Tax Insights: Dividend equivalents ─ Internal Revenue Service extends section 871(m) effective dates to 2025

Issue 2022-25

In brief

The United States Treasury (US Treasury) and Internal Revenue Service (IRS) have once again extended the effective dates for various provisions related to the taxation of dividend equivalent amounts under Internal Revenue Code (IRC) section 871(m). On August 23, 2022, the IRS released Notice 2022-37, which provides much‑anticipated relief for financial institutions, by extending the status quo through December 31, 2024 (the provisions will be effective January 1, 2025, instead of January 1, 2023). This allows more time for the IRS and industry participants to continue discussions on the many challenges to implement the section 871(m) regulations.

In detail

Section 871(m) – a brief recap  

Section 871(m) includes certain derivative contracts in fixed, determinable, annual and periodic income (FDAP) and therefore subjects them to withholding and reporting under Chapters 3 and 4 of the IRC. Section 871(m) is intended to ensure that non-US investors, who attempt to replicate the economic performance of a security without actually owning the security, do not avoid US withholding tax.

Elements of the regulations that have proven particularly challenging to implement include:

• the “combination rules,” including the availability and the expansive scope of information and the volume of calculations
• lack of established frameworks for collecting and sharing information with counterparties and participants
• data requirements and other challenges for qualified derivatives dealers (QDDs)
• the substantial equivalence test, which includes significant subjectivity and often results in inconsistent scoping determinations from issuer to issuer
• the promised sunsetting of the qualified securities lender (QSL) regime, which may result in entities obtaining full qualified intermediary (QI)/QDD status for the sole purpose of engaging in securities lending

Since the section 871(m) regulations were published in 2015, the US Treasury and IRS have issued a series of notices delaying the full implementation of the regulations. The previous notice, issued in 2020, postponed the effective date of various provisions to January 1, 2023; Notice 2022-37 extends these dates another two years to January 1, 2025.

While there are many elements to the section 871(m) regulations, the following table highlights the relief available now and the anticipated requirements as of the delayed January 1, 2025 effective date:

What financial institutions should do

Significant questions remain for many financial institutions that are working towards implementing the section 871(m) regulations. Notice 2022-37 reminds taxpayers that the US Treasury and IRS will continue to evaluate the regulations and are open to conversations and comments from industry participants. Taxpayers should continue to coordinate with their industry associations and colleagues and provide meaningful comments to the US Treasury and IRS over the next few months.

Taxpayers who maintain QI status should be on the lookout for the revised QI Agreement, which will replace Revenue Procedure 2017-15, and is expected to be effective January 1, 2023. While some proposed revisions were recently published, that document only contained changes related to IRC section 1446 and did not include any preview of potential changes related to section 871(m).

The takeaway

The implementation of section 871(m) has been a stop and go endeavour for several years. Financial institutions should not use this latest extension to refocus their time on other matters, but should use this as an opportunity to:

• provide substantive comments to the US Treasury and IRS
• revisit service provider and technology solutions
• develop any new policies and procedures that will be required once the revised QI Agreement is published