IRS extends section 871(m) relief through 2028

Background

Previously, foreign-to-foreign “substitute payments” for securities loans (and similar transactions) had been treated by the Internal Revenue Service (IRS) merely as contractual fees rather than as dividend distributions. As a result, certain uses of derivatives or securities lending transactions received undue tax reductions or exemptions.

In 2008, the U.S. government decided to regulate equity swap transactions under section 871(m) of the U.S. Internal Revenue Code (IRC), enacted by the HIRE Act. On 18 September 2015, final and temporary regulations under section 871(m) were published, addressing the treatment of U.S. sourced dividend equivalents paid to non-U.S. persons.

In a nutshell, section 871(m) treats “dividend-equivalent” payments as U.S.-source dividends. As a result, dividend-equivalent payments are subject to QI and FATCA (IRC Chapters 3 & 4) withholding. Accordingly, a withholding agent is generally required to withhold tax at a rate of 30% on any dividend-equivalent payment unless either an exemption from withholding or a lower withholding rate applies. The scope of section 871(m) was expected to expand exponentially to, inter alia, sophisticated tracking of derivatives/products whose price sensitivity to their underlying U.S. stock(s) exceeds 80% (“delta”). Various IRS notices have, however, postponed this extension of scope.

News

The IRS has released Notice 2026-61, announcing a further two-year extension of the transition relief previously provided under Notice 2024-44. The relief concerns compliance with the final dividend-equivalent regulations under sections 871(m), 1441, 1461 and 1473.

In particular, Notice 2026-61:

Limits the application of section 871(m) to delta-one transactions through 2028;
Extends the good-faith compliance standard to delta-one transactions through 2028 and to non-delta-one transactions for 2029;
Treats qualified derivatives dealers (QDDs) as satisfying their obligations under the qualified intermediary agreement through 2028 where they make a good-faith compliance effort;
Exempts QDD activities from periodic review for 2027 and 2028;
Requires the combination of over-the-counter contracts in 2027 and 2028 only where they are priced, marketed or sold in connection with one another;
Provides that QDDs will not be subject to tax or withholding on dividends and dividend equivalents received in their equity derivatives dealer capacity during 2027 and 2028; and
Permits withholding agents to apply the qualified securities lender regime to payments made in 2027 and 2028.

The Treasury Department and IRS intend to amend the section 871(m) regulations to reflect the delayed applicability dates.

Nevertheless, the anti-abuse rule under Treasury Regulation § 1.871-15(o) remains applicable throughout the phase-in period. Consequently, a transaction that would not otherwise fall within section 871(m), including because of the extended transition relief, may still be treated as a section 871(m) transaction where the anti-abuse rule applies.