On December 16, 2019, the Treasury and the IRS released final regulations under section 871(m) of the Internal Revenue Code. The regulations finalize the 2017 temporary and proposed section 871(m) regulations without any substantive change. On the same day, the Treasury and the IRS released Notice 2020-2 to extend through 2022 the relief provided in Notice 2018-72.
The final section 871(m) regulations define “broker” for purpose of section 871(m), provide guidance relating to when the delta of an option that is listed on a foreign regulated exchange may be calculated based on the delta of the option at the close of business on the business day before the date of issuance, and provide guidance identifying which party to a potential section 871(m) transaction is responsible for determining whether a transaction is a section 871(m) transaction when multiple brokers or dealers are involved in the transaction.
The Treasury did not adopt a taxpayer’s comment that the final regulations should eliminate the $10 billion threshold requirement contained in the 2017 proposed and temporary regulations. Under the 2017 proposed and temporary regulations, a foreign exchange is a regulated exchange only if it had trades for which the average trading volume exceeded $10 billion per day during the prior calendar year. The preamble to the final regulations states that the $10 billion threshold requirement is intended to ensure that the exchange has sufficient level of trading activity so that pricing cannot be manipulated. However, the final regulations clarify that the $10 billion threshold is determined based on the notional amount of the options, which is the number of shares referenced by the option multiplied by the stock price of those shares at the time of the computation. The Treasury also noted that it will continue to study the $10 billion threshold requirements in connection with future guidance projects related to President Trump’s Executive Order instructing the Treasury Department to identify and reduce regulatory burdens. The preamble to the final regulations invites taxpayer comments on alternative thresholds, such as a threshold based on only the average daily trading volume of equity options on the exchange or only the average daily trading volume of equity options for specific stock or stock index on the exchange.
In conjunction with the final regulations, Notice 2020-2 extends the transition relief provided in Notice 2018-72 for two additional years through 2022. Specifically, the effective date for Treas. Reg. § 1.871-15(d)(2) and (e) will be revised to provide those rules will not apply to any payment made regarding any non-delta-one transaction issued before January 1, 2023. The anti-abuse rule provided in Treas. Reg. § 1.871-15(o) will continue to apply during the phase-in years. Consistent with the further delay of the effective date, the IRS will continue to apply the good faith standard in enforcing the section 871(m) regulations for any delta-one transactions in 2017 through 2022, and any non-delta-one transactions in 2023. In addition, the good faith standard for the qualified derivatives dealer is extended through 2022. The simplified standard for determining combined transactions is further extended to include 2021 and 2022. Finally, the final section 871(m) regulations will be amended to provide that a qualified derivatives dealer will not be subject to tax on dividends and dividend equivalents received in 2021 and 2022 in its equity derivatives dealer capacity or withholding on those dividends.