Chief Counsel Advice
201727006
Released July 7, 2017
Advice
Training explains qualified derivatives dealer responsibilities
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This page covers one taxpayer's ruling from 2017, which can't be cited as precedent. Ezel answers your situation under the current Code and IRS guidance, with citations.
Not precedent. Under 26 U.S.C. § 6110(k)(3), this written determination may not be used or cited as precedent. It resolved one taxpayer's situation on its specific facts, and identifying details were redacted by the IRS before release. The official IRS release (linked on this page as a PDF) is the authoritative source.
About this page: The plain-English summary and ruling snapshot below were written by Ezel based on the official IRS release. The full text is the IRS's own document.
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Plain-English summary
Chief Counsel training materials explain the application, documentation, withholding, reporting, and compliance duties of a qualified derivatives dealer (QDD). An eligible entity must be a qualified intermediary, and each home office or branch must qualify and receive approval separately. A QDD assumes primary withholding responsibility for payments it makes as a QDD, including dividend equivalents and certain other U.S.-source payments connected with potential section 871(m) transactions. It must use and collect appropriate withholding certificates, deposit withheld taxes, file the required Forms 1042, 1042-S, 1099, and income tax returns, and maintain systems for calculating its section 871(m) amount and QDD tax liability. The materials also describe responsible-officer certifications, periodic reviews, special good-faith transition rules for 2017, and examples showing how withholding and net delta exposure operate.
Ruling snapshot
- Question: What application, documentation, withholding, reporting, tax-liability, and compliance rules apply to qualified derivatives dealers?
- Outcome: advice given
- Key authorities: IRC §§ 3406, 6302, 871(m), 881, and 1441; Treas. Reg. §§ 1.871-15 and 1.1441-1
Full text (IRS public release)
CC:INTL:B05 Third Party Communication: None
PRESP-130410-14 Date of Communication: Not Applicable
UILC: 871.00-00, 1441.00-00
Number: 201727006
Release Date: 7/7/2017
This may not be used or cited as precedent.
Slide 1
Qualified Derivative Dealers Training:
May 2nd and 3rd, 2017
PRESP-130410-14 2
Slide 2 2
Agenda
Day 1:
Technical Overview:
1. Common Equity Derivative Transactions
2. Section 871(m) Overview
3. QDD and Eligible Entity
4. QDD Tax Liability
5. Few Additional Points
Day 2:
Duties and Obligations of a QDD:
1. QDD Application
2. Documentation Requirements
3. Withholding and Reporting Obligations
4. QDD Compliance
Examples
Slide 3 Duties and Obligations: Application for QDD Status
3
Who Can Apply for QDD Status?:
• An eligible entity that is a QI
• “Any other person otherwise acceptable to the IRS” category is not
meant to significantly expand the definition of an eligible entity; it is
meant to give the IRS the discretion to accept an entity that is very
similar to the specified categories of eligible entities but that does not
satisfy the precise technical requirements in the definition as an eligible
entity.
• Each home office or branch that is a QI must qualify independently and be
approved to act as a QDD
• The application should note why the applicant is an eligible entity
• If applicable, applicant must provide the name and jurisdiction of its
regulator (and the regulator of its home office)
• A partnership can apply to be a QDD if it qualifies as an eligible entity
additional terms that would apply in the case of an agreement entered
into with a partnership
Slide 4 Duties and Obligations: Application for QDD Status
4
What Information Should an Applicant Provide?:
• Applicants must apply to enter into a QI agreement and include the
information on the application relating to QDDs:
• Business operated
• Types of potential section 871(m) transactions for which it makes
payments (and approximate value in U.S. dollars)
• Types of potential section 871(m) transactions and underlying securities
for which it receives payments (and approximate value in U.S. dollars)
• Equity derivatives dealer business activities
• Each applicant applicant’s entity classification (such as a corporation,
partnership, or disregarded entity)
• Branch applicants entity classification of its home office
• Account Opening Procedures
Note re Application in 2017: Applicant may indicate that the value of the
previous year’s transactions is zero when relevant information is unavailable.
PRESP-130410-14 3
Slide 5 Duties and Obligations: Application for QDD Status Continued
5
What about a QI who is renewing its application and wants to become a QDD?:
• A QI that seeks to renew its QI agreement and also seeks to act as a QDD
must supplement the renewal request by providing all of the information
required by the application relating to a QDD.
What “Know your customer” (KYC) requirements apply to QDD applicants? :
• The KYC rules generally applicable to a QI also apply to a QDD
• If QI is a FFI and applying for QDD status on behalf of the home office or any
branch, the applicant may only act as a QDD if that branch is located in a
jurisdiction identified on the IRS’s Approved KYC List
• If a QI is a NFFE and applying for QDD status on behalf of the home office or
any branch, the QDD is not required to be located in a jurisdiction identified on
the IRS’s Approved KYC List
• These QDDs must document its account holders with withholding
certificates
Slide 6 Duties and Obligations: Application for QDD Status Continued
6
Can a Foreign Branch of a U.S. financial institution apply to be a QDD?:
• Yes, A foreign branch of a U.S. financial institution may also apply for QI and
QDD status provided it separately qualifies as an eligible entity .
What tax return does a foreign branch of a U.S. financial institution file?:
• The QDD activities must be include on the appropriate U.S. income tax return
(e.g., Form 1120, U.S. Corporation Income Tax Return)
• Any income, deductions, or losses reported on the Form 1120 and pay its
tax liability under chapter 1
• A QDD that is a foreign branch of a U.S. financial institution does not have a
separate QDD tax liability
Slide 7 Duties and Obligations: Documentation Requirements for a QDD
7
What type of Withholding Certificate must a QDD provide to its counterparties?:
• A QDD must provide to its counterparties a QI withholding certificate (Form W-8IMY)
indicating that it is receiving the payment as a QDD
• Form W-8IMY is being revised as follows:
• Part 1, Question 3 will be revised to clarify that a QI may be a QDD
• An additional certification will state that the QDD assumes primary withholding and
reporting responsibilities under chapters 3, 4, and 61 and section 3406 for any payments
it makes on potential section 871(m) transactions
• The QDD will be required to identify its entity classification (Corporation, Partnership, or
disregarded entity)
• In 2017, a QDD may provide a Form W-8IMY indicating that it is “awaiting QI-EIN” generally
a withholding agent may rely on this for up to 6-months
What Additional Information a QDD provide on the Form W -8IMY?:
• The QDD’s Form W-8IMY must designates the accounts for which the QDD:
(1) Receives payments from potential section 871(m) transactions or underlying securities
as a QDD:
(2) Receives payments on potential section 871(m) transaction for which withholding is not
required;
(3) Receives payments on underlying securities for which withholding is required; and
(4) Identify the home office or branch that is treated as the owner for U.S. tax purposes, if
applicable.
PRESP-130410-14 4
Slide 8 Duties and Obligations: What Document Must a QDD Obtain
8
from its Counterparties?
What efforts must a QDD makes to obtain documentation from its customers? :
• A QDD is required to obtain a withholding certificate (or other appropriate
documentation) from each of its counterparty to whom it makes a dividend
equivalent payment.
• The general documentation requirements applicable to a QI apply to a QDD A
QDD agrees to use best efforts to obtain documentation from customers for which it
is acting as a QDD and to whom it makes a reportable payment
• When a QDD cannot reliably associate a payment with valid documentation from
the customer presumption rules under chapter 3 or 4 apply (under section 3406 if
backup withholding is required).
Slide 9 Duties and Obligations: QDD’s Obligation to Withhold
9
Assumption of Primary Withholding Responsible: A QDD must assume primary
withholding responsibility for purposes of chapters 3 and 4 for all payments it
makes as a QDD
• Dividend equivalent Payments: A QDD must treat any dividend
equivalent as a U.S. Source dividend
• Non-Dividend equivalent Payments: A QDD also assumes primary
withholding responsibility for any U.S. source FDAP payments made with
respect to a potential section 871(m) transaction even if the payment is not
a dividend equivalent
• Treaty Rates: If a QDD pays a dividend equivalent to a beneficial owner
claiming a treaty benefits under the dividends article of an applicable
income tax treaty, it may reduce the rate of withholding under chapter 3
• Election re Other payments: A QI can elect whether or not to assume
primary withholding responsibility for purposes of chapters 3 and 4 for
payments for which it is not required to act as a QDD
Backup Withholding: A QDD is responsible for backup withholding under section
3406 for payments made as a QDD with respect to any potential section 871(m)
transaction provided the amount paid is an amount subject to chapter 3 or 4
withholding or a reportable payment under chapter 61.
Slide 10 Duties and Obligations: QDD’s Obligation to Withhold Continued
10
Time for Withholding: A QDD must withhold with respect to a dividend equivalent
payment on the dividend payment date for the applicable dividend
• When stock has a record date that is earlier than the payment date
dividends are considered paid on the payment date
• The QDD must notify each payee in writing that it will withhold on the
dividend payment date before the time for determining the payee’s first
dividend equivalent payment
• A QDD must determine whether any payment it makes on a potential
section 871(m) transaction is a dividend equivalent.
Deposits: A QDD must deposit amounts withheld as provided under section 6302
(see §1.6302-2) by electronic funds transfer as provided under §31.6302-1(h).
• If the QDD has accumulated at the close of any calendar month an
aggregate amount of undeposited taxes of $200 or more deposit is due
by the 15th day of the following month
• If at the close of any quarter-monthly period within a calendar month, the
aggregate amount of undeposited taxes is $2,000 or more deposit is due
within 3 business days after the close of such quarter-monthly period
PRESP-130410-14 5
Slide 11 Duties and Obligations: QDD’s Reporting Obligations
11
Self-Reporting: The QDD (other than a foreign branch of a U.S. financial
institution) must report its withholding tax liability under chapters 3 and 4 on Form
1042 and must report its QDD tax liability on the appropriate U.S. tax return.
• For 2017, the appropriate form is a Form 1120-F
• It is expected that a QDD tax liability will be reported on a QDD by QDD
basis (that is, each QDD branch or QDD home office would separately
report the QDD tax liability)
• Reconciliation statement prepared (and available upon request) that tracks
the section 871(m) amount for each dividend separately for each QDD
Separate Forms 1042-S: When QI is acting as both a QI and a QDD, it must file
separate Forms 1042-S to report payments made in each capacity
• Box 12b requires the withholding agent to identify the appropriate chapter 3
status should be checked on the Form 1042-S:
• Code 12 = Qualified Intermediary
• Code 35 = Qualified Derivatives Dealer
Payments to U.S. Persons: A QI acting as a QDD must assume primary Form
1099 reporting provided the amount paid is a reportable payment under chapter 61.
Slide 12 Duties and Obligations of a Withholding Agent Making Payments
12
to a QDD:
• Non-QDD Payments Received by a QDD: all payments (other than dividend
equivalent payments) made to a QDD with respect to underlying securities will
be subject to withholding and reporting if the payments would be subject to
withholding and reporting to a non-QDD.
• A QDD will be subject to withholding on dividends (including deemed
dividends) beginning with those payments received on or after January 1,
2018
• A QDD will be subject to withholding on all payments, other than dividend
equivalents, received by the QDD with respect to underlying securities.
• Separate Form 1042-S to Each QDD: when a withholding agent makes a
payment to a QDD that is subject to reporting under chapter 3 or 4, a separate
Form 1042-S is required for each QDD
• Each home office QDD and each branch QDD should receive a separate
Form 1042-S.
Slide 13 Duties and Obligations: Compliance with QI Agreement--
13
Responsible Officer
Who is the Responsible Office for purposes of QDD compliance?
• Generally, the responsible officer is an officer of the QI with sufficient
authority to fulfill the duties of a responsible officer, including the
requirements to periodically certify and to respond to requests by the IRS
for additional information to review the QI’s compliance.
• Only a QI’s responsible Officer may make the certification to the IRS
• A QI’s responsible officer may designate a specific person to be responsible
for QDD compliance
• The QI application and the Accounts Management System must
identify the responsible officer
PRESP-130410-14 6
Slide 14 Duties and Obligations: Compliance Program
14
• The responsible office must establish a compliance program. The compliance
program components applicable to a QI generally apply to a QDD as well.
• For a QDD, the compliance program specifically includes the following:
• Written Policies and Procedures: addressing the documentation,
withholding, reporting, and other obligations, and necessary to satisfy its
QDD tax liability
• Training: communicating the policies and procedures to any line of
business that entering into potential section 871(m) transactions as a QDD
• QDD Tax Liability Determinations: ensuring that the QDD has
appropriate systems to:
• Identify section 871(m) transactions, potential section 871(m)
transactions;
• Calculate the amount of dividends received in its QDD equity
derivatives dealer capacity and the section 881 taxes paid thereon,
• Calculate its net delta exposure,
• Determine the dividend amount per share,
• Determine its section 871(m) amount (and the related section 881
taxes paid), and its QDD tax liability amount
• Determine the amount of dividend equivalent payments made by the
QDD
Slide 15 Duties and Obligations: Periodic Review
15
What information must the QDD provide as part of the Periodic Review:
• QDD must require a reviewer to test obligations under the QI agreement
regarding its QDD activities. The periodic review for the certification period will
evaluate the QDD’s:
• Determinations as to whether or not transactions are section 871(m)
transactions;
• Computations and determinations of dividend equivalent amounts,
dividends, and taxes paid;
• Determinations regarding whether transactions are in its equity derivatives
dealer capacity,
• Net delta exposure computation,
• Section 871(m) amount and the calculation of its QDD tax liability
• Calculations of any other amounts required to be included on the
reconciliation schedule.
• Sampling is permitted to test accounts provided that the QDD has more than 60
accounts
• The QDD and QI activities must be reviewed separately
Slide 16 Duties and Obligations: Periodic Review Continued
16
• If the reviewer determines that underwithholding has occurred, the QDD must
report and pay any amount due.
• The reviewer must review accounts of a QDD that received a reportable
payment to determine whether the QDD has documented the status of account
holders properly
• The reviewer must determine that the QDD withheld when required on payments
that it made with respect to potential section 871(m) transactions
• The results of the periodic review must be documented in a written report
addressed to the responsible officer and must be available to the IRS upon
request. The report for a QDD must also include:
• The number of accounts that were not correctly categorized (such as
improperly designated as principal accounts or non-principal accounts,
equity derivatives dealer or non-equity derivatives dealer accounts).
• Errors with the QDD tax liability (such as, incorrect determination of the net
delta exposure, the section 871(m) amount and the taxes on the section
871(m) amount)
PRESP-130410-14 7
Slide 17 Duties and Obligations: Periodic Review Continued
17
• The reviewer must determine whether the amounts of income, taxes, and other
information reported was accurate by:
(1) reviewing the reconciliation schedule and any information used to prepare
the schedule or compute its QDD tax liability, reviewing the amounts required
to determine the QDD’s section 871(m) amounts and its QDD tax liability over
the applicable period, and reviewing such information to determine whether
the section 871(m) amounts and QDD tax liability have been properly
calculated;
(2) reviewing amounts shown on Forms 1042 and Forms 1042-S to determine
whether the QDD properly took the information into account (for example, to
calculate its QDD tax liability)
• The reviewer must review accounts designated as accounts for which QI acted
as a QDD to determine whether:
(1) The QI acted as a QDD for all potential section 871(m) transactions and
underlying securities for which it is required to be a QDD (and not any other
transactions); and
(2) the section 871(m) amount includes only the amounts in its equity
derivatives dealer capacity and not amounts in its non-equity derivatives
dealer capacity.
Slide 18 Duties and Obligations: Certification of Internal Controls
18
• The responsible officer must make the certification required by the QI
Agreement and must disclose any material failures that occurred during the
certification period (or a prior certification period if not previously discovered and
disclosed).
• Material failures related to QDDs:
• Failing to establish written policies regarding its obligations as a QDD under
this Agreement;
• Failing to satisfy or timely pay its QDD tax liability;
Slide 19 Duties and Obligations: Calendar Year 2017 Phase-in
19
• Calendar Year 2017 = Phase-in Year for QDDs: QDDs must made a good faith
effort to comply with the section 871(m) regulations and the relevant provisions
of the QI agreement
• Relaxed Enforcement: If a QDD makes a good faith effort, it is expected
that the IRS will take that into account when enforcing and administering the
QDD rules if QDD does not act in good faith, it is not entitled to Phase-in
relief
• Exemption for Withholding: When a QDD receives (1) a dividend on
physical shares of stock or (2) a dividend equivalents those payments
are not subject to tax if received in the QDD’s capacity as an equity
derivatives dealer
• Periodic Review: A QDD is not required to perform a periodic review with
respect to its QDD activities or provide the factual information specified in
Appendix I.
• QDD Certification: the certification of internal controls as applicable to its
QDD activities is not required for the certification period ending in calendar
year 2017 QDD only needs to certify that it has made a good faith effort
to comply with the relevant provisions of the QI Agreement
• The certification is not required to be filed QDD must retain a record
of the certification and supporting information until the end of the
calendar year 2022
PRESP-130410-14 8
Slide 20 Example 1: Documentation Required
20
Form W-8IMY
Foreign
USA TRS: 150
100 Shares Shares of USA Corp 1
Corp
QDD Corp (15%)
(15%) W-8BEN
TRS: 200 W-8BEN
Shares of USA
Foreign Corp Foreign
Broker Call Option Corp 2
(Delta 0.5):
Dealer (30%)
300 Shares of
Form W-8IMY USA Corp
• Assume all transaction are in the QDD’s equity derivatives dealer capacity
• QDD provides a Form W-8IMY to USA Corp. and Foreign Broker Dealer
• The Form W-8IMY indicates that it is acting as a QDD and assumes primary withholding
responsibility
• Assuming that both are the beneficial owners of the transactions, QDD receives the appropriate
W-8BEN from Foreign Corp. 1 and Foreign Corp. 2
• Foreign Corp. 1 completes Part II of the W -8BEN claiming treaty benefits
Slide 21 Example 2: Withholding on 2017 Q1 Dividend
21
TRS: 150 Foreign
USA 100 Shares Shares of USA Corp 1
Corp Corp
QDD (15%)
(15%)
Foreign Call Option Foreign
TRS: 200 (Delta 0.5): Corp 2
Broker Shares of USA 300 Shares of (30%)
Dealer Corp USA Corp
• Assume that USA Corp pays a $1 per share dividend in the 1 st Quarter 2017.
• USA Corp does not withhold on the dividend payment to QDD. See §1.1441-1(b)(4)(xxii)(C).
• Foreign Broker Dealer does not need to withhold on its dividend equivalent payment to QDD
because it received a valid form W-8IMY. See §1.1441-1(b)(4)(xxii)(B).
• QDD will withhold $22.50 (1.00x150x15%) with respect to the dividend equivalent payment to
Foreign Corp. 1. See §1.1441-1(b)(4)(xv).
• QDD will not withhold on the call option held by Foreign Corp. 2 because a call with a delta of 0.5 is
not a section 871(m) transaction. See §1.1441-1(b)(4)(xxi)
• Note: Section 871(m) Amount is zero (long positions = short positions)
Slide 22 Example 3: Withholding on 2018 Q1 Dividend
22
Foreign
USA TRS: 150
100 Shares Shares of USA Corp 1
Corp
QDD Corp (15%)
(15%)
Foreign Foreign
Call Option
Broker TRS: 200 (Delta .5): 300 Corp 2
Shares of USA Shares of USA (30%)
Dealer Corp Corp
• Assume the facts are the same as Example 2, except USA Corp. pays a $1 per share dividend in
Q1 of 2018
• USA Corp must withhold on the dividend payment to QDD because the exemption from withhold on
actual dividends only applies in 2017. See §1.1441-1(b)(4)(xxii)(C).
• USA Corp. would withhold $15.
• The withholding obligations of Foreign Broker Dealer and QDD will be the same as in Example 2.
• Note: Section 871(m) Amount is zero (long positions = short positions) and QDD is not entitled to a
refund for the amount withheld by USA Corp.
PRESP-130410-14 9
Slide 23 Example 4: Net Delta Exposure to USA Shares on Q1 2018
23
TRS: 150 Foreign
USA
100 Shares Shares of USA Corp 1
Corp Corp (15%)
QDD
(15%)
Foreign Foreign
TRS: 200 Call Option Corp 2
Broker Shares of USA (Delta 0.8):
Dealer Corp 150 Shares of
(30%)
USA Corp
• The facts are the same as Example 1, except that Foreign Corp. 2 has purchased a Call Option on 150 with a
delta of 0.8. Also, assume that the deltas of the transactions remain the same as the initial delta. This
example also assumes that QDD calculations its long and short exposure in a commercially reasonable
manner that only takes the delta and the number of shares into account.
• QDD calculates its net delta exposure to USA Corp. shares at the end of the ex-dividend date for the Q1
dividend. See §§1.871-15(q)(4).
• QDD’s Long Exposure to USA Corp: 300 shares ((100 x Delta 1.0) + (200 x Delta 1.0))
• QDD’s Short Exposure to USA Corp: 270 shares ((150 x Delta 1.0) + (150 x Delta 0.8))
• Net Delta Exposure: 30 Shares
• QDD’s Tax Liability with respect to its section 871(m) amount for the Q1 2018 dividend is $0.
• QDD’s section 871(m) amount with respect to USA Corp.’s Q1 dividend is $30 (Net delta exposure (30)
x per share dividend amount ($1))
• The tax liability on the section 871(m) amount ($30 x 15% =$4.5) is reduced (but not below zero) by the
tax paid by the QDD on the dividend it received ($100 x 15% =$15)
Slide 24 Example 5: Net Delta Exposure With Multiple QDD Branches
24
Foreign TRS 100 Shares Foreign
Customer (QDD Long Party) Corp 1
A Home 0.5 Delta Call (30%)
Office Option on 200
QDD shares
Foreign (30%) TRS Foreign
Broker 100 Shares Corp 2
TRS 100 Shares
Dealer 1 (QDD Long Party) (30%)
QDD
TRS
Branch B
100 Shares
(30%)
Foreign QDD
Branch A Foreign
Broker
Forward (30%) Corp 3
Dealer 2 Forward
100 Shares (30%)
100 Shares
• Each QDD must determine its net delta exposure separately and only take into account transactions recognized and
attributable to that QDD for U.S. federal tax purposes.
• All transactions are in the QDDs’ equity derivatives dealer capacity and with respect to the same stock and dividend
Home Office QDD QDD Branch A QDD Branch B
Withholding: Withholding: Withholding:
- 0% withholding by Foreign Customer A - 0% withholding by Foreign BD 2 - 0% by Home Office QDD on
- 0% withholding by Foreign BD 1 - 30% withholding by QDD Branch A TRS with QDD Branch
- 0% withholding by QDD on Call Option - 30% by QDD Branch B on TRS
- 0% on TRS with QDD Branch B with Foreign Corp 2
Net Delta: 100 Shares Net Delta: 0 Shares Net Delta: 0 shares
Long Positions: 200 Long Positions: 100 • Long Positions: 0
Short Positions: 100 Short Positions: 100 • Short Positions: 100
Slide 25 Example 6: Low Delta Calls Option with Customers
25
Call Option Foreign
USA (Delta 0.5):
Corp 1
Corp 100 Shares 300 Shares of
USA Corp (15%)
QDD
(15%)
TRS: 200
Shares of USA Foreign
Foreign Call Option
Corp
(Delta 0.5): Corp 2
Broker 300 Shares of
Dealer USA Corp
(30%)
• Assume that USA Corp pays a $1 per share dividend in the 1 st Quarter 2018.
• USA Corp must withhold on the dividend payment to QDD because the exemption from withhold on
actual dividends only applies in 2017. See §1.1441-1(b)(4)(xxii)(C).
• USA Corp. would withhold $15.
• Foreign Broker Dealer does not need to withhold on its dividend equivalent payment to QDD
because it received a valid form W-8IMY. See §1.1441-1(b)(4)(xxii)(B).
• QDD will not withhold on the call options held by Foreign Corp. 1 and Foreign Corp. 2 because a
call with a delta of 0.5 is not a section 871(m) transaction. See §1.1441-1(b)(4)(xxi)
• Note that the QDD does not have a withholding obligation on call options with customers and the
section 871(m) amount is zero because long positions equal the short positions
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