10.31.2017
By Rob Daly

Industry Preps for Derivatives Transaction Tax

Derivative operations teams have received a one-year breather from implementing much of the Internal Revenue Code’s section 871(m), which aims to collect withholding tax from non-US persons who hold US equity-based derivatives.

Non-US persons will wind up paying a 15% or 30% withholding tax on equity-linked certificates, convertible bonds, indices, repos, securities lending, structured notes, swaps, and warrants depending in which foreign jurisdiction they are located.

The withholding tax applies to any equity-linked derivatives that pay dividends during their lifecycles and have delta valuations more than 0.8 or meet the substantial equivalency test. Aggregated transactions also fall under the regulation’s purview even if the derivatives have a delta valuation less than 0.8.

Everyone is going to feel the pain of this sell-side tax, except in very limited circumstances, Kerril Burke, CEO of Meritsoft told Markets Media.

Affected firms initially had until January 3, 2018, to implement a process to monitor the products that may be subject to the new regulation, implement withholding, and file the necessary reports, before the Internal Revenue Service granted a 12-month delay in August.

There is going to be a lot of heavy lifting for derivatives operations people as they have to do things that they had not had to do before, noted Burke.

He doubts that firms will be able to meet their obligations without some level of automation since they may have to track dividend payment through the lifesome instruments, which may have lifespans of 30 years or more.

“When you are called before the IRS in 10 years from now, you probably have already lost the spreadsheet by then,” he said.

Although many firms may not see it as a silver lining, meeting 871(m)’s requirement will put firms in a good place for when other jurisdictions decide to put a similar transaction tax in place.

France already implemented a financial transaction tax on securities in 2012 and Italy enacted a similar tax on securities and derivatives a year later.

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