Section 871(m) amendment - ISDA Provision: Difference between revisions

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[[Section 871(m)]] of the [[Internal Revenue Code]] clamps down on dirty foreigners avoiding [[withholding tax]] for dividends on US [[Share - Equity Derivatives Provision|equities]]. Previously, US dividend [[Withholding tax|withholding]] did not apply to returns on notional principal contracts and instruments linked to underlying US equities.
 
That’s all changed now.
 
The new regulations will establish up to a 30% [[withholding tax]] on foreign investors on dividend-equivalent payments under [[equity derivative|equity derivatives]].  There are a wide range of products that fall into this camp including [[swap]]s, [[option]]s, [[future]]s, [[convertible bond|convertible debt]], [[structured note|structured notes]] and other customised derivative where the  ...
 
===Beware of {{tag|Greeks}}===
... [[delta]] (see what I did there?) against the underlying stock is .08 or greater.
 
{{delta}}
 
The calculation is cumulative so even if the delta threshold isn’t met in one transaction, it may be as a result a connected transaction.
 
It applies from 1 January 2017.
 
===So does that mean I can bin all this [[hypothetical broker-dealer]] nonsense?===
[[There’s no bright line test]], obviously.
 
=====''What'' “[[hypothetical broker-dealer]] nonsense”?=====
{{Hypothetical broker-dealer capsule}}
=====Okay. So ...?=====
Since [[871(m)]] means that {{tag|WHT}} is now applied on [[high-delta equity derivative]]s in the same way it applies to physical cash trades, the [[recharacterisation]] risk is surely less fraught now, isn’t it? do we really care whether the counterparty controls the hedge?  Can we therefore get rid of that tiresome “[[hypothetical broker-dealer]]” language, which so mightily confuses many counterparties, and just reference the actual hedge liquidation price as the closing price of the derivative?
 
No, because [[871(m)]] does not apply to all underliers that might feature in a [[synthetic equity]] transaction. and also because there are [[WHT]] and [[stamp duty]] regimes in other jurisdictions ([[SDRT]] on UK equities for example) where a derivative acheives preferential tax treatment over a cash equity trade.
 
But you’re right: the [[hypothetical broker-dealer]] business ''is'' [[Don’t take a piece of paper to a knife fight|ridiculous]].
{{sa}}
*[[ISDA 2015 Section 871(m) Protocol]]
*[[Synthetic prime brokerage]]
*[[Don’t take a piece of paper to a knife fight]]
 
{{c|tax}}

Revision as of 16:11, 15 June 2023

2002 ISDA Master Agreement

A Jolly Contrarian owner’s manual™

871(m) amendment in a Nutshell™

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871(m) amendment in all its glory

Section 871(m)
(i) The amendments set out in the Attachment to the ISDA 2015 Section 871(m) Protocol published by ISDA on November 2, 2015, as published on the ISDA website (www.isda.org) apply to this Agreement.
(ii) “Dividend Equivalent Tax” includes any tax imposed on deemed payments treated as dividends from sources within the United States under Section 871(m) or any Applicable Rules issued thereunder.
(iii) This Agreement will be deemed to be a Covered Master Agreement and the Implementation Date will be the effective date of this Agreement for the purposes of such protocol.

Related agreements and comparisons

Click here for the text of Section 871(m) amendment in the 1992 ISDA
Template:Isdadiff 871(m) amendment

Resources and Navigation

This provision in the 1992

Resources Wikitext | Nutshell wikitext | 1992 ISDA wikitext | 2002 vs 1992 Showdown | 2006 ISDA Definitions | 2008 ISDA | JC’s ISDA code project
Navigation Preamble | 1 • (a) (b) (c) | 2 • (a) (b) (c) (d) | 3 • (a) (b) (c) (d) (e) (f) (g) | 4 • (a) (b) (c) (d) (e) | 5 • 5(a) Events of Default: 5(a)(i) Failure to Pay or Deliver 5(a)(ii) Breach of Agreement 5(a)(iii) Credit Support Default 5(a)(iv) Misrepresentation 5(a)(v) Default Under Specified Transaction 5(a)(vi) Cross Default 5(a)(vii) Bankruptcy 5(a)(viii) Merger Without Assumption 5(b) Termination Events: 5(b)(i) Illegality 5(b)(ii) Force Majeure Event 5(b)(iii) Tax Event 5(b)(iv) Tax Event Upon Merger 5(b)(v) Credit Event Upon Merger 5(b)(vi) Additional Termination Event (c) (d) (e) | 6 • (a) (b) (c) (d) (e) (f) | 7 | 8 • (a) (b) (c) (d) | 9 • (a) (b) (c) (d) (e) (f) (g) (h) | 10 | 11 | 12 • (a) (b) | 13 • (a) (b) (c) (d) | 14 |

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2002 ISDA
1992 ISDA

Overview

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Section 871(m) was one of the range of sweeping US tax changes that were ushered in in the second decade of the 21st century, in reaction to the financial crisis. It specifically tries to do away with WHT arbitrage between those trading physical equities, and those trading on swap.

Summary

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Before Section 871(m) of the Internal Revenue Code was enacted, non-resident investors in US equities suffered 30% withholding on US-source taxable income — dividends, in other words. This was in practice mediated by double tax treaties in may jurisdictions, but that is the principle, and it remains the case. However previously, US dividend withholding did not apply to returns on notional principal contracts and instruments linked to underlying US equities. Equity derivatives, for example. It was therefore more efficient to invest in US equities through contracts for difference and equity swaps. You will never guess what tax-savvy offshore investors therefore tended to do.

Yes! You’re right! They invested in swaps all the time!

The HIRE Act, by amending Section 871(m) of the Inland Revenue Code, clamps down on naughty foreigners avoiding withholding tax for dividends on US equities and provides that everyone gets taxed at the same rate.

The new regulations establish up to a 30% withholding tax on foreign investors on dividend-equivalent payments under equity derivatives.

What counts as an in-scope equity derivative?

The thing about derivatives is they can easily be “funked up”. This was great fun in 2005 but honestly, in this day and age, they tend not to so much. It is all very formulaic and pass-through. But you can imagine naughty Johnny Foreigner making some tiny little, formalistic, funky change to a swap payoff and claiming it is no longer a derivative of a US equity.

US tax people are cleverer than that and decreed an option delta of more than 80% counts as an in-scope equity derivative. There are a wide range of products that fall into this camp including swaps, options, futures, convertible debt, structured notes and other customised derivatives — as long as the delta against the underlying stock is .08 or greater.

The calculation is cumulative so even if the delta threshold isn’t met in one transaction, it may be as a result a connected transaction. (Foiled, tricksy foreigners!)

Documentationary things

There is an ISDA-sponsored Hire Act Protocol you can sign up to, and a standardised amendment to Section 2(d) of the ISDA to take account of the Hire Act and make sure all your reporting is right.

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See also

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References

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