Global Tax Adviser
January 31, 2012

IRS Proposes FATCA Regulations for Derivative Contracts

Ian Bristol
GTA, U.S. Corporate Tax

The U.S. Treasury Department and the IRS released temporary and proposed regulations that provide guidance on derivative type contracts such as certain payments determined by reference to the payment of U.S. sourced dividends. The regulations apply to Canadian payors (i.e., non-resident aliens and foreign corporations) that hold a notional principal contract (NPC). The IRS is accepting comments on the proposed regulations until April 6, 2012, and will discuss the regulations at a public hearing on April 27, 2012. These proposed regulations will generally apply after December 31, 2012.

The regulations implement provisions enacted under section 871 of the Internal Revenue Code by the Hiring Incentives to Restore Employment Act (HIRE) of 2010. The HIRE Act also includes Foreign Account Tax Compliance Act (FATCA). Additional FATCA regulations are expected to be released in the near future.

Background
As enacted under the HIRE Act, the regulations apply to:

  • Securities loans
  • Sale-repurchase transactions (REPOs)
  • Certain NPCs defined as “specified notional principal contracts” (specified NPCs).
  • Any similar transactions that provide for a payment contingent upon or determined by reference to a U.S. source dividend (i.e., a dividend equivalent). Generally, such dividend equivalents, if made after September 14, 2010, will be treated as dividends from sources within the United States for certain purposes.

For payments made after March 18, 2012, any NPC will be a “specified NPC” unless the U.S. Treasury Department and the IRS determine that the contract does not have the potential for tax avoidance.

Temporary regulations
The temporary regulations:

  • Incorporate the definition of a “specified NPC”
  • Extend application of the statutory definition of a “specified NPC” through December 31, 2012 to allow taxpayers and withholding agents the time to modify their systems to comply with the proposed rules
  • Amend certain other regulations.

Notwithstanding the temporary regulations, the preamble allows the IRS to challenge transactions designed to avoid the application of these rules. The IRS can also still assert that a contract labeled as an NPC or other equity derivative is an ownership interest in the equity referenced in the contract.

Proposed regulations
The proposed regulations apply to Canadian payors (i.e., non-resident aliens and foreign corporations) that hold certain financial products that provide for payments that are contingent on, or determined by, reference to payments of dividends from sources within the United States. Among other things, the proposed regulations:

  • Define when payments are to be treated as a dividend equivalent from sources within the United States
  • Define a “specified NPC” and provide a transition period for payments made prior to January 1, 2013
  • Identify when a NPC will be treated as a “specified NPC” for periods beginning on January 1, 2013
  • Require a withholding agent to withhold tax owed on a dividend equivalent (under section 1441)
  • Treat a dividend equivalent as a “dividend” for purposes of determining the appropriate rate of withholding tax under an applicable income tax treaty.

The IRS is accepting comments on the proposed regulations until April 6, 2012, and will discuss the regulations at a public hearing on April 27, 2012.

For more information, contact your KPMG adviser.

 


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