Deduction or Withholding for Tax - ISDA Provision
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ISDA Anatomy™
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So?
Section 2(d) does the following:
- Net obligation: if a counterparty suffers withholding it generally doesn’t have to gross up – it just remits tax to the revenue and pays net.
- Refund obligation where tax subsequently levied: if a counterparty pays gross and subsequently is levied the tax, the recipient must refund an equivalent amount to the tax.
- Indemnifiable Tax: the one exception is “Indemnifiable Tax” - this is tax arises as a result of the payer’s own status vis-à-vis the withholding jurisdiction. In that case the payer has to gross up.
There’s no great difference between the 2002 ISDA and the 1992 ISDA:
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Both are excruciating in the conveyance of a fairly simple idea, which, in a Nutshell™ is this:
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.
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.