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Tax News
Dividend Equivalent Proposed Regulations Clip the Wings of Single Stock Futures
December 10, 2013
Administrative Actions
On December 5th Treasury released final and proposed regulations under Sec. 871(m).  This section deals with dividend equivalent payments and it was designed to shut down tax avoidance run around U.S. dividend withholding rules.  For previous coverage, see here. The regulations withdraw a set of previous proposed regulations (from Jan 2012) and replace them with a regime which appears to be more detrimental to the hedge fund industry.   Many of the provisions of the proposed regulations do not kick in until several years down the road (for e.g. rules on Specified ELIs apply after January, 2016), but the industry may have to focus on their implication right now if it wants to be ahead of the curve, or possibly affect the ultimate final regulations.

There is a lot to these regulations and they generally seem to not be industry favorable. I have not gone through all the details yet but one thing jumped at me.  It appears that the regulations specifically single out and eliminate the perceived exception under the old proposed regulations that applied to Single Stock Futures (SSF). In light of the old proposed regulations and the lobbying efforts by OneChicago, the industry was hopeful that SSFs would not be subject to the withholding rules of Sec. 871(m). However, this time, Treasury was not so accommodating. As Treasury explains in the 2013 proposed regs preamble, the 2012 proposed regulations provided that estimates of expected dividends were not dividend equivalents unless the estimate was adjusted to reflect actual dividend payments. This was basically the rule that OneChicago and other SSF proponents were hoping that they will fall under.  However, Treasury hits this nail straight on the head eliminating this exception and explicitly treating estimated dividend payments as dividend equivalents. The reason being twofold: one, the economic benefit of a dividend is present in contracts that use estimated dividends in much the same way as a contract that adjusts for actual dividends, and two, Treasury was concerned that taxpayers may inappropriately avoid section 871(m) if estimated dividends are not treated as dividend equivalents.  I would not go that far and say that Treasury bases regulation decisions on tax practitioner commentary, but I can’t help but notice that early this year Lee Sheppard in Delta Dawn: No Escape From Dividend Withholding singled out OneChicago dividend risk 1C SSFs, implicitly, as shady financial instruments used to get 100% dividend exposure.  I am not sure where the lobbying and battle between Chicago and Washington will end on this one, but it looks like things are shifting for the worse for Chicago.
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Tags: Section 871(m), Section 871(m) proposed regulations, single stock futures