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ISDA Anatomy™
In a Nutshell™ Section 2(d):
2(d) Deduction or Withholding for Tax
- 2(d)(i) Gross-Up. The parties must pay without withholding unless required by law. Where a payer has to withhold, it must:—
- (1) promptly tell the recipient;
- (2) promptly pay the withheld amount to the relevant authorities (including the withholding on any required gross-up);
- (3) give the recipient a receipt for the tax payment; and
- (4) gross up any Indemnifiable Tax, so that the recipient receives the amount it would otherwise have received (free of Indemnifiable Taxes). However, the payer need not gross up any withholding that arose only because:—
- (A) the recipient did not provide Section 4(a) tax information, or breached its Payee Tax Representations; or
- (B) the recipient's Payee Tax Representations were not true (other than because of regulatory action taken after execution of the Transaction or a Change in Tax Law.
- 2(d)(ii) Liability. If the payer :—
- (1) is required by law to withhold a non-Indemnifiable Tax;
- (2) nonetheless does not do so; and
- (3) suffers by direct assessment a liability for that Tax,
- then, unless the recipient has satisfied the Tax liability directly, it must reimburse the payer for that liability (plus interest, but not penalties unless it failed to provide tax information required under Section 4(a), or breached any Payee Tax Representations.
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2002 ISDA full text of Section 2(d):
2(d) Deduction or Withholding for Tax
- 2(d)(i) Gross-Up. All payments under this Agreement will be made without any deduction or withholding for or on account of any Tax unless such deduction or withholding is required by any applicable law, as modified by the practice of any relevant governmental revenue authority, then in effect. If a party is so required to deduct or withhold, then that party (“X”) will:―
- (1) promptly notify the other party (“Y”) of such requirement;
- (2) pay to the relevant authorities the full amount required to be deducted or withheld (including the full amount required to be deducted or withheld from any additional amount paid by X to Y under this Section 2(d)) promptly upon the earlier of determining that such deduction or withholding is required or receiving notice that such amount has been assessed against Y;
- (3) promptly forward to Y an official receipt (or a certified copy), or other documentation reasonably acceptable to Y, evidencing such payment to such authorities; and
- (4) if such Tax is an Indemnifiable Tax, pay to Y, in addition to the payment to which Y is otherwise entitled under this Agreement, such additional amount as is necessary to ensure that the net amount actually received by Y (free and clear of Indemnifiable Taxes, whether assessed against X or Y) will equal the full amount Y would have received had no such deduction or withholding been required. However, X will not be required to pay any additional amount to Y to the extent that it would not be required to be paid but for:―
- (A) the failure by Y to comply with or perform any agreement contained in Section 4(a)(i), 4(a)(iii) or 4(d); or
- (B) the failure of a representation made by Y pursuant to Section 3(f) to be accurate and true unless such failure would not have occurred but for (I) any action taken by a taxing authority, or brought in a court of competent jurisdiction, after a Transaction is entered into (regardless of whether such action is taken or brought with respect to a party to this Agreement) or (II) a Change in Tax Law.
- 2(d)(ii) Liability. If:―
- (1) X is required by any applicable law, as modified by the practice of any relevant governmental revenue authority, to make any deduction or withholding in respect of which X would not be required to pay an additional amount to Y under Section 2(d)(i)(4);
- (2) X does not so deduct or withhold; and
- (3) a liability resulting from such Tax is assessed directly against X,
- then, except to the extent Y has satisfied or then satisfies the liability resulting from such Tax, Y will promptly pay to X the amount of such liability (including any related liability for interest, but including any related liability for penalties only if Y has failed to comply with or perform any agreement contained in Section 4(a)(i), 4(a)(iii) or 4(d)).
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Click here for the text of Section 2(d) in the 1992 ISDA
Index: Click ᐅ to expand:Navigation
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You can revel in the full heft of these provisions at right.
Observant and obedient scholars will notice that the 1992 ISDA and the 2002 ISDA versions are, more or less, identical. Observant and less obedient scholars will remark what a pig’s ear the ISDA drafting committee made of a relatively simple concept and, when given a once-in-a-decade opportunity to improve it in 2002, the combined intellectual might of ISDA, its members, friends, relations and their divers counsel, retinue and entourage, couldn’t.
Or didn’t.
This is, therefore, Q.E.D., the apex of all possible derivatives drafting. Especially the triple negative in Indemnifiable Tax.
Make you feel great to be alive, doesn’t it. I bet you wish it could be simplified. Here: let me have a go.
Gross-Up in a Nutshell™ (ISDA edition)
- 2(d)(i) Gross-Up. The parties must pay without withholding unless required by law. Where a payer has to withhold, it must:—
- (1) promptly tell the recipient;
- (2) promptly pay the withheld amount to the relevant authorities (including the withholding on any required gross-up);
- (3) give the recipient a receipt for the tax payment; and
- (4) gross up any Indemnifiable Tax, so that the recipient receives the amount it would otherwise have received (free of Indemnifiable Taxes). However, the payer need not gross up any withholding that arose only because:—
- (A) the recipient did not provide Section 4(a) tax information, or breached its Payee Tax Representations; or
- (B) the recipient's Payee Tax Representations were not true (other than because of regulatory action taken after execution of the Transaction or a Change in Tax Law.
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Withholding under the ISDA
TL;DR: The basic rationale is this:
- if the tax relates to the underlying instrument, rather than the {{{{{1}}}|Payer}}’s residence or tax status, the {{{{{1}}}|Payer}} does not have to gross up.
- if the tax relates to the {{{{{1}}}|Payer}}’s residence or tax status, then the Payer does have to gross up unless the {{{{{1}}}|Payee}} should have provided information to the {{{{{1}}}|Payer}} which would have entitled the {{{{{1}}}|Payer}} to avoid the tax.
- if you’ve agreed the {{{{{1}}}|FATCA Amendment}}, the {{{{{1}}}|Payer}} doesn’t have to gross up any {{{{{1}}}|FATCA Withholding Tax}}es.
The combination of the {{{{{1}}}|Payer Tax Representations}} and the {{{{{1}}}|Gross-Up}} clause of the ISDA Master Agreement has the following effect:
- Section {{{{{1}}}|3(e)}}: I promise you that I do not have to withhold on my payments to you (as long as all your {{{{{1}}}|Payee Tax Representations}} are correct and you have, under Section {{{{{1}}}|4(a)}}, given me everything I need to pay free of withholding);
- Section {{{{{1}}}|2(d)}}: I will not withhold on any payments to you. Unless I am required to by law. Which I kind of told you I wasn’t... If I have to withhold, I'll pay the tax the authorities and give you the receipt. If I only had to withhold because of my connection to the taxing jurisdiction (that is, if the withholding is an {{{{{1}}}|Indemnifiable Tax}}), I’ll gross you up. (You should look at the drafting of {{{{{1}}}|Indemnifiable Tax}}, by the way. It's quite a marvel). ...
- {{{{{1}}}|Gross-Up}}: Unless the tax could have been avoided if the {{{{{1}}}|Payee}} had taken made all its {{{{{1}}}|3(f)}} representations, delivered all its {{{{{1}}}|4(a)}} material, or had its {{{{{1}}}|3(f)}} representations been, like, true).
- {{{{{1}}}|Stamp Tax}} is a whole other thing.
- As is FATCA, which (as long as you’ve made your {{{{{1}}}|FATCA Amendment}} or signed up to a {{{{{1}}}|FATCA Protocol}}, provides that {{{{{1}}}|FATCA Withholding Tax}}es are excluded from the Section {{{{{1}}}|3(e)}} {{{{{1}}}|Payer Tax Representations}}, and also from the definition of {{{{{1}}}|Indemnifiable Tax}}. Meaning one doesn't have to rep, or gross up, FATCA payments.