IRS Extends Grandfathering Date for Application of New Withholding Rules on Equity-Linked Instruments

The IRS announced on March 4 that new withholding rules on equity-linked instruments under Section 871(m) of the Internal Revenue Code would be changed in final regulations so that such rules would only apply to equity-linked instruments issued on or after 90 days after the publication of final regulations. Under proposed regulations issued in December 2013, the IRS and Treasury proposed starting in 2016 to impose withholding tax of up to 30% on dividend equivalent payments made, or deemed made, to non-U.S. persons on "specified notional principal contracts" (i.e., equity swaps) and specified "equity-linked instruments" (futures, forwards, options and other contracts) that reference dividend-paying U.S. stocks. The proposed regulations, however, provide that the new withholding rules would only apply to equity-linked instruments acquired by the taxpayer on or after March 5, 2014, regardless when issued.

According to the IRS, the IRS and Treasury received numerous comments from many sources that the new rules should not apply to equity-linked instruments issued prior to the finalization of the regulations to avoid pricing disruption of these instruments between 2014 and the effective date of withholding in 2016, and to permit banks and other financial institutions the time to set up systems and documentation to address such withholding. As a result, in Notice 2014-14 the IRS and Treasury announced that when the regulations are finalized, the new withholding rules will apply to equity-linked instruments issued on or after the date that is 90 days after publication of the final regulations. Thus the new regulations will not apply to equity-linked instruments issued before such date that they are acquired by a taxpayer after the regulations are finalized.

The new effective date applies only to equity-linked instruments, and does not apply to equity swaps. Accordingly, notional principal contracts that reference dividend-paying U.S. equities that are currently in existence may be subject to the new withholding rules starting in 2016.

See: IRS Notice 2014-14.