[Federal Register Volume 77, Number 14 (Monday, January 23, 2012)]
[Rules and Regulations]
[Pages 3108-3111]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-1234]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

RIN 1545-BK53


Dividend Equivalents From Sources Within the United States

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

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SUMMARY: This document contains temporary regulations relating to 
dividend equivalents for purposes of section 871(m) of the Internal 
Revenue Code (Code). The regulations provide guidance to nonresident 
aliens and foreign corporations that hold notional principal contracts 
(NPCs) providing for payments determined by reference to payments of 
dividends from sources within the United States. The text of the 
temporary regulations also serves as the text of the proposed 
regulations set forth in the notice of proposed rulemaking on this 
subject in the Proposed Rules Section in this issue of the Federal 
Register.

DATES: Effective Date: These regulations are effective January 23, 
2012.
    Applicability Date: For dates of applicability, see Sec. Sec.  
1.863-7T(f),1.871-16T(g), 1.881-2T(f), 1.1441-2T(g), 1.1441-3T(k), 
1.1441-4T(h), 1.1441-7T(h), and 1.1461-1T(j).

FOR FURTHER INFORMATION CONTACT: Mark E. Erwin or D. Peter Merkel at 
(202) 622-3870 (not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    This document contains temporary regulations under section 871(m). 
Congress enacted section 871(m) (originally designated as section 
871(l)) on March 18, 2010 in section 541 of the Hiring Incentives to 
Restore Employment Act (HIRE Act), Public Law 111-147 (124 Stat. 71).
    Section 871(m) applies to securities loans, sale-repurchase 
transactions (repos), certain NPCs defined as ``specified notional 
principal contracts'' (specified NPCs), and any similar transactions 
that provide for a payment contingent upon or determined by reference 
to a U.S. source dividend (dividend equivalent). Section 871(m) treats 
a dividend equivalent as a dividend from sources within the United 
States for purposes of sections 871(a), 881, and 4948(a), and chapters 
3 and 4 of subtitle A of the Code. Section 871(m) generally applies to 
any dividend equivalent made after September 14, 2010. With respect to 
payments made after March 18, 2012, section 871(m)(3)(B) provides that 
any NPC will be a specified NPC unless the Secretary determines that 
such contract is of a type which does not have the potential for tax 
avoidance.
    Notice 2010-46, 2010-24 IRB 757, outlined a proposed framework for 
limiting withholding in the case of a series of securities lending or 
sale-repurchase transactions. While the Treasury Department and the IRS 
anticipate issuing proposed regulations addressing the issues raised in 
Notice 2010-46, these regulations do not address these concerns. See 
Sec.  601.601(d)(2).

Explanation of Provisions

    Section 1.871-16T(b) of these temporary regulations incorporates 
the definition of a specified NPC as provided in section 871(m)(3)(A). 
These temporary regulations extend the applicability of the section 
871(m)(3)(A) statutory definition of a specified NPC through December 
31, 2012. Proposed regulations set forth in the notice of proposed 
rulemaking on this subject in the Proposed Rules Section in this issue 
of the Federal Register outline the proposed treatment of dividend 
equivalents under section 871(m) beginning January 1, 2013. The 
Treasury Department and the IRS believe that an extension of the 
statutory definition of the term specified NPC is necessary to allow 
taxpayers and withholding agents to modify their systems and other 
operating procedures to comply with the rules described in the notice 
of proposed rulemaking.
    These temporary regulations also amend several regulations to 
clarify the application of section 871(m). For example, temporary 
regulations modify Sec.  1.863-7 to provide that that section does not 
apply to a dividend equivalent under section 871(m). Section 1.881-
2T(b)(3) provides that section 871(m) and Sec.  1.871-16T apply to 
dividend equivalents received by foreign corporations. Certain 
regulations under section 1441 have been amended to

[[Page 3109]]

require a withholding agent to withhold tax owed with respect to a 
dividend equivalent.
    Notwithstanding these temporary regulations, the Commissioner may 
challenge transactions that are designed to avoid the application of 
these rules under applicable judicial doctrines. Nothing in these rules 
precludes the Commissioner from asserting that a contract labeled as an 
NPC or other equity derivative is in fact an ownership interest in the 
equity referenced in the contract.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. For the 
applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), 
refer to the special analyses section of the preamble to the cross-
reference notice of proposed rulemaking published in the proposed rules 
section in this issue of the Federal Register. Pursuant to section 
7805(f) of the Code, these temporary regulations have been submitted to 
the Chief Counsel for Advocacy of the Small Business Administration for 
comment on the impact on small businesses.

Drafting Information

    The principal author of these regulations is D. Peter Merkel, the 
Office of Associate Chief Counsel (International). Other personnel from 
the Treasury Department and the IRS participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority:  26 U.S.C. 871(m) and 7805 * * *


0
Par. 2. Section 1.863-7 is amended by revising paragraph (a)(1) to read 
as follows:


Sec.  1.863-7  Allocation of income attributable to certain notional 
principal contracts under section 863(a).

    (a) Scope--(1) Introduction. [Reserved]. For further guidance, see 
Sec.  1.863-7T(a)(1).
* * * * *


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Par. 3. Section 1.863-7T is added as follows:


Sec.  1.863-7T  Allocation of income attributable to certain notional 
principal contracts under section 863(a) (temporary).

    (a) Scope--(1) Introduction. This section provides rules relating 
to the source and, in certain cases, the character of notional 
principal contract income. However, this section does not apply to 
income from a section 988 transaction within the meaning of section 988 
and the regulations thereunder, relating to the treatment of certain 
nonfunctional currency transactions. Further, this section does not 
apply to a dividend equivalent as defined in section 871(m) or Sec.  
1.871-15. Notional principal contract income is income attributable to 
a notional principal contract as defined in Sec.  1.446-3(c). An 
agreement between a taxpayer and a qualified business unit (as defined 
in section 989(a)) of the taxpayer, or among qualified business units 
of the same taxpayer, is not a notional principal contract, because a 
taxpayer cannot enter into a contract with itself.
    (a)(2) through (e) [Reserved]. For further guidance, see Sec.  
1.863-7(a)(2) through (e).
    (f) Effective/applicability date. This section applies to payments 
made on or after January 23, 2012.
    (g) Expiration date. This section expires January 16, 2015.

0
Par. 4. Section 1.871-15T is added and reserved to read as follows:


Sec.  1.871-15T  Treatment of dividend equivalents (temporary). 
[Reserved]

0
Par. 5. Section 1.871-16T is added to read as follows:


Sec.  1.871-16T  Specified notional principal contracts (temporary).

    (a) [Reserved].
    (b) Specified notional principal contracts between March 18, 2012 
and January 1, 2013. With respect to payments made after March 18, 2012 
and before January 1, 2013, the term specified notional principal 
contract means any notional principal contract (as defined in Sec.  
1.446-3) if--
    (1) In connection with entering into such contract, any long party 
to the contract transfers the underlying security to any short party to 
the contract;
    (2) In connection with the termination of such contract, any short 
party to the contract transfers the underlying security to any long 
party to the contract;
    (3) The underlying security is not readily tradable on an 
established securities market; or
    (4) In connection with entering into such contract, the underlying 
security is posted as collateral by any short party to the contract 
with any long party to the contract.
    (c) through (f) [Reserved].
    (g) Effective/applicability date. This section applies to payments 
made on or after January 23, 2012.
    (h) Expiration date. This section expires January 16, 2015.
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Par. 6. Section1.881-2 is amended by adding paragraph (b)(3) to read as 
follows:


Sec.  1.881-2  Taxation of foreign corporations not engaged in U.S. 
business.

* * * * *
    (b) * * *
    (3) [Reserved]. For further guidance, see Sec.  1.881-2T(b)(3).
* * * * *
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Par. 7. Section 1.881-2T is added as follows:


Sec.  1.881-2T  Taxation of foreign corporations not engaged in U.S. 
business (temporary).

    (a) through (b)(2) [Reserved]. For further guidance, see Sec.  
1.881-2(a) through (b)(2).
    (3) Dividend Equivalents. For rules applicable to a foreign 
corporation's receipt of a dividend equivalent, see section 871(m) and 
Sec.  1.871-16T.
    (c) through (e) [Reserved]. For further guidance, see Sec.  1.881-
2(c) through (e).
    (f) Effective/applicability date. This section applies on or after 
January 23, 2012.
    (g) Expiration date. The applicability of this section expires on 
January 16, 2015.
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Par. 8. Section 1.1441-2 is amended by adding paragraphs (b)(6) and 
(e)(7) to read as follows:


Sec.  1.1441-2  Amounts subject to withholding.

* * * * *
    (b) * * *
    (6) [Reserved]. For further guidance, see Sec.  1.1441-2T(b)(6).
* * * * *
    (e) * * *
    (7) [Reserved]. For further guidance, see Sec.  1.1441-2T(e)(7).
* * * * *

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Par. 9. Section 1.1441-2T is added to read as follows:

[[Page 3110]]

Sec.  1.1441-2T  Amounts subject to withholding (temporary).

    (a) through (b)(5) [Reserved]. For further guidance, see Sec.  
1.1441-2(a) through (b)(5).
    (6) Dividend equivalents. Amounts subject to withholding include 
the payment of a dividend equivalent described in section 871(m). For 
this purpose, the term payment includes any gross amount that is used 
in computing any net amount that is transferred to or from the taxpayer 
under the terms of the contract.
    (c) through (e)(6) [Reserved]. For further guidance, see Sec.  
1.1441-2(c) through (e)(6).
    (7) Rules for dividend equivalents. With respect to a dividend 
equivalent described in section 871(m), a payment is considered made to 
a person when any gross amount is used in computing any net amount that 
is transferred to or from the person under the terms of the contract 
pursuant to a transaction described in section 871(m)(2). When a 
dividend equivalent is used to determine a net payment, the person 
entitled to the gross dividend equivalent is considered to have 
received a payment even if that person receives no payment because the 
net payment equals zero or that person makes a net payment.
    (f) [Reserved]. For further guidance, see Sec.  1.1441-2(f).
    (g) Effective/applicability date. This section applies on or after 
January 23, 2012.
    (h) Expiration date. The applicability of this section expires on 
January 16, 2015.

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Par. 10. Section 1.1441-3 is amended by redesignating paragraph (h) as 
paragraph (j) and adding new paragraphs (h) and (i) to read as follows:


Sec.  1.1441-3  Determination of amounts to be withheld.

* * * * *
    (h) [Reserved]. For further guidance, see Sec.  1.1441-3T(h).
    (i) [Reserved]. For further guidance, see Sec.  1.1441-3T(i).
* * * * *

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Par. 11. Section 1.1441-3T is added to read as follows:


Sec.  1.1441-3T  Determination of amounts to be withheld (temporary).

    (a) through (g) [Reserved]. For further guidance, see Sec.  1.1441-
3(a) through (g).
    (h) Dividend equivalents--(1) In general. The gross amount of a 
dividend equivalent described in section 871(m) is subject to 
withholding in an amount equal to the gross amount of the dividend 
equivalent used in computing any net amount that is transferred to or 
from the taxpayer.
    (2) Procedures for withholding with respect to a dividend 
equivalent paid prior to a notional principal contract (NPC) becoming a 
specified NPC. [Reserved].
    (i) Estimate or other determination of the portion of a 
distribution attributable to a dividend equivalent--(1) In general. In 
determining the amount subject to withholding as a dividend equivalent, 
a withholding agent may use a distributing corporation's estimate or 
other determination with respect to the underlying security (as defined 
in section 871(m)(4)(C)) in applying the provisions of paragraphs 
(c)(2) through (c)(4) of this section. However, a withholding agent 
that elects to use any such estimate will be liable for the amount by 
which the actual amount required to be withheld exceeds the amount 
actually withheld and applicable penalties and interest resulting from 
its reliance on such estimate or determination. Failure of the 
withholding agent to withhold the required amount shall not be 
attributed to the distributing corporation.
    (2) [Reserved]
    (j) [Reserved]. For further guidance, see Sec.  1.1441-3(j).
    (k) Effective/applicability date. This section applies on or after 
January 23, 2012.
    (l) Expiration date. The applicability of this section expires on 
January 16, 2015.

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Par. 12. Section 1.1441-4 is amended by revising paragraph (a)(3)(i) 
and adding paragraph (a)(3)(iii) to read as follows:


Sec.  1.1441-4  Exemptions from withholding for certain effectively 
connected income and other amounts.

    (a) * * *
    (3) * * *
    (i) [Reserved]. For further guidance, see Sec.  1.1441-3T(a)(3)(i).
* * * * *
    (iii) [Reserved]. For further guidance, see Sec.  1.1441-
3T(a)(3)(iii).
* * * * *

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Par. 13. Section 1.1441-4T is added to read as follows:


Sec.  1.1441-4T  Exemptions from withholding for certain effectively 
connected income and other amounts (temporary).

    (a)(1) through (a)(2) [Reserved]. For further guidance, see Sec.  
1.1441-4(a)(1) through (a)(2).
    (3) Income on notional principal contracts--(i) General rule. 
Except as otherwise provided in paragraph (a)(3)(iii) of this section, 
a withholding agent that pays amounts attributable to a notional 
principal contract described in Sec.  1.863-7(a) or Sec.  1.988-2(e) 
shall have no obligation to withhold on the amounts paid under the 
terms of the notional principal contract regardless of whether a 
withholding certificate is provided. However, a withholding agent must 
file returns under Sec.  1.1461-1(b) and (c) reporting the income that 
it must treat as effectively connected with the conduct of a trade or 
business in the United States under the provisions of this paragraph 
(a)(3). Except as otherwise provided in paragraph (a)(3)(ii) of this 
section, a withholding agent must treat the income as effectively 
connected with the conduct of a U.S. trade or business if the income is 
paid to, or to the account of, a qualified business unit of a foreign 
person located in the United States or, if the payment is paid to, or 
to the account of, a qualified business unit of a foreign person 
located outside the United States, the withholding agent knows, or has 
reason to know, the payment is effectively connected with the conduct 
of a trade or business within the United States. Income on a notional 
principal contract does not include the amount characterized as 
interest under the provisions of Sec.  1.446-3(g)(4).
    (ii) [Reserved]. For further guidance, see Sec.  1.1441-
4(a)(3)(ii).
    (iii) Exception for specified notional principal contracts. A 
withholding agent that makes a payment attributable to a specified 
notional principal contract described in section 871(m), or Sec.  
1.871-16T that is not treated as effectively connected with the conduct 
of a trade or business within the United States shall have an 
obligation to withhold on the amount of such payment that is a dividend 
equivalent.
    (b) through (g) [Reserved]. For further guidance, see Sec.  1.1441-
4(b) through (g).
    (h) Effective/applicability date. This section applies on or after 
January 23, 2012.
    (i) Expiration date. The applicability of this section expires on 
January 16, 2015.

0
Par. 14. Section 1.1441-7 is amended by:
0
1. Redesignating paragraph (a)(2) as paragraph (a)(3) and revising 
newly designated paragraph (a)(3).
0
2. Adding a new paragraph (a)(2).
    The revision and addition reads as follows:


Sec.  1.1441-7  General provisions relating to withholding agents.

    (a) * * *
    (2) [Reserved]. For further guidance, see Sec.  1.1441-7T(a)(2).

[[Page 3111]]

    (3) Examples. The following examples illustrate the rules of 
paragraph (a)(1) of this section:
    Examples 1 through 5. [Reserved]. For further guidance, see Sec.  
1.1441-7T(a)(3) Examples 1 through 5.
    Example 6. [Reserved]. For further guidance, see Sec.  1.1441-
7T(a)(3) Example 6.
* * * * *

0
Par. 15. Section 1.1441-7T is added to read as follows:


Sec.  1.1441-7T  General provisions relating to withholding agents 
(temporary).

    (a)(1) [Reserved]. For further guidance, see Sec.  1.1441-7(a)(1).
    (2) Withholding agent with respect to dividend equivalents. Each 
person that is a party to any contract or arrangement that provides for 
the payment of a dividend equivalent, as defined in section 871(m), 
shall be treated as having control and custody of such payment.
    (3) Examples. The following examples illustrate the rules of 
paragraphs (a)(1) and (a)(2) of this section:
    Example 1 through Example 5 [Reserved]. For further guidance, see 
Sec.  1.1441-7(a)(3), Example 1 through Example 5.

    Example 6. FC, a foreign corporation, enters into a notional 
principal contract (NPC) with Bank X, a bank organized in the United 
States. The NPC is a specified NPC for purposes of section 871(m). 
FC is the long party to the contract and Bank X is the short party. 
The NPC references a specified number of shares of dividend-paying 
common stock issued by a domestic corporation. As the long party, FC 
receives payments from Bank X based on any appreciation in the value 
of the common stock and dividends paid with respect to the common 
stock. As the short party, Bank X receives payment from FC based on 
any depreciation in the value of the common stock and a payment 
based on LIBOR. Bank X is a withholding agent because Bank X is 
deemed to have control and custody of a dividend equivalent as a 
party to the NPC. If FC's tax liability under section 881 has not 
been satisfied in full by Bank X as withholding agent, FC is 
required to file a return on Form 1120-F (U.S. Income Tax Return of 
a Foreign Corporation).

    (b)(1) through (g) [Reserved]. For further guidance, see Sec.  
1.1441-7(b)(1) through (g).
    (h) Effective/applicability date. This section applies on or after 
January 23, 2012.
    (i) Expiration date. The applicability of this section expires on 
January 16, 2015.

0
Par. 16. Section 1.1461-1 is amended by:
0
1. Redesignating paragraphs (c)(2)(i)(L) and (c)(2)(i)(M) as 
(c)(2)(i)(M) and (c)(2)(i)(N), respectively.
0
3. Adding a new paragraph (c)(2)(i)(L).
    The addition reads as follows:


Sec.  1.1461-1  Payment and returns of tax withheld.

* * * * *
    (c) * * *
    (2) * * *
    (i) * * *
    (L) [Reserved]. For further guidance, see Sec.  1.1461-1T(c)(2)(L).
* * * * *

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Par. 17. Section 1.1461-1T is added as follows:


Sec.  1.1461-1T  Payment and returns of tax withheld (temporary).

    (a) through (c)(2)(i)(K) [Reserved]. For further guidance, see 
Sec.  1.1461-1(a) through (c)(2)(i)(K).
    (L) Dividend equivalents as defined in section 871(m) and the 
regulations thereunder;
    (c)(2)(i)(M) through (i) [Reserved]. For further guidance, see 
Sec.  1.1461-1(c)(2)(i)(M) through (i).
    (j) Effective/applicability date. This section applies on or after 
January 23, 2012.
    (k) Expiration date. The applicability of this section expires on 
January 16, 2015.

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.
    Approved: January 3, 2012.
Emily S. McMahon,
Acting Assistant Secretary of the Treasury, Tax Policy.
[FR Doc. 2012-1234 Filed 1-19-12; 11:15 am]
BILLING CODE 4830-01-P