be widely traded and 
must not be formed or availed of with a principal purpose of tax 
avoidance.
    Comments to the qualified indices rules in the 2015 final 
regulations also requested that the Treasury Department and the IRS 
address how the rules apply to an index in the first year it is 
created. Accordingly, these final regulations add Sec.  1.871-
15(l)(2)(ii) to provide that, for the first year, an index is tested on 
the first business day it is listed, and the dividend yield calculation 
is determined using the dividend yield that the index would have had in 
the immediately preceding year if it had the same components throughout 
that year that it has on the day it is created.

VII. Combined Transactions

    For purposes of determining whether transactions are section 871(m) 
transactions, the 2015 final regulations treat two or more transactions 
as a single transaction when a long party (or a related person) enters 
into multiple transactions that reference the same underlying security, 
the combined potential section 871(m) transactions replicate the 
economics of a transaction that would be a section 871(m) transaction, 
and the transactions were entered into in connection with each other. 
The 2015 final regulations also provide brokers acting as short parties 
with two presumptions that may be applied to determine whether to 
combine potential section 871(m) transactions. First, a broker may 
presume that transactions are not entered into in connection with each 
other if the long party holds the transactions in separate accounts. 
Second, a broker may presume that transactions entered into two or more 
business days apart are not entered into in connection with each other. 
A broker, however, cannot rely on the first presumption if it has 
actual knowledge that the long party created or used separate accounts 
to avoid section 871(m). In addition, neither presumption applies if 
the broker has actual knowledge that transactions were entered into in 
connection with each other. Section 1.1441-1(b)(4)(xxiii) also permits 
withholding agents to rely on these presumptions.
    Comments suggested several changes to the combined transaction 
rules. Comments noted that it will be burdensome to identify every 
contract that a customer entered into with respect to the same 
underlying security within two days of each other. To replace the 
presumptions, comments recommended that a withholding agent only be 
required to combine contracts if the withholding agent had actual 
knowledge that two contracts were priced, marketed, or sold in 
connection with each other.
    The Treasury Department and the IRS disagree that the priced, 
marketed, or sold standard should replace the combination presumptions. 
Comments noted a ``not uncommon'' example of an active foreign investor 
who acquires or sells within a two-day period hundreds of listed 
options referencing the same underlying security. The Treasury 
Department and the IRS, however, intended to treat those transactions 
as combined to the extent that the potential section 871(m) 
transactions are entered into in connection with each other and satisfy 
the other requirements of Sec.  1.871-15(n)(1). The priced, marketed, 
or sold standard provides an inadequate substitute for the combined 
transaction test and the presumptions because investors can replicate a 
section 871(m) transaction by entering into multiple potential section 
871(m) transactions. For example, an investor could replicate a delta 
one transaction by entering into a put option and a call option on the 
same underlying security at the same time, with the same strike price, 
whether or not the options are priced, marketed, or sold together. For 
this reason, the priced, marketed, or sold standard provides an 
inadequate substitute for the presumptions. The comments submitted with 
respect to the combination rule acknowledge short parties and 
withholding agents are aware that foreign investors use multiple 
transactions in a manner that are combined under the final regulations. 
The ``priced, marketed, or sold'' standard would undermine the 
enforcement of the combination rules.
    Notwithstanding the prior paragraph, Notice 2016-76 provides a 
simplified standard for withholding agents to determine whether 
transactions entered into in 2017 are combined transactions. A 
withholding agent will only be required to combine transactions entered 
into in 2017 for purposes of determining whether the transactions are 
section 871(m) transactions when the transactions are over-the-counter 
transactions that are priced, marketed, or sold in connection with each 
other. Withholding agents will not be required to combine any 
transactions that are listed securities that are entered into in 2017.
    Another comment noted that the final regulations indicated that 
transactions would only be combined into simple contracts. This comment 
recommended that the final regulation be amended if the Treasury 
Department and the IRS disagreed with this reading of the combination 
rule. The Treasury Department and the IRS agree that transactions will 
only be combined into simple transactions pursuant to Sec.  1.871-
15(n); therefore, the final regulations are not amended.
    Other comments suggested some clarifications to the combination 
rules to resolve ambiguities. For example, comments requested, among 
other things, that (1) ordering rules provide that a contract cannot be 
combined more than once and (2) no combination transaction should have 
a delta of more than one. The final regulations are not amended to 
address these issues because the final regulations are intended to 
provide a general framework for determining when two or more 
transactions should be combined. The comments received to date show 
that industry understanding of how the combination rules may be 
administered continues to develop as financial institutions work to 
establish systems. As this understanding evolves, the Treasury 
Department and the IRS may publish subsequent guidance to address the 
issues raised by these comments. Until such further guidance is issued, 
taxpayers may adopt any reasonable methodology to combine transactions 
within the general framework of the final regulations.

VIII. Party Responsible for Determining Delta and Other Information

    The 2015 final regulations provide that when one of the parties to 
a potential section 871(m) transaction is a broker or dealer, that 
broker or dealer is responsible for determining whether the transaction 
is a section 871(m) transaction. When both parties to a potential 
section 871(m) transaction are a broker or dealer or neither party to a 
potential section 871(m) is a broker or dealer, the short party to the 
transaction must determine whether the transaction is a section 871(m) 
transaction.
    Comments noted that multiple parties could be responsible for 
determining whether a transaction is a section 871(m) transaction 
because the definition of a ``party to the transaction'' includes a 
long party, a short party, any agent acting on behalf of a long party 
or short party, and any person acting as an intermediary with respect 
to a potential section 871(m) transaction. Comments noted that both a 
short party and one or more agents of the short party may be a broker 
or dealer; in this case, the 2015 final regulations do not identify 
which of the responsible parties has the

[[Page 8150]]

primary obligation to determine whether the transaction is a section 
871(m) transaction.
    Comments requested that the regulations clarify which broker has 
the obligation to determine whether a listed option is a section 871(m) 
transaction when multiple brokers or dealers are involved. One comment 
recommended that the long party's broker that has custody of the 
transaction at the end of the day would be best suited to act as the 
responsible party. Comments also noted that the short party or the 
agent of a short party may not have the relevant information necessary 
to determine when withholding should take place. For example, when a 
long party has sold an instrument in the secondary market, the short 
party and its agent may not have any knowledge of that sale. As a 
result, the long party's broker should be the responsible party.
    Other comments indicated that the issuer should be the responsible 
party when the issuer itself is a broker or a dealer, or when the 
issuer has an affiliate that is a broker or dealer. In these cases, the 
issuer or its affiliate is likely to have the information necessary to 
determine whether the transaction is a section 871(m) transaction. As 
noted in other comments, an intermediary to a transaction issued by a 
broker or dealer, such as a clearinghouse, will not have the 
information necessary to determine whether a potential section 871(m) 
transaction is a section 871(m) transaction, and is unlikely to know 
either the time or the amount to withhold.
    The Treasury Department and the IRS agree that the final 
regulations may result in multiple parties to a transaction qualifying 
as the party responsible for determining whether a potential section 
871(m) transaction is a section 871(m) transaction. New temporary 
regulations resolve this duplication of responsible parties under Sec.  
1.871-15(p)(1) in the following circumstances: (1) Both the short party 
and an agent or intermediary of the short party are a broker or a 
dealer; (2) the short party is not a broker or dealer and more than one 
of the agents or intermediaries of the short party is a broker or 
dealer; (3) the short party and its agents or intermediaries are not 
brokers or dealers, and more than one agent or intermediary acting on 
behalf of the long party is a broker or dealer; and (4) potential 
section 871(m) transactions are traded on an exchange and cleared by a 
clearing organization.
    Specifically, Sec.  1.871-15T(p)(1)(ii) provides that the short 
party is the responsible party when both the short party and an agent 
or intermediary acting on behalf of the short party are a broker or 
dealer. In these circumstances, the Treasury Department and the IRS 
have determined that the short party should be the responsible party 
because it will have access to the relevant data regarding that 
transaction, whereas an agent or intermediary may not have the 
necessary information. As the responsible party, the short party may 
contract with a third party to make the determinations on its behalf; 
however, the short party remains responsible for the accuracy of any 
calculations by the third party.
    In addition, if the short party is not a broker or dealer, but more 
than one agent or intermediary acting on behalf of the short party is a 
broker or dealer, Sec.  1.871-15T(p)(1)(ii) provides that the broker or 
dealer closest to the short party in the payment chain is the 
responsible party. The Treasury Department and the IRS have determined 
that the agent or intermediary closest in the chain to the short party 
will have the best access to any information the short party has that 
is necessary to determine whether a potential section 871(m) 
transaction is a section 871(m) transaction and to make other relevant 
determinations.
    Section 1.871-15T(p)(1)(ii) also generally provides that when one 
or more agents or intermediaries acting on behalf of the long party are 
brokers or dealers, the agent or intermediary that is closest to the 
long party in the payment chain is the responsible party when neither 
the short party nor any agent or intermediary acting on behalf of the 
short party is a broker or dealer. In this situation, the temporary 
regulations place the responsibility with the agent or intermediary 
closest to the long party because this agent or intermediary will know 
whether or not the long party is subject to tax under section 871 or 
881 and when the long party has terminated or otherwise disposed of the 
transaction.
    Similarly, these temporary regulations also provide a rule for 
determining the responsible party when potential section 871(m) 
transactions are traded on an exchange and cleared by a clearing 
organization. When more than one broker or dealer acts as an agent or 
intermediary between the short party and a foreign investor on an 
exchange-traded contract, the broker or dealer that has an ongoing 
customer relationship with the foreign investor is the responsible 
party. Generally, this intermediary will be the clearing firm.
    Finally, these temporary regulations provide that the issuer of a 
potential section 871(m) transaction will be the responsible party for 
certain ELIs. Specifically, the issuer is the responsible party for 
structured notes (including contingent payment debt instruments), 
warrants, convertible stocks, and convertible debt instruments. Because 
the issuer of these ELIs ordinarily will have structured the ELI, 
determined the pricing of the ELI, and hedged the ELI, the issuer 
ordinarily will be in the best position to act as the responsible 
party. While the issuer of an ELI may not be a broker or dealer, an 
issuer of an ELI typically is advised by a broker or dealer.

IX. Qualified Derivatives Dealer

    Section 1.871-15T(q) permits a QDD to reduce its liability under 
section 871 or 881 for a dividend or dividend equivalent to the extent 
it makes an offsetting dividend equivalent payment in its dealer 
capacity. Only an eligible entity that has entered into a QI agreement 
can be a QDD. An eligible entity is defined as: (1) A dealer in 
securities subject to regulatory supervision as a dealer, (2) a bank 
subject to regulatory supervision as a bank, or (3) a wholly-owned 
entity of a bank subject to regulatory supervision as a bank when the 
wholly-owned entity (a) issues potential section 871(m) transactions to 
customers and (b) receives dividends or dividend equivalent payments 
from stock or potential section 871(m) transactions that hedge the 
potential section 871(m) transactions issued to customers. Sec.  
1.1441-1T(e)(6). An entity is only a QDD when acting in its QDD 
capacity.

A. Income Tax Treaties

    In general, section 871(m) and the regulations thereunder apply to 
a dividend equivalent payment without regard to whether the payor of 
the dividend equivalent payment is domestic or foreign. Section 1.894-
1(c)(2) provides that ``[t]he provisions of an income tax convention 
relating to dividends paid to or derived by a foreign person apply to 
the payment of a dividend equivalent described in section 871(m) and 
the regulations thereunder.'' Consistent with the foregoing, the 2017 
QI Agreement provides that a QDD must treat any dividend equivalent as 
a dividend from sources within the United States for purposes of 
section 881 and chapters 3 and 4 consistent section 871(m) and the 
regulations thereunder. The 2017 QI Agreement provides that a QDD may 
reduce the rate of withholding under chapter 3 based only on a 
beneficial owner's claim that it is entitled to a reduced rate of 
withholding for portfolio dividends under the dividends article of an 
applicable income tax treaty.

[[Page 8151]]

B. Eligible Entities

    Comments requested that the Treasury Department and the IRS expand 
the scope of entities that qualify as an eligible entity under Sec.  
1.1441-1(e), and therefore can act as a QDD under a QI agreement. One 
comment requested that the eligibility criteria be expanded to permit a 
controlled foreign corporation (CFC) of a U.S financial institution to 
act as a QDD even if the CFC is not a QI. Other comments recommended 
that the definition of an eligible entity be expanded to include a bank 
holding company if the entity regularly issues potential section 871(m) 
transactions to customers and receives dividends or dividend equivalent 
payments pursuant to potential section 871(m) transactions to hedge the 
transactions issued to customers. Comments noted that a bank holding 
company is subject to a wide range of regulatory regimes.
    Comments also recommended that the scope of eligible entities be 
expanded to include subsidiaries of securities dealers and bank holding 
companies that regularly issue potential section 871(m) transactions to 
customers and receive dividends or dividend equivalent amounts with 
respect to hedges of those customer transactions. Comments noted that 
these entities are part of a regulated financial group.
    In response to comments, the 2017 QI Agreement announced the 
expansion of the definition of eligible entities to include a bank 
holding company and subsidiaries of a bank holding company. The 
Treasury Department and the IRS agree that a bank holding company and 
subsidiaries of a bank holding company should be included in the 
definition of an eligible entity because these entities are regulated 
financial institutions.
    The 2017 QI Agreement clarified that the eligible entity test is 
applied at the home office or branch level, and that each home office 
or branch is a separate QDD. The 2017 QI Agreement also expanded what 
constitutes an eligible entity to include a foreign branch of a U.S. 
financial institution that would meet the requirements of an eligible 
entity if the branch were a separate entity, though such a branch will 
not be subject to tax on its QDD tax liability because it is otherwise 
subject to tax on a net income basis under chapter 1. Both of these 
changes are incorporated in these final regulations. These final 
regulations also clarify that a subsidiary of a bank or bank holding 
company could be indirectly wholly-owned by the qualifying bank or bank 
holding company provided that the subsidiary, acting in its equity 
derivatives dealer capacity, (1) issues potential section 871(m) 
transactions to customers, and (2) receives dividends with respect to 
stock or dividend equivalent payments pursuant to potential section 
871(m) transactions that hedge potential section 871(m) transactions 
that it issues.
    These final regulations do not expand the eligible entity 
definition to specifically include CFCs. The comments generally did not 
adequately explain why CFCs cannot avail themselves of the QI regime 
(with the QDD provisions). Permitting CFCs that are not QIs to be QDDs 
would eliminate the compliance benefits provided in the 2017 QI 
Agreement and would make it more difficult for the IRS to verify 
compliance with the QDD rules. However, to provide the IRS with 
flexibility to administer the QDD regime, an eligible entity is defined 
to include any other person acceptable to the IRS, which is similar to 
the allowance provided to the IRS in defining persons eligible to enter 
into a QI agreement as provided in Sec.  1.1441-1(e)(5)(ii)(D).
    A comment also raised a technical issue with who can qualify as a 
QI, expressing concern that some eligible entities that are not foreign 
financial institutions may not be able to enter into QI agreements 
because they are not eligible to become a QI. The 2017 QI Agreement and 
these final regulations now clarify that an eligible entity 
(notwithstanding that the entity otherwise would not be eligible to be 
a QI) can enter into a QI agreement in order to implement the QDD 
provisions.

C. Section 871(m) Amount and QDD's Tax Liability

    Section 1.871-15T(q)(1) of the 2015 temporary regulations provided 
that a QDD generally would not be liable for tax under section 871 or 
881 on a dividend or dividend equivalent payment that the QDD receives 
in its capacity as a QDD, provided that the QDD complies with its 
obligations under the qualified intermediary agreement. Section 1.1441-
1T(e)(6) of the 2015 temporary regulations provided that a QDD would 
not be subject to withholding on such dividends or dividend 
equivalents. Section D of this Part IX describes certain changes to the 
foregoing rules that the Treasury Department and the IRS determined are 
appropriate in light of the adoption of the net delta approach 
described in this Part IX.C.
    Section 1.871-15T(q)(1) of the 2015 temporary regulations further 
provides that, if a QDD receives a dividend or dividend equivalent 
payment and the offsetting dividend equivalent payment the QDD is 
contractually obligated to make on the same underlying security is less 
than the dividend and dividend equivalent amount the QDD received, the 
QDD would be liable for tax under section 871(a) or 881 for the 
difference.
    The QI Notice described proposed changes to the QI agreement that 
would implement the QDD tax liability described in Sec.  1.871-15T(q). 
Under the QI Notice, a QDD's section 871(m) amount for a dividend was 
the excess of the dividends on underlying securities associated with 
potential section 871(m) transactions and dividend equivalent payments 
that it received that reference the same dividend over dividend 
equivalent payments and any qualifying dividend equivalent offsetting 
payment that the QDD made or was contractually obligated to make with 
respect to the same dividend. The QI Notice described a qualifying 
dividend equivalent offsetting payment as (a) any payment made or 
contractually obligated to be made to a United States person that would 
be a dividend equivalent payment if made to a person who was not a 
United States person and (b) any payment made to a foreign person that 
would be a dividend equivalent payment if the payment were not treated 
as income effectively connected with the conduct of a U.S. trade or 
business.
    In addition, the QI Notice proposed rules regarding how a QDD would 
calculate its QDD tax liability. Specifically, under the QI Notice, the 
QDD tax liability was the sum of a QDD's liability under sections 
871(a) and 881 for (a) its section 871(m) amount; (b) its dividends 
that are not on underlying securities associated with potential section 
871(m) transactions and its dividend equivalent payments received as a 
QDD in its non-dealer capacity; and (c) any other payments, such as 
interest, received as a QDD with respect to potential section 871(m) 
transactions or underlying securities that are not dividend or dividend 
equivalent payments.
    Comments requested that a QDD be permitted to elect to calculate 
its section 871(m) amount either by using (1) the method described in 
the QI Notice or (2) its net delta exposure to an underlying security. 
According to comments, the net delta exposure is a calculation, 
measured in shares of stock, that aggregates all the shares of an 
underlying security and all equity derivative transactions referring to 
the same underlying security that the QDD has entered into in a dealer 
capacity (whether customer transactions or hedging transactions). 
Comments explained that net delta accurately measures a QDD's residual 
exposure to

[[Page 8152]]

an underlying security. Comments noted that financial institutions use 
net delta exposure for business and non-tax regulatory purposes.
    Comments also requested that the Treasury Department and the IRS 
expand the offsetting dividend equivalent payment to include all 
customer transactions, such as potential section 871(m) transactions 
with a delta below 0.8, grandfathered transactions, and transactions 
that reference a qualified index.
    In response to comments relating to the QI Notice, Notice 2016-76 
announced that the regulations would be revised to require a QDD to 
calculate its section 871(m) amount based on the net delta approach. 
The Treasury Department and the IRS agree that the net delta approach 
provides an administrable and accurate method for a QDD to determine 
its residual exposure to underlying securities. The Treasury Department 
and the IRS, however, do not agree with comments indicating that QDDs 
should be permitted to elect to use the net delta exposure method or 
the rule described in the QI Notice. It would be burdensome to the IRS 
to administer a system that permits a QDD to use multiple methods to 
calculate its section 871(m) amount. The Treasury Department and the 
IRS, however, will consider comments that explain in more detail why a 
choice of methods for determining the section 871(m) amount is in the 
best interests of both taxpayers and the government.
    These final regulations further explain how a QDD's section 871(m) 
amount is computed. The amount is determined separately for each 
dividend on an underlying security. For example, if a QDD enters into 
section 871(m) transactions that reference stock A (which pays a $5 
dividend per share), hedges the transactions by acquiring actual shares 
of stock, and has a net delta exposure to one share of stock, the QDD 
will have a tax liability pursuant to sections 871(a) and 881 with 
respect to a $5 dividend based on its net delta exposure to one share 
of stock A. Amounts with respect to other dividends on the same stock 
or another stock are not taken into account.
    Because these final regulations adopt the net delta exposure method 
for calculating the section 871(m) amount, the concepts of offsetting 
dividend equivalent payments and qualifying dividend equivalent 
offsetting payments have been eliminated from these final regulations.
    These final regulations revise the calculation of a QDD's tax 
liability on the section 871(m) amount to correspond with the changes 
regarding the determination of the section 871(m) amount discussed in 
this section and the changes to withholding on payments to a QDD that 
are discussed in the following section of this preamble. Specifically, 
a QDD's tax liability on its section 871(m) amount is, for each 
dividend on each underlying security, the amount by which its tax 
liability under section 881 for its section 871(m) amount exceeds the 
amount of tax paid by the QDD under section 881 (including amounts 
withheld on payments to the QDD) on dividend payments received by the 
QDD in its capacity as an equity derivatives dealer. The QDD also is 
liable for tax under section 881 for dividend equivalent payments 
received by a QDD in its non-equity derivatives dealer capacity and for 
any other payments (including dividends) it receives as a QDD to the 
extent the full liability was not satisfied by withholding.

D. Withholding on Dividends Paid to a QDD

    In general, under the law in effect prior to 2017, an eligible 
entity that would qualify as a QDD under these final regulations 
generally was subject to tax under section 881 and to withholding tax 
under chapters 3 and 4 on actual dividends in the same manner as any 
other foreign recipient. As described in the preceding section, the 
2015 temporary regulations provided that a QDD would no longer be 
subject to tax or to withholding on actual dividends received in its 
capacity as a QDD. The Treasury Department and the IRS are concerned 
that this exemption in the 2015 temporary regulations, when combined 
with the net delta exposure method, could result in U.S. source 
dividends escaping U.S. tax completely in certain circumstances. For 
example, if a QDD holds physical shares of an underlying security that 
it uses to hedge a delta 0.5 option, both the dividend and the option 
would not be subject to tax under section 871 or section 881. In 
response to this concern, Notice 2016-76 announced that the Treasury 
Department and the IRS intended to revise Sec. Sec.  1.871-15T(q)(1) 
and 1.1441-1(b)(4)(xxii) to provide that a QDD will remain liable for 
tax under section 881(a)(1) and subject to withholding under chapters 3 
and 4 on dividends on physical shares and deemed dividends received. 
These final regulations revise Sec. Sec.  1.871-15T(q)(1) and 1.1441-
1(b)(4)(xxii) accordingly. However, as announced in the 2017 QI 
Agreement, in order to allow taxpayers time to implement the net delta 
approach, these regulations continue to provide that dividends on 
physical shares and deemed dividends received by a QDD in its QDD 
capacity in 2017 will not be subject to tax under section 881(a)(1) or 
subject to withholding under chapters 3 and 4. A QDD will be subject to 
withholding on dividends (including deemed dividends) received on or 
after January 1, 2018.
    The Treasury Department and the IRS will consider comments 
recommending approaches for alleviating any overwithholding (and 
preventing any underwithholding) that might occur on dealer 
transactions with customers and on positions that hedge customer 
transactions when withholding on dividends (including deemed dividends) 
paid to QDDs resumes in 2018.
    The QI Notice provided that a withholding agent (other than a 
withholding agent that itself was acting as a QDD) would not be 
required to withhold or report on payments made to a QDD with respect 
to potential section 871(m) transactions and underlying securities, 
other than reporting for dividends and substitute dividends. A comment 
requested that a withholding agent should only be exempt from 
withholding and reporting on dividends and dividend equivalents paid to 
a QDD. In response to this comment, the 2017 QI Agreement provides that 
all payments (other than dividend equivalent payments) made to a QDD 
with respect to underlying securities will be subject to withholding 
and reporting if the payments would be subject to withholding and 
reporting to a non-QDD. Consistent with the 2017 QI Agreement, the 
final regulations provide that all payments (other than dividend 
equivalent payments) made to a QDD with respect to underlying 
securities will be subject to withholding and reporting if those 
payments would be subject to withholding and reporting when received by 
a foreign person.

E. Dealer Versus Proprietary Capacity

    The 2015 temporary regulations only permitted a taxpayer to act as 
a QDD with respect to certain payments received in its dealer capacity. 
Comments requested that a taxpayer be permitted to act as a QDD for 
payments received in its proprietary capacity for administrative 
reasons. The QI Notice and the 2017 QI Agreement reflect this change to 
the scope of QDD payments. The change in QDD scope does not impact the 
limitation on amounts entitled to be offset, which remain limited to 
dealer activity.
    Consistent with the 2015 regulations, the QI Notice and the 2017 QI 
Agreement provide that, for purposes of determining the QDD tax 
liability,

[[Page 8153]]

payments received by a QDD acting as a proprietary trader are treated 
as payments received in its non-dealer capacity, while transactions 
properly reflected in a QDD's dealer book are presumed to be held by a 
dealer in its dealer capacity. For purposes of determining the QDD tax 
liability, dealer activity is limited to its activity as an equity 
derivatives dealer. One comment requested that the regulations clarify 
and qualify the distinction between receiving a payment in a dealer 
versus in a proprietary trader capacity and the impact of the 
distinction on the ability of an entity to act as a QDD. The Treasury 
Department and the IRS have determined that the regulations adequately 
delineate between dealer and proprietary transactions in Sec.  1.871-
15(q)(2).

F. Timing of Withholding

    Generally, newly redesignated Sec.  1.1441-2(e)(7) (formerly Sec.  
1.1441-2(e)(8)) provides that a withholding agent must withhold on a 
dividend equivalent on the later of the date on which the amount of the 
dividend equivalent is determined and the date that a payment occurs. A 
payment generally occurs when money or other property is paid to or by 
the long party, or the long party sells, exchanges, transfers, or 
otherwise disposes of a section 871(m) transaction. Notwithstanding 
this general rule applicable to withholding agents, the QI Notice 
announced that a QDD must withhold with respect to a dividend 
equivalent payment on the dividend payment date for the applicable 
dividend on the underlying security as determined in Sec.  1.1441-
2(e)(4).
    Comments noted that this change would require a QDD to pay tax 
prior to the date that other withholding agents would have been 
required to withhold. In addition, comments expressed concern that this 
rule would result in cashless withholding for many transactions. 
Comments also noted that withholding agents have been building 
withholding systems according to the general rule provided in the final 
section 871(m) regulations. Comments recommended that the final section 
871(m) regulations be amended to permit a QDD to elect to withhold on 
the payment of the dividend equivalent as provided in newly 
redesignated Sec.  1.1441-2(e)(7) or on the dividend payment date as 
determined in Sec.  1.1441-2(e)(4).
    The Treasury Department and the IRS have determined that a QDD 
should continue to be required to withhold on the dividend payment date 
as determined in Sec.  1.1441-2(e)(4), because the time that a QDD 
withholds on customer transactions should match the time period for 
which it determines its own tax liability with respect to the section 
871(m) amount. This is because the withholding tax that may apply to 
customer transactions is the justification for relieving the QDD from 
tax on its section 871(m) amount. In addition, this rule simplifies the 
reconciliation statement, makes it easier for reviewers and the IRS to 
verify that a QDD has complied with the requirements of the 2017 QI 
Agreement, and avoids a number of other issues that would arise under 
the requested approach, including statute of limitation issues. With 
respect to the concerns expressed regarding the need to build systems, 
the Treasury Department and the IRS note that this timing rule is 
consistent with the rule that was proposed in the QI Notice, released 
July 1, 2016. Moreover, as described in Notice 2016-76, during 2017, 
the IRS will take into account the extent to which a QDD has made a 
good faith effort to comply with the QDD provisions in the QI agreement 
when enforcing those provisions.

G. Qualified Securities Lenders (QSL) and Credit Forward

    Notice 2010-46, 2010-24 I.R.B. 757 (see Sec.  
601.601(d)(2)(ii)(b)), (QSL Notice) outlined a proposed credit forward 
system that allowed a withholding agent to limit the aggregate U.S. 
gross-basis tax in a series of securities lending transactions to the 
amount of U.S. gross-basis tax applicable to the foreign taxpayer 
receiving a substitute or actual dividend in the series of transactions 
who bears the highest rate of U.S. gross-basis tax. The preamble to the 
2015 regulations indicated that the credit forward system remained 
under consideration, but noted that, during the transition period 
provided in Notice 2010-46, the IRS has experienced difficulty 
verifying that prior withholding has occurred. Comments were requested 
on the need for the regime and how it could be implemented.
    Comments requested that the credit forward system be retained. One 
comment requested that the credit forward system be retained when QDD 
status was not available. In contrast, another comment suggested that 
the stringency resulting from tightening the eligibility requirements 
for QDDs to QIs that are subject to reporting and compliance 
requirements would improve the ability to verify that prior withholding 
occurred.
    As discussed in Part IX.B of this preamble the Treasury Department 
and the IRS have concluded that it is not appropriate to permit credits 
or offsets for any entity that does not qualify as an eligible entity. 
In reaching this conclusion, the Treasury Department and the IRS agree 
with the comment that indicated that the QDD rules provide a more 
administrable method of determining that withholding properly occurred. 
If the entity is acting as an intermediary instead of acting as a 
principal, it may choose to be a QI that is not a QDD. The second 
comment did not explain why the existing QDD regime is insufficient.
    In addition to comments regarding the credit forward system, a 
comment requested that QSL status be preserved as a standalone rule for 
securities lending transactions that are part of a separate line of 
business from other potential section 871(m) transactions. Another 
comment recommended reverting to the eligibility requirements for a QSL 
in the QSL Notice by extending QDD status to custodian QIs that are 
subject to regulatory supervision by a governmental authority in the 
jurisdiction in which the entity was created, as long as the entity 
agrees to assume primary withholding and reporting responsibility with 
respect to dividend equivalent payments and complies with all QDD 
certification requirements.
    While the Treasury Department and the IRS understand that the QSL 
regime was administratively more convenient for taxpayers than the QI 
regime, it created administrability problems, particularly with respect 
to verification, for the IRS. That regime is being replaced by 
incorporating the QDD rules into the existing QI framework, including 
the specific rules for pooled reporting on Form 1042-S, and the QI 
requirements for compliance review and certification. With respect to 
banks, custodians, and clearing organizations that do not issue 
potential section 871(m) transactions to customers, the Treasury 
Department and the IRS are concerned that reverting to the eligibility 
requirements for a QSL in the QSL Notice would permit an entity to act 
as a QDD that does not act as a financial intermediary in a chain of 
section 871(m) transactions.
    As part of the transition relief announced in Notice 2016-76, the 
Treasury Department and the IRS announced that taxpayers may continue 
to rely on the QSL Notice during 2017. The QSL Notice will be obsoleted 
as of January 1, 2018.

X. Rules for Withholding on Dividend Equivalents

    Newly designated Sec.  1.1441-2(e)(7) provides that a withholding 
agent is not

[[Page 8154]]

obligated to withhold on a dividend equivalent until the later of when 
a payment is made with respect to a section 871(m) transaction and when 
the amount of a dividend equivalent is determined. For purposes of 
Sec.  1.1441-2(e)(7), a payment with respect to a section 871(m) 
transaction occurs when the long party receives or makes a payment, 
when there is a final settlement of the section 871(m) transaction, or 
when the long party sells or otherwise disposes of the section 871(m) 
transaction. The 2015 final regulations adopted this approach in 
response to taxpayer comments.

A. Transactions Transferred to a Different Account

    The 2015 final regulations provide that a payment occurs when the 
long party sells or disposes of a section 871(m) transaction; however, 
when a long party transfers a section 871(m) transaction from one 
broker or custodian to another broker or custodian, the 2015 final 
regulations do not treat that transfer as a payment. A comment noted 
that it is common for investors to change relationships with brokers 
and custodians who hold their securities, which may result in section 
871(m) transactions being transferred from one broker or custodian to 
another. The comment asserted that it is inappropriate and burdensome 
for a withholding agent to be responsible for dividend equivalent 
amount calculations relating to dividends that occurred before the date 
that the new broker or custodian holds the section 871(m) transaction 
on behalf of a long party. The comment recommended that the Treasury 
Department and the IRS amend the 2015 final regulations to provide that 
a transfer of a section 871(m) transaction from one broker or custodian 
to another, without a change in beneficial ownership, constitutes a 
payment for purposes of Sec.  1.1441-2(e)(7).
    The Treasury Department and the IRS agree that requiring a broker 
or custodian to withhold on dividend equivalent payments that occurred 
before holding a section 871(m) transaction on behalf of a customer 
would be burdensome to the withholding agent. As a result, Sec.  
1.1441-2(e)(7) is revised to provide that a payment of a dividend 
equivalent occurs when a section 871(m) transaction is transferred to 
an account not maintained by the withholding agent or upon a 
termination of the account relationship.

B. Option To Withhold on Dividend Payment Date

    While Sec.  1.1441-2(e)(7) generally defers withholding on a 
section 871(m) transaction until there is a payment made pursuant to 
the transaction, comments noted that Sec.  1.1441-2(e)(7) will require 
cashless withholding in certain circumstances. To implement the 2015 
final regulations, comments noted that market participants would be 
required to develop or amend collateral and indemnity arrangements with 
customers. Some comments recommended amending the 2015 final 
regulations to allow withholding agents to treat a dividend equivalent 
as paid and subject to withholding on the dividend payment date for the 
underlying security referenced by the section 871(m) transaction. 
Comments indicated that some withholding agents believe that it will be 
easier to implement withholding on the dividend payment date for the 
underlying security because their systems are already designed to track 
the time and amount of actual dividends. Many withholding agents, 
however, have contractual agreements with customers that prohibit 
withholding earlier than a date permitted by regulations.
    The Treasury Department and the IRS appreciate that some 
withholding agents would rather not develop new systems to track 
dividend equivalents over multiple years, while other financial 
institutions prefer the time for withholding provided by Sec.  1.1441-
2(e)(7). To accommodate both approaches, the Treasury Department and 
the IRS are amending the regulations to allow withholding agents the 
flexibility to withhold either based on the ``later of'' rule, as 
determined under Sec.  1.1441-2(e)(7), or on the dividend payment date 
for the underlying security. This change will allow withholding agents 
that prefer to withhold on the dividend payment date to do so, without 
eliminating the ``later of'' rule in Sec.  1.1441-2(e)(7) that 
generally ties withholding to a cash payment. As discussed in Part IX.F 
of this preamble, if a withholding agent acts as a QDD, it will be 
required to use the dividend payment date.
    A withholding agent that chooses to withhold on the dividend 
payment date for the underlying security referenced by the section 
871(m) transaction must apply the election consistently to all section 
871(m) transactions of the same type. In other words, a withholding 
agent that chooses to withhold on the dividend payment date for 
securities lending transactions must do so for all securities lending 
transactions, but may choose to withhold on NPCs under the rule in 
Sec.  1.1441-2(e)(7). When a withholding agent withholds on the 
dividend payment date under this alternate method, the withholding 
agent must notify each payee in writing before the time for determining 
the long party's first dividend equivalent payment. A withholding agent 
that withholds on the dividend payment date for the underlying security 
also must attach a statement to its Form 1042 for the year of the 
change notifying the IRS of the change and when it applies.

XI. Applicability Date

    The current regulations provide that Sec.  1.871-15(d)(2) and (e) 
apply to any payment made on or after January 1, 2017, with respect to 
any transaction issued on or after January 1, 2017. Several comments 
requested that implementation of these provisions be delayed until at 
least January 1, 2018. One comment requested that implementation be 
delayed until at least one year after the date guidance resolving all 
issues raised by the comment is issued. The primary reasons comments 
provided for the requests to delay implementation were the need for 
additional guidance, the need for additional time to make systems 
operational, and the recent release of additional QDD guidance in the 
QI Notice and in Notice 2016-76. Comments also requested a delay in the 
combination rule generally. Another comment agreed with the request for 
a delayed effective date for the combination rule, unless the rule was 
revised to require withholding agents only to combine transactions that 
the withholding agent has actual knowledge are priced, marketed, or 
sold in connection with each other. A comment also requested a 
transition period until December 31, 2018, for enforcement and 
administration of QDD obligations.
    The 2013 proposed regulations provided that the proposed sections 
would apply to payments made on or after the date the regulations were 
finalized. However, when the regulations were finalized in 2015, the 
Treasury Department and the IRS provided that the regulations generally 
would only apply to transactions issued on or after January 1, 2017, to 
ensure adequate time to develop systems needed to implement the 
regulations.
    Both the 2015 regulations and the amendments to those regulations 
that are included in these regulations, many of which were previously 
announced in the QI Notice, Notice 2016-76, and the 2017 QI Agreement, 
make the withholding required under section 871(m) easier to implement 
and more

[[Page 8155]]

administrable. In light of these revisions, the Treasury Department and 
the IRS have determined that it is not necessary or appropriate to 
uniformly extend the applicability date for all section 871(m) 
transactions. In particular, taxpayers have had ample time to develop 
systems to implement withholding on section 871(m) transactions that 
are delta one transactions. The Treasury Department and the IRS have 
determined, however, that taxpayers and withholding agents need 
additional time to implement the section 871(m) regulations for section 
871(m) transactions other than delta one transactions. Accordingly, 
these regulations postpone the implementation of the section 871(m) 
regulations with respect to non-delta one transactions until January 1, 
2018.
    In addition, in response to comments, Notice 2016-76 announced 
transition relief for combined transactions by providing a simplified 
rule for withholding agents to determine whether transactions entered 
into in 2017 are combined transactions. Also in response to comments, 
Notice 2016-76 delayed the application of section 871(m) for certain 
exchange-traded notes. Notice 2016-76 also announced that calendar 
years 2017 and 2018 would be phase-in years. In enforcing and 
administering section 871(m) (1) with respect to delta-one transactions 
in 2017, and (2) with respect to non-delta-one transactions in 2018, 
the IRS will take into account the extent to which the taxpayer or 
withholding agent made a good faith effort to comply with the section 
871(m) regulations. Similarly, Notice 2016-76 and the 2017 QI Agreement 
provide that calendar year 2017 will be a phase-in year for QDDs. As 
discussed in Part XI.D, the 2017 QI Agreement and these regulations 
provide that a QDD will not be subject to withholding on actual or 
deemed dividends in 2017. Finally, the 2017 QI Agreement and these 
final regulations do not impose tax on a QDD's section 871(m) amount 
for tax years beginning before January 1, 2018.

Effect on Other Documents

    Notice 2010-46 (2010-24 I.R.B. 757) is obsolete as of January 1, 
2018.

Special Analyses

    Certain IRS regulations, including these, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It is hereby certified that these regulations will not 
have a significant economic impact on a substantial number of small 
entities. This certification is based on the fact that few, if any, 
small entities will be affected by these regulations. The regulations 
primarily will affect multinational financial institutions, which tend 
to be larger businesses, and foreign persons. Therefore, a Regulatory 
Flexibility Analysis is not required. Pursuant to section 7805(f) of 
the Code, the notice of proposed rulemaking preceding this regulation 
was submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on their impact on small business.

Drafting Information

    The principal authors of these regulations are D. Peter Merkel and 
Karen Walny of the Office of Associate Chief Counsel (International). 
Other personnel from the Treasury Department and the IRS also 
participated in the development of these regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by removing 
the sectional authority for Sec.  1.871-15 and adding in its place a 
sectional authority for Sec. Sec.  1.871-15 and 1.871-15T to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

    Sec. Sec.  1.871-15 and 1.871-15T also issued under 26 U.S.C. 
871(m). * * *

0
Par. 2. Section 1.871-15 is amended by:
0
1. Revising paragraph (a)(1).
0
2. Revising paragraph (a)(14)(i).
0
3. Adding a new second sentence to paragraph (a)(14)(ii)(B).
0
4. Revising paragraph (c)(2)(ii).
0
5. Revising paragraph (c)(2)(iv).
0
6. Revising paragraphs (g)(2) through (g)(3), redesignating paragraph 
(g)(4) as (g)(5), and adding new paragraph (g)(4).
0
7. Revising paragraph (h).
0
8. Revising paragraphs (i)(3)(ii) and (i)(3)(iii).
0
9. Adding introductory text to paragraph (j)(1).
0
10. Adding paragraph (j)(4).
0
11. Revising paragraph (l)(2).
0
12. Revising paragraph (l)(4).
0
13. Redesignating paragraphs (n)(3)(i) and (n)(3)(ii) as (n)(3)(ii) and 
(n)(3)(iii), respectively.
0
14. Adding new paragraph (n)(3)(i).
0
15. Revising paragraph (p)(1).
0
16. Adding paragraphs (p)(4)(iii) and (p)(5).
0
17. Revising paragraph (q).
0
18. Revising paragraphs (r)(3) and (r)(4).
0
19. Adding paragraph (r)(5).
    The additions and revisions read as follows:


Sec.  1.871-15   Treatment of dividend equivalents.

    (a) * * * (1) Broker. [Reserved]. For further guidance, see Sec.  
1.871-15T(a)(1).
* * * * *
    (14) * * * (i) Simple contract. A simple contract is an NPC or 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 (as determined in paragraph (j)(3) of this section) of 
the underlying security, provided that the number of shares can be 
ascertained at the calculation time for the contract, and there is a 
single maturity or exercise date with respect to which all amounts 
(other than any upfront payment or any periodic payments) are required 
to be calculated with respect to the underlying security. For purposes 
of this section, a contract that provides an adjustment to the number 
of shares of the underlying security for a merger, stock split, cash 
dividend, or similar corporate action that affects all holders of the 
underlying securities proportionately will not cease to be treated as 
referencing a single, fixed number of shares solely as a result of that 
provision. A contract has a single exercise date even though it may be 
exercised by the holder at any time on or before the stated expiration 
of the contract. An NPC or ELI that includes a term that 
discontinuously increases or decreases the amount paid or received 
(such as a digital option), or that accelerates or extends the maturity 
is not a simple contract. A simple contract that is an NPC is a simple 
NPC. A simple contract that is an ELI is a simple ELI.
* * * * *
    (ii) * * * (B)

    Example. * * * Pursuant to paragraph (j)(3) of the section, the 
ELI references 200 shares when Stock X appreciates, but only 100 
shares when Stock X depreciates. * * *
    (c) * * *
    (2) * * * (ii) Section 305 coordination. A dividend equivalent 
received by a long party, who is a shareholder as defined in Sec.  
1.305-1(d) of an instrument that gives rise to a dividend pursuant to 
sections 305(b)

[[Page 8156]]

and (c) (including a debt instrument that is convertible into shares of 
stock and stock that is convertible into shares of another class of 
stock) that is also a section 871(m) transaction, is reduced by any 
amount treated as a dividend by sections 305(b) and (c) to the long 
party. For other section 871(m) transactions that reference an 
underlying security that is an instrument treated as paying a dividend 
pursuant to sections 305(b) and (c) and for which the long party is not 
a shareholder as defined in Sec.  1.305-1(d), the dividend equivalent 
received by the long party with respect to the section 871(m) 
transaction includes (and is not reduced by) any amount treated as a 
dividend pursuant to sections 305(b) and (c).
* * * * *
    (iv) Payments made pursuant to annuity, endowment, and life 
insurance contracts--(A) Insurance contracts issued by domestic 
insurance companies. A payment made pursuant to a contract that is an 
annuity, endowment, or life insurance contract issued by a domestic 
corporation (including its foreign or U.S. possession branch) that is a 
life insurance company described in section 816(a) does not include a 
dividend equivalent if the payment is subject to tax under section 
871(a) or section 881.
    (B) Insurance contracts issued by foreign insurance companies. A 
payment does not include a dividend equivalent if it is made pursuant 
to a contract that is an annuity, endowment, or life insurance contract 
issued by a foreign corporation that would be subject to tax under 
subchapter L if it were a domestic corporation.
    (C) Insurance contracts held by foreign insurance companies. A 
payment made pursuant to a policy of insurance (including a policy of 
reinsurance) does not include a dividend equivalent if it is made to a 
foreign corporation that would be subject to tax under subchapter L if 
it were a domestic corporation.
* * * * *
    (g) * * *
    (2) Time for determining delta--(i) In general. Except as provided 
in paragraph (g)(4) of this section, the delta of a potential section 
871(m) transaction is determined at the calculation time for the 
potential section 871(m) transaction.
    (ii) Calculation time. The calculation time for a potential section 
871(m) transaction is the earlier of when the potential section 871(m) 
transaction is priced and when the potential section 871(m) transaction 
is issued. Notwithstanding the preceding sentence, if the pricing time 
is more than 14 calendar days before the potential section 871(m) 
transaction is issued, the calculation time is when the potential 
section 871(m) transaction is issued.
    (iii) Pricing time. A potential section 871(m) transaction is 
priced when all material economic terms for the transaction have been 
agreed upon, including the price at which the transaction is sold.
    (3) Simplified delta calculation for certain simple contracts that 
reference multiple underlying securities. If an NPC or ELI references 
10 or more underlying securities and an exchange-traded security (for 
example, an exchange-traded fund) is available that would fully hedge 
the NPC or ELI at the calculation time, the delta of the NPC or ELI may 
be calculated by determining the ratio of the change in the fair market 
value of the simple contract to a small change in the fair market value 
of the exchange-traded security. A delta determined under this 
paragraph (g)(3) must be used as the delta for each underlying security 
for purposes of calculating the amount of a dividend equivalent as 
provided in paragraph (j)(1)(ii) of this section.
    (4) Delta calculation for listed options--(i) In general. The delta 
of an option contract that is listed on a regulated exchange described 
in paragraph (g)(4)(ii) of this section is the delta of that option at 
the close of business on the business day before the date of issuance. 
On the date an option contract is listed for the first time, the delta 
is the delta of that option at the close of business on the date of 
issuance. Notwithstanding the preceding two sentences, the delta of a 
listed option that is also a customized option is determined under the 
rules of paragraphs (g)(2) and (g)(3) of this section.
    (ii) Regulated exchange. For purposes of paragraph (g)(4)(i) of 
this section, a regulated exchange is any exchange that is either:
    (A) Described in paragraph (l)(3)(vii) of this section; or
    (B) [Reserved]. For further guidance, see Sec.  1.871-
15T(g)(4)(ii)(B).
* * * * *
    (h) Substantial equivalence test--(1) In general. The substantial 
equivalence test described in this paragraph (h) applies to determine 
whether a complex contract is a section 871(m) transaction. The 
substantial equivalence test assesses whether a complex contract 
substantially replicates the economic performance of the underlying 
security by comparing, at various testing prices for the underlying 
security, the differences between the expected changes in value of that 
complex contract and its initial hedge with the differences between the 
expected changes in value of a simple contract benchmark (as described 
in paragraph (h)(2) of this section) and its initial hedge. If the 
complex contract contains more than one reference to a single 
underlying security, all references to that underlying security are 
taken into account for purposes of applying the substantial equivalence 
test with respect to that underlying security. With respect to an 
equity derivative that is embedded in a debt instrument or other 
derivative, the substantial equivalence test is applied to the complex 
contract without taking into account changes in the market value of the 
debt instrument or other derivative that are not directly related to 
the equity element of the instrument. The complex contract is a section 
871(m) transaction with respect to an underlying security if, for that 
underlying security, the expected change in value of the complex 
contract and its initial hedge is equal to or less than the expected 
change in value of the simple contract benchmark and its initial hedge 
when the substantial equivalence test described in this paragraph (h) 
is calculated at the calculation time for the complex contract. To the 
extent that the steps of the substantial equivalence test set out in 
this paragraph (h) cannot be applied to a particular complex contract, 
a taxpayer must use the principles of the substantial equivalence test 
to reasonably determine whether the complex contract is a section 
871(m) transaction with respect to each underlying security. For 
purposes of this section, the test must be applied and the inputs must 
be determined in a commercially reasonable manner. The term of the 
simple contract benchmark must be, and the inputs must use, a 
reasonable time period, consistently applied (for example, in 
determining the standard deviation and probability). If a taxpayer 
calculates any relevant input for non-tax business purposes, that input 
ordinarily is the input used for purposes of this section.
    (2) Simple contract benchmark. The simple contract benchmark is an 
actual or hypothetical simple contract that, at the calculation time 
for the complex contract, has a delta of 0.8, references the applicable 
underlying security referenced by the complex contract, and has terms 
that are consistent with all the material terms of the complex 
contract, including the maturity date. If an actual simple contract 
does not exist, the taxpayer must create a hypothetical

[[Page 8157]]

simple contract. Depending on the complex contract, the simple contract 
benchmark might be, for example, a call option, a put option, or a 
collar.
    (3) Substantial equivalence. A complex contract is a section 871(m) 
transaction with respect to an underlying security if the complex 
contract calculation described in paragraph (h)(4) of this section 
results in an amount that is equal to or less than the amount of the 
benchmark calculation described in paragraph (h)(5) of this section.
    (4) Complex contract calculation--(i) In general. The complex 
contract calculation for each underlying security referenced by a 
potential section 871(m) transaction that is a complex contract is 
computed by:
    (A) Determining the change in value (as described in paragraph 
(h)(4)(ii) of this section) of the complex contract with respect to the 
underlying security at each testing price (as described in paragraph 
(h)(4)(iii) of this section);
    (B) Determining the change in value of the initial hedge for the 
complex contract at each testing price;
    (C) Determining the absolute value of the difference between the 
change in value of the complex contract determined in paragraph 
(h)(4)(i)(A) of this section and the change in value of the initial 
hedge determined in paragraph (h)(4)(i)(B) of this section at each 
testing price;
    (D) Determining the probability (as described in paragraph 
(h)(4)(iv) of this section) associated with each testing price;
    (E) Multiplying the absolute value for each testing price 
determined in paragraph (h)(4)(i)(C) of this section by the 
corresponding probability for that testing price determined in 
paragraph (h)(4)(i)(D) of this section;
    (F) Adding the product of each calculation determined in paragraph 
(h)(4)(i)(E) of this section; and
    (G) Dividing the sum determined in paragraph (h)(4)(i)(F) of this 
section by the initial hedge for the complex contract.
    (ii) Determining the change in value. The change in value of a 
complex contract is the difference between the value of the complex 
contract with respect to the underlying security at the calculation 
time for the complex contract and the value of the complex contract 
with respect to the underlying security if the price of the underlying 
security were equal to the testing price at the calculation time for 
the complex contract. The change in value of the initial hedge of a 
complex contract with respect to the underlying security is the 
difference between the value of the initial hedge at the calculation 
time for the complex contract and the value of the initial hedge if the 
price of the underlying security were equal to the testing price at the 
calculation time for the complex contract.
    (iii) Testing price. The testing prices must include the prices of 
the underlying security if the price of the underlying security at the 
calculation time for the complex contract were alternatively increased 
by one standard deviation and decreased by one standard deviation, each 
of which is a separate testing price. In circumstances where using only 
two testing prices is reasonably likely to provide an inaccurate 
measure of substantial equivalence, a taxpayer must use additional 
testing prices as necessary to determine whether a complex contract 
satisfies the substantial equivalence test. If additional testing 
prices are used for the substantial equivalence test, the probabilities 
as described in paragraph (h)(4)(iv) of this section must be adjusted 
accordingly.
    (iv) Probability. For purposes of paragraphs (h)(4)(i)(D) and (E) 
of this section, the probability of an increase by one standard 
deviation is the measure of the likelihood that the price of the 
underlying security will increase by any amount from its price at the 
calculation time for the complex contract. For purposes of paragraphs 
(h)(4)(i)(D) and (E) of this section, the probability of a decrease by 
one standard deviation is the measure of the likelihood that the price 
of the underlying security will decrease by any amount from its price 
at the calculation time for the complex contract.
    (5) Benchmark calculation. The benchmark calculation with respect 
to each underlying security referenced by the potential section 871(m) 
transaction is determined by using the computation methodology 
described in paragraph (h)(4) of this section with respect to a simple 
contract benchmark for the underlying security.
    (6) Substantial equivalence calculation for certain complex 
contracts that reference multiple underlying securities. If a complex 
contract references 10 or more underlying securities and an exchange-
traded security (for example, an exchange-traded fund) is available 
that would fully hedge the complex contract at its calculation time, 
the substantial equivalence calculations for the complex contract may 
be calculated by treating the exchange-traded security as the 
underlying security. When the exchange-traded security is used for the 
substantial equivalence calculation pursuant to this paragraph (h)(6), 
the initial hedge is the number of shares of the exchange-traded 
security for purposes of calculating the amount of a dividend 
equivalent as provided in paragraph (j)(1)(iii) of this section.
    (7) Example. The following example illustrates the rules of 
paragraph (h) of this section. For purposes of this example, Stock X is 
common stock of domestic corporation X. FI is the financial institution 
that structures the transaction described in the example, and is the 
short party to the transaction. Investor is a nonresident alien 
individual.

    Example.  Complex contract that is not substantially equivalent. 
(i) FI issues an investment contract (the Contract) that has a 
stated maturity of one year, and Investor purchases the Contract 
from FI at issuance for $10,000. At maturity, the Contract entitles 
Investor to a return of $10,000 (i) plus 200 percent of any 
appreciation in Stock X above $100 per share, capped at $110, on 100 
shares or (ii) minus 100 percent of any depreciation in Stock X 
below $90 on 100 shares. At the calculation time for the Contract, 
the price of Stock X is $100 per share. Thus, for example, Investor 
will receive $11,000 if the price of Stock X is $105 per share at 
maturity of the Contract, but Investor will receive $9,000 if the 
price of Stock X is $80 per share when the Contract matures. At 
issuance, FI acquires 64 shares of Stock X to fully hedge the 
Contract issued to Investor. The calculation time for this example 
is the issuance.
    (ii) The Contract references an underlying security and is not 
an NPC, so it is classified as an ELI under paragraph (a)(4) of this 
section. At the calculation time for the Contract, the Contract does 
not provide for an amount paid at maturity that is calculated by 
reference to a single, fixed number of shares of Stock X. When the 
Contract matures, the amount paid is effectively calculated based on 
either 200 shares of Stock X (if the price of Stock X has 
appreciated up to $110) or 100 shares of Stock X (if the price of 
Stock X has declined below $90). Consequently, the Contract is a 
complex contract described in paragraph (a)(14) of this section.
    (iii) Because it is a complex ELI, FI applies the substantial 
equivalence test described in paragraph (h) of this section to 
determine whether the Contract is a specified ELI. FI determines 
that the price of Stock X would be $120 if the price of Stock X were 
increased by one standard deviation, and $79 if the price of Stock X 
were decreased by one standard deviation. Based on these results, FI 
next determines the change in value of the Contract to be $2000 at 
the testing price that represents an increase by one standard 
deviation ($12,000 testing price minus $10,000 issue price) and a 
negative $1,100 at the testing price that represents a decrease by 
one standard deviation ($10,000 issue price minus $8,900 testing 
price). FI performs the same calculations for the 64 shares of Stock 
X that constitute the initial hedge, determining that the change in 
value of the initial hedge is $1,280 at the testing price that 
represents an increase by one standard

[[Page 8158]]

deviation ($6,400 at issuance compared to $7,680 at the testing 
price) and negative $1,344 at the testing price that represents a 
decrease by one standard deviation ($6,400 at issuance compared to 
$5,056 at the testing price).
    (iv) FI then determines the absolute value of the difference 
between the change in value of the initial hedge and the Contract at 
the testing price that represents an increase by one standard 
deviation and a decrease by one standard deviation. Increased by one 
standard deviation, the absolute value of the difference is $720 
($2,000-$1,280); decreased by one standard deviation, the absolute 
value of the difference is $244 (negative $1,100 minus negative 
$1,344). FI determines that there is a 52% chance that the price of 
Stock X will have increased in value when the Contract matures and a 
48% chance that the price of Stock X will have decreased in value at 
that time. FI multiplies the absolute value of the difference 
between the change in value of the initial hedge and the Contract at 
the testing price that represents an increase by one standard 
deviation by 52%, which equals $374.40. FI multiplies the absolute 
value of the difference between the change in value of the initial 
hedge and the Contract at the testing price that represents a 
decrease by one standard deviation by 48%, which equals $117.12. FI 
adds these two numbers and divides by the number of shares that 
constitute the initial hedge to determine that the transaction 
calculation is 7.68 ((374.40 plus 117.12) divided by 64).
    (v) FI then performs the same calculation with respect to the 
simple contract benchmark, which is a one-year call option that 
references one share of Stock X, settles on the same date as the 
Contract, and has a delta of 0.8. The one-year call option has a 
strike price of $79 and has a cost (the purchase premium) of $22. 
The initial hedge for the one-year call option is 0.8 shares of 
Stock X.
    (vi) FI first determines that the change in value of the simple 
contract benchmark is $19.05 if the testing price is increased by 
one standard deviation ($22.00 at issuance to $41.05 at the testing 
price) and negative $20.95 if the testing price is decreased by one 
standard deviation ($22.00 at issuance to $1.05 at the testing 
price). Second, FI determines that the change in value of the 
initial hedge is $16.00 at the testing price that represents an 
increase by one standard deviation ($80 at issuance to $96 at the 
testing price) and negative $16.80 at the testing price that 
represents a decrease by one standard deviation ($80.00 at issuance 
to $63.20 at the testing price).
    (vii) FI determines the absolute value of the difference between 
the change in value of the initial hedge and the one-year call 
option at the testing price that represents an increase by one 
standard deviation is $3.05 ($16.00 minus $19.05). FI next 
determines the absolute value of the difference between the change 
in value of the initial hedge and the option at the testing price 
that represents a decrease by one standard deviation is $4.15 
(negative $16.80 minus negative $20.95). FI multiplies the absolute 
value of the difference between the change in value of the initial 
hedge and the option at the testing price that represents an 
increase by one standard deviation by 52%, which equals $1.586. FI 
multiplies the absolute value of the difference between the change 
in value of the initial hedge and the option at the testing price 
that represents a decrease by one standard deviation by 48%, which 
equals $1.992. FI adds these two numbers and divides by the number 
of shares that constitute the initial hedge to determine that the 
benchmark calculation is 4.473 ((1.586 plus 1.992) divided by .8).
    (viii) FI concludes that the Contract is not a section 871(m) 
transaction because the transaction calculation of 7.68 exceeds the 
benchmark calculation of 4.473.

    (i) * * *
    (3) * * * (ii) Publicly available dividend amount. For purposes of 
paragraph (i)(3)(i) of this section, if a section 871(m) transaction 
references the same underlying securities as a security (for example, 
stock in an exchange-traded fund) or index for which there is a 
publicly available quarterly dividend amount, the publicly available 
dividend amount may be used to determine the per-share dividend amount 
for the section 871(m) transaction with any adjustment for special 
dividends.
    (iii) Dividend amount for a section 871(m) transaction using the 
simplified delta calculation. When the delta of a section 871(m) 
transaction is determined under paragraph (g)(3) of this section, the 
per-share dividend amount for that section 871(m) transaction must be 
determined using the dividend amount for the exchange-traded security 
that would fully hedge the section 871(m) transaction (whether or not 
the exchange-traded security is actually acquired).
* * * * *
    (j) * * * (1) Calculation of the amount of a dividend equivalent. 
The long party is liable for tax on any dividend equivalents required 
to be determined pursuant to paragraph (j)(2) of this section only with 
respect to dividend equivalents that arise while the long party is a 
party to the transaction. The amount of any dividend equivalent is 
determined as follows:
* * * * *
    (4) Taxable year of a dividend equivalent. A long party is liable 
for tax on a dividend equivalent in the year the dividend equivalent is 
subject to withholding pursuant to Sec.  1.1441-2(e)(7). 
Notwithstanding the preceding sentence, a long party that is a 
qualified derivatives dealer is liable for tax on a dividend equivalent 
when the applicable dividend on the underlying security would be 
subject to withholding pursuant to Sec.  1.1441-2(e)(4). The amount of 
the long party's tax liability, however, is determined by reference to 
the amount that would have been due at the time the dividend equivalent 
amount is determined pursuant to paragraph (j)(2) of this section based 
on the beneficial owners at that time (for example, based on the tax 
rate at that time, whether the long party qualified for a treaty 
benefit at that time, and in the case of a partnership, based on the 
partners at that time).
* * * * *
    (l) * * *
    (2) Qualified index not treated as an underlying security--(i) In 
general. For purposes of this section, a qualified index is treated as 
a single security that is not an underlying security. The determination 
of whether an index referenced in a potential section 871(m) 
transaction is a qualified index is made at the calculation time for 
the transaction based on whether the index is a qualified index on the 
first business day of the calendar year containing the calculation 
time.
    (ii) Rule for the first year of an index. In the case of an index 
that was not in existence on the first business day of the calendar 
year containing the calculation time for the transaction, paragraph 
(l)(2) of this section is applied by testing the index on the first 
business day it is created, and the dividend yield calculation required 
by paragraph (l)(3)(vi) of this section is determined by using the 
dividend yield that the index would have had in the immediately 
preceding year if it had the same components throughout that year that 
it has on the day it is created.
* * * * *
    (4) Safe harbor for certain indices that reference assets other 
than underlying securities. Notwithstanding paragraph (l)(3) of this 
section, an index is a qualified index if the index is widely traded, 
the referenced component underlying securities in the aggregate 
comprise 10 percent or less of the weighting of the component 
securities in the index, and the index was not formed or availed of 
with a principal purpose of avoiding U.S. withholding tax.
* * * * *
    (n) * * *
    (3) Short party presumptions regarding combined transactions--(i) 
In general. If a short party relies on the presumption provided in 
paragraph (n)(3)(ii) of this section or in paragraph (n)(3)(iii) of 
this section, the short party is not required to treat those potential 
section 871(m) transactions as part of a

[[Page 8159]]

single transaction pursuant to paragraph (n)(1) of this section.
* * * * *
    (p) * * * (1) Responsible party--(i) In general. If a broker or 
dealer is a party to a potential section 871(m) transaction with a 
counterparty or customer that is not a broker or dealer, the broker or 
dealer is required to determine whether the potential section 871(m) 
transaction is a section 871(m) transaction. If both parties to a 
potential section 871(m) transaction are brokers or dealers, or neither 
party to a potential section 871(m) transaction is a broker or dealer, 
the short party must determine whether the potential section 871(m) 
transaction is a section 871(m) transaction.
    (ii) [Reserved]. For further guidance, see Sec.  1.871-
15T(p)(1)(ii).
    (iii) [Reserved]. For further guidance, see Sec.  1.871-
15T(p)(1)(iii).
    (iv) [Reserved]. For further guidance, see Sec.  1.871-
15T(p)(1)(iv).
    (v) Obligations of the responsible party. The party to the 
transaction that is required to determine whether a transaction is a 
section 871(m) transaction must also determine and report to the 
counterparty or customer the timing and amount of any dividend 
equivalent (as described in paragraphs (i) and (j) of this section). 
Except as otherwise provided in paragraph (n)(3) of this section, the 
party required to make the determinations described in this paragraph 
is required to exercise reasonable diligence to determine whether a 
transaction is a section 871(m) transaction, the amount of any dividend 
equivalents, and any other information necessary to apply the rules of 
this section. The information must be provided in the manner prescribed 
in paragraphs (p)(2) and (p)(3) of this section. The determinations 
required by paragraph (p) of this section are binding on the parties to 
the potential section 871(m) transaction and on any person who is a 
withholding agent with respect to the potential section 871(m) 
transaction unless the person knows or has reason to know that the 
information received is incorrect. The determinations are not binding 
on the Commissioner.
* * * * *
    (4) * * *
    (iii) Recordkeeping required for certain options. With respect to 
any option to which paragraph (g)(4) of this section applies, 
contemporaneous documentation is not required to be retained provided 
that there is a pre-existing documented methodology that is sufficient 
to permit the delta for the transaction to be verified at a later time.
    (5) [Reserved]. For further guidance, see Sec.  1.871-15T(p)(5).
    (q) Dividend and dividend equivalent payments to a qualified 
derivatives dealer--(1) In general. Except as otherwise provided in 
this paragraph (q), a qualified derivatives dealer described in Sec.  
1.1441-1(e)(6) that receives a payment (within the meaning of paragraph 
(i) of this section) of a dividend equivalent in its equity derivatives 
dealer capacity will not be liable for tax under section 881 on that 
dividend equivalent, provided that the qualified derivatives dealer 
complies with its obligations under the qualified intermediary 
agreement described in Sec. Sec.  1.1441-1(e)(5) and 1.1441-1(e)(6). A 
qualified derivatives dealer is liable for tax under section 881(a)(1) 
on its section 871(m) amount for each dividend on each underlying 
security. This tax liability is reduced (but not below zero) by the 
amount of tax paid by the qualified derivatives dealer under section 
881(a)(1) on dividends it receives with respect to that underlying 
security on that same dividend in its capacity as an equity derivatives 
dealer. In addition, a qualified derivatives dealer is liable for tax 
under section 881(a)(1) for all dividend equivalents it receives that 
are not received in its equity derivatives dealer capacity. A qualified 
derivatives dealer also is liable for tax under section 881(a)(1) for 
all dividends it receives, other than dividends received in 2017 in its 
equity derivatives dealer capacity. This paragraph does not apply for a 
qualified derivatives dealer that is a foreign branch of a United 
States financial institution (within the meaning of Sec.  1.1471-5(e)).
    (2) Transactions on the books of an equity derivatives dealer. 
Transactions properly reflected in a qualified derivatives dealer's 
equity derivatives dealer book are presumed to be held by the dealer in 
its equity derivatives dealer capacity for purposes of determining the 
qualified derivatives dealer's tax liability. For purposes of 
determining whether a dealer is acting in its equity derivatives dealer 
capacity, only the dealer's activities as an equity derivatives dealer 
are taken into account. Accordingly, for purposes of this paragraph 
(q), a dividend or dividend equivalent is treated as received by a 
qualified derivatives dealer acting in its non-equity derivatives 
dealer capacity if the dividend or dividend equivalent is received by a 
qualified derivatives dealer acting as a proprietary trader.
    (3) Section 871(m) amount. For each dividend on each underlying 
security, the section 871(m) amount is the product of:
    (i) The qualified derivatives dealer's net delta exposure to the 
underlying security for the applicable dividend, multiplied by;
    (ii) The applicable dividend amount per share.
    (4) Net delta exposure. The net delta exposure to an underlying 
security is the amount (measured in number of shares) by which (A) the 
aggregate number of shares of an underlying security that the qualified 
derivatives dealer has exposure to as a result of positions in the 
underlying security (including as a result of owning the underlying 
security) with values that move in the same direction as the underlying 
security (the long positions) exceeds (B) the aggregate number of 
shares of an underlying security that the qualified derivatives dealer 
has exposure to as a result of positions in the underlying security 
with values that move in the opposite direction from the underlying 
security (the short positions). The net delta exposure calculation only 
includes long positions and short positions that the qualified 
derivatives dealer holds in its equity derivatives dealer capacity (as 
described in paragraph (q)(2) of this section). Any long positions or 
short positions that are treated as effectively connected with the 
qualified derivatives dealer's conduct of a trade or business in the 
United States for U.S. federal income tax purposes are excluded from 
the net delta exposure computation. The net delta exposure to an 
underlying security is determined at the end of the day on the date 
provided in Sec.  1.871-15(j)(2) for the applicable dividend. For 
purposes of this calculation, net delta must be determined in a 
commercially reasonable manner. If a qualified derivatives dealer 
calculates net delta for non-tax business purposes, the net delta 
ordinary will be the delta used for that purpose, subject to the 
modifications required by this definition. Each qualified derivatives 
dealer must determine its net delta exposure separately only taking 
into account transactions that are recognized and are attributable to 
that qualified derivatives dealer for U.S. federal income tax purposes.
    (5) Examples. The following examples illustrate the rules of this 
paragraph (q):

    Example 1. Forward contract entered into by a foreign equity 
derivatives dealer. (i) Facts. FB is a foreign bank that is a 
qualified intermediary that acts as a qualified derivatives dealer. 
On April 1, Year 1, FB enters into a cash settled forward contract 
initiated by a foreign customer (Customer) that entitles Customer to 
receive from FB all of the appreciation and dividends on 100 shares 
of Stock X, and obligates Customer to

[[Page 8160]]

pay FB any depreciation on 100 shares of Stock X, at the end of 
three years. FB hedges the forward contract by entering into a total 
return swap contract with a domestic broker (U.S. Broker) and 
maintains the swap contract as a hedge for the duration of the 
forward contract. The swap contract entitles FB to receive an amount 
equal to all of the dividends on 100 shares of Stock X and obligates 
FB to pay an amount referenced to a floating interest rate each 
quarter, and also entitles FB to receive from or pay to U.S. Broker, 
as the case may be, the difference between the value of 100 shares 
of Stock X at the inception of the swap and the value of 100 shares 
of Stock X at the end of 3 years. Stock X pays a quarterly dividend 
of $0.25 per share. At the end of the day on the date provided in 
paragraph (j)(2) of this section for the dividend, FB owns the 
forward contract and total return swap; FB does not own any shares 
of Stock X or any other transactions that reference Stock X. FB 
provides valid documentation to U.S. Broker that FB will receive 
payments under the swap contract in its capacity as a qualified 
derivatives dealer, and FB contemporaneously enters both the swap 
contract with U.S. Broker and the forward contract with Customer on 
its equity derivatives dealer books.
    (ii) Application of rules. At the end of the day on the date 
provided in paragraph (j)(2) of this section for the dividend, FB is 
a long party on a delta one contract (the total return swap) and a 
short party on a delta one contract (the forward contract with 
Customer). Pursuant to Sec.  1.1441-1(b)(4)(xxii), U.S. Broker is 
not obligated to withhold on the dividend equivalent payments to FB 
on the swap contract that are referenced to Stock X dividends 
because U.S. Broker has received valid documentation that it may 
rely upon to treat the payment as made to FB acting as a qualified 
derivatives dealer. Pursuant to paragraph (q)(1) of this section, FB 
is not liable for tax under sections 871(m) and 881 on the payments 
it receives from U.S. Broker referenced to Stock X dividends because 
FB's net delta exposure with respect to 100 shares of Stock X is 
zero at the end of the day on the date provided in paragraph (j)(2) 
of this section for the dividend. The net delta exposure is zero 
because the taxpayer has 100 shares of Stock X long position 
exposure as a result of the total return swap that is reduced by 100 
shares of Stock X short position exposure as a result of the forward 
contract. FB is required to withhold on dividend equivalent payments 
to Customer on the forward contract in accordance with Sec.  1.1441-
2(e)(7).
    Example 2. At-the-money option contract entered into by a 
foreign equity derivatives dealer. (i) Facts. The facts are the same 
as Example 1, but Customer purchases from FB an at-the-money call 
option on 100 shares of Stock X with a term of one year. The call 
option has a delta of 0.5, and FB hedges the call option by entering 
into a total return swap that references 50 shares of Stock X with 
U.S. Broker. At the end of the day on the date provided in paragraph 
(j)(2) of this section for the dividend, the call option has a delta 
of 0.6, FB hedges the call option with a total return swap that 
references 60 shares of Stock X with U.S. Broker, and FB has no 
shares of Stock X or other transactions that reference Stock X.
    (ii) Application of rules. At the end of the day on the date 
provided in paragraph (j)(2) of this section for the dividend, FB is 
a long party on 60 shares of Stock X through the total return swap 
and a short party on an option. Because the option has a delta of 
less than 0.8 at the calculation time, it is not a section 871(m) 
transaction. Therefore, there will be no dividend equivalent 
payments made by FB to Customer that are subject to withholding. 
Pursuant to Sec.  1.1441-1(b)(4)(xxii), U.S. Broker is not obligated 
to withhold on the dividend equivalents with respect to Stock X paid 
to FB because U.S. Broker has received valid documentation that it 
may rely upon to treat the dividend equivalents as paid to FB acting 
as a qualified derivatives dealer. The net delta exposure is zero at 
the end of the day on the date provided in paragraph (j)(2) of this 
section for the dividend because FB has a long position of 60 shares 
as a result of the total return swap, which is reduced by FB's short 
position of 60 shares as a result of the option.
    Example 3. In-the-money option contract entered into by a 
foreign equity derivatives dealer. (i) Facts. The facts are the same 
as Example 2, but Customer purchases from FB an in-the-money call 
option on 100 shares of Stock X with a term of one year. The call 
option has a delta of 0.8 and FB hedges the call option by 
purchasing 80 shares of Stock X, which are held in an account with 
U.S. Broker, who also acts as paying agent. The price of Stock X 
declines substantially and the option lapses unexercised. At the end 
of the day on the date provided in paragraph (j)(2) of this section 
for the dividend, the call option has a delta of 0.48 and FB has 
reduced its hedge to 50 shares of Stock X with U.S. Broker. In 
addition, on that date, FB owns no other shares of Stock X or any 
other transactions that reference Stock X in its equity derivatives 
dealer capacity.
    (ii) Application of rules. At the end of the day on the date 
provided in paragraph (j)(2) of this section for the dividend, FB is 
a long party on 50 shares of Stock X and a short party on an option. 
Because the option has a delta of 0.8 at the calculation time, it is 
a section 871(m) transaction. Therefore, FB is required to withhold 
on dividend equivalent payments to Customer on the option contract 
in accordance with Sec.  1.1441-2(e)(7). U.S. Broker is required to 
withhold on the Stock X dividends paid to FB. Assuming that FB is a 
qualified resident of a country that provides withholding on 
dividends at a 15 percent rate, U.S. Broker is required withhold on 
the dividends with respect to the 50 shares of stock held by FB. 
FB's net delta exposure is two shares of Stock X at the end of the 
day on the date provided in paragraph (j)(2) of this section because 
FB has a long position of 50 shares, reduced by FB's short position 
of 48 shares as a result of the option. FB's section 881 tax on the 
$0.50 (two shares multiplied by a dividend of $0.25 per share) is 
reduced (but not below zero) by the section 881 tax amount paid by 
qualified derivatives dealer on the 50 shares. Therefore, FB's 
section 871(m) amount is zero.

    (r) * * *
    (3) Effective/applicability date for paragraphs (d)(2) and (e). 
Paragraphs (d)(2) and (e) of this section apply to any payment made on 
or after January 1, 2017, with respect to any transaction with a delta 
of one issued on or after January 1, 2017. Paragraphs (d)(2) and (e) of 
this section apply to any payment made on or after January 1, 2018, 
with respect to any other transaction issued on or after January 1, 
2018. Notwithstanding the prior sentence, paragraphs (d)(2) and (e) of 
this section will apply to any payments made on or after January 1, 
2020, with respect to the exchange-traded notes issued on or after 
January 1, 2017, that are identified in a separate notice, and not 
payments made before January 1, 2020, with respect to those notes. 
Notwithstanding the first sentence of this paragraph (r)(3), paragraphs 
(d)(2) and (e) of this section do not apply to payments made in 2017 to 
a qualified derivatives dealer in its equity derivatives dealer 
capacity to hedge transactions that have a delta of less than one.
    (4) Effective/applicability date for paragraphs (c)(2)(iv), (h), 
and (q) of this section. Paragraphs (c)(2)(iv), (h), and (q) of this 
section apply to payments made on or after January 1, 2017.
    (5) Effective/applicability date for paragraphs (g)(4)(ii)(B), 
(p)(1)(ii) through (iv), and (p)(5) of this section. [Reserved]. For 
further guidance, see Sec.  1.871-15T(r)(5).


Sec.  1.871-15   [Amended]

0
Par. 3. For each section listed in the table, remove the language in 
the ``Remove'' column and add in its place the language in the ``Add'' 
column as set forth below:

------------------------------------------------------------------------
           Section                   Remove                  Add
------------------------------------------------------------------------
Sec.   1.871-15(a)(3).......  section 316.........  section 316 (even if
                                                     there is no actual
                                                     distribution of
                                                     cash or property).
Sec.   1.871-15(a)(5).......  the time the NPC or   the calculation time
                               ELI is issued,.       for the NPC or
                                                     ELI,.
Sec.   1.871-                 issuance............  the calculation
 15(a)(14)(ii)(B), newly                             time.
 designated third sentence.

[[Page 8161]]

 
Sec.   1.871-15(a)(15),       a payment with        ....................
 first sentence.               respect to.
Sec.   1.871-15(c)(1)         paragraph (2).......  paragraph (c)(2) of
 introductory text.                                  this section.
Sec.   1.871-15(c)(1)(i)....  references the        references a
                               payment of a          dividend.
                               dividend.
Sec.   1.871-15(c)(1)(ii)...  references the        references a
                               payment of a          dividend.
                               dividend.
Sec.   1.871-15(c)(1)(iii)..  references the        references a
                               payment of a          dividend.
                               dividend.
Sec.   1.871-15(c)(2)(i),     section 871.........  section 871(a).
 first sentence and second
 sentence.
Sec.   1.871-15(d)(2)(i)....  when the NPC is       at the calculation
                               issued.               time for the NPC.
Sec.   1.871-15(d)(2)(ii)...  when the NPC is       at the calculation
                               issued.               time for the NPC.
Sec.   1.871-15(e)(1).......  when the ELI is       at the calculation
                               issued.               time for the ELI.
Sec.   1.871-15(e)(2).......  when the ELI is       at the calculation
                               issued.               time for the ELI.
Sec.   1.871-15(i)(1).......  references the        references a
                               payment of a          dividend.
                               dividend.
Sec.   1.871-15(i)(2)(i)....  estimated payment of  estimated dividend.
                               dividends.
Sec.   1.871-15(i)(2)(ii)...  estimated dividend    estimated dividend.
                               payment.
Sec.   1.871-15(i)(2)(iii),   the time the          the calculation
 first sentence and second     transaction is        time.
 sentence.                     issued.
Sec.   1.871-15(i)(2)(iii),   to pay a dividend...  to have a dividend.
 last sentence.
Sec.   1.871-15(j)(1)(i)....  each underlying       each dividend on an
                               security.             underlying
                                                     security.
Sec.   1.871-15(j)(1)(ii)     each underlying       each dividend on an
 introductory text.            security.             underlying
                                                     security.
Sec.   1.871-15(j)(1)(iii)    each underlying       each dividend on an
 introductory text.            security.             underlying
                                                     security.
Sec.   1.871-15(l)(1), first  The purpose of this   The purpose of this
 sentence.                     section.              paragraph (l).
Sec.   1.871-15(l)(1),        described in this     described in this
 second sentence.              paragraph.            paragraph (l).
Sec.   1.871-15(l)(7).......  references a          references an
                               security (for         exchange-traded
                               example, stock in     fund.
                               an exchange-traded
                               fund).
Sec.   1.871-15(m)(2)(ii),    at the time the       at the calculation
 first sentence.               potential 871(m)      time for the
                               transaction           potential section
                               referencing that      871(m) transaction
                               partnership           referencing that
                               interest is issued.   partnership
                                                     interest.
Sec.   1.871-15(m)(2)(ii),    paragraph (m)(2)(i).  paragraph (m)(2)(i)
 first sentence.                                     of this section.
Sec.   1.871-15(n)(4)(iii),   less than...........  fewer than.
 heading and first sentence.
Sec.   1.871-15(p)(4)(ii)...  10 business days of   10 business days of
                               the date the          the date containing
                               potential section     the calculation
                               871(m) transaction    time for the
                               is issued.            potential section
                                                     871(m) transaction.
Sec.   1.871-15(r)(4),        paragraphs            paragraphs
 heading.                      (c)(2)(iv), (h),      (g)(4)(ii)(B),
                               and (q).              (p)(1)(ii) through
                                                     (iv), and (p)(5).
------------------------------------------------------------------------


0
Par. 4. Revise Sec.  1.871-15T to read as follows:


Sec.  1.871-15T   Treatment of dividend equivalents (temporary).

    (a) [Reserved]. For further guidance, see Sec.  1.871-15(a).
    (1) Broker. A broker is a broker within the meaning provided in 
section 6045(c), except that the term does not include any corporation 
that is a broker solely because it regularly redeems its own shares.
    (a)(2) through (g)(4)(ii)(A) [Reserved]. For further guidance, see 
Sec.  1.871-15(a)(2) through (g)(4)(ii)(A).
    (B) A foreign securities exchange that:
    (1) Is regulated or supervised by a governmental authority of the 
country in which the market is located;
    (2) Has trading volume, listing, financial disclosure, 
surveillance, and other requirements designed to prevent fraudulent and 
manipulative acts and practices, to remove impediments to and perfect 
the mechanism of a free and open, fair and orderly market, and to 
protect investors, and the laws of the country in which the exchange is 
located and the rules of the exchange ensure that those requirements 
are actually enforced;
    (3) Has rules that effectively promote active trading of listed 
options on the exchange; and
    (4) Has an average daily trading volume on the exchange exceeding 
$10 billion during the immediately preceding calendar year. If an 
exchange in a foreign country has more than one tier or market level on 
which listed options may be separately listed or traded, each tier or 
market level is treated as a separate exchange.
    (g)(5) through (p)(1)(i) [Reserved]. For further guidance, see 
Sec.  1.871-15(g)(5) through (p)(1)(i).
    (ii) Transactions with multiple brokers. For a potential section 
871(m) transaction in which both the short party and an agent or 
intermediary acting on behalf of the short party are a broker or 
dealer, the short party must determine whether the potential section 
871(m) transaction is a section 871(m) transaction. For a potential 
section 871(m) transaction in which the short party is not a broker or 
dealer and more than one agent or intermediary acting on behalf of the 
short party is a broker or dealer, the broker or dealer that is a party 
to the transaction and closest to the short party in the payment chain 
must determine whether the potential section 871(m) transaction is a 
section 871(m) transaction. For a potential section 871(m) transaction 
in which neither the short party nor any agent or intermediary acting 
on behalf of the short party is a broker or dealer, and the long party 
and an agent or intermediary acting on behalf of the long party are a 
broker or dealer, or more than one agent or intermediary acting on 
behalf of the long party is a broker or dealer, the broker or dealer 
that is a party to the transaction and closest to the long party in the 
payment chain must determine whether the potential section 871(m) 
transaction is a section 871(m) transaction.
    (iii) Responsible party for transactions traded on an exchange and 
cleared by a clearing organization. Except as provided in paragraph 
(p)(1)(iv) of this section, for a potential section 871(m) transaction 
that is traded on an exchange and cleared by a clearing organization, 
and for which more than one broker-dealer acts as an agent or 
intermediary between the short party and a foreign payee, the broker or 
dealer that has an ongoing customer relationship with the foreign payee 
with respect to that transaction (generally the clearing firm) must 
determine whether the potential section 871(m) transaction is a section 
871(m) transaction.

[[Page 8162]]

    (iv) Responsible party for certain structured notes, warrants, and 
convertible instruments. When a potential section 871(m) transaction is 
a structured note, warrant, convertible stock, or convertible debt, the 
issuer is the party responsible for determining whether a potential 
section 871(m) transaction is a section 871(m) transaction.
    (p)(1)(v) through (p)(4) [Reserved]. For further guidance, see 
Sec.  1.871-15(p)(1)(v) through (p)(4).
    (5) Example. The following example illustrates the rules of 
paragraph (p) of this section:

    Example 1. CO is a domestic clearing organization and is not a 
broker as defined in Sec.  1.871-15(a)(1). CO serves as a central 
counterparty clearing and settlement service provider for 
derivatives exchanges in the United States. EB and CB are brokers 
organized in the United States and members of CO. FC, a foreign 
corporation, instructs EB to execute the purchase of a call option 
that is a specified ELI (as described in Sec.  1.871-15(e)). EB 
effects the trade for FC on the exchange and then, as instructed by 
FC, transfers the option to CB to be cleared with CO. The exchange 
matches FC's order with an order for a written call option with the 
same terms and then sends the matched trade to CO, which clears the 
trade. CB and the clearing member representing the person who sold 
the call option settle the trade with CO. Upon receiving the matched 
trade, the option contracts are novated and CO becomes the 
counterparty to CB and the counterparty to the clearing member 
representing the person who sold the call option. Both EB and CB are 
broker-dealers acting on behalf of FC for a potential section 871(m) 
transaction. Under paragraph (p)(1)(iii) of this section, however, 
only CB is required to make the determinations described in Sec.  
1.871-15(p).

    (q) through (r)(4) [Reserved]. For further guidance, see Sec.  
1.871-15(r)(1) through (4).
    (5) Effective/applicability date. This section applies to payments 
made on or after on January 19, 2017.
    (s) Expiration date. This section expires January 17, 2020.
0
Par. 5. Section 1.1441-1 is amended by:
0
1. Revising paragraphs (b)(4)(xxii), (e)(3)(ii)(E), (e)(5),and (e)(6).
0
2. Adding a new sentence to the end of paragraph (e)(2)(i).
0
3. Adding new paragraph (f)(5).
    The additions and revisions read as follows:


Sec.  1.1441-1  Requirement for the deduction and withholding of tax on 
payments to foreign persons.

* * * * *
    (b) * * *
    (4) * * *
    (xxii) Certain payments to qualified derivatives dealers (as 
described in paragraph (e)(6) of this section). For purposes of this 
withholding exemption, the qualified derivatives dealer must furnish to 
the withholding agent the documentation described in paragraph 
(e)(3)(ii) of this section. A withholding agent that makes a payment to 
a qualified intermediary that is acting as a qualified derivatives 
dealer is not required to withhold on the following payments if the 
withholding agent can reliably associate the payment with a valid 
qualified intermediary withholding certificate as described in 
paragraph (e)(3)(ii) of this section, including the certification 
described in paragraph (e)(3)(ii)(E):
    (A) A payment with respect to a potential section 871(m) 
transaction that is not an underlying security;
    (B) A payment of a dividend equivalent; or
    (C) A payment of a dividend in 2017.
* * * * *
    (e) * * *
    (2) * * *
    (i) * * * For purposes of a qualified intermediary acting as a 
qualified derivatives dealer, a qualified intermediary withholding 
certificate, as described in paragraph (e)(3)(ii) of this section is a 
beneficial owner withholding certificate for purposes of treaty claims 
for dividends.
* * * * *
    (3) * * *
    (ii) * * *
    (E) In the case of any payment with respect to a potential section 
871(m) transaction (including any dividend equivalent payment within 
the meaning of Sec.  1.871-15(i)) or underlying security (as defined in 
Sec.  1.871-15(a)(15)) received by a qualified intermediary acting as a 
qualified derivatives dealer, a certification that the home office or 
branch receiving the payment, as applicable, meets the requirements to 
act as a qualified derivatives dealer as further described in paragraph 
(e)(6) of this section and that the qualified derivatives dealer 
assumes primary withholding and reporting responsibilities under 
chapters 3, 4, and 61, and section 3406 with respect to any payments it 
makes with respect to potential section 871(m) transactions;
* * * * *
    (5) Qualified intermediaries--(i) In general. A qualified 
intermediary, as defined in paragraph (e)(5)(ii) of this section, may 
furnish a qualified intermediary withholding certificate to a 
withholding agent. The withholding certificate provides certifications 
on behalf of other persons for the purpose of claiming and verifying 
reduced rates of withholding under section 1441 or 1442 and for the 
purpose of reporting and withholding under other provisions of the 
Code, such as the provisions under chapter 61 and section 3406 (and the 
regulations under those provisions), or for the qualified derivative 
dealer (if applicable). Furnishing such a certificate is in lieu of 
transmitting to a withholding agent withholding certificates or other 
appropriate documentation for the persons for whom the qualified 
intermediary receives the payment, including interest holders in a 
qualified intermediary that is fiscally transparent under the 
regulations under section 894. Although the qualified intermediary is 
required to obtain withholding certificates or other appropriate 
documentation from beneficial owners, payees, or interest holders 
pursuant to its agreement with the IRS, it is generally not required to 
attach such documentation to the intermediary withholding certificate. 
Notwithstanding the preceding sentence, a qualified intermediary must 
provide a withholding agent with the Forms W-9, or disclose the names, 
addresses, and taxpayer identifying numbers, if known, of those U.S. 
non-exempt recipients for whom the qualified intermediary receives 
reportable amounts (within the meaning of paragraph (e)(3)(vi) of this 
section) to the extent required in the qualified intermediary's 
agreement with the IRS. When a qualified intermediary is acting as a 
qualified derivatives dealer, the withholding certificate entitles a 
withholding agent to make payments with respect to potential section 
871(m) transactions that are not underlying securities and dividend 
equivalent payments on underlying securities to the qualified 
derivatives dealer free of withholding. A withholding agent is required 
to withhold on all other U.S. source FDAP payments made to a qualified 
derivatives dealer as required by applicable law. Paragraph (e)(6) of 
this section contains detailed rules prescribing the circumstances in 
which a qualified intermediary can act as a qualified derivatives 
dealer. A person may claim qualified intermediary status before an 
agreement is executed with the IRS if it has applied for such status 
and the IRS authorizes such status on an interim basis under such 
procedures as the IRS may prescribe.
    (ii) [Reserved]. For additional guidance, see Sec.  1.1441-
1T(e)(5)(ii).
    (A) Through (C) [Reserved]. For additional guidance, see Sec.  
1.1441-1T(e)(5)(ii)(A)-(C).
    (D) A foreign person that is a home office or has a branch that is 
an eligible entity as described in paragraph (e)(6)(ii) of this 
section, without regard

[[Page 8163]]

to the requirement that the person be a qualified intermediary; or
    (E) [Reserved]. For additional guidance, see Sec.  1.1441-
1T(e)(5)(ii)(E).
    (iii) [Reserved]. For additional guidance, see Sec.  1.1441-
1T(e)(5)(iii).
    (iv) [Reserved]. For additional guidance, see Sec.  1.1441-
1T(e)(5)(iv).
    (v) [Reserved]. For additional guidance, see Sec.  1.1441-
1T(e)(5)(v).
    (A) [Reserved]. For additional guidance, see Sec.  1.1441-
1T(e)(5)(v)(A).
    (B) [Reserved]. For additional guidance, see Sec.  1.1441-
1T(e)(5)(v)(B).
    (1)-(3) [Reserved]. For additional guidance, see Sec.  1.1441-
1T(e)(5)(v)(B)(1)-(3).
    (4) If a qualified intermediary is acting as a qualified 
derivatives dealer, designate the accounts:
    (i) For which the qualified derivatives dealer is receiving 
payments with respect to potential section 871(m) transactions or 
underlying securities as a qualified derivatives dealer;
    (ii) For which the qualified derivatives dealer is receiving 
payments with respect to potential section 871(m) transactions (and 
that are not underlying securities) for which withholding is not 
required;
    (iii) For which qualified derivatives dealer is receiving payments 
with respect to underlying securities for which withholding is 
required; and
    (iv) If applicable, identifying the home office or branch that is 
treated as the owner for U.S. income tax purposes; and
    (6) Qualified derivatives dealers--(i) In general. To act as a 
qualified derivatives dealer under a qualified intermediary withholding 
agreement, the home office or branch that is a qualified intermediary 
must be an eligible entity as described in paragraph (e)(6)(ii) of this 
section and, in accordance with the qualified intermediary agreement, 
must--
    (A) Furnish to a withholding agent a qualified intermediary 
withholding certificate (described in paragraph (e)(3)(ii) of this 
section) that indicates that the home office or branch receiving the 
payment is a qualified derivatives dealer with respect to the payments 
associated with the withholding certificate;
    (B) Agree to assume the primary withholding and reporting 
responsibilities, including the documentation provisions under chapters 
3, 4, and 61, and section 3406, the regulations under those provisions, 
and other withholding provisions of the Internal Revenue Code, for 
payments made as a qualified derivatives dealer with respect to 
potential section 871(m) transactions. For this purpose, a qualified 
derivatives dealer is required to obtain a withholding certificate or 
other appropriate documentation from each counterparty to whom the 
qualified derivatives dealer makes a reportable payment (including a 
dividend equivalent payment within the meaning of Sec.  1.871-15(i)). 
The qualified derivatives dealer is also required to determine whether 
any payment it makes with respect to a potential section 871(m) 
transaction is, in whole or in part, a dividend equivalent;
    (C) Agree to remain liable for tax under section 881, if any, on 
any payment with respect to a potential section 871(m) transaction 
(including a dividend equivalent payment within the meaning of Sec.  
1.871-15(i)) and underlying securities (including dividends) it 
receives as a qualified derivatives dealer, or in the case of dividend 
equivalents received in the equity derivatives dealer capacity, the 
taxes required pursuant to Sec.  1.871-15(q);
    (D) Comply with the compliance review procedures applicable to a 
qualified intermediary that acts as a qualified derivatives dealer 
under the qualified intermediary withholding agreement, which will 
specify the time and manner in which a qualified derivatives dealer 
must:
    (1) Certify to the IRS that it has complied with the obligations to 
act as a qualified derivatives dealer (including its performance of a 
periodic review applicable to a qualified derivatives dealer);
    (2) Report to the IRS any amounts subject to reporting on Forms 
1042-S (including dividend equivalent payments that it made);
    (3) Report to the IRS on the appropriate U.S. tax return, its tax 
liabilities, including its tax liability pursuant to Sec.  1.871-
15(q)(1) and any other taxes on payments with respect to potential 
section 871(m) transactions or underlying securities as defined in 
Sec.  1.871-15(a)(15) it receives; and
    (4) Respond to inquiries from the IRS about obligations it has 
assumed as a qualified derivatives dealer in a timely manner;
    (E) Agree to act as a qualified derivatives dealer for all payments 
made as a principal with respect to potential section 871(m) 
transactions and all payments received as a principal with respect to 
potential section 871(m) transactions and underlying securities as 
defined in Sec.  1.871-15(a)(15) (including dividend equivalent 
payments within the meaning of Sec.  1.871-15(i)), excluding any 
payments made or received by the qualified derivatives dealer to the 
extent the payment is treated as effectively connected with the conduct 
of a trade or business within the United States within the meaning of 
section 864, and not act as a qualified derivatives dealer for any 
other payments. For purposes of this paragraph (E), any securities 
lending or sale-repurchase transaction that the qualified intermediary 
enters into that is a section 871(m) transaction is treated as entered 
into as a principal unless the qualified intermediary determines that 
it is acting as an intermediary with respect to that transaction; and
    (F) Each home office or branch must qualify and be approved for 
qualified derivatives dealer status and must represent itself as a QDD 
on its Form W-8IMY and separately identify the home office or branch as 
the recipient on a withholding statement (if necessary). The home 
office means a foreign person, excluding any branches of the foreign 
person, that applies for qualified derivatives dealer status. Each home 
office or branch that obtains qualified derivatives dealer status must 
be treated as a separate qualified derivatives dealer.
    (ii) Definition of eligible entity. An eligible entity is a home 
office or branch that is a qualified intermediary and that, treating 
the home office or branch as a separate entity, is--
    (A) An equity derivatives dealer subject to regulatory supervision 
as a dealer by a governmental authority in the jurisdiction in which it 
was organized or operates;
    (B) A bank or bank holding company subject to regulatory 
supervision as a bank or bank holding company (as applicable) by a 
governmental authority in the jurisdiction in which it was organized, 
or operates or an entity that is wholly-owned (directly or indirectly) 
by a bank or bank holding company subject to regulatory supervision as 
a bank or bank holding company (as applicable) by a governmental 
authority in the jurisdiction in which the bank or bank holding company 
(as applicable) was organized or operates and that in its equity 
derivatives dealer capacity--
    (1) Issues potential section 871(m) transactions to customers; and
    (2) Receives dividends with respect to stock or dividend equivalent 
payments pursuant to potential section 871(m) transactions that hedge 
potential section 871(m) transactions that it issued;
    (C) A foreign branch of a U.S. financial institution, if the 
foreign branch would meet the requirements of paragraph (A) or (B) of 
this section if it were a separate entity; or

[[Page 8164]]

    (D) Any person otherwise acceptable to the IRS.
* * * * *
    (f) * * *
    (5) Effective/applicability date. Paragraphs (e)(5)(ii)(D) and 
(e)(5)(v)(B)(4) of this section apply to payments made on or after on 
January 19, 2017.

0
Par. 6. Section 1.1441-1T is amended by:
0
1. Redesignating paragraph (e)(5)(ii)(D) as paragraph (e)(5)(ii)(E), 
redesignating paragraph (e)(5)(v)(B)(4) as paragraph (e)(5)(v)(B)(5) 
and adding new paragraphs (e)(5)(ii)(D) and (e)(5)(v)(B)(4).
0
2. Revising paragraphs (e)(3)(ii)(E), (e)(5)(i), (e)(5)(v)(B)(4), and 
(e)(6).
0
3. Removing the language ``Except for paragraphs (e)(3)(ii)(E) and 
(e)(6), this section'' from the first sentence of paragraph (f)(3) and 
adding in its place ``This section'', and removing the third sentence 
in paragraph (f)(3), and
0
4. Removing the language ``Except for paragraphs (e)(3)(ii)(E) and 
(e)(6), the applicability'' from the first sentence of paragraph (g) 
and adding in its place ``The Applicability'' and removing the second 
sentence in paragraph (g).


Sec.  1.1441-1T   Requirement for the deduction and withholding of tax 
on payments to foreign persons (temporary).

* * * * *
    (e) * * *
    (3) * * *
    (ii) * * *
    (E) [Reserved]. For additional guidance, see Sec.  1.1441-
1(e)(3)(ii)(E).
* * * * *
    (5) Qualified Intermediaries--(i) [Reserved]. For additional 
guidance, see Sec.  1.1441-1(e)(5)(i).
    (ii) * * *
    (D) [Reserved]. For additional guidance, see Sec.  1.1441-
1(e)(5)(ii)(D).
* * * * *
    (v) * * *
    (B) * * *
    (4) [Reserved]. For additional guidance, see Sec.  1.1441-
1(e)(5)(v)(B)(4).
* * * * *
    (6) [Reserved]. For additional guidance, see Sec.  1.1441-1(e)(6).
* * * * *

0
Par. 7. Section 1.1441-2 is amended by:
0
1. Revising paragraphs (e)(7)(i) and (e)(7)(ii).
0
2. Removing ``paragraph (e)(8)(ii)(A)'' from paragraph (e)(7)(iii) and 
adding in ``paragraph (e)(7)(ii)(A)'' in its place.
0
3. Adding paragraphs (e)(7)(iv) through (ix).
0
4. Revising the last sentence of paragraph (f)(1) and adding a new last 
sentence.
    The revisions and additions read as follows:


Sec.  1.1441-2  Amounts subject to withholding.

* * * * *
    (e) * * *
    (7) Payments of dividend equivalents--(i) In general. Subject to 
paragraphs (e)(7)(iv), (vi), and (vii) of this section, a payment of a 
dividend equivalent is not considered to be made until the later of 
when--
    (A) The amount of a dividend equivalent is determined as provided 
in Sec.  1.871-15(j)(2), and
    (B) A payment occurs with respect to the section 871(m) transaction 
after the amount of a dividend equivalent is determined as provided in 
Sec.  1.871-15(j)(2).
    (ii) Payment. For purposes of paragraph (e)(7) of this section, a 
payment occurs with respect to a section 871(m) transaction when--
    (A) Money or other property is paid to or by the long party, unless 
the section 871(m) transaction is described in Sec.  1.871-15(i)(3), in 
which case a payment is treated as being made at the end of the 
applicable calendar quarter;
    (B) The long party sells, exchanges, transfers, or otherwise 
disposes of the section 871(m) transaction (including by settlement, 
offset, termination, expiration, lapse, or maturity); or
    (C) The section 871(m) transaction is transferred to an account 
that is not maintained by the withholding agent or the long party 
terminates the account relationship with the withholding agent.
* * * * *
    (iv) Option to withhold on dividend payment date. A withholding 
agent may withhold on the payment date described in paragraph (e)(4) of 
this section for the applicable dividend on the underlying security 
(the dividend payment date) if it withholds on that date for all 
section 871(m) transactions of the same type (securities lending or 
sale-repurchase transaction, NPC, or ELI) and satisfies the 
requirements to paragraph (e)(7)(v) of this section.
    (v) Changes to time of withholding. This paragraph describes how a 
withholding agent changes the time that it withholds on a dividend 
equivalent payment to a time described in paragraph (e)(7)(i) or (iv) 
of this section and these requirements must be satisfied for a 
withholding agent to change the time it withholds. A withholding agent 
must apply the change consistently to all transactions of the same type 
entered into on or after the change. For transactions of the same type 
entered into before the change, a withholding agent must withhold under 
the original approach throughout the term of the transaction. When a 
withholding agent changes the time that it will withhold, the 
withholding agent must notify each payee in writing that it will 
withhold using the approach described in paragraph (e)(7)(i) or (iv) of 
this section, as applicable, before the time for determining the 
payee's first dividend equivalent payment (as determined under Sec.  
1.871-15(j)(2)). With respect to transactions held by an intermediary 
or foreign flow-through entity, a withholding agent is treated as 
providing notice to each payee holding that transaction through the 
entity when it notifies the intermediary or foreign flow-through entity 
of the time it will withhold, as described in the preceding sentence, 
provided that the intermediary or foreign flow-through entity agrees to 
provide the same notice to each payee. The withholding agent must 
attach a statement to its relevant income tax return (filed by the due 
date, including extensions) for the year of the change notifying the 
IRS of the change and when it applies, identifying the types of section 
871(m) transaction to which the change applies, and certifying that has 
notified its payees. For purposes of this paragraph, a withholding 
agent will be considered to have entered into a transaction on the 
first date the withholding agent becomes responsible for withholding on 
the transaction (based on the rule in paragraph (e)(7)(ix) of this 
section).
    (vi) Withholding by qualified derivatives dealers. A withholding 
agent that is acting as a qualified derivatives dealer must withhold 
with respect to a dividend equivalent payment on the payment date 
described in paragraph (e)(4) of this section for the applicable 
dividend on the underlying security and must notify each payee in 
writing that it will withhold on the dividend payment date before the 
time for determining the payee's first dividend equivalent payment (as 
determined under Sec.  1.871-15(j)(2)).
    (vii) Withholding with respect to derivatives that reference 
partnerships. To the extent that a withholding agent is required to 
withhold with respect to a partnership interest described in Sec.  
1.871-15(m), the liability for withholding arises on March 15 of the 
year following the year in which the payment of a dividend equivalent 
(determined under Sec.  1.871-15(i)) occurs.
    (viii) Notification to holders of withholding timing. If a 
withholding agent is required to notify a payee of when it will 
withhold under paragraph (e)(7)(v) of this section, it may use the 
reporting methods prescribed in Sec.  1.871-15(p)(3)(i).

[[Page 8165]]

    (ix) Withholding agent responsibility. A withholding agent is only 
responsible for dividend equivalent amounts determined (as provided in 
Sec.  1.871-15(j)(2)) during the period the withholding agent is a 
withholding agent for the section 871(m) transaction.
* * * * *
    (f) * * * (1) Except as otherwise provided in this paragraph, 
paragraph (e)(7) of this section applies to payments made on or after 
September 18, 2015. Paragraphs (e)(7)(ii)(D) and (e)(7)(iv) through 
(viii) of this section apply to payments made on or after January 19, 
2017.

0
Par. 8. Section 1.1441-7 is amended by:
0
1. Revising Example 7 in paragraph (a)(3).
0
2. Adding Example 8 and 9 to paragraph (a)(3).
0
3. Adding a sentence to the end of paragraph (a)(4).
    The additions read as follows:


Sec.  1.1441-7   General provisions relating to withholding agents.

    (a) * * *
    (3) * * *

    Example 7.  CO is a domestic clearing organization. CO serves as 
a central counterparty clearing and settlement service provider for 
derivatives exchanges in the United States. CB is a broker organized 
in Country X, a foreign country, and a clearing member of CO. CB is 
a nonqualified intermediary, as defined in Sec.  1.1441-1(c)(14). FC 
is a foreign corporation that has an account with CB. FC instructs 
CB to purchase a call option that is a specified ELI (as described 
in Sec.  1.871-15(e)). CB effects the trade for FC on the exchange. 
The exchange matches FC's order with an order for a written call 
option with the same terms. The exchange then sends the matched 
trade to CO, which clears the trade. CB and the clearing member 
representing the person who sold the call option settle the trade 
with CO. Upon receiving the matched trade, the option contracts are 
novated and CO becomes the counterparty to CB and the counterparty 
to the clearing member representing the person who sold the call 
option. To the extent that there is a dividend equivalent with 
respect to the call option, both CO and CB are withholding agents as 
described in paragraph (a)(1) of this section. As a withholding 
agent, CO and CB must each determine whether it is obligated to 
withhold under chapter 3 of the Internal Revenue Code and the 
regulations thereunder.
    Example 8.  FCO is a foreign clearing organization. FCO serves 
as a central counterparty clearing and settlement service provider 
for derivatives exchanges in Country A, a foreign country. CB is a 
broker organized in Country A, and a clearing member of FCO. CB is a 
nonqualified intermediary, as defined in Sec.  1.1441-1(c)(14). FC 
is a foreign corporation that has an account with CB. FC instructs 
CB to purchase a call option that is a section 871(m) transaction. 
CB effects the trade for FC on the exchange. The exchange matches 
FC's order with an order for a written call option with the same 
terms. The exchange then sends the matched trade to FCO, which 
clears the trade. CB and the clearing member representing the call 
option seller settle the trade with FCO. Upon receiving the matched 
trade, the option contracts are novated and FCO becomes the 
counterparty to CB and the counterparty to the clearing member 
representing the call option seller. To the extent that there is a 
dividend equivalent with respect to the call option, both FCO and CB 
are withholding agents as described in paragraph (a)(1) of this 
section.
    Example 9.  The facts are the same as Example 8, except that CB 
is a qualified intermediary, as defined in Sec.  1.1441-1(c)(15), 
that has assumed the primary obligation to withhold, deposit, and 
report amounts under chapters 3 and 4 of Internal Revenue Code. CB 
provides a written statement to FCO representing that it has assumed 
primary withholding responsibility for any dividend equivalent 
payment with respect to the call option. FCO, therefore, is not 
required withhold on a dividend equivalent payment to CB.

    (4) * * * Example 8 and Example 9 of paragraph (a)(3) of this 
section apply to payments made on or after January 19, 2017.
* * * * *


Sec.  1.1461-1   [Amended]


0
Par. 9. For each section listed in the table, remove the language in 
the ``Remove'' column and add in its place the language in the ``Add'' 
column as set forth below:

------------------------------------------------------------------------
           Section                   Remove                  Add
------------------------------------------------------------------------
Sec.   1.1461-1(c)(2)(i)      a withholding agent   a withholding agent
 introductory text, fourth     withheld an amount.   withheld (including
 sentence.                                           under Sec.   1.1441-
                                                     2(e)(7)) an amount.
Sec.   1.1461-1(c)(2)(i)(M).  references the        references a
                               payment of a          dividend.
                               dividend.
Sec.   1.1461-1(c)(2)(ii)(J)  or (xxiii);.........  or (xxiii). This
                                                     exception does not
                                                     apply to
                                                     withholding agents
                                                     that are qualified
                                                     derivatives
                                                     dealers;
------------------------------------------------------------------------


John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: January 11, 2017.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2017-01163 Filed 1-19-17; 4:15 pm]
 BILLING CODE 4830-01-P