New IRS Rules Would Impose U.S. Withholding Tax on Many Derivatives and Other Financial Transactions Linked to U.S. Stock

December 19, 2013

On December 5, 2013, the U.S. Department of the Treasury and the Internal Revenue Service published proposed regulations that would impose U.S. withholding tax on a wide range of financial instruments linked to stock issued by U.S. issuers, including most equity swaps and many other equity derivatives, and many mandatory convertible bonds and structured notes that provide for the delivery of, or payment by reference to, U.S. equities. The withholding tax also will apply to certain conventional convertible bonds acquired in the secondary market. As drafted, the rules appear to apply to certain kinds of U.S. equity-based deferred compensation, M&A and joint venture transactions involving the acquisition of a minority stake and certain types of insurance although it is not clear that all of those applications were intended.

The withholding tax would apply to payments and deemed payments by U.S. and non-U.S. payors on financial instruments held by nonresident aliens and legal entities organized outside the United States that are “long” the underlying stock, including individuals, hedge funds, activist shareholders, special purpose vehicles, and dealers trading for their own account, starting January 1, 2016. The rules generally would apply to equity swaps outstanding on that date, and would apply to other equity-linked instruments acquired on or after March 5, 2014, regardless of when they were issued or entered into.