Delay to the §871(m) Dividend Equivalent Withholding Regime

On 23 August, the IRS released Notice 2022-37, extending the current lite version of the §871(m) regime, which has been in effect since the issuance of Notice 2016-76 (and was further prolonged via Notices 2018-72 and 2020-2). Per the terms of the new Notice, the “§871(m) Lite” regime shall remain in effect for at least another two years.
 
The lite version of §871(m) relaxes the following key elements of the §871(m) regime, each of which was prolonged per the new Notice–

• Only derivative instruments with a delta equal to one at the time of issuance will be in-scope for §871(m) withholding. This limitation to delta one products has multiple material consequences, such as–
  • The exclusion of virtually any product with an optionality dimension
  • A reduction in the overall volume of in-scope derivative instruments
  • The sidelining of the Substantial Equivalent Test for complex contracts (as their deltas by definition cannot be measured and thus cannot equal one)
• The simplification of the “combination transaction” anti-abuse rule so that only products that are deliberately packaged together must be treated as a single derivative instrument under §871(m) Lite
• The extension of a “good faith” defense for Withholding Agents and taxpayers in cases of non-compliance
• The allowance for Qualified Derivatives Dealers (QDDs) qua QDDs to continue to receive actual dividend payments gross (i.e. not just synthetic ones), thereby allowing QDDs to continue to hedge their exposures as derivative issuers with physical equites, rather than only with equity derivative instruments
• The relief for QDDs until 2025 to satisfy the full set of compliance duties prescribed by the Qualified Intermediary Agreement, such as periodic reviews and the determination of their so-called “net delta”

 
Undoubtedly, the extension is welcome news. Few affected parties were ready to revamp their withholding mechanisms and other system’s requirements by 1 January 2023 in time to fulfill their duties under a new §871(m) regime or under a reversion to the 2015 §871(m) Treasury Regulations. Thanks to Notice 2022-37, all affected parties will enjoy another full two-year period to implement any changes to the §871(m) regime. The problem now is not knowing what those changes are.
 
The latest §871(m) extension provided scant indication of how or when the IRS intends to revise the regime as set out in the 2015 §871(m) Treasury Regulations. We can reasonably draw two conclusions about the future of §871(m): It will neither remain in its Lite form nor revert to the regime described in the 2015 Treasury Regulations. If either of those outcomes were its permanent destiny, then presumably the IRS would have said so by now. Instead, we must wait and wonder what regime change will come.