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Section 871(m) of the Internal Revenue Code (IRC)
Providing financial institutions with a better basic understanding
IRC Section 871(m) has been enacted to ensure that non-US persons could no longer avoid partially or entirely US withholding tax on US-source dividend payments by using financial derivatives. It does so by introducing a new term, “dividend equivalent” payments, and treating such payments as US-source income, that is subject to US withholding tax. As simplistic as it sounds, the regulations under Section 871(m) are more complex and subject to multiple interpretations. Even if many financial institution stakeholders have already heard of Section 871(m), most of them do not have a clear picture of what it is. Therefore, our paper is here to introduce the environment which led to Section 871(m) and explain what we believe are the key aspects of it, namely, the in-scope test, the simple and complex contracts, the delta threshold, the combined transactions rule, the newly created Qualified Derivatives Dealer (QDD) status, and the QDD tax liability.
Since the 2008 financial crisis, the financial world witnessed tremendous changes in the taxation and compliance areas with the introduction of two major regulations, the US Foreign Account Tax Compliance Act (FATCA) and OECD’s Automatic Exchange of Information (AEOI), which now provide a legal basis supporting governments around the world in their combat against tax evasion.
2017 marks the entry into force of a third major tax regulation, the US Internal Revenue Code (IRC) Section 871(m) regulations (hereafter 871(m)), and a new era for the financial derivative world. Even if 871(m) only focuses on taxing US-source dividends (and also what the US believes to be similar to US-source dividends) paid to non-US persons, its impact is global due to the importance of the US financial market.
In addition, the US Internal Revenue Service (IRS) has intertwined 871(m) with the Qualified Intermediary (QI) Agreement. Consequently, it is of upmost importance for non-US financial institutions to not only understand but also fully comply with 871(m). Non-compliance might lead as far as termination of the QI Agreement by the IRS.
Deloitte published the paper “Introduction to Section 871(m) of the Internal Revenue Code (IRC)” to provide the readers with a basic introduction to 871(m) while avoiding as much as possible the several, controversial and challenging interpretations of some of its numerous technical aspects.
Accordingly, the paper is split into two parts as follows: the first part consists of a short introduction to familiarize readers with the pre-871(m) environment and the logic that has led to 871(m). The second part provides an overview of financial instruments that are subject to 871(m) as well as the method to determine whether a financial instrument is potentially subject to 871(m) and the newly introduced Qualified Derivatives Dealer (QDD) status.
Markus Weber - Partner, Tax & Legal, Financial Services Switzerland
Markus heads Deloitte’s Financial Services Tax team in Switzerland and is a subject matter expert in US tax topics like QI, FATCA or 871(m) regulations, tax transparency initiatives like AEOI/CRS and operational taxes in general.
Markus is a Swiss Certified Tax Expert and financial economist with more than 16 years of combined experience in advising financial institutions in the banking and asset management sector, covering the full range of relevant taxes and working in leading tax and management roles in the financial services industry.
+41 58 279 7527
Truong-Chi Nguyen, CAIA – Consultant, Tax & Legal, Financial Services Switzerland
Truong-Chi is a Consultant in the FSI Tax team in Zurich where he focuses on IRC Section 871(m), FATCA and AEOI/CRS. Prior to joining Deloitte, Truong-Chi worked more than 3 years as a Junior Client Advisor at the Asia-Pacific desk of a leading Swiss-based global bank.
Since joining Deloitte, Truong-Chi has leveraged his knowledge and experience in pricing and selling structured products to advise financial institutions on the comprehension, interpretation and implementation of 871(m) regulations. Besides being a CAIA charterholder, Truong-Chi graduated from IE Business School with a Master in Advanced Finance and is an incoming student for the MSc in Taxation at the University of Oxford.
+41 58 279 6678