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John M. Staples Bank Depository User Group 2008 Annual Meeting Proposed Regulations Regarding 1441 Withholding on Redemptions September 15, 2008.

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Presentation on theme: "John M. Staples Bank Depository User Group 2008 Annual Meeting Proposed Regulations Regarding 1441 Withholding on Redemptions September 15, 2008."— Presentation transcript:

1 John M. Staples Bank Depository User Group 2008 Annual Meeting Proposed Regulations Regarding 1441 Withholding on Redemptions September 15, 2008

2  Redemption distribution treated as  “Distribution in part or full payment of stock” (i.e., gain treatment), or  “Distribution of property to which §301 applies”  Distribution receives gain treatment if --  Not essentially equivalent to a dividend  “ Substantially Disproportionate”  Can be problematic because of 80% and voting stock requirements  In complete redemption of all shareholder’s stock Distributions in Redemption of Stock – Background 2

3 Distributions in Redemption of Stock – Background (Cont’d)  United States v. Davis, 397 U.S. 301 (1970). Supreme Court: “not essentially equivalent to a dividend” requires “meaningful reduction in proportionate interest” in the corporation  Application of Davis to publicly traded stock:  Rev. Rul  Reduction from % (actual and constructive) to % (all constructive) of stock in publicly traded corporation is “meaningful reduction”  Rev. Rul  Shareholder who owned 0.2% of stock widely held publicly traded company before and after redemption did not satisfy “meaningful reduction” 3

4 Current Regulations  Treas. Reg. § (d)(1): If do not know amount subject to withholding because calculation of amount depends upon unknown facts, must withhold on entire amount or  Make a “reasonable estimate” of the amount and hold such portion in escrow until amount determined 4

5 Current Regulations (Cont’d)  Treas. Reg. § (c)(1): intermediary required to withhold on entire amount of corporate distribution unless it elects to reduce the withholding under exceptions of -3(c)(2)  Treas. Reg. § (c)(2)(B): intermediary may elect not to withhold on a distribution to the extent it represents a distribution in part or full payment in exchange for stock 5

6 Issue Addressed by Proposed Regulations  Do reasonable estimate/escrow procedures apply to situations where distribution may be dividend or gain?  If so, how?  PLR – addressed issue  Prop. Reg. generally follows PLR 6

7 Prop. Reg. – In General  Would apply to distributions after 12/31/2008, but preamble states may apply before that date  Applies only to distributions in redemption of stock for which there is an established financial market (a “Public §302 Distribution”)  Must withhold on entire distribution unless apply “Escrow Procedure” 7

8 Escrow Procedure – Establishing Escrow  Can be used only by an intermediary that is a U.S. financial institution  Can be used only for documented foreign beneficial owners  Note: current reg. does not require documentation (Treas. Reg. § (c)(1))  Set aside 30% (or applicable treaty dividend rate) of distribution attributable to stock of foreign account holders 8

9 Escrow Procedure – Information Provided to Foreign Beneficial Owner  U.S. financial institution provides to foreign beneficial owner --  Total number of shares outstanding before and after Public §302 Distribution  Explanation of when a Public §302 Distribution will be treated as a dividend or a payment in exchange for stock (including an explanation of constructive ownership rules)  Request for beneficial owner to provide a certification (“§302 Payment Certification) within 60 days stating whether Public §302 Distribution is a dividend or payment in exchange for stock (gain) 9

10 Escrow Procedure - §302 Payment Certification  §302 Payment Certification must contain  Beneficial owner’s name and account number  Distributing corporation’s name  Total shares outstanding before and after Public §302 Distribution  Certification that the Public §302 Distribution is a --  Payment in exchange for stock because beneficial owner’s proportionate interest has been reduced (gain treatment)  Payment in exchange for stock because beneficial owner’s interest completely terminated (gain treatment)  Dividend 10

11 Escrow Procedure - §302 Payment Certification (Cont’d)  §302 Payment Certification must contain  Number of shares owned by beneficial owner and percentage ownership before and after distribution  Penalties of perjury statement  Signature and date of signature 11

12 Escrow Procedure – Certification of Gain  If §302 Payment Certification received within 60 days specifies gain treatment, amount set aside in escrow credited to beneficial owner  Entire amount reported on Form 1042-S as capital gains  Subject to “know or have reason to know” standard 12

13 Escrow Procedure - Certification of Dividend  If payment certification received within 60 days specifies dividend treatment, amount set aside treated as tax withheld and deposited with IRS  Entire amount reported on Form 1042-S as dividend 13

14 Escrow Procedure – No or Unreliable Certification  If no payment certification received or if U.S. financial institution believes §302 Payment Certification claiming gain treatment is unreliable or incorrect, must treat amount set aside as tax withheld as of 61 st day and deposit  Entire payment reported on Form 1042-S as dividend 14

15 Escrow Procedure – Late Certifications  If certification stating gain treatment received after 60 day period, U.S. financial institution may apply reimbursement or set-off procedures of § (a) 15

16 Escrow Procedure – Miscellaneous  U.S. non-exempt recipients holding stock through foreign intermediaries or flow-throughs are treated in accordance with the §302 Payment Certifications they provide  U.S. financial institution must notify distributing corporation by filing date of Form 1042-S of aggregate amounts treated as capital gains and dividends 16

17 Qualified Intermediaries  QIs cannot use escrow procedure  Escrow amount of U.S. financial institution includes 30% (or applicable treaty dividend rate) of amount attributable to QIs  U.S. financial institution provides same information to QI as it does to its direct foreign beneficial owners  QI provides information to its account holders  QI receives §302 Payment Certifications from its account holders  QI incorporates results in its withholding statement  Same procedures apply to withholding foreign partnerships and withholding foreign trust 17

18 Implementation Issues  Implement now or wait  How can financial institution identify affected transactions  Prop. Regs. apply to more than just self-tenders  How much detail should be provided regarding dividend vs. exchange and constructive ownership rules  Capital gains reporting on Form 1042-S required  Currently, capital gain reporting not required  Systems issues  Indirect U.S. non-exempt shareholders must apparently get DIV or 1099-B whereas direct U.S. non-exempt shareholders can get 1099-B + explanation.  Systems issues  Effect on 1099-B + explanation rule 18

19 Implementation Issues (Cont’d)  Procedures for notifying distributing corporation of treatment  Usefulness of requirement?  Different reporting treatment of direct and indirect U.S. non-exempt recipients  No reporting for U.S. exempt recipients.  How to handle inconsistencies between Prop. Reg and PLR (deliberate changes vs. oversights)  Interest on escrow accounts  60 day period very short – retail business issues  Prop. Regs. ask for comments 19

20 Is This An Effective Solution?  Small shareholders in publicly traded companies do not have control and cannot manipulate redemption  If redemption not pro rata, dividend treatment unlikely  Increased compliance costs  Requires non-U.S. passive investors to apply substantive tax rules  Probably little tax gain to government  Could complicate future basis reporting  Is it proper to extend Davis to small shareholders in publicly traded corporations? 20

21 John M. Staples Burt, Staples & Maner LLP 1250 Eye St. NW, Suite 850 Washington, DC Phone:  Fax: Contact Information 21


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