Section 871(m) amendment - ISDA Provision

2002 ISDA Master Agreement A Jolly Contrarian owner’s manual™ 871(m) amendment in a Nutshell™ The JC’s Nutshell™ summary of this term has moved uptown to the subscription-only ninja tier. For the cost of ½ a weekly 🍺 you can get it here. Sign up at Substack. You can even ask questions! Ask about it here. 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. edit 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 | Index: Click ᐅ to expand: 2002 ISDA 1992 ISDA Premium version of this page

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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• ISDA 2015 Section 871(m) Protocol
• Synthetic prime brokerage
• Don’t take a piece of paper to a knife fight